From a small northwestern observatory…

Is securitized real estate a stock, or is it real estate?  It’s a bit of both, but the degree of correlation between securitized real estate (most often “REITs” in the U.S., other forms elsewhere) and the stock market in general has long been a matter of some debate.  In my own work I’ve cited studies that show a high correlation between REIT returns and the S&P 500, but I’ve always been a bit uncomfortable with such gross generalizations.

In the current issue of the Journal of Real Estate Research, Prof. Nafessa Yunis of U. Baltimore does an excellent job exploring this topic, not only in the U.S. market but also nine other countries that have both mature stock exchanges as well as mature securitized real estate markets.  She not only looks at inter-market correlation, but also controls for other macro-variables, including GDP changes and interest rates.

She finds that real estate securities returns are “cointegrated” with both the respective stock market returns as well as key macroeconomic factors, but that the degree of linkage varies among countries.  The greater the degree of market maturity, the greater the cointegration.  In general, shocks to the stock market or to macro-variables impacts the real estate market, but not necessarily the other way around.  Intriguingly, shocks in stock returns, M1, GDP, and CPI have positive impacts on real estate returns, but shocks to long-term interest rates induce negative but temporary responses in real estate returns.

In a way, these findings are both useful and disturbing to portfolio managers.  On one hand, Dr. Yunis’ findings help allay fears that real estate securities are “something else” and difficult to understand.  However, she also notes that there are no diversification gains (she doesn’t use “arbitrage”, but I believe that’s what she means) from holding both real estate and non-real estate securities.

Full disclosure — I’m a reviewer for this journal, although I did not review her paper.  The Journal of Real Estate Research is widely regarded as one of the two top real estate academic journals in the world.  Inclusion in this journal is a mark of distinction for any young author, and it gives significant credence to Dr. Yunis’ findings.