REIT Characteristics and the Sensitivity of REIT Returns

Previous research on the returns to real estate investment trusts (REITs) has considered whether REITs are systematically exposed to general stock-market risk and interest-rate risk. This study examines how the sensitivity of REIT returns to these factors may be influenced by various REIT characteristics. Using a sample of publicly traded REITs, we estimate the sensitivity of REIT returns to stock market and interest-rate changes. We then propose and implement a model for testing whether differences in asset structure, financial leverage, management strategy, and degree of specialization in the REIT portfolios are related to their sensitivity to interest rate and market risk. Our results permit us to offer some inferences about how REITs can alter their risk exposure by managing these characteristics.     

Monetary Shocks and REIT Returns

We investigate the influence of unanticipated changes in US monetary policy on Equity Real Estate Investment Trusts (REIT’s). Although a number of studies have investigated the issue of interest rate changes, the effect of unanticipated changes has not previously been addressed in terms of possible effects on both REIT’s returns and volatility. The results show a strong response in both the first and second moments of REIT returns to unexpected policy rate changes. The results for the impact of the shock on both mean and volatility of returns is consistent with results from studies addressing broader equity markets. However, we find evidence both against behavioral changes in volatility coincident to US monetary policy decisions and asymmetric responses to the monetary policy shock.

Investor Sentiment and REIT Returns

Recent advances in the field of behavioral finance have given a fillip to the use of behavioral factors in asset pricing models. This study adds to the understanding of the REIT return generating process by exploring the behavioral impact of investor sentiment on REIT returns. The results show that when investors are optimistic (pessimistic), REIT returns become higher (lower). These findings are robust when conventional control variables are considered. Empirical analysis indicates steady erosion in the importance of the default and term structure interest rate variables previously considered as important determinants of REIT returns. Previous noise trading papers that consider the impact of institutional traders conclude that institutional investors cannot arbitrage away noise trader risk. The results of this paper find an exception in the case of small REITs. Examination of REITs based on size reveals that the return generating process of small REITs differs from that of mid-size and large REITs. Analysis of the return generating process by performance shows high performance REITs are more sensitive to the independent variables in the model as compared to the low and mid performance REITs.     

Idiosyncratic Risk and REIT Returns

The volatility of a stock returns can be decomposed into market and firm-specific volatility, with the former commonly known as systematic risk and the later as idiosyncratic risk. This study examines the relevance of idiosyncratic risk in explaining the monthly cross-sectional returns of REIT stocks. Contrary to the CAPM theory, a significant positive relationship is found between idiosyncratic volatility and the cross-sectional returns. This suggests that firm-specific risk matters in REIT pricing. The regression results further show that once idiosyncratic risk is controlled for in the asset-pricing model, the size and book-to-market equity ratio factors ceased to be significant. The explanatory power of the momentum effect remains robust in the presence of idiosyncratic risk.

Fundamental Drivers of Dependence in REIT Returns

We analyse the empirical relationships between firm fundamentals and the dependence structure between individual REIT and stock market returns. In contrast to previous studies, we distinguish between the average systematic risk of REITs and their asymmetric risk in the sense of a disproportionate likelihood of joint negative return clusters between REITs and the stock market. We find that REITs with low systematic risk are typically small, with low short-term momentum, low turnover, high growth opportunities and strong long-term momentum. Holding systematic risk constant, the main driving forces of asymmetric risk are leverage and, to some extent, short-term momentum. Specifically, we find that leverage has an asymmetric effect on REIT return dependence that outweighs the extent to which it increases the average sensitivity of REIT equity to market fluctuations, explaining the strong negative impact of leverage on firm performance especially during crisis periods that has been documented in recent empirical work.     

Momentum and Autocorrelation in Stock Returns

This article studies momentum in stock returns, focusing onthe role of industry, size, and book-to-market (B/M) factors.Size and B/M portfolios exhibit momentum as strong as that inindividual stocks and industries. The size and B/M portfoliosare well diversified, so momentum cannot be attributed to firm-or industry-specific returns. Further, industry, size, and B/Mportfolios are negatively autocorrelated and cross-seriallycorrelated over intermediate horizons. The evidence suggeststhat stocks covary "too strongly" with each other. I argue thatexcess covariance, not underreaction, explains momentum in theportfolios.     

