Do Common Risk Factors in the Returns on Stocks and Bonds Explain Returns on REITs?

The monthly returns on equity and mortgage real estate investment trusts (REITs) are analyzed over the period July 1976 to December 1992. The results indicate that risk premiums on equity REITs are significantly related to risk premiums on a market portfolio of stocks as well as to the returns on mimicking portfolios for size and book-to-market equity factors in common stock returns. Mortgage REIT risk premiums are significantly related to the three stock market factors and two bond market factors in returns. Also, mortgage REIT shares underperform by an average of 6.8% per year.     

Asset Location,Timing Ability and the Cross‐Section of Commercial Real Estate Returns

This study examines the sensitivity of equity REIT returns to time‐varying MSA allocations of REIT property portfolios. Using a large sample of individual commercial property holdings, we find significant cross‐sectional and time variation in REIT geographic exposures and the ability of these exposures to explain the cross‐section of REIT returns. We further find evidence consistent with REIT managers being able, on average, to time allocation decisions ahead of MSA outperformance. This effect is most prevalent in non‐gateway markets, varies significantly across MSAs and over time, and is concentrated in financially flexible firms with a more diversified geographic portfolio.     

Diversification Benefits of REIT Preferred and Common Stock: New Evidence from a Utility‐based Framework

We study the diversification benefits of REIT preferred and common stock using a utility‐based framework in which investors segment based on risk aversion. We examine optimal mean‐variance portfolios of investors with different levels of risk aversion given access to different classes of assets and establish three main results. First, REIT common stock helps low risk aversion investors attain portfolios with higher returns, while REIT preferred stock helps high risk aversion investors by providing a venue for risk reduction. Second, REIT preferred stock has a risk‐return profile not easily replicated by other asset classes. Finally, conclusions drawn from the empirical analysis are markedly different under these constraints compared to the classical unconstrained setting.     

Returns and Information Transmission Dynamics in Public and Private Real Estate Markets

This paper examines U.S. public and private commercial real estate returns at the aggregate level and by the four major property types over the 1994–2012 time period. Returns are carefully adjusted for differences between public and private markets in financial leverage, property type focus and management fees. Unconditionally, we find that passive portfolios of unlevered core real estate investment trusts (REITs) outperformed their private market benchmark by 49 basis points (annualized) over the 1994–2012 sample period. Our baseline vector autoregression results suggest that REIT returns do not embed additional commercial real‐estate‐specific information useful in predicting private market returns. These results strongly suggest that equity REIT returns react to fundamental (latent) asset pricing information more quickly than private market returns given their greater liquidity and price revelation. REITs therefore serve as a fundamental information transmission channel to private market returns when asset pricing variables are omitted.     

The Dynamics of REIT Capital Flows and Returns

This study examines the effects of capital flows into the REIT sector on REIT returns and, simultaneously, the effects of REIT returns on subsequent REIT capital flows. The dynamic relation between REIT capital flows and returns is estimated using vector autoregression (VAR) techniques. Unlike static regression techniques, our dynamic model produces estimates of the short-run relationships, long-run relationships, impulse response functions and forecast variance decompositions. We find evidence that REIT equity flows are significantly positively related to the prior quarter's flows and negatively related to flows from two quarters ago. The evidence on the responsiveness of flows to prior returns is time-period specific. In the important post-1992 subperiod, REIT returns do not significantly affect REIT flows in any of the VAR model specifications. Simultaneously, REIT capital flows do appear to have a significant influence on equity REIT returns.     

Price Signaling and Return Chasing: International Evidence from Maturing REIT Markets

This article examines the liquidity of international real estate securities across 10 markets over the period 1990–2015. We apply and compare results for four different measures of liquidity, and find that while liquidity has increased consistently, wide variations still exist across markets, with the United States and Japan in the lead. Our results also suggest that the introduction of local REIT regimes did not have any pervasive effects on stock liquidity. When we study the relationship between liquidity and returns, we document new and consistent evidence for international return chasing behavior, whose pattern is a function of local market efficiency, listed real estate market maturity and stock ownership dispersion. The introduction of REIT regimes seems to weaken the importance of extra performance over and above general equity returns as investors tend to allocate funds to real estate securities within real estate rather than equity portfolios.     

