Linkages between international REITs: the role of economic factors
| Pages | 473-492 |
| DOI | https://doi.org/10.1108/14635781211256747 |
| Published date | 03 August 2012 |
| Date | 03 August 2012 |
| Author | Jing Liu,Geoffrey Loudon,George Milunovich |
| Subject Matter | Property management & built environment |
Linkages between international
REITs: the role of economic
factors
Jing Liu and Geoffrey Loudon
Department of Applied Finance and Actuarial Studies, Macquarie University,
Sydney, Australia, and
George Milunovich
Department of Economics, Macquarie University, Sydney, Australia
Abstract
Purpose – The purpose of this paper is to study correlations between the national real estate
investment trusts (REIT) markets in the USA and the four Asia-Pacific countries of Australia,
Hong Kong, Japan and Singapore, and document the extent to which the time variation present in these
correlations can be explained from a set of 11 economic and financial factors. Both US dollar and local
currency returns are used.
Design/methodology/approach – Time-varying correlations are estimated using a DCC-GARCH
model that allows for asymmetries in both the correlations and volatilities. The correlations are then
regressed on a set of four economic and seven financial factors, and tests of statistical significance
are conducted in order to discriminate between relevant and irrelevant explanatory variables.
The authors estimate a fixed-effects panel regression as well as individual regressions for each
dynamic correlation.
Findings – Significant time variation is found in the four REIT correlation series. Panel regressions
suggest that REIT correlations rise with increases in the interaction of national inflation rates and with
higher global equity market uncertainty. It is also found that REIT correlations fall with increases in
the US default risk premium and global equity market volume. Relaxing the structure imposed by the
panel data model, individual regressions confirm most of the results, although there are some
exceptions. It is also found that there are no substantial differences in the dynamics of the correlation
coefficients when switching from the US dollar to local currency denominated returns.
Practical implications – Investors in real estate securities across national markets should take into
account information about the credit spread, the volatility and volume of global equity markets, and
inflation rates when modeling correlations. These variables may alert the investors to the possibility
that, under a set of circumstances, investing in real estate across different markets may not provide
the expected diversification benefits. Another implication relates to the impact of currency hedging.
It appears that the impact of switching from US dollar to local currency denominated returns does
not substantially change the time dynamics of the correlations, or the importance of explanatory
variables.
Originality/value – Although considerable progress has been made in modelling time-varying
correlations between various REIT markets, to the authors’ knowledge, this is one of the first papers to
investigate the underlying causes of the co-movement, especially between the US and Asia-Pacific
markets. The paper’s results will help investors and risk managers make better choices by identifying
those factors that have more systematic effects on the change in the REIT correlations, rather than
more transient forces.
Keywords United Statesof America, Australia, Hong Kong, Japan,Singapore, Property, Investments,
Propertyfinance, Real estate investmenttrusts, Conditional correlations,Economic drivers,Asia-Pacific,
Property investment
Paper type Research paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
International
REITs
473
Journal of Property Investment &
Finance
Vol. 30 No. 5, 2012
pp. 473-492
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781211256747
1. Introduction
Financial deregulation, integration of national capital markets, and periods of financial
contagion have been found to strengthen interdependency across global share markets,
and hence reduce the benefits of international portfolio diversification (Longin and
Solnik, 1995; Koutmos and Booth, 1995). As a result fund managers engage in active
search for additional sources of diversification, and real estate has become one of the
major alternative investment vehicles.
Investors may gain exposure to changes in real estate prices in several ways. Direct
property investment occurs where investors acquire and hold property interests by
directly investing in land and buildings. Alternatively, investors may acquire property
indirectly by holding equity in entities which themselves invest in real estate. These
entities may be companies which invest in equity real estate investment portfolios or
investment trusts. They may be listed or unlisted. Although all these avenues provide
exposure to real estate, their different characteristics are likely to lead to variation in
their attractiveness to different classes of investors.
Several papers investigate the extent to which returns on indirect property
investment have similar distributional characteristics as direct property investment[1].
Compared to indirect property returns, returns to direct real estate holdings tend to be
less volatile, more persistent and slower to impound value relevant information.
However, long-run dynamic analysis in Oikarinen et al. (2011) shows that a tight
relationship exists between the two market segments, implying that similar long-term
diversification benefits accrue to holders of real estate through both direct and indirect
holdings.
Relative to direct property investments and unlisted property trusts, listed real estate
investment trusts (REITs) are particularly popular with fund managers and investo rs
due to their liquidity, transparency and transaction cost advantages. While REITs
provide exposure to real estate with these important advantages, they increasingly
share the characteristics of other equities due to the ongoing process of financialization.
Indeed many fund managers now treat REITs as a specialist sector within the broad
equity market. This contrasts with unlisted property trusts which retain their status as
an alternative asset class since they are more insulated from the transient trends and
volatility episodes that are common in listed equity prices.
Global demand for these productshas lead to a significant body of academic literature
that explores the risk and return characteristics of REITs. Worzala and Sirmans (2003)
provide a comprehensive survey of the literatureon investing in international real estate
securities. Evidence from this literature relevant to our paper suggests that securitized
real estate returns exhibit lower correlations across international markets than other
asset classes, and provide significant diversification benefits (Eichholtz, 1996; Wilson
and Okunev, 1996; Gordon et al., 1998 and others). These effects continue to be seen in
later papers such as Liow and Adair (2009) and Gallo and Zhang (2010).
While the early papers largely analyse unconditional correlations, more recent
studies use multivariate time series modelling techniques to explore the extent to which
the correlation between the returns to securitized property returns and other asset
classes varies through time. For instance, Cotter and Stevenson (2006), Michayluk et al.
(2006), Chong et al. (2009), Liow et al. (2009), Case et al. (2012), and Huang and Zhong
(2011), use the multivariate GARCH framework to estimate conditional correlations[2].
These papers document important time-varying behavior in the correlations between
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