The Stock Return Difference between Industrial REITs and Manufacturing Firms: Space Supply and Demand Effects

By Cheng, Hwahsin; Mejia, Luis C. et al. | Journal of Real Estate Portfolio Management, September-December 2006 | Go to article overview

The Stock Return Difference between Industrial REITs and Manufacturing Firms: Space Supply and Demand Effects


Cheng, Hwahsin, Mejia, Luis C., Tu, Charles C., Journal of Real Estate Portfolio Management


Executive Summary.

This paper compares and studies the stock performance of industrial real estate investment trusts (REITs) and other industrial companies. The return difference between industrial REITs and manufacturing firms is modeled as a function of industrial space supply and demand. A graphical analysis illustrates the connection between the manufacturing goods and the industrial space markets, showing that performance differences between the two markets can be explained by changes in space supply and demand. An empirical analysis using aggregate industry data confirms this premise.

The industrial real estate market has been the subject of various research papers during the last two decades. Researchers have attempted to explain the performance of industrial real estate assets using property and market factors. One aspect of the industrial real estate market that is important to investors seeking portfolio diversification but has not been thoroughly investigated is the stock return difference between industrial real estate investment trusts (REITs) and manufacturing firms.

Industrial REITs and manufacturing companies have common systematic and sector components. Therefore, their portfolio returns should have some degree of correlation. However, although driven by similar underlying factors, the returns of industrial REITs and manufacturing firms do not exhibit much co-movement over time. This paper compares the stock returns of industrial REITs with manufacturing companies, and examines the difference between these two return series. The divergence can be modeled as a function of industrial space supply and demand factors. A graphical framework shows that changes in space supply and demand may affect the relative performance of the industrial space and the manufacturing goods markets. These effects are tested empirically using aggregate industry data while controlling for the funds flowing into REITs and the traditional stock markets.

The remainder of this paper is organized as follows. First, there is a brief literature review on the industrial real estate market. Second, the paper discusses the stock return difference between industrial REITs and manufacturing companies. Third, a graphical framework explains performance differences between the manufacturing goods and the industrial space markets. Fourth, there is a discussion of an empirical test of the effect of space supply and demand factors. Lastly, the paper closes with concluding remarks.

Literature Review

Early research to understand industrial property performance was completed by Hoag (1980), who constructs an industrial real estate value index as a function of property and market factors. Grissom, Hartzell, and Liu (1987) expand on Hoag's research by explaining regional risk across industrial properties. Wheaton and Torto (1990) follow with an industrial real estate investment model, defining industrial space production as an investment decision driven by employment and cost of capital factors. Ambrose (1990), in turn, shows that industrial property asking prices and rents are explained largely by property attributes such as building size, office space, and other physical characteristics.

In a second group of studies, Atteberry and Rutherford (1993) find that monetary base and industrial construction explain changes in industrial real estate prices. Fehribach, Rutherford, and Eakin (1993) extend the Hoag (1980) and Ambrose (1990) studies by examining the effect of financial economic variables, in addition to physical characteristics, on industrial property prices. Hughes (1994) also adds to the literature by listing factors, including labor force, infrastructure, and population, that affect industrial property demand. Lastly, Lockwood and Rutherford (1996) find that physical characteristics, market conditions, and local factors affect industrial property value.

On another front, researchers have attempted to explain the behavior of REIT stock returns. …

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