The short-run dynamics of Australian real estate investment trusts and direct real estate at the subsector level

Date01 December 2020
Pages383-407
DOIhttps://doi.org/10.1108/JPIF-08-2020-0088
Published date01 December 2020
Subject MatterProperty management & built environment,Real estate & property,Property valuation & finance
AuthorJames Giannarelli,Piyush Tiwari
The short-run dynamics of
Australian real estate investment
trusts and direct real estate at the
subsector level
James Giannarelli and Piyush Tiwari
Faculty of Architecture, Building and Planning, University of Melbourne,
Melbourne, Australia
Abstract
Purpose This paper examines the extent of the short-run relationship between Australian real estate
investment trusts (A-REITs) and direct real estate returns on both a commercial property sector and a prime
and secondary grade basis, i.e. a subsector basis.
Design/methodology/approach Two-step methodology is used. First, we identify the dynamic
interdependencies between A-REITs and each commercial property subsector to determine whether the
returns of A-REITs lead each subsector or vice versa. Second, short-run deviations between these asset returns
are estimated by measuring their individual response behaviours to changes in key economic and financial
market factors that are expected to influence these returns.
Findings Results suggest that each subsector shares a unique relationship to A-REITs, given each prime
and secondary grade commercial property return series varies in behaviour. Some property subsector returns
can be predicted by movements in A-REIT returns, whereas returns for others move independent to changes in
A-REITs. Similarly, some subsectors commove with A-REITs in response to changes in certain market factors,
whereas others diverge. As such, these findings have practical significance to fund managers and portfolio
selection, as each commercial subsector embodies its own exposure to A-REITs and vulnerabilities to market
forces. Subsectors that commovewith A-REITs in response to certain market forces may be used as substitutes
in a portfolio. Alternatively, subsectors that diverge from A-REITs in response to market forces may offer
diversification benefits when combined.
Practical implications These findings extend beyond existing research to offer critical decision-making
guidance at the acquisition level, as fund managers may more closely consider the impact that prime or
secondary grade properties within a given commercial sector may have on a portfolio that consists of public
and private Australian real estate. Ultimately, a more informed acquisition may be carried out as consideration
of a propertys asset grade allows for a deeper insight into the propertys risk profile and its anticipated short-
run impact on a portfolio.
Originality/value This paper extends previous studies that focus mostly on aggregate or sector-level
returns by measuring REIT and real estate dynamics at the subsector level, allowing for practical significance
at not only the portfolio level but crucially at the acquisition level, a pivotal decision-making stage for fund
managers. This is also the first paper to study REIT and real estate causality and response patterns to changes
in market factors at the Australian sector level.
Keywords Vector autoregression, Granger causality, Impulse response analysis, Appraisal smoothing,
Commercial real estate, Prime and secondary returns, A-REIT, Public and private real estate
Paper type Research paper
1. Introduction
Over the past two decades, Australian real estate investment trusts (A-REITs) have become
an increasingly popular alternative investment vehicle to direct real estate investment. Given
their liquidity and efficiency, A-REITs allow for more flexible transactions than traditional
methods. Despite the underlying asset composition of A-REITs consisting of direct real estate
itself, A-REIT returns do not always align with those of direct real estate over time: that is,
short-run deviations are present between these asset returns causing them to deviate from
their long-run trend. If the deviations are vast and continuous, their long-run relationship
may become weak. In either case, this leads to issues with portfolio selection, in determining
Australian real
estate
investment
trust
383
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1463-578X.htm
Received 13 August 2020
Revised 13 October 2020
Accepted 6 November 2020
Journal of Property Investment &
Finance
Vol. 39 No. 4, 2021
pp. 383-407
© Emerald Publishing Limited
1463-578X
DOI 10.1108/JPIF-08-2020-0088
whether A-REITs and real estate can be considered substitutes or may offer diversification
benefits when combined.
It has been well-documented that the fundamental reasoning behind this short-run
deviation is the contrasting nature of the markets in which these two assets operate: REITs,
being listed securities, sit within a highly liquid and informationally efficient market,
whereby new economic and financial events are fully reflected in current prices (Fama, 1970).
In contrast, the private nature of direct real estate generally translates to an informationally
inefficient, illiquid market, where returns can be far slower in adjusting to influential market
events, as discovered in Hoesli et al. (2015).
The objective of this paper is to study the short-run dynamics between A-REITs and
Australian direct real estate by identifying the extent of their interdependency and by
determining the differences in response behaviours of these assets to movements (shocks) in
key market forces (i.e. economic and financial indicators) and shocks in themselves.
Moreover, insight is sought on how these dynamics vary when disaggregating real estate
returns by sector (office, retail industrial) and grade (prime and secondary, which pertain to
the quality and condition of the property itself). Oikarinen et al. (2010),Boudry et al. (2012),
Hoesli and Oikarinen (2012) and Hoesli et al. (2015) set the foundations for this research, being
the early researchers that modelled response speeds of REITs and real estate to shocks in
market variables at the sector level. They affirm the significance in examining sector-level
returns as these sectors carry their own risk profile and resistance to market forces.
Sector-level research enables calculated decision-making at the portfