Academic journal article Journal of Real Estate Portfolio Management

The Time-Varying Nature of the Link between REIT, Real Estate and Financial Asset Returns

Academic journal article Journal of Real Estate Portfolio Management

The Time-Varying Nature of the Link between REIT, Real Estate and Financial Asset Returns

Article excerpt

Executive Summary. This study examines the sensitivity of equity real estate investment trust (REIT) returns to returns on other asset classes, including real estate, using an estimation method that explicitly allows for variation over time in the sensitivities. The results show that the relationship between REIT returns and returns to bonds, small cap stocks, large cap stocks and unsecuritized real estate has changed over time. During the 1990s, REITs began to exhibit a direct link to real estate returns, indicating that REITs do provide portfolios with some exposure to the real estate asset class. The strength of this link, however, is cyclical in nature. The sensitivity of REIT returns to large cap stocks has declined through time. REIT returns exhibit a sensitivity to small cap returns that has a strong cyclical component, with the two becoming more closely linked in REIT market downturns.

Introduction

The relationship between the performance of unsecuritized and securitized property investment vehicles has intrigued both academics and practitioners for some time.1 Understanding the links) between the two markets has become increasingly important in recent years, as institutional investors have looked to the public markets (real estate investment trusts or REITs) for a more liquid way to gain exposure to the real estate asset class.2 During the REIT market "boom" over the 19931997 period, it was claimed by many market commentators that the dramatic growth and maturation of the REIT sector was making REITs more like real estate and less like stock.3 REIT share prices, it was suggested, more accurately reflected property market fundamentals, given the wider analyst following and increased sophistication of the investors (institutional versus retail). Essentially, this line of reasoning suggests that the REIT sector went (and continues to go) through a maturation process in which the information available about REITs has become better and more widely distributed. This has resulted from increased investor interest in REITs (especially from institutional investors) and the concomitant increase in analyst following. With better information about REITs available, REIT returns can begin to better reflect their "true" nature and therefore have a stronger relationship to unsecuritized real estate returns. The idea that the REIT market has matured informationally, in this sense, is consistent with evidence presented in Clayton and MacKinnon (2000) who report structural changes in the nature of REIT returns. It is also consistent with Khoo, Hartzell and Hoesli (1993) who find that equity REIT betas underwent a structural change in the 1980s, with REIT betas (with respect to the overall equity market) decreasing. They argue that this is related to the changing information environment for REITs.

This study aims to provide additional evidence on and new insights about the changing dynamic of the relationship between REIT performance and returns to direct property investment and financial (stock and bond) markets. Specifically, it examines the sensitivities of REIT returns to returns on four broad asset classes (bond, large cap stock, small cap stock and real estate) over the 1978-1998 period, and evaluates whether these sensitivities of REIT returns vary over time. A simple multi-factor return model is employed in which REIT returns are regressed on stock, bond and real estate returns.

The approach taken in this study is similar to those followed by Liang, McIntosh and Webb (1995) and Goldstein and Nelling (1999) in their investigations of the links between REIT and financial asset returns. Liang, McIntosh and Webb use a two-index (large cap stocks and bonds) model of the return generating process for REITs to investigate the stability of stock and bond sensitivities (betas) over the 1973-1989 sample period. They find evidence of a structural break in the return generating process for equity REITs in the 1983-1984 period and also report that the stock market beta decreases following this shift. …

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