From the Research Desk

7/8/2014 | By Brad Case

Published in the July/August 2014 issue of REIT magazine.

Volatility No Higher for Listed Equity REITs than for Private Real Estate

SOURCE: “Estimating Private Equity Returns from Limited Partner Cash Flows,” unpublished working paper, November 2013.
AUTHORS: Andrew Ang (Columbia University), Bingxu Chen (Columbia University), William N. Goetzmann (Yale University), and Ludovic Phalippou (Oxford University)
SYNOPSIS: Researchers from Columbia, Yale and Oxford universities developed a new method to estimate the historical time series of returns to private equity investments, including real estate, using actual cash flows. The authors found that the actual volatility of private real estate investments is nearly identical to the volatility of stock exchange-listed U.S. equity REIT investments, and private equity real estate has generally provided negative alpha.

“A major drawback of private equity is the lack of transactions-based performance measures. This greatly hampers the use of optimal portfolio allocation, which requires information about the risk, return, and covariance of asset classes.

We find that the estimated time series of private equity returns are more volatile than standard industry indexes. For example, ... the NCREIF real estate index has a volatility of only 5 percent, while our estimated volatility of private real estate funds is 19 percent, which is close to the volatility of publicly traded REITs. … In addition, we find that … private equity return time series currently in use may be subject to smoothing biases due to the appraisal process or delayed and partial adjustment to market prices.

Most specifications show a negative alpha for real estate funds.”

Pension Fund REIT Investments Outperform Private Real Estate

SOURCE: “Value Added From Investment Managers in Private Markets? An Examination of Pension Fund Investments in Real Estate,” working paper, July 2013.
AUTHORS: Aleksandar Andonov (Maastricht University), Piet Eichholtz (Limburg Institute for Financial Economics) and Nils Kok (Maastricht University)
SYNOPSIS: Three Dutch economists compared the performance of REITs and private equity real estate investments in the portfolios of several hundred pension funds in the U.S. and overseas. The authors found that stock exchange-listed REIT holdings significantly outperformed their unlisted counterparts.

“Using a large sample of pension funds, we find strong scale advantages in pension fund real estate investments: large pension funds not only have lower investment costs, but also achieve higher net benchmark-adjusted returns. Surprisingly, larger funds are also more likely to invest in REITs.

The average gross return of pension funds in real estate is about 7 percent during the 1990-2009 period. REITs delivered a higher gross return (10.92 percent) as compared to direct real estate investments (6.70 percent).

Especially smaller pension funds do not seem to recognize that REITs represent an investment approach in real estate that is comparable to selecting external managers investing in direct real estate (and much better than fund-of-funds managers) but with substantially lower investment costs.”

Liquidity Lifts REIT Stocks

SOURCE: “REITs and Market Microstructure: A Comprehensive Analysis of Market Quality,” working paper, December 2013.
AUTHORS: Mark Sunderman (University of Memphis), Janean Westby-Gibson (University of Memphis) and Pawan Jain (Central Michigan University)
SYNOPSIS: Three fi nance professors compared the liquidity of stock exchange-listed REITs before and after the liquidity crisis to comparable non-REIT stocks. The authors found that REITs used to be less liquid than non-REIT stocks, but have been more liquid since the 2008-2009 crisis.

“The 2008 financial crisis has dramatically changed the market quality for REITs. We find that, during the post-crisis period, REITs have higher liquidity, lower volatility, lower price impact of trades, and greater trading activity than non-REIT stocks of comparable market cap. Overall our results suggest that REITs have become more liquid during the post-crisis period. Additionally, their volatility and cost of trading has declined significantly, making them an attractive vehicle for adding diversification to any stock portfolio.”

REITs Belong in Every Investor’s Portfolio

SOURCE: “Time Variation in Diversification Benefits of Commodity, REITs, and TIPS,” published in Journal of Real Estate Finance and Economics, 2013.
AUTHORS: Jingzhi Huang (Penn State University) and Zhaodong Zhong (Rutgers University)
SYNOPSIS: Researchers from Penn State and Rutgers evaluated time-variation in optimal portfolio allocations to stock exchange-listed REITs, TIPS, commodities, and seven other asset classes. The authors found that all three inflation-protecting assets belong in investors’ portfolios, with REITs increasingly the most important of the three.

“Should investors include all three asset classes in their portfolios, given that each of them is considered an instrument against inflation? That is, are these three asset classes substitutes for each other? This paper documents that the three asset classes are in general not substitutes for each other, and all three asset classes ought to be included in investors’ portfolios.

We measure diversification benefits using the increase in the portfolio Sharpe ratio (a measure of risk-adjusted returns) due to the addition of each test asset. In terms of the average increase over the whole sample period, REITs provide the largest diversification benefit with an average increase of 0.47. TIPS rank second with 0.36, and commodities rank last with 0.07. TIPS make up the largest portion of the tangent portfolio in the beginning of the sample period, but their portion becomes smaller in the later period; in contrast, REITs make up an increasingly important portion of the tangent portfolio from 1999 to 2006. The weights of commodities are much lower relative to those of REITs and TIPS. The increases in Sharpe ratios due to REITs and TIPS started to rebound in late 2009 and early 2010.

REITs and TIPS remain important diversifiers even after controlling for the presence of each other, and large portions of the tangent portfolio should be invested in these two assets.”


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