The Asymmetric Response of Equity REIT Returns to Inflation

This paper posits that the failure of past studies to document a positive relationship between REIT (Real Estate Investment Trust) returns and inflation is an artifact of the empirical framework that has predominated in these studies. Applying a pooled estimation methodology to an expansive data set containing 195 publicly traded equity REITs for the period 1981–2002, the study documents a strong asymmetry in the response of equity REIT returns to inflation. Specifically, when expected and unexpected inflation are separated into positive and negative changes, results indicate that equity REIT returns rise in response to both increases and decreases in inflation. The evidence, which is partly contingent on the prevailing monetary policy environment, carries important policy implications for portfolio management and provides insights into the observed anomalous relationship between REITs and inflation.     

Cross-Sectional and Time-Series Determinants of Momentum Returns

Portfolio strategies that buy stocks with high returns overthe previous 3–12 months and sell stocks with low returnsover this same time period perform well over the following 12months. A recent article by Conrad and Kaul (1998) presentsstriking evidence suggesting that the momentum profits are attributableto cross-sectional differences in expected returns rather thanto any time-series dependence in returns. This article showsthat Conrad and Kaul reach this conclusion because they do nottake into account the small sample biases in their tests andbootstrap experiments. Our unbiased empirical tests indicatethat cross-sectional differences in expected returns explainvery little, if any, of the momentum profits.     

Dynamic Correlations Among Asset Classes: REIT and Stock Returns

We use the Dynamic Conditional Correlation model with Generalized Autoregressive Conditional Heteroskedasticity (DCC-GARCH) developed by Engle (Journal of Business & Economic Statistics 20(3):339–350, 2002) to examine dynamics in the correlation of returns between publicly traded REITs and non-REIT stocks. The results suggest that REIT-stock correlations form three distinct periods. During the first period, ending in August 1991 with the start of the modern REIT era, correlations were high and without trend, never dipping below 59%. During the second period, ending in September 2001 with the inclusion of REITs in broad stock market indexes, correlations declined precipitously to 30%, enabling substantially higher portfolio allocations to both high-return asset classes and therefore higher portfolio returns without increasing portfolio volatility. During the third period, since September 2001, correlations increased steadily but only reached 59% in late 2008. A simple portfolio optimization suggests that asset managers would be willing to pay 20 basis points per year, plus the difference in transaction costs, for the ability to use DCC-GARCH modeling of dynamic correlations in place of rolling 24-month asset correlations.     

Multiscale Analysis of International Linkages of REIT Returns and Volatilities

This paper extends the REIT literature on international market linkages by introducing a time scale dimension. In particular, we apply the maximum overlap discrete wavelet transform (MODWT) to seven major global REIT markets, and investigate their linkages among returns and volatilities at different time scales. Our findings suggest strong scale-dependency of the market linkages. Specifically, the linkage among returns generally increases with time scale, implying that portfolio diversification is most efficient at short time horizons. Moreover, the return linkage is found to be time varying and its dynamics varies across scales. In addition, results on the volatility linkage, which manifests itself through volatility comovements and spillover, show that volatility comovements generally strengthen as scale increases and volatility spillover varies across scales in terms of strength and direction. Our findings cast doubt on the use of the scale-free correlation coefficient as a universal measure of market linkage. Our findings can be utilized by time-scale-conscious investors to improve portfolio selection and risk management.     

Liquidity and the Future Stock Returns of the REIT Industry

This paper examines how deviations from expected optimal cash holdings affect future stock returns in the real estate investment trust (REIT) industry. Our findings indicate that REIT managers elect to hold less cash to reduce the agency problems of cash flow, supporting the pecking order theory that growth opportunities lead managers to retain more cash on hand. The results show that any deviation from the estimated optimal cash holdings is significantly detrimental to future market performance, suggesting that excess or insufficient cash is harmful to stock returns. The adverse influence of deviations above the optimal value is insignificantly stronger than that of deviations below the optimal value. We also find that the return performances of deviations that do not differ from the expected optimal value surpass those of deviations that differ significantly from the expected level. This implies that REIT managers determine their cash policies based on future growth opportunities and the external costs of capital. Finally, for REIT firms, holding excess or insufficient cash increases the possibility of agency conflict or underinvestment, which will consequently worsen the firm??s future performance.     

