Published November/December 2013
REIT: An enduring question is whether actively managed REIT mutual funds outperform REIT index funds. What does your own research suggest?
Brounen: According to most research, the answer is yes. The basis for this firm confirmation lies in the positive alpha that is reported for almost all REIT mutual funds. However, a “yes” is often followed by a “but.”
In 2009 I discovered the “but” after analyzing the returns of 282 U.S. REIT mutual funds and the underlying equity REIT time series. We found clear evidence of exceptionally strong momentum in REIT returns. In other words, in the equity REIT market, winners remained winners, and losers rarely turned into winners in the next period.
This momentum is very REIT-specific and therefore not adequately controlled for by standard performance evaluation models. One could even say that, in this market, selecting last year’s winners would generate positive alpha in the next period. Hence, positive alpha is perhaps not the best metric for true outperformance in this market.
To truly evaluate the performance of mutual fund managers (their timing and selection skills) we suggested incorporating REIT momentum in the evaluation models. That way the average alpha in this market is zero, as it is supposed to be, and only the really skillful managers will be left with positive reports. Our results show that when doing this, only half of REIT mutual fund managers outperformed.
REIT: In one recent article you investigated whether constraints on short selling may prevent markets from processing information efficiently. What effect does that have on REIT stock prices, and how might investment managers make use of your findings?
Brounen: In effect we explored the upside of short selling—something many investors don’t realize exists. In line with earlier work, we examined the market-clearing potential of short sales. In the absence of short sales, investors can only signal optimism by buying stocks. Like in an auction they’ll bid up against each other to establish a fair price. But if investors cherish only dark expectations, not buying stocks will have little effect on the stock price.
Our results show, in fact, that if short selling is restricted or even banned, REIT prices have the tendency to exceed their fundamental NAV values. Since investors benefit from fair stock pricing, short selling allows for a more symmetric transfer of both optimism and pessimism into REIT prices.
How can investors benefit from this notion? One could easily build investment strategies on avoiding REITs for which short selling is restricted, since they have the biggest odds of hazardous overvaluation.
REIT: Another recent project asked whether the increased institutional ownership of listed property companies has affected their return volatility. Can you explain what you found?
Brounen: We followed the example of earlier researchers who wondered who would blink in volatile markets—in other words, who sells when the going gets tough? It turned out that institutional investors don’t.
In talks with REIT CEOs we discovered that although they know their largest block holders, they rarely have a good and full overview of their stockholder base. We show that they should, since our data indicated that it matters how your equity base is divided and who owns your stocks. Institutional investors tend to be more loyal, but we also show that the label “institutional investors” calls for more detail as banks, insurance companies and pension funds differ greatly in their effective REIT investment styles.
REIT: You’ve also looked at the rise of the private equity real estate fund industry in Europe. How has that industry been affected by the financial crisis?
Brounen: This industry in fact has been under examined, especially considering its vast size. Many investors still seek a fuller understanding of the styles and structures that are available. Especially in Europe, these tend to differ quite a lot.
During the recent crisis years, the private equity real estate fund market suffered from the combined effects of stressful refinancing needs and the lack of liquidity for equity investors that were seeking an exit. Values dropped by 15 percent, and the number of funds in the market stagnated at the 2008 level of 450. Again, though, there is a “but.” Thanks to the work of INREV, the European Association for Investors in Non-Listed Real Estate Vehicles, the market used these hard past five years to improve transparency, which has strengthened investors’ confidence again.
REIT: Are REITs part of your investment portfolios?
Brounen: I invest some of my wealth in the REIT market, and I firmly believe that more people ought to do the same.
Dirk Brounen is professor of real estate economics at Tilburg University in the Netherlands, where he has authored or co-authored more than 40 published articles in real estate investments and related topics such as financial literacy and environmental sustainability.