The Risk-Return Behavior of Real Estate Mezzanine Investment (REMI) – The Singapore Experience

Abstract

REMI is a new financial instrument for Asia’s real estate market offering superior returns than those for the typical commercial bank loans. The resultant risk exposure is relatively high. With recent and robust growth of the Singapore real estate market, there is the fast-growing real estate investment trust market. This paper examines the REMI structure, the measurement and characteristics of its risks and returns via a forward-looking binomial asset tree (BAT) model. Risk neutral pricing probability is adopted to construct the BAT tree. TRs are measured by the probability weighted average returns and discussed under different scenarios. REMI bears more risk than typical commercial bank loans, resulting in higher interest rates than pure equity. Different risk issues focus on two major sources - the financial LTV ratio risk and the real estate and capital markets risk. Empirical analysis involves a rigorous discrete-time forecasting of the market rent and capital value expectations of Singapore’s prime office sector, given the conditions and assumptions unique to this market. This paper fulfils the need to close the gap concerning the REMI structure and performance in the steady state, utilizing reliable, authoritative information and data sources.