The Integration of Commercial Real Estate Markets and Stock Markets

This paper tests whether commercial real estate markets (both exchange-traded and non-exchange-traded) are integrated with stock markets using multifactor asset pricing models. The results support the hypothesis that the market for exchange-traded real estate companies, including REITs, is integrated with the market for exchange-traded (non-real-estate) stocks. Moreover, the degree of integration has significantly increased during the 1990s. However, when appraisal-based returns (adjusted for smoothing) are used to construct real estate portfolio returns, the results fail to support the integration hypothesis, although this may reflect the inability of these estimated private market returns to accurately proxy for commercial real estate returns. Interestingly, the growth rate in real per capita consumption is consistently priced in both commercial real estate markets and stock markets, whereas previous studies have found mixed evidence on the role of consumption in explaining ex ante stock returns.     

Temporal Aggregation in Real Estate Return Indices

Temporal aggregation is defined as the use of spot valuations of properties occuring over an interval of time to impute the spot value of a property or of a real estate value index as of a single point in time. Temporal aggregation may characterize not only appraisal-based indices but also indices based directly on transaction prices, such as the National Real Estate Index (NREI) and regression-based indices such as hedonic or repeat-sales indices. This paper analyzes the effect of temporal aggregation on the smoothing of the time series second moments in the resulting real estate return index. Assuming true spot returns are uncorrelated, temporal aggregation-induced smoothing will cause the empirically observed real estate index to understate the own-variance by one-third and the beta by one-half. This amount of bias in the second moments can have major implications for the real estate share in an optimal portfolio. Thus, empirical-based investment analysis could be led astray by smoothing even if the real estate return index is "transaction-based" rather than "appraisal-based."     

The Substitutability of Real Estate Assets

This paper investigates the degree of substitutability between securitized real estate assets and real estate assets whose prices are appraisal-based. Given the insensitivity of unsecuritized asset's returns to the returns on stock market indices, equilibrium asset pricing models cannot be used to compare these two avenues of investment. Two assets are deemed substitutable if the information sets underlying unbiased, minimum error variance estimates of their pricing parameters are identical. The empirical evidence shows that the prices of the transactions-based assets—real estate investment trusts and the stock price index of the home building industry—follow a random walk while the prices of the appraisal-based assets—FRC/NCREIF indices—do not. The variance decompositions of the vector autoregressions also show that the level of economic activity helps predict the price indices of appraisal-based assets while the stock market index and the term structure of interest rates are better predictors of the prices of transactions-based assets     

An Approach to Industrial Real Estate Market Segmentation and Valuation Using the Arbitrage Pricing Paradigm

This paper investigates whether a segmented market exists for industrial real estate with respect to risk and return characteristics. Given the existence of industrial market segmentation, the next issue examined is whether a submarket perspective or an integrated real estate market orientation provides better rate of return estimates for individual industrial properties using an Arbitrage Pricing Theory (APT) framework. The results support the existence of regional markets for industrial real estate. A submarket orientation rather than an integrated perspective is also found more appropriate in predicting returns on industrial real estate.     

Real Estate Investments,Product Market Competition and Stock Returns

By limiting operating flexibility, real estate investments are found to increase firm risk, thus expected returns. This study introduces product market competition as a critical determinant of the relation between real estate investments and stock returns. As part of capacity strategies, these investments are generally associated with increased market power and lower cash flow volatility in oligopolistic industries. I present a simple model of oligopolistic competition showing a negative relation between real estate holdings and firm beta, and empirically confirm this prediction. Controlling for product market competition enhances identification of the endogenous relation between real estate investments and stock returns.     

What Does the Stock Market Tell Us About Real Estate Returns?

This paper analyzes the risks and returns of different types of real estate-related firms traded on the New York and American stock exchanges (NYSE and AMEX). We examine the relation between real estate stock portfolio returns and returns on a standard appraisal-based index, and find that lagged values of traded real estate portfolio returns can predict returns on the appraisal-based index after controlling for persistence in the appraisal series. The stock market reflects information about real estate markets that is later imbedded in infrequent property appraisals. Additional analysis suggests that the differences in the return and risk characteristics across different types of traded real estate firms can be explained in part by appealing to real estate market fundamentals relating to the degree of dependence of the real estate firm upon rental cash flows from existing buildings. These findings highlight the heterogeneity of securitized real estate-related firms.     

