The predictability of returns on equity REITs and their co-movement with other assets

Abstract

Recent evidence suggests that the variation in the expected excess returns is predictable and arises from changes in business conditions. Using a multifactor latent variable model with time-varying risk premiums, we decompose excess returns into expected and unexpected excess returns to examine what determines movements in expected excess returns for equity REITs are more predictable than all other assets examined, due in part to cap rates which contain useful information about the general risk condition in the economy. We also find that the conditional risk premiums (expected excess returns) on EREITs move very closely with those of small cap stocks and much less with those of bonds.Recent evidence suggests that the variation in the expected excess returns over time is predictable and is the result of changes in business conditions. 1 We offer further evidence on this issue by extending the previous literature to include real estate, particularly equity real estate investment trusts (EREITs). 2 What is unique about EREITs is that it is traded as a stock on a stock exchange but represents an underlying ownership in a portfolio of real estate. This feature raises the possibility that different variables may be required to capture the time variation in its risk premiums relative to those for bond and non-REIT stocks. Another issue related to the hybrid nature of EREITs is whether EREITs are a hybrid of stocks and bonds and whether the stock component is representative of large cap stocks or small cap stocks. More specifically, the questions addressed in this article include: (1) Do the same variables forecast stocks, bonds, and real estate returns so that the expected returns (conditional risk premiums) on these assets move together? In particular, do cap rates carry information about the conditional risk premium for equity REITs but no other asset class? (2) Is the variation in the expected returns on equity REITs related to business conditions? (3) To what extent do REITs resemble stocks with large capitalizations, stocks with small capitalizations, and bonds?While Mengden and Hartzell (1986), Giliberto (1990), and Corgel and Rogers (1991), among others, have studied the hybrid nature of REITs in the past, none of these studies

The Hybrid Nature of Real Estate Trusts

“…Liu and Mei (1992) as well was Clayton and MacKinnon (2003) are representative of this class of studies. Liu and Mei (1992) decompose REIT returns into expected and unexpected excess returns and show that expected excess returns for equity REITs are not only predictable but also are partly driven by a commercial real estate pricing factor vis-a-vis cap rates.…”

“…Liu and Mei (1992) as well was Clayton and MacKinnon (2003) are representative of this class of studies. Liu and Mei (1992) decompose REIT returns into expected and unexpected excess returns and show that expected excess returns for equity REITs are not only predictable but also are partly driven by a commercial real estate pricing factor vis-a-vis cap rates. Clayton and MacKinnon (2003) do a slightly different decomposition of REIT returns using a multi-factor model consisting of large cap stocks, small cap stocks, bonds and real estate that are first orthogonalized.…”

“…We show the results of the second conversion procedure only given that the results are similar. Since prior studies have shown that securitized real estate tends to be a leading indicator of the underlying real estate (see Gyourko and Keim (1992), Liu and Mei (1992)), the monthly real estate data is lead 9 months 22 such that it is "as if" we can observe real estate and RET data on a contemporaneous basis. Figure 4 shows that direct real estate did not decline until after 1930 which could account for why RETs exhibited superior performance over the 1928-1930 period.…”

Threshold Effects in the Relationships of REITs and Other Financial Securities in Developed Countries

“…Most researchers have documented that change in REIT prices are closely related to stock markets (e.g., (Mengden and Hartzell, 1986;Ross and Zisler, 1987;Goetzmann and Ibbotson, 1990;Ennis and Burik, 1991;Ross and Zisler, 1991;Liu and Mei, 1992;Myer and Webb, 1993;Myer and Webb, 1994). In addition, some researchers provided empirical results in which the stock market plays an important role in pricing REIT stock (Gyourko and Linneman, 1988;Giliberto, 1990;Park et al, 1990;Mengden, 1998;Ewing and Payne, 2005).…”

Financing of Low-Rent Housing REITs in China

“…REITs can be classified into equity REITs, mortgage REITs and hybrid REITs. Equity REITs mainly invest in real estate [36,45] , mortgage REITs in real estate loans, and hybrid REITs invest in both. In abroad, equity REITs occupy a large proportion in both the interbank market and the exchange market [21,40−41] , Considering the characteristics of equity REITs, we suggest China develop equity REITs for low-rent housing, allow it to invest in the rental income of real estate to generate stable cash flow, and timely distribute the cash income of REITs as dividends.…”