The effects of economic policy uncertainty on the US REITs ETFs: A quantile analysis

ABSTRACT

This paper investigates the impact of economic policy uncertainty (EPU) on real estate investment trusts (REITs) ETFs in a quantile-based framework by employing the nonparametric causality test and the quantile autoregressive (QAR) model. Using data covering the returns of eight major United States (US) Real Estate Investment Trusts (REIT) exchange-traded funds (ETFs) over the period spanning 2 January 2012 to 28 February 2019, we find that there is a weak predictive power of EPU in REITs’ returns and volatility. Our findings indicate that EPU has a leading effect on the real estate market returns at the mean level. However, we find no causality running from EPU to real estate markets volatility at all quantiles, indicating a weak influence of uncertainty on the real estate markets. Besides, our results report a significant impact of the EPU on the returns at the lower and upper quantiles. Yet, the impact is not symmetrical since the EPU shows a positive (negative) impact on the returns during the bearish (bullish) market condition. Moreover, the lagged EPU impacts the REITs negatively only during the normal and bullish market conditions, given all the estimated coefficients being negative and significant. Our results entail policy implications for investors, regulators, and asset managers.

KEYWORDS:

• causality-in-quantile
• quantile regression
• economic policy uncertainty
• REITs

JEL CODES:

• C32
• R30

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 For a global review of financial literature on the US REIT market and its characteristics, see Coletta and Busato (2019).

2 REITs might appear similar to stocks since both offer a stream of income for investors; however, they differ regarding dividend payments and tax status. While some stocks may not pay any dividends at all, REITs are obligated to pay out 90% of their income in the form of dividends every quarter. REITs also do not pay any corporate taxes and investors in these assets are taxed at the personal income rates, while common stocks are subject to double taxation. Finally, REITs are considered as an inflation hedge, and are more sensitive to interest rate changes relative to stocks (Zhang & Hansz, 2022).

3 Bilgin et al. (2018) note also that market uncertainty can have a positive or negative impact on assets prices, depending on the market conditions, whereas Shiller (2007) linked the housing bubble in 2005–2006 to some psychological factors and not economic fundamentals. REITs are no different than other assets and can be linked to some irrational market sentiment that may play a role in driving their prices.

4 Data on the US EPU index are obtained from www.policyuncertainty.com.

5 It is worth mentioning that REITs returns are often related to economic growth, inflation, and interest rates. For example, periods of higher inflation are typically marked by higher economic growth, which in turn can drive increased demand for commercial real estate, enabling landlords to have rent increases. The increase in rents may offset rising property ownership costs associated with inflation. Further, the rising rents can enable REITs to increase their distribution streams and tend to support rising share prices. This is applicable for some property types with shorter lease terms like hotels, self-storage, apartments, single-family rentals, student housing and manufactured homes. Sectors with long-term leases may benefit also from the mark-to-market effect upon lease renewal in an economy characterized by faster growth and inflationary expectations. Serious active real estate fund managers may tailor the average lease duration of their portfolios in order to benefit from both inflation and economic growth.

6 For more details on the probability and the cumulative density functions, see Koenker and Xiao (2004).

7 We refer the reader to the website of www.iShares.com for a detailed description of the composition of each fund and the weights of the different assets.

8 It is known that the systematic risk cannot be eliminated by means of diversification. However, financial derivatives such as index options or futures can be used as means of hedging the overall market uncertainty (systematic risk). The inclusion of financial derivatives in some funds, implies that those funds are hedged against market uncertainty, and therefore, it is expected that they are not reacting to the overall market uncertainty measured by EPU.

9 It is worth noting that REITs can be affected by factors that impact the overall economy, like economic growth, inflation, and interest rate changes, all embodied in the EPU changes. For example, in times when expectations about future interest rates change suddenly, REITs (as well as other asset classes) have often experienced high volatility and rapid price changes. This was evident in May 2013, when Fed Chair Ben Bernanke suggested that the Quantitative Easing taper could start earlier than most market participants expected. At that time, the comments made by the Federal Reserve Chair led to a sharp selloff of REITs, including other asset classes such as emerging market equities. At the same time, Dow Jones US Select REIT Index dropped 17.9% from its peak on 21 May 2013 (the day preceding the Fed comments), to its 2013 low on 19 August 2013. However, as markets settled, the market index recovered, subsequently reaching new highs in 2014, and continued to rise along with broad-based equity gains in 2017.