Academic journal article Journal of Real Estate Portfolio Management

REIT Stlye and Performance

Academic journal article Journal of Real Estate Portfolio Management

REIT Stlye and Performance

Article excerpt

Executive Summary. Applying a performance style model developed by Sharpe, we investigate the style and performance of real estate investment trusts from March 1984 through December 1997. Total returns of the ScP 500, ScP MidCap 400, ScP SmallCap 600, Lehman Brothers' government bond index, and Salomon Brothers' three-month Treasury bill index are used to replicate the performance of all REIT, equity REIT and mortgage REIT portfolios. We find that all REITs and equity REITs have remarkably stable style attributes over time: they behave similarly to a portfolio of 40% small capitalization stocks and 60% bonds (including Treasury bills). The behavior of mortgage REITs, however, has been more erratic. Sharpe's alpha, a performance measure similar to Jensen's alpha, indicates that equity REITs performed approximately at par to its style portfolio prior to 1994 and has dramatically outperformed its style portfolio since then. All REITs and mortgage REITs that underperformed at first, outperformed their respective style portfolios in recent years. REITs, in general, have become more "unique" as the R-squared value of the Sharpe model has declined dramatically over the last five years for all REITs as well as equity REITs.

INTRODUCTION

Over the past five years, the growth of the public REIT market has been nothing short of spectacular-from a market capitalization of about $13 billion at the end of 1992 to more than $140 billion at year-end 1997. Even so, public market penetration into commercial real estate is still at low or very low levels. For example, research at Prudential Real Estate Investors estimated in August 1997 that public market penetration into the office, warehouse and apartment sectors was only 2.6%, 3.7% and 7.4%, respectively. Although the public market has already controlled 17.3% of the hotel rooms and 21.9% of the regional malls in the U.S., these penetration levels are still well below the 50%+ penetration commonly achieved by mature industries. As REITs and other public real estate companies further infiltrate the historically private commercial real estate, public market real estate investments will inevitably account for an increasingly larger proportion of institutional investors' portfolios. Consequently, both investors and portfolio managers are asking with renewed interest: What are REITs?

Researchers have examined REITs from many different angles. For example, McIntosh and Liang (1998) concluded that the REIT market appeared to have switched its allegiance from stocks to real estate. Their results indicate that almost 80% of equity REIT performance in the last five years could not be explained by stock and bond market factors, while the remaining 20% was performing similarly to a portfolio comprised of 60% bonds plus cash and 40% small capitalization stocks.

Han and Liang (1995), among many others, found that REITs behaved like small capitalization stocks. Ghosh, Miles and Sirmans' (1996) results revealed that correlation between REITs and the overall stock market declined in recent years. Liang, McIntosh and Webb (1995) found that the systematic risk of REITs, measured by beta, was not stable over time and a declining trend was observed. In addition, Han and Liang (1995) first summarized the REIT performance literature and then concluded that REIT performance was consistent with the security market line.

Sharpe (1988, 1992) developed a model to analyze the performance of mutual funds and to study a fund's effective asset mix. This model has been applied to real estate on several occasions. Myer and Webb (1996) applied the model to commingled funds, disaggregating their performance into returns relating to five property types: office, retail, R&D office, warehouse, and apartment. McIntosh and Liang (1998) applied the Sharpe model to REITs, decomposing equity REIT performance into five categories: large cap stocks, midcap stocks, small cap stocks, bonds, and cash. …

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