The Long-Lasting Momentum in Weekly Returns

Reversal is the current stylized fact of weekly returns. However, we find that an opposing and long‐lasting continuation in returns follows the well‐documented brief reversal. These subsequent momentum profits are strong enough to offset the initial reversal and to produce a significant momentum effect over the full year following portfolio formation. Thus, ex post, extreme weekly returns are not too extreme. Our findings extend to weekly price movements with and without public news. In addition, there is no relation between news uncertainty and the momentum in 1‐week returns.     

Short Sales Constraints and Momentum in Stock Returns

Abstract:   We show that stock characteristics identified by D'Avolio (2002) provide a reliable index of the mostly unobservable short sales constraints. Specifically, we find that this index is positively related to the level of short interest and to short selling costs implied by the disparity in prices in the options and stock markets, and is negatively related to future returns. Using this index, we show that the magnitude of momentum returns for the period 1984 to 2001 is positively related to short sales constraints, and loser stocks rather than winner stocks drive this result. We conclude that short sales constraints are important in preventing arbitrage of momentum in stock returns.     

Momentum, Business Cycle, and Time-varying Expected Returns

A growing number of researchers argue that time-series patterns in returns are due to investor irrationality and thus can be translated into abnormal profits. Continuation of short-term returns or momentum is one such pattern that has defied any rational explanation and is at odds with market efficiency. This paper shows that profits to momentum strategies can be explained by a set of lagged macroeconomic variables and payoffs to momentum strategies disappear once stock returns are adjusted for their predictability based on these macroeconomic variables. Our results provide a possible role for time-varying expected returns as an explanation for momentum payoffs.     

The Predictability of Equity REIT Returns: Time Variation and Economic Significance

This article presents evidence on predictability of excess returns for equity REITs relative to the aggregate stock market, small-capitalization stocks, and T-bills using best-fit models from prior time periods. We find that excess equity REIT returns are far less predictable out-of-sample than in-sample. This inability to forecast out-of-sample is particularly true in the 1990s. Nevertheless, in the absence of transaction costs, active-trading strategies based on out-of-sample predictions modestly outperform REIT buy-and-hold strategies. However, when transaction costs are introduced, profits from these active-trading strategies largely disappear.     

Volatilities and Momentum Returns in Real Estate Investment Trusts

We examine the relation of time-varying idiosyncratic risk and momentum returns in REITs using a GARCH-in-mean model and incorporate liquidity risk in the asset pricing model. This is important because illiquidity may be more severe for REITs due to the nature of their underlying assets. We find that momentum returns display asymmetric volatility, i.e., momentum returns are higher when volatility is higher. Additionally, we find evidence that REITs with lowest past returns (losers) have higher idiosyncratic risks than those with highest past returns (winners) and that investors require a lower risk premium for holding losers’ idiosyncratic risks. Therefore, although losers have higher levels of idiosyncratic risks, their low risk premia cause low returns, which contribute to momentum. Lastly, we find a positive relation between REITs’ momentum return and turnover.     

Further Evidence on the Integration of REIT,Bond, and Stock Returns

This study examines the integration of REIT, bond, and stock returns. Cointegration and vector autoregressive models are employed to explore the causality and long-run economic linkages among these securities. Our results show that REITs behave more like stocks and less like bonds after the structural changes in the early 1990s. Overall, results suggest that the benefits of diversification by including REITs in multiasset portfolios diminish after 1992.     

The Relative Importance of Stock, Bond and Real Estate Factors in Explaining REIT Returns

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 1980s 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 1993–1998 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.     

Market States and the Effect on Equity REIT Returns due to Changes in Monetary Policy Stance

This study investigates the effect of changes in monetary policy on US equity real estate investment trust (EREIT) returns in lower and higher return ranges during bull, bear, and volatile stock market states using quantile regression. Results show that EREIT returns are sensitive to changes in monetary policy at different EREIT return ranges in different market states. During bull markets, changes in monetary policy have a significant negative impact on EREIT when investors have lower expectations of real estate price increases, but are not effective when investors have higher expectations of real estate price increases. During volatile and bear markets, EREIT returns are not sensitive to changes in monetary policy stance. Results also show that EREIT returns respond positively to stock returns in various states and conditions.