Academic journal article Journal of Real Estate Portfolio Management

REITs and Correlations with Other Asset Classes: A European Perspective

Academic journal article Journal of Real Estate Portfolio Management

REITs and Correlations with Other Asset Classes: A European Perspective

Article excerpt

Executive Summary.

Long present in the United States, real estate investment trusts (REITs) are a fairly new phenomenon in Europe. This paper examines the sensitivity of European REIT returns to returns in other asset classes, including equities, bonds, and commodities. Consistent with previous studies, the results suggest that a significant positive correlation is observed between REITs and equities, especially small cap- and value stocks; REIT correlation to fixed income securities is found negative. Temporal variations in asset volatilities and their effect on correlations are assessed: The motivation is for investors and portfolio managers alike to incorporate the time-varying nature of the relationship in their decision making. Whereas the diversification benefits for equities decrease with increasing volatility, fixed income assets provide an increased hedge. The case of commodities in this sense remains to a large extent blurred.

Real estate assets, and their qualities as portfolio diversifiers in a multi-asset portfolio, have been studied in a number of papers. It has been of interest to study how real estate assets' returns correlate with those of other financial assets; are diversification benefits attainable? In this paper the researchers add to the existing literature by performing a study with European real estate investment trusts (REIT data). The return characteristics of European REITs are compared and analyzed with a host of benchmark assets.

In general, two major ways in which institutional investors can invest in real estate can be distinguished: private and public (Seiler, Webb, and Myer, 2001). Private real estate is acquired by investing directly, or through property pools, commingled real estate funds (CREFs), syndications or separate accounts managed by real estate professionals. The second category, public real estate, involves the purchase of securitized real estate. According to Feldman (2003), both categories have their place in a mixed-asset framework.

Originating from the United States, REITs are set to take over Europe. The number of European countries with special REIT legislation currently amounts to 14; European REIT assets total euro63 billion. This makes up more than 22% of the global REIT assets of euro287 billion. Out of all REITs globally, nearly one quarter are found in Europe (Exhibit 1, EPRA, 2009).

Even though the history of European REITs dates back to the 1990s, the legislation really started to win ground in the mid-2000s. The largest European REIT countries today are France, the United Kingdom, and the Netherlands, in this order. France has 46 REITs with a combined market value of euro32.2 billion; the respective figures are 21/euro18.7 billion for the U.K. and 8/ euro5.9 billion for the Netherlands. The remaining REIT countries (10) manage total REIT assets of euro6.5 billion (Exhibit 2, EPRA 2009).

Bearing in mind the short history of European REITs, the aforementioned figures are rather remarkable. Europe is quickly becoming a globally notable player in the REIT industry. This is evident as the European REIT market is constantly expanding, the latest adopters of special legislation being Finland, Spain, and Lithuania.

According to Friday, Sirmans, and Conover (1999), REITs are essentially closed-end investment companies providing investors with a passive medium to invest in income-producing real estate and mortgages. A clear distinction between European REITs and non-REIT real estate companies has to be made: To qualify as a REIT, a real estate company must satisfy certain requirements set forth in national legislation. Non-REIT real estate companies are those that are either domiciled in countries without REIT legislation or that have opted for non-REIT status for other reasons (FTSE 2009).

Compared to the REIT legislation in the U.S. dating back to the 1960s, Europe is severely lagging behind. So far, there is no unified REIT legislation in Europe; the laws are passed on a country level. …

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