Asset Pricing Information in Vintage REIT Returns: An Information Subset Test

REIT return data prior to the new REIT era offer important asset pricing information. At issue is whether empiricists should focus attention on returns series covering only the new period. We use a generalized asset pricing and information subset test to disentangle REIT information from information available in several benchmark series. Results indicate that REIT returns are informative about the discounting process during the pre–new-era period. Thus, the distribution of vintage REIT returns is not fully explained by either broad market indexes or from size-based anomalies. This study should be viewed as a useful empirical precedent for those studying REIT data preceding the new REIT era.     

REIT Stock Market Volatility and Expected Returns

We study the relation between REIT stock volatility and future returns, focusing particularly on the financial crisis period of 2007–2009. There is ongoing debate about whether stock volatility can forecast future returns. Our findings suggest that REIT‐implied volatility is negatively related to contemporaneous stock returns; there is a significant positive relationship between REIT implied volatility and future stock volatility; and there is a significant negative relation between REIT implied volatility and future stock returns. Lastly, we develop trading rules based on REIT implied volatility to test whether these relationships are exploitable. The result suggests a potentially profitable trading strategy.     

The Fractal Structure of Real Estate Investment Trust Returns: The Search for Evidence of Market Segmentation and Nonlinear Dependency

This article presents a further test for market segmentation between the real estate market and the capital markets. We use rescaled range analysis developed in the fractal geometry literature to test for nonlinear trends in the returns series for different asset classes. We make three major conclusions: (1) the stock market displays tendencies consistent with a random walk, (2) portfolios of mortgage and equity REIT returns display tendencies consistent with a random walk and, (3) conditional upon the methods used, segmentation does not exist between different real estate markets and between the real estate and stock markets.     

Liquidity, Return and Order-Flow Linkages Between REITs and the Stock Market

This article represents the first exploration of liquidity and order flow spillovers across New York Stock Exchange stocks and real estate investment trusts (REITs). Impulse response functions and Granger causality tests indicate the existence of persistent liquidity spillovers running from REITs to non-REITs. Specifically, REIT liquidity indicators are forecastable from non-REIT ones, at both daily and monthly horizons. I also provide evidence of a liquidity premium inherent in REIT returns. While REIT prices appear to be set efficiently in that neither REIT nor non-REIT order flows forecast REIT returns, I find that order flows and returns in the stock market negatively forecast REIT order flows. This result is consistent with the notion that real estate markets are viewed as substitute investments for the stock market, which causes down-moves in the stock market to increase money flows to the REIT market.     

Markov Switching Dynamics in REIT Returns: Univariate and Multivariate Evidence on Forecasting Performance

We document the presence of Markov switching regimes in expected returns, variances and the implied reward‐to‐risk ratio of real estate investment trust (REIT) returns and compare them to properties of stocks and bonds. Our evidence suggests that regime switching techniques are more successful over the period 1972–2008 than other time‐series models are. When the analysis is extended to a multivariate setting in which REIT, stock and bond returns are modeled jointly, we find that the data call for the specification of four separate regimes. These result from the absence of synchronicity among the regimes that characterize univariate REIT, stock and bond returns.     

Risk and Return on Real Estate: Evidence from Equity REITs

We analyze monthly returns on an equally weighted index of eighteen to twenty-three equity (real property) real estate investment trusts (REITs) that were traded on major stock exchanges over the 1973–87 period. We employ a multifactor Arbitrage Pricing Model using prespecified macroeconomic factors. We also test whether equity REIT returns are related to changes in the discount on closed-end stock funds, which seems plausible given the closed-end nature of REITs.
Three factors, and the percentage change in the discount on closed-end stock funds, consistently drive equity REIT returns: unexpected inflation and changes in the risk and term structures of interest rates. The impacts of these variables on equity REIT returns is around 60% of the impacts on corporate stock returns generally. As expected, the impacts are greater for more heavily levered REITs than for less levered REITs. Real estate, at least as measured by the return performance of equity REITs, is less risky than stocks generally, but does not offer a superior risk-adjusted return and is not a hedge against unexpected inflation.     

They Would If They Could: Assessing the Bindingness of the Property Holding Constraints for REITs

This study examines the bindingness of the property holding constraints which Real Estate Investment Trusts (REITs) face on their portfolios (the dealer rule), and illustrates how these constraints hinder REITs from exploiting opportunities to time the property market. I first simulate a set of filter‐based market timing strategies, which outperform a buy‐and‐hold strategy out of sample, and show that imposing a four‐year (or even the newer two‐year) holding constraint significantly reduces the excess returns the strategies generate. I then analyze actual holding periods of properties in REIT portfolios and find that there seems to exist a large degree of demand for short property holding periods and that the trades generated by the filter strategy generally resemble actual REIT trading activity, validating the relevance of the simulation results. A direct test for the constraint reveals that REITs' propensity to hold a property beyond the minimum period increases, the higher the profit from the transaction, consistent with the asymmetric nature in which the rule is enforced. By contrast, this effect is insignificant for Umbrella‐Partnership REITs (UPREITs), which are not as affected by the constraint. I further show that UPREITs overall achieve significantly better ex‐post market timing performance than non‐UPREITs. I thus find that overall REITs are limited by the dealer rule.     

Alternative Benchmarks for Evaluating Mutual Fund Performance

While real estate investment trusts (REITs) have experienced very high growth rates over the past 15 years, the growth in mutual funds that invest in REITs has been even more dramatic. REIT mutual fund returns are typically presented relative to the return on a simple value-weighted REIT index. We ask whether including additional factors when benchmarking funds' returns can improve the explanatory power of the models and offer more precise estimates of alpha. We investigate three sets of REIT-based benchmarks, plus an index of returns derived from non-REIT real estate firms, namely homebuilders and real estate operating companies. The REIT-based factors are a set of characteristic factors, a set of property-type factors and a set of statistical factors. Using traditional single-index benchmarks, we find that about 6% of the REIT funds exhibit significant positive performance using traditional significance levels, which is more than twice what random chance would predict. However, with the multiple-index benchmarks that we prefer, this falls considerably to only 0.7%. In addition, we find that these sets of factors and the non-REIT indices better explain the month-to-month returns of the REIT mutual funds. This suggests that investors or researchers evaluating REIT mutual fund performance may benefit from a multiple-benchmark approach.     

The Consequences of REIT Index Membership for Return Patterns

The impact of stock market index membership on Real Estate Investment Trust (REIT) stock returns is unclear. Returns may become more like those of other indexed stocks and less like those of their underlying properties. Taking advantage of the inclusion of REITs in major S&P indexes starting in 2001, we find that shared index membership significantly increases the correlation between REIT returns. However, index membership also enhances the link between REIT returns and the underlying real estate, consistent with improved pricing efficiency.     

The Cross Section of Expected REIT Returns

In this study, we examine the cross-sectional determinants of expected REIT returns. We examine both the pre- and post-1990 periods, since the structure of the REIT market changed substantially around 1990. The determinants of expected returns differ between the two subperiods. In the pre-1990 subperiod, momentum, size, turnover and analyst coverage predict REIT returns. In the post-1990 period, momentum is the dominant predictor of REIT returns. Given the strength of the momentum effect in the post-1990 period, we examine it in great detail. For the whole period, and for the post-1990 period where the momentum profit is strongest, our evidence is generally consistent with the studies on common stocks other than REITs. The only striking exception is that we find that momentum is stronger for the larger REITs rather than for the smaller REITs. In our multiple regressions that include the characteristics as well as interactions between past returns and firm characteristics, the turnover–momentum interaction effect provides the most significant results. More specifically, momentum effects are stronger for more liquid REITs.     

Why Do REIT Returns Poorly Reflect Property Returns? Unrealizable Appreciation Gains due to Trading Constraints as the Solution to the Short‐Term Disparity

This study addresses the short‐term disparity between REIT returns and direct property returns, and argues that this phenomenon is due to the trading constraints in the direct property market imposed on REITs (the dealer rule). This renders REITs unable to time markets in order to realize short‐term property appreciation profits, making REITs primarily a property income investment rather than a full property investment, and explains the observed disparity. Empirically, I find that REIT returns consistently reflect property income returns, but not property appreciation returns. This makes this study the first in the literature to find a consistent link between REIT returns and any portion of direct property returns at short time horizons, in the context of a linear factor model. I then set up a natural laboratory to test the trading‐constraints explanation by examining the appreciation dependence of different types of REITs, which should be differently affected by the trading constraints. I find that returns to UPREITs, which are less affected by the constraints, have a stronger appreciation dependence than returns to regular REITs. I also perform a size test and find that large REITs, which are less affected by the constraints, have a stronger appreciation dependence than small REITs. When testing the effects of UPREIT and size characteristics simultaneously, I find a consistent UPREIT effect. I further find that Real Estate Operating Companies (REOCs), which are not subject to trading constraints, show short‐term property appreciation dependence. These findings offer strong support for the trading‐restrictions explanation.     

Uncertainty premia in REIT returns

We provide a systematic study of how financial and real estate uncertainty affect the aggregate return performance of the U.S. REIT market from 1994 to 2017. A temporal causality analysis reveals a negative uncertainty impact on REIT returns. The asset pricing analysis confirms the predictive relation and suggests that REITs are statistically significantly exposed to changes in market-wide uncertainty, for which investors require a return compensation. We also identify economic state variables to explain time-varying uncertainty exposures as well as periodic hedging characteristics of REITs. Finally, we find evidence that the source of uncertainty matters for compensating expected REIT returns.     

REIT Stock Price Volatility and the Effects of Leverage

This article sheds light on several puzzling empirical observations. We examine the volatility implications of equity Real Estate Investment Trust (REIT) stock returns over the sample period from January 1985 through October 2012. We find a negative “leverage effect” in the pre‐ and post‐Greenspan era, but not during the Greenspan era (circa 1994–2006). We argue that the positive elasticity of variance with respect to the value of equity during the Greenspan era can be explained by a decline in the spread between the yield on commercial mortgages and 10‐year Treasuries, which triggered a wealth transfer from REIT equity holders to REIT debt holders. We also argue that the declining commercial‐mortgage‐10‐year‐Treasury yield spread during the Greenspan era allowed REITs to take on far more risk than most people realized. We then document that average REIT stock return volatility increased significantly in the 2007–2010 period in the midst of a historic decline in REIT stock prices. The results have significant implications for the good deal of interest and debate in the media over the status of REITs and whether equity REITs have become excessively risky relative to the returns they generate.     

The Underlying Return-Generating Factors for REIT Returns: An Application of Independent Component Analysis

Multifactor approaches to real estate returns have emphasized a macro-variables approach in preference to the latent factor approach originally used in arbitrage pricing theory. Use of high-frequency data, trading strategies and growing emphasis on the risks of extreme events makes the macrovariable procedure problematic. This article explores an alternative to the principal components analysis approach: independent components analysis (ICA). ICA seeks independence and maximizes a chosen risk parameter. We apply an ICA procedure based on a kurtosis maximization algorithm to real estate investment trust (REIT) data. The results show that ICA successfully captures kurtosis characteristics of REIT returns, offering possibilities for developing of risk management strategies that are sensitive to extreme events and tail distributions, augmenting traditional mean–variance approaches.