Further Proof: Investment in REITs Diversifies Portfolios, Hedges Against Inflation
[March/April 2007]
Compiled by Brad Case
Editor’s Note:
This column features summaries and excerpts from the latest research and academic perspectives on the income-producing real estate industry.
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From “Co-integration of Real Estate Stocks and REITs with Common Stocks, Bonds and Consumer Price Inflation: An International Comparison,” by Peter Westerheide, an unpublished working paper, August 2006
Peter Westerheide, an economist at the Centre for European Economic Research, uses the techniques of co-integration analysis across eight countries from 1990 to 2004 to study whether returns to REITs and REIT-like investments are co-integrated with stock and bond investments or whether they move independently. Westerheide’s results agree with several previous studies: he finds no co-integration of REITs with stocks and bonds, meaning that REIT investments tend to provide diversification benefits. There is, however, some co-integration between REITs and inflation measures, implying that REIT investments tend to provide an inflation hedge.
“The results let us conclude that almost no evidence exists for a tight long-term relationship between real estate securities and the development of broader stock markets. With respect to bonds, there is also little evidence for a stable long-run relationship to real estate securities. In almost every country, weak evidence exists for a long-run equilibrium between real estate stock indicators and the consumer price index (CPI), indicating that real estate stocks could serve as an inflation hedge.
In general, real estate securities seem to represent an asset class distinct from bonds and stocks in most countries. In the long run, they seem to reflect the performance of direct real estate investments and provide a potential for further diversification of asset portfolios. Additionally, real estate stocks provide a weak hedge against consumer price inflation in almost every country.”
 Source: Peter Westerheide, Centre for European Economic Research
Surge of Institutional Investment in REITs
Made REIT Returns More Like Pure Real Estate
From “REIT Mimicking Portfolio Analysis,” by Kevin
C.H. Chiang, Kirill Kozhevnikov, Ming-Long Lee and
Craig H. Wisen, published in International Real
Estate Review, 2006
Four finance economists constructed REIT-based
mimicking portfolios to understand the linkages
between REIT share prices and either stock prices
or direct real estate investments. They find that
REITs have behaved more like their underlying real
estate assets and less like the broader stock markets
since 1993, and they attribute that change to growing
REIT investments by sophisticated institutional
investors.
“The market beta of a REIT portfolio appears to
converge to the market beta of the NCREIF Property
Index under the new analysis framework. The evidence
is consistent with the notion that a high degree
of participation from institutional investors in
the new REIT era strengthens the linkage between
REIT returns and the underlying real estate factor.
The result is important because it provides evidence
about the fundamental linkage between public and
private real estate.
It appears that the Revenue Reconciliation Act of
1993 may have made REITs more attractive for institutional
investors. It seems plausible that prior to 1993,
REIT prices were largely influenced by individual
investors who perceived REITs to be more like stocks.
Therefore, stock-based factors were useful for explaining
REIT returns. With the subsequent influx of institutional
investors in the post-1993 era, the link between
REITs and their underlying properties has strengthened
over time. The result is in line with the notion
that there is a strong fundamental linkage between
REITs and the underlying real estate in the new
REIT era as evident by their similar market exposures.”
Property Sales Improve Asset Allocation, Increase
Stock Prices
From “Value Creation in REIT Property Sell-Offs,”
by Robert D. Campbell, Milena Petrova and C.F. Sirmans,
published in Real Estate Economics, Summer
2006
A team of finance economists studied REIT property
sell-offs from 1992 to 2002—sales of one or more
properties to the same buyer in the same transaction
when the total price is greater than $20 million—and
found evidence that most sales improved both asset
allocation efficiency and share prices.
“We measure abnormal returns for these transactions,
finding that announcement window returns are significantly
positive. We find significantly positive abnormal
returns in one-day, two-day and three-day windows
around the announcement date. This result is evidence
that returns in real estate sell-offs for all types
of companies emanate largely from asset reallocation
efficiencies and not entirely from tax benefits
or from analysts’ undervaluation of real estate
assets.”
The Value of the S&P 500
| Summary
of REITs in S&P Indexes |
| S&P 500 Constituents |
Equity Market Cap
(in millions) |
| Simon Property Group |
24,898.8 |
| Public Storage |
17,233.6 |
| Vornado Realty |
17,853.3 |
| Equity Residential |
14,792.3 |
| ProLogis |
16,363.6 |
| Boston Property |
14,030.6 |
| Archstone-Smith Trust |
12,318.8 |
| Kimco Realty Corp. |
12,544.0 |
| Avalonbay Communities |
10,231.2 |
| Plum Creek Timber Co. |
7,021.2 |
| Apartment Investment &
Management |
5,720.7 |
| Subtotal |
153,008.1 |
From “A New Era: Real Estate Industry in the S&P
500 Index,” by Erik Lam and Dogan Tirtiroglu, an
unpublished working paper, January 2007
Two economists conducted an event study of Standard
& Poor’s announcement on Oct. 3, 2001 that REITs
would henceforth be included in its indices, including
the S&P 500. Erik Lam and
Dogan Tirtiroglu of Cambridge University found
that the announcement increased the value not only
of those REIT stocks specified for inclusion, but
of most other REITs as well.
“Because S&P’s goal is to make its indices reflect
the U.S. economy as much as possible, it felt that
the growth and importance of REITs warranted inclusion.
On average, the excess returns on Oct. 4 were significantly
greater than zero for five out of the six firms
explicitly mentioned in the S&P announcement. The
same result holds on average for the top 46 REITs,
top 10 REITs and top 23 REITs.”
Source: Eric Lam and Doǧan Tirtiroǧlu, Cambridge University
Brad Case is vice president, research & industry information at NAREIT.
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