REIT: Some of your most powerful research results concern the role of U.S. REITs in global investment portfolios. Not only did you find that REITs should consistently receive substantial allocations in efficient portfolios, but specifically you found that REITs benefit longer-term investors especially. Does your research provide a general lesson applicable to both individual and institutional investors?
Stevenson: One of the key advantages REITs have as an investment class is the minimum dividend payout. This isn’t necessarily from a tax point of view, but rather more that it provides REITs with bond-like investment characteristics due to the nature of their dividends.
This means that REITs can provide diversification potential across the spectrum of risk preferences. It isn’t the same form of diversification benefit that the private real estate market provides: REITs aren’t just a substitute for the private market. Both can contribute to a mixed-asset portfolio.
Recent work I’ve done on REIT volatility would also imply a potential role of the mandatory dividend payout. As with all traded assets, trading volume is a key determinant in volatility. REITs were found to be half as sensitive as the general equity market to increases in volume.
Some work I’m currently working on has illustrated that when considering REITs at a global level an important element is the relationship with their domestic markets. Those listed real estate markets that are more integrated with their overall markets tend to also display greater integration at a global level.
REIT: In a different study, you found that there are significant diversification benefits to holding U.S. REITs alongside a diversified direct property portfolio such as the NCREIF Property Index. Considering not just risk-adjusted returns and correlation but also other factors such as liquidity, transparency, accountability, leverage and cost, how should institutional investors think about the different ways of investing in real estate?
Stevenson: This has really been the transformation of real estate investment in the last two decades. Not only the growth of REITs, but the expansion of the CMBS market and the growth in the private fund sector have increased the variety of opportunities open to real estate investors. While all forms of investment are based on, and respond to, what happens in the private market, the nature of the securities and the manner in which they are priced and traded all give them different characteristics for investors.
One key element is that alternative forms of investment will often quantitatively display greater volatility than conventional ungeared real estate investment. Investors looking at vehicles such as REITs and geared funds need to be aware of this and be comfortable with the enhanced risk they will be taking on.
REIT: You’ve studied property markets in several countries, including Australia, the United Kingdom and the United States, and you’ve focused on the links among different property markets. How should a global property investor think about the recent downturn and recovery that have reached across asset markets and across borders?
Stevenson: We have been through a very rough few years and since the bounce back we saw in many markets in 2009 we’ve seen fairly neutral, almost non-committal, conditions. Whilst the worst of the impact of the financial crisis is hopefully behind us, in Europe we still have a large degree of uncertainty regarding sovereign debt. This is obviously hindering any economic recovery and therefore an upswing in real estate fundamentals.
However, for those investors who have solid financial positions, there will inevitably be bargains to pick up. There have been a few interesting aspects to the current downturn. Firstly, it hasn’t been accompanied in most commercial real estate markets by oversupply. This does mean that when economic growth does return in force the underlying real estate fundamentals should recover relatively quickly. Secondly, capital hasn’t dried up. We’ve still seen both REITs and private funds being able to raise capital. Whilst obviously not at as attractive terms as pre-2007, capital hasn’t totally dried up. Finally, whilst we often refer to the last five years as a global financial crisis, the reality is that countries in the Asia-Pacific region weren’t affected to anywhere near the extent that those in the west were. It does however mean that they are at a very different stage of the cycle in comparison to North America and Europe.
REIT: Changes in interest rates affect REIT returns, but the relationship is not simple. Can you summarize the effects that you found for the U.K. market, and comment on the relationship in other markets as well?
Stevenson: The study on the U.K. was interesting in that it was firstly during the pre-REIT era in the U.K., and it covered a period of historically low and stable interest rates. Yet, we still found that the share prices of property companies were highly sensitive to changes in market interest rates.
Furthermore, this relationship extended beyond returns in that interest rate volatility significantly impacted the volatility of property companies and these relationships stretched across different maturities of interest rates. In a broader context, real estate securities of all shapes and forms are potentially highly sensitive to interest rates due to the traditional high use of gearing in the real estate industry, the impact of rate changes on property yields and the indirect impact on the real economy and therefore occupational demand. While REITs will generally not use as high a level of gearing due to the lack of the tax advantage in issuing debt they will still be exposed.
Work I’ve done on the U.S. has shown that while they generally aren’t as sensitive to market interest rates, they do significantly respond to unexpected changes in Fed rates. A PhD student of mine is just finishing off some really nice work on the interest rate sensitivity of REITs globally and has found some very interesting results. In particular he has found that REITs are sensitive not just to specific rates but to the actual shape and curvature of the yield curve.