The Time-Varying Nature of the Link between REIT, Real Estate and Financial Asset Returns (original) (raw)
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The Relative Importance of Stock, Bond and Real Estate Factors in Explaining REIT Returns
SSRN Electronic Journal, 2000
This paper examines the link between REIT, financial asset and real estate returns, and tests whether it changed subsequent to the "REIT boom" of the early 1990s. The main focus is on answering the question do REIT returns now better reflect the performance of underlying direct (unsecuritized) real estate? We develop and implement a variance decomposition for REIT returns that separates REIT return variability into components directly related to major stock, bond, and real estate-related return indices, as well as idiosyncratic or sector-specific effects. This is applied to aggregate REIT sector (NAREIT) returns as well as returns to size and property-type based REIT portfolios. Our results show that the REIT market went from being driven largely by the same economic factors that drive large cap stocks through the 1970s and 80s to being more strongly related to both small cap stock and real estate-related factors in the 1990s. There is also a steady increase over time in the proportion of volatility not accounted for by stock, bond or real estate related factors. We also find that small cap REITs are "more like real estate" compared to larger cap REITs, at least over the 1993-98 period. We argue that this could be a result of the institutionalization of the ownership of larger cap REITs that took place in the 1990s.
The predictability of returns on equity REITs and their co-movement with other assets
The Journal of Real Estate Finance and Economics, 1992
Recent evidence suggests that the variation in the expected excess returns is predictable and arises from changes in business conditions. Using a multifactor latent variable model with time-varying risk premiums, we decompose excess returns into expected and unexpected excess returns to examine what determines movements in expected excess returns for equity REITs are more predictable than all other assets examined, due in part to cap rates which contain useful information about the general risk condition in the economy. We also find that the conditional risk premiums (expected excess returns) on EREITs move very closely with those of small cap stocks and much less with those of bonds. Recent evidence suggests that the variation in the expected excess returns over time is predictable and is the result of changes in business conditions. 1 We offer further evidence on this issue by extending the previous literature to include real estate, particularly equity real estate investment trusts (EREITs). 2 What is unique about EREITs is that it is traded as a stock on a stock exchange but represents an underlying ownership in a portfolio of real estate. This feature raises the possibility that different variables may be required to capture the time variation in its risk premiums relative to those for bond and non-REIT stocks. Another issue related to the hybrid nature of EREITs is whether EREITs are a hybrid of stocks and bonds and whether the stock component is representative of large cap stocks or small cap stocks. More specifically, the questions addressed in this article include: (1) Do the same variables forecast stocks, bonds, and real estate returns so that the expected returns (conditional risk premiums) on these assets move together? In particular, do cap rates carry information about the conditional risk premium for equity REITs but no other asset class? (2) Is the variation in the expected returns on equity REITs related to business conditions? (3) To what extent do REITs resemble stocks with large capitalizations, stocks with small capitalizations, and bonds?
REITS and Underlying Real Estate Markets: Is There a Link?
SSRN Electronic Journal, 2000
This paper utilizes the Carlson, Titman, and Tiu (2010) model of REIT returns to estimate the strength of the relationship between REIT and underlying real estate returns. Our work further offers an innovative method for computing the returns of the real estate properties underlying each REIT using the Moody's/REAL commercial property price indices by region and property type. We find a statistically significant relationship between REIT and real estate returns only in the office sector. Other property types offer only very weak and insignificant relationships. This finding suggests that direct real estate investment or investment through the property price index derivatives cannot be replicated using REITs.
A Note on REIT Returns and the Case-Shiller Home Price Index
Journal of Real Estate Practice and Education, 2015
In this note, we examine the relationship between real estate investment trust (REIT) returns and the Case-Shiller Home Price Index using panel data on 159 unique REITs over the 25-year period of 1989-2013. Although the literature provides conflicting evidence, after controlling for inflation, financial risk, size, and property focus, our empirical results suggest that a strong positive correlation exists between the Case-Shiller Home Price Index and REIT returns. While additional research is needed, these findings certainly have implications for investors utilizing REITs to obtain real estate portfolio diversification.
2011
Real Estate Investment Trusts (REITs) are the only truly liquid assets related to real estate investments. We study the behavior of U.S. REITs over the past three decades and document their return characteristics. REITs have somewhat less market risk than equity; their betas against a broad market index average about .65. Decomposing their covariances into principal components reveals several strong factors. REIT characteristics differ to some extent from those of the S&P/Case-Shiller (SCS) residential real estate indexes. This is partly attributable to methods of index construction. Our examination of REITs suggests that investment in real estate is far more risky than what might be inferred from the widely-followed SCS series. REITs, unlike SCS series are forward looking, and this helps them in the prediction of SCS returns. REIT forecasts of SCS returns are reasonably precise over a number of periods.
