Impact of economic forces and fundamental variables on REIT returns

ABSTRACT

We examine the impacts of economic forces and fundamental variables on REIT returns. Our models endogenously select breakpoints to distinguish the heterogenous nature of the underlying properties with varying risk-return characteristics. Default risk premium and unanticipated inflation had an adverse effect, while GDP and federal funds rate had a positive effect on REITs. Market, size and value risk-premiums are significant for time periods that include the GFC but not for subsequent periods. Momentum is negative and significant for extreme events, and insignificant during calm periods. Higher beta values during the GFC followed by lower beta values confirm ‘leveraging’ and ‘deleveraging’ effects.

KEYWORDS:

• Economic and fundamental variables
• breakpoints
• sensitivity of returns
• leveraging effects

JEL CLASSIFICATION:

• R3
• R330
• G10
• G11
• G12
• G14

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Another approach is suggested by Franses and Groot (2013) who associated GDP growth with the real estate rental prices.

² Real Estate Investment Trusts (REITs) are companies that own and operate income generating real estate properties in different real estate sectors and similar to mutual funds, REITs pool the capital of many investors who are able to participate in real estate investment without having to buy, own, and manage these properties. Many REITs are publicly owned and thus trade like stocks.

³ This measure of unanticipated inflation has been extensively analysed by various researchers that includes a study by Titman and Warga (1989) who used this measure to investigate the relationship between stock returns as predictors of interest rates and inflation.

⁴ Hansen (2001) suggests calculating structural break(s) with an unknown timing followed by estimating timing of structural break(s). Additionally, tests to distinguish between random walk process and broken trend function should be performed on a time series.

⁵ As pointed out by Zhou (2013), for REITs, downside risks have generally become more common place than the upside gains. Since REITs are highly leveraged and there is a distinct problem of illiquidity in this market, during extreme and volatile periods there is a higher probability of large declines.

⁶ For example, Chen, Roll, and Ross (1986) and McElroy, Burmeister, and Wall (1985) use different macroeconomic variables that include industrial production, change in consumption, anticipated and unanticipated inflation, default and term risk premium to explain behaviour of asset prices that include stock returns.

⁷ For instance, commercial and business properties rise or fall gradually as compared to residential real estate, which experiences more immediate responses to changes in inflation.

⁸ Johnson (2002) has pointed out that infrequent but persistent shocks to business conditions arising from innovations, technological changes and other structural variations may lead to higher growth rate of the companies which can, in turn, increase dividend yields. This higher dividend yield can cause price momentum of returns. Since REITs distribute most of their earnings as dividends, there is some likelihood of finding price momentum for real estate sectors.

⁹ Ling and Naranjo (2003) suggest that this transformation of the REITs structurally changed their beta attributes as new REITs were relatively larger with significant amount of debt in their capital structure. However, deleveraging occurred after GFC.

¹⁰ Sing, Tsai, and Chan (2016) also suggest time varying beta attributes of equity REITs in the 90’s and 2000s as these companies used more external debt to acquire other REITs and/or develop more properties which may have resulted in structural shift of these companies.

¹¹ The authors would like to thank the reviewers for this suggestion. The stability tests improved the results and enabled us to find regression coefficients with greater power and stability.