You Should Expand into Research on Investing in Real Estate
Posted in Individual Investing, Real Estate
September 12, 2009
A reader suggested: “I’m an active real estate investor (private lending and passive income single and multi-family properties) and I sure wish I could find this kind of site for real estate investors. You all should venture out.”
Searches of the Social Science Research Network (SSRN) indicate that there is relatively little academic research available on real estate as an asset class compared to that done for equities and bonds. It may be that the geographical variation of the real estate market makes research difficult. There is a stream of research on real estate investment trusts (REIT). Some of the top papers in SSRN (based on number of downloads in descending order) derived from searches for “real estate” and “REIT” are:
“Global Real Estate Markets: Cycles And Fundamentals”: The correlations among international real estate markets are surprisingly high, given the degree to which they are segmented. While industrial, office and retail properties exist all around the world, they are not economic substitutes because of locational specificity. In addition, the broad securitization of real estate property companies has, until recently, lagged that of other types of companies. Never-the-less, international property returns move together in dramatic fashion. In this paper, we use eleven years of global property returns to explore the factors influencing this co-movement. We attribute a substantial amount of the correlation across world property markets to the effects of changes in GNP, suggesting that real estate is a bet on fundamental economic variables which are correlated across countries. A decomposition shows that a local production factor is more important in some countries than in others.
“Institutional Perspectives on Real Estate Investing: The Role of Risk and Uncertainty”: In this paper we address the factors influencing the institutional decision to allocate resources to real estate. We survey a sample of major institutional investors via a web questionnaire. They were willing to answer questions about their target real estate allocation, their plans to increase or decrease their allocation, the major reasons for investing in real estate, and views on the major risks and relative expense of doing so. We find that the endowments in our sample typically had a relatively short history of real estate investment, but planned to increase their allocation to the asset class – more so than pension funds. We also find uncertainty about use of historical data to be a significant factor in the allocation choice.
“Predictability of Equity REIT Returns: Implications for Property Tactical Asset Allocation”: This study presents further evidence on the predictability of excess Equity REIT returns. Recent evidence on forecasting excess returns using fundamental variables has resulted in poor out of sample performance. Trading strategies based upon these forecasts have not outperformed the buy hold strategy in the 1990′s. We develop an alternative strategy which is based upon the time variation of investors risk premium. Our results indicate that a strategy based upon modeling this time variation of the risk premium is able to outperform the buy hold strategy both in and out of sample. By modeling the dynamic behavior of the risk premium we are implicitly capturing economic risk premiums which are not captured by conventional multi beta asset pricing models.
“The Performance of Real Estate Portfolios: A Simulation Approach”: In this paper we simulate the performance of real estate portfolios using cash flows from commercial properties over the period 1977 Q4 through 2004 Q2. Our methodology differs from analyses that rely upon historical time-weighted rates of return on property. We relax implicit rebalancing and mark to market assumptions inherent in time-series analysis. We use the distribution of internal rates of return to analyze the performance distribution of commercial property investment. We examine the performance of real estate in the context of portfolios of stocks and bonds over the same period.
“Real Estate and its Role in Asset Pricing”: This study examines whether residential and commercial real estate risks carry positive risk premiums. Real estate assets have been excluded from most of the empirical asset pricing literature because of perceived data and measurement problems. This paper shows, on the contrary, that the available data are sufficient to capture risks inherent in holding real estate assets. Using both Fama-MacBeth cross-sectional regression techniques and a stochastic discount factor GMM framework, I test whether the cross-sectional explanatory power of well-known asset pricing models can be improved by adding a real estate factor. I find strong evidence for the hypothesis that both residential and commercial real estate risks are priced by the market and therefore have a definite role in empirical asset pricing specifications. The main finding that returns to real estate improve the performance of empirical asset pricing specifications is not sensitive to the choice of assets being priced and holds for size and pre-beta sorted portfolios, size and book-to-market sorted portfolios, and portfolios in which assets are sorted initially by market value and then by sensitivity to a real estate index. The research set forth in this study is not only relevant for a better understanding of the empirical performance of linear asset pricing models but also has implications for the development of optimal investment strategies. Since most equity market investors are homeowners, the existence of a common real estate factor in asset prices has to be considered in portfolio choice decisions.
“The Relative Importance of Stock, Bond and Real Estate Factors in Explaining REIT Returns”: This papers offers a new approach to answering the question, “how much of a REIT’s return is driven by real estate market influences, and how much by stock and bond factors?” Specifically, we develop a method that allows for the decomposition of the volatility of REIT returns into stock market, bond market, real estate market and idiosyncratic effects. Our results show that from 1978 to 1998, the REIT market has gone from being driven mostly by large cap stocks to being driven by both a small cap stock factor and a real estate factor. There is also a steady increase over time in the proportion of volatility not accounted for by any stock, bond or real estate factors. The analysis indicates that some of this this unaccounted for volatility is due to a REIT sector factor that is common to most REITs but independent of the stock, bond and real estate markets. Attempts to explain cross-sectional differences in the volatility determinants for different REITs meets with only limited success, although it seems that REITs with larger market capitalization are more like stocks.
“Explaining the Discount to NAV in REIT Pricing: Noise or Information?”: This paper explores the determinants of both the level of and changes in premiums to NAV in REIT pricing over the 1996-1999 period. The first part of the paper specifies and estimates a model of cross-sectional and time variation in premiums to NAV using a sample of individual REITs. We find that the level of premium to NAV is positively related to REIT size (market capitalization), debt to equity ratio and the level of REIT liquidity as measured by the relative effective spread. Changes in premiums to NAV over time have a strong common element across REITs, which is related to but not entirely explained by a common element in REIT liquidity. The common, sector effect is stronger in the 1998-99 down-market. The second part of the paper aims to determine if the common effect in REIT pricing relative to NAV reflects informed trading or noise. We examine changes in REIT spreads in relation to fluctuations in the average REIT sector premium to NAV and show that the transaction costs of trading in REITs increase when REIT prices are getting closer to NAVs. This holds when controlling for changes in volume and changes in volatility. This result is consistent with a higher proportion of uninformed traders being in the market when REIT prices are diverging from NAV, which in turn is consistent with the noise theory of departures from NAV.
“Commercial Real Estate Return Distributions: A Review of Literature and Empirical Evidence”: This paper reviews the literature on the distribution of commercial real estate returns. There is growing evidence that the assumption of normality in returns is not safe. Distributions are found to be peaked, fat-tailed and, tentatively, skewed. There is some evidence of compound distributions and non-linearity. Public traded real estate assets (such as property company or REIT shares) behave in a fashion more similar to other common stocks. However, as in equity markets, it would be unwise to assume normality uncritically. Empirical evidence for UK real estate markets is obtained by applying distribution fitting routines to IPD Monthly Index data for the aggregate index and selected sub-sectors. It is clear that normality is rejected in most cases. It is often argued that observed differences in real estate returns are a measurement issue resulting from appraiser behaviour. However, unsmoothing the series does not assist in modeling returns. A large proportion of returns are close to zero. This would be characteristic of a thinly-traded market where new information arrives infrequently. Analysis of quarterly data suggests that, over longer trading periods, return distributions may conform more closely to those found in other asset markets. These results have implications for the formulation and implementation of a multi-asset portfolio allocation strategy.
“The Long-Run Performance of REIT IPOs”: Real estate and real estate investment trust performance has been examined in a number of papers. In general, there has been little evidence that real estate investment trusts (REITs) have earned significant positive abnormal returns based on REIT indices such as NAREIT and Wilshire. There is, however, empirical evidence that REITs exhibit positive abnormal returns in the case of initial public offerings (IPOs). While short-run REIT IPO behavior has been examined, the long-run behavior of REIT IPOs has not been examined within the context of a factor-based asset pricing model. We find that REIT IPOs generate long-run positive abnormal returns based on a sample of REIT IPOs. This sample period coincides with a period of two initial public offering waves for the REIT industry. We find that (using a Fama and French (1993) type four factor model for long-run IPO behavior) REIT IPOs generated significant and positive abnormal returns in the 1990s but not the 1980s. In comparison, the NAREIT and Wilshire Indices did not generate positive and significant abnormal returns over the same period.
“An Analysis of Relative Return Behavior: REITs vs Stocks”: We have analyzed the return behavior of the equity REIT, mortgage REIT, and SP500 indices using monthly data for the period of 1972-2001. Following a large monthly gain, investors can benefit by adopting a momentum buying strategy for stocks or mortgage for REITs, but not for equity REITs. Investors can also profitably employ a mean reversion strategy for any of the three indices. They would wait for a large decline and then buy the index and hold it for six months. Significant calendar effects were found for both REIT and stock indices involving positive January, and negative August and October effects, although there are some differences in seasonal effects between REITs and stocks. The correlation coefficients between all three asset classes are similar, but the relationship between stocks and equity REITs has lessened over time. We also show that equity REITs dominate mortgage REITs on a risk-return basis and that REITs compare favorably with stocks. Our findings suggest that equity REITs can enhance the risk-return relationship of an investment portfolio and should be considered as a major asset class just like stocks or bonds.
“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 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.
There is just a little relevant research on CXOadvisory.com, such as:
“Home Prices and the Stock Market”
“Are Homebuilder Stocks Early Warning Indicators for Equities in General?”
For many individual investors, owned residences are the principal real estate investments. These investments are often leveraged via mortgages and illiquid in terms of actual disposal (but somewhat liquid in terms of adjusting leverage via refinancing).
You May Also Enjoy...
- REITs a Proxy for Real Estate?
- Can Real Estate Experts Provide Reliable Advice for Commercial Property Investing?
It costs less than a single trading commission. Learn more here.