On the Time-Series Properties of Real Estate Investment Trust Betas

The relation between real estate investment trust (REIT) returns and stock market returns is of significant importance to investors, practitioners and academics. The temporal properties of this relationship have a critical impact on the usefulness of REIT risk estimates and portfolio allocations to this asset class. Recent studies have suggested a decline in the market betas of equity real estate investment trusts (EREITs). This study applies a rigorous statistical test of the hypothesis that the market betas of EREITs have remained unchanged during the 1972 through 2002 time period. There is weak evidence of a downward trend in EREIT betas using a single-factor model; however, the hypothesis is not rejected when using a three-factor model.     

Public Versus Private Real Estate Equities: A More Refined, Long-Term Comparison

In this article we compare public and private real estate equities. In so doing, we control for three of the main differences between these investment alternatives: property-type mix, leverage and appraisal smoothing. With these two restated indices, we then run tests to determine in a statistical sense whether the restated means and volatilities of the two series were different from one another. The clear answer is that they were not. The results of the statistical tests combined with the fact that the average difference between the two (restated) return series has substantially narrowed (to approximately 60 basis points) in the more recent (1993–2001) period jointly suggest a seamless real estate market in which public- and private-market vehicles display a long-run synchronicity. This has important implications for portfolio management. First, public- and private-market vehicles ought to be viewed as offering investors a risk/return continuum of real estate investment opportunities. Second, while the "platform" did not matter in terms of observed return characteristics, the platform may matter with regard to liquidity, governance, transparency, control, executive compensation and so forth; an apparent clientele effect hints at these issues being valued differently by large and small investors.     

Systematic Risk and Diversification in the Equity REIT Market

This paper employs stock market-based data to examine the systematic risk and diversification properties of publicly traded equity real estate investment trusts (REITs). A unique data sample is created by combining firm return data with information on their property type holdings and the location of their investments. The systematic risk of equity REITs appears to vary by the type of property in which they invest, with beta being significantly higher for retail-oriented REITs than for REITs owning industrial and warehouse properties. In addition, the stock market data provides no evidence that REIT diversification across property types or broad geographic regions actually results in meaningful diversification as reflected in a standard market-based measure—the R ² from a simple market model regression.     

Real Estate Returns: A Comparison with Other Investments

Real estate returns, measured unleveraged, have been between those of stocks and bonds over 1960–1982. Due to appraisal smoothing and imperfect marketability, one must be careful about directly comparing measured real estate returns with those on other assets. It is likely, however, that low correlations with stocks and bonds make real estate a diversification opportunity for traditional portfolio managers. In addition, the issue of how various assets are priced is addressed. While stocks are priced primarily on market or beta risk, and bonds are priced primarily on interest rate and default risk, the real estate pricing mechanism includes residual risk and non-risk factors such as taxes, marketability costs and information costs.     

Correlation Dynamics and Determinants in International Securitized Real Estate Markets

We find the correlation movements among eight developed securitized real estate markets and among their stock markets are quite synchronized over the period from 1995 through 2012. There is a high degree of correlation dependence with many of the realized correlation series subject to regime switching. Moreover, international correlations of public property returns could be significantly explained by five real estate variables that include global real estate securities market volatility, co‐existence of real estate investment trust (REIT) influence, underlying direct real estate return performance differential, real estate securities volatility differential and real estate securities market size differential after controlling for macroeconomic influence and stock market effect. The importance of the control and real estate variables in explaining the return correlations varies across the economies examined.     

Gains From Diversifying Into Real Estate: Three Decades of Portfolio Returns Based on the Dynamic Investment Model

This paper compares the investment policies and returns for portfolios of stocks and bonds with and without up to three categories of real estate. Both domestic and global settings are examined, with and without the possibility of leverage. The portfolios were generated via the dynamic investment model based on the empirical probability assessment approach applied to past (joint) realizations of returns, both with and without correction for "smoothing" in the real estate data series. Our principal findings are: (1) the gains from adding real estate, on a semi-passive (equal-weighted) basis, to portfolios of either U.S. or global financial assets were relatively modest; in contrast, (2) the gains from adding real estate to the universe of U.S. financial assets under an active strategy were rather large (in some cases highly statistically significant), especially for the very risk-averse strategies; (3) the gains from adding U.S. real estate to a universe of global financial assets under an active strategy were mixed, although generally favorable for the highly risk-averse strategies; (4) correcting for second-moment smoothing in the real estate returns series had a relatively small impact for the more risk-tolerant strategies; and (5) there was some evidence that desmoothing resulted in improved probability estimates.     