The Stock-REIT Relationship and Optimal Asset Allocations
Journal of Real Estate Portfolio Management, 2006
Executive Summary. In this paper, the marginal effects of changes (due to non-stationarity or estimation errors) in the REIT-stock risk premium and the REIT-stock cor- relation on the optimal portfolio asset mix of REITs, stocks, and bonds are determined. Employing a mean- variance utility function and considering different levels of investor risk aversion, the findings reveal that the ex- pected return of REITs, relative to that of stocks, is a much more important factor than the REIT-stock corre- lation in making portfolio decisions. A 1% change in the forecast return for REITs dramatically impacts optimal portfolio allocations for investors of all risk levels. A sig- nificant change of 0.1 in the REIT-stock correlation, on the other hand, has only minimal impact on optimal portfolio weights.
An Investigation into the Substitutability of Equity and Mortgage REITs in Real Estate Portfolios
The Journal of Real Estate Finance and Economics, 2016
This paper reconciles the controversy regarding the substitutability between equity REITs (EREITs) and mortgage REITs (MREITs) in existing literature. Using CRSP/Ziman data from 1992 to 2011, we show that the driving economic factors on EREIT returns are different from those driving MREIT returns, which rejects the substitutability hypothesis. Additional tests confirm that causality runs unilaterally from EREITs to MREITs, implying the leading (subordinate) role of EREITs (MREITs). Finally, EREITs and MREITs possess disparate risk and return profiles under the full and sub-periods. In sum, strong evidence reveals that EREITs and MREITs are in fact not substitutable.
Conditional Correlations and Real Estate Investment Trusts
Proceedings of the 14th Annual European Real Estate Society Conference - London, UK, 2007
The paper studies the temporal variations in the conditional correlations between REIT returns and equity, bond and commodity returns. While REITs are often presented as useful tools for diversification, little is known of the way their returns correlate with the returns of other asset classes over time and in periods of high volatility. This paper addresses this issue and draws two conclusions. First, the correlations between REITs and equity returns rose over the period analyzed, while the correlations with bonds and commodities fell. This indicates to equity portfolio managers that real estate has lost some of its diversification properties, but to bond and commodity portfolio managers it has become attractive for strategic asset allocation. Second, the correlations with REITs rose especially in periods of above average volatility in equity and bond markets. This is unfortunate as it is precisely in periods of high volatility that investors need the benefits of diversification the most. There are, however, two noticeable exceptions (for the US government securities and the GSCI), where the conditional correlations with REITs fell in periods of high volatility in these markets. This indicates that to reduce the total risk of their portfolio investors in US government securities and commodities should tilt their asset allocation more towards real estate when they anticipate changes in monetary policy or abnormal fluctuations in commodity prices.
The Dynamics of REIT Capital Flows and Returns
Real Estate Economics, 2003
This study examines the effects of capital flows into the REIT sector on REIT returns and, simultaneously, the effects of REIT returns on subsequent REIT capital flows. The dynamic relation between REIT capital flows and returns is estimated using vector autoregression (VAR) techniques. Unlike static regression techniques, our dynamic model produces estimates of the short-run relationships, long-run relationships, impulse response functions, and forecast variance decompositions. We find evidence that REIT equity flows are significantly positively related to the prior quarter's flows and negatively related to flows from two quarter's ago. The evidence on the responsiveness of flows to prior returns is time period specific. In the important post-1992 subperiod, REIT returns do not significantly affect REIT flows in any of the VAR model specifications. Simultaneously, REIT capital flows do appear to have a significant influence on equity REIT returns.
Predictability of Equity Reit Returns: Implications for Property Tactical Asset Allocation
SSRN Electronic Journal, 2000
This study presents further evidence of the predictability of excess equity REIT (real estate investment trust) returns. Recent evidence on forecasting excess returns using fundamental variables has resulted in diminishing returns from the 1990's onward. Trading strategies based on these forecasts have not significantly outperformed the buy/hold strategy of the 1990's. We have developed an alternative strategy that is based on the time variation of the risk premium of investors. Our results indicate that it is possible to outperform the buy/hold strategy by modeling the time variation of the risk premium. By modeling the dynamic behavior of the risk premium, we are able to implicitly capture economic risk premiums that are not captured by conventional multi beta asset pricing models.