Real Estate for the Long Term: The Effect of Return Predictability on Long‐Horizon Allocations

Abstract

We examine how the predictability of real estate returns affects the risk of, and optimal allocations to, real estate for investors of differing investment horizons. Returns to direct real estate are mean reverting, and risk decreases with horizon. This is driven by a tendency for property transaction prices to overshoot inflation. Mean reversion in real estate returns is weaker than that of equities, resulting in real estate having similar risk to equities for long-term investors. However, optimal portfolios have large allocations to direct real estate at all horizons, and the allocation increases with horizon. Finally, we find that real estate investment trusts are a redundant asset class for investors with access to direct real estate as an asset class, but they do have a role in optimal allocations when direct property investment is not feasible. Copyright (c) 2009 American Real Estate and Urban Economics Association.

Are REITs real estate? Evidence from international sector level data

“…However, as in the long run both markets should adjust to shocks in the fundamentals and the impact of noise in securitized real estate prices should vanish, securitized real estate should strongly co-vary with the returns on a portfolio composed of equivalent direct real estate investments, since the fundamental asset is essentially the same in both markets. In line with this assumption, it has been established that over long horizons the linkages between indirect and direct real estate are substantially stronger than suggested by the simple contemporaneous correlation figures (Giliberto, 1990;Geltner and Kluger, 1998;MacKinnon and Al Zaman, 2009;Oikarinen et al, 2011).…”

“…Direct real estate investments have been shown to provide significant diversification benefits in a portfolio containing stocks (Hoesli et al, 2004;MacKinnon and Al Zaman, 2009;Brounen et al, 2010). However, direct real estate assets have several disadvantages such as relatively low liquidity, high transaction costs, and lumpiness.…”

Outperforming the benchmark: online information demand and REIT market performance

“…By its very nature, the REIT market is an ongoing subject of debate with regard to the question of whether it is more similar to the stock or direct real estate market (e.g. Geltner and Kluger, 1998;Giliberto, 1990;Ross and Zisler, 1991;Myer and Webb, 1994;Brounen and Eichholtz, 2003;MacKinnon …”

“…Outperforming the benchmark and Al Zaman, 2009;Sebastian and Schaetz, 2009;Oikarinen et al, 2011;Hoesli and Oikarinen, 2012). We approach this issue by exploring the nature of information demand by real estate (equity) investors.…”

Threshold Effects in the Relationships of REITs and Other Financial Securities in Developed Countries

“…However, some studies have documented that over long horizons the linkages between indirect and direct real estate are quite strong (Giliberto, 1990;Seck, 1996;Ziering et al, 1997;Geltner and Kluger, 1998;Seiler et al, 2001;Mackinnon and Zaman, 2009;Oikarinen et al, 2011;Hoesli and Oikarinen, 2012). The study of Hoesli and Oikarinen (2012) shows that long-run REIT market performance is much more like the direct real estate market than the general stock market, while the short term comovement between REITs and stocks is stronger than that between REITs and direct real estate We use the Panel Smooth Transition Regression (PSTR) model, which was recently developed by Gonzàlez et al (2005) to set 3-month interest rate change as threshold variables, and to determine the relative influence of stock, fixed-income securities and direct real estate to Japan and the U.S. REITs as a whole in different regimes.…”