Market Efficiency and Return Statistics: Evidence from Real Estate and Stock Markets Using a Present-Value Approach

This paper develops a methodology to identify asset price response to news in the framework of the Campbell–Shiller log-linear present-value equation. We further show that a slow price adjustment in real estate markets not only induces a high serial autocorrelation in excess returns, but also dampens the return volatility and the correlation with excess returns in other asset markets. Using Hong Kong real estate and stock market data, we find that the quarterly real estate price assimilates only about half the effect of market news, whereas the quarterly stock price incorporates the news fully. Our analysis identifies a cumulative price adjustment that recovers lost information in real estate returns due to market inefficiency and thereby restores the real estate return volatility and the correlation between real estate and stock markets.     

Using Nonlinear Tests to Examine Integration Between Real Estate and Stock Markets

An alternative approach to test whether the real estate and stock markets are cointegrated is presented. A nonlinear test, which allows for a stochastic trend term as opposed to a deterministic drift term, is developed. The results of the nonlinear model are compared to the results obtained using conventional cointegration tests. The cointegration results support the view that the real estate and stock markets are segmented, whereas the nonlinear model supports the view that the markets are fractionally integrated. There is a nonlinear relationship between the stock and real estate markets, but movement of the real estate market towards the stock market is slow and divergence between the two markets can be prolonged.     

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.     

The Markets for Real Estate Assets and Space: A Conceptual Framework

In this study, we present a simple analytic framework that divides the real estate market into two markets: the market for real estate space and the market for real estate assets. After describing the size and character of flows and stocks in the U.S. real estate market, we use our framework to demonstrate the important connections between the space and asset markets. We illustrate how these real estate markets are affected by the nation's macroeconomy and financial markets, tracing out the impacts resulting from various exogenous shocks on rents, asset prices, construction and the stock of real estate.     

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.     

The Impact of Market Imperfections on Real Estate Returns and Optimal Investor Portfolios

This study investigates the consequences of several imperfections associated with real estate markets on pricing and optimal investor portfolios from a CAPM context. CAPM assumptions are relaxed to recognize illiquidity, the consumption and investment attributes of owner-occupied housing, and a mildly segmented market structure. The study finds that relaxing the CAPM assumptions lead to a separate pricing paradigm for financial assets, income-producing real estate and owner-occupied housing respectively, that a "dividend effect" arises for real estate as the result of illiquidity, and that illiquidity reduces the extent to which investors hold real estate in their portfolios.     

Errors in Variables, Links between Variables and Recovery of Volatility Information in Appraisal-Based Real Estate Return Indexes

The present article proposes a multivariate approach to unsmoothing appraisal-based real estate return indexes to recover the true market volatility information in real estate returns. It scrutinizes the role played by errors in variables, in conjunction with an analysis of other economic activities relevant to real estate returns, to exploit the functional relationship and the mechanism of interactions between real estate returns and these economic activities. Appraisal smoothing can therefore be detected and corrected properly and efficiently, without presuming a weakly efficient real estate market. The approach is then applied to U.K. real estate indexes as empirical examples. The results suggest a reasonable volatility in U.K. real estate investment that is close to reality. It is found that the volatility of the true market return on real estate is 1.5404–1.9282 times that of the return on the appraisal-based indexes, in contrast to figures of 2.4862–5.8720 produced by the fully unsmoothing procedure.     

The Stock Performance of Securitized Real Estate and Master Limited Partnerships

This paper examines the stock performance of 144 master limited partnerships (MLPs) holding real estate and other types of assets. MLP stocks were found to underperform the market on a risk-adjusted basis during the period 1981–1991. The evidence indicates that the MLP organizational form has not been a superior vehicle for holding real estate. Also, the performance of real estate MLP stocks is similar to the performance of the stocks of other types of MLPs and that of real estate MLP stock performance is comparable to the performance of real estate investment trust stocks.