John Glascock and Shaun Bond are colleagues in the finance and real estate department of the University of Cincinnati College of Business. Glascock has published more than 50 research articles on real estate and REITs, while Bond has published more than 20.
Portfolio: The two of you collaborated on a study of the portfolio benefits of publicly traded European listed property companies. What performance and diversification benefits did you find?
Glascock and Bond: Overall, our research found that publicly traded European real estate provided strong diversification benefits for investors with European portfolios. When we looked at the 10-year risk adjusted performance figures, we found that the performance of real estate exceeded that of equities in all European countries in the sample. If real estate was added to a portfolio of stocks, bonds and cash, the benefit from holding European real estate in a mixed-asset European portfolio could be clearly seen.
Portfolio: Professor Bond, you co-authored a separate study of listed property company returns in Asia and North America as well as Europe, and found that diversification opportunities for U.S. dollar investors with global portfolios are even stronger in Asia than in Europe. How should global investors go about constructing their real estate allocation?
Bond: International real estate investors need to look beyond global and even country-specific stock market impacts and focus on the factors that differentiate returns on local listed property companies, such as book-to-market ratios (i.e., value) and relative market cap (size). It is these local fundamentals that create the potential for diversification. This is particularly important for investors in the Asian markets.
Portfolio: Professor Glascock, you did an analysis of REIT stock price movements during the severe stock market decline of Oct. 27, 1997. You found that the REIT decline was about half as severe as the decline for non-REIT stocks. Also, you found that REIT bid-ask spreads narrowed the following day, while non-REIT spreads did not. During the current market downturn, though, REITs haven't maintained that same defensive posture. Are REITs suffering collateral damage from their classification with financial stocks?
Glascock: The 1997 decline was a general market adjustment, and REITs provided very good liquidity and price behavior during that period. The most recent adjustment, however, was partly a specific industry-led event, with both mortgage portfolios and real estate assets, such as offices, being extensively leveraged. Thus, there are two parts to the current market disruption.
First, real estate assets will be revalued in the new lending market (producing higher cap rates and higher equity requirements for leverage due to our current expectation that risk is higher than we thought), and that has had a negative impact on REIT shares. Second, there is a general market adjustment due to the overall economic decline. While this market adjustment is impacting REIT share prices now, I expect that real estate, and in particular REITs, should perform relatively better than the market as a whole.
Portfolio: Continuing on the theme of the current market turmoil, Professor Bond, you co-authored a study analyzing volatility in both the securitized (REIT) and unsecuritized (direct) property markets. Can you explain the significance of that study in the context of the current volatility in both markets?
Bond: Most researchers believe that measures of the performance of direct real estate markets, such as the NCREIF index, underestimate the volatility of the overall real estate market (something that many investors are only now beginning to realize). However, others believe that the REIT market is excessively volatile because of the influence of the overall stock market.
My co-author and I used an advanced statistical technique to combine information from both direct and securitized real estate markets and form a measure of what we call the "fundamental" volatility of the real estate asset class. We found that fundamental volatility generally declined over our study period, from July 1987 through January 2001. We believe that investors who consider information from both direct and securitized markets will be able to make better decisions about investing in the real estate asset class.
Portfolio: Professor Glascock, you co-authored a study challenging the conventional wisdom of the late 1990s that REITs are not an effective inflation hedge. Many investors are concerned that the Federal government's actions to stimulate the economy may cause inflationary pressures. What is the role of REITs as an inflation hedge?
Glascock: My view is that REITs generally offer good inflation protection, in that rental rates for commercial property tend to follow inflation rates. The key is to remember that rental rates will follow the ability of retail and office users to increase their product and services rates as inflation occurs.
REITs tend to lease to Fortune 500 and equivalent clients. Those companies generally have the pricing power to keep pace with inflation and generate the marginal revenue to pay higher rents.
A key to this discussion is to disentangle price-level adjustments from inflation. If prices in the economy are increasing due to a secular increase in oil prices (e.g., oil producers increase their take of world income) then real estate will not protect from this type of adjustment. However, when inflation is from money supply increases without key price level adjustments, then real estate should provide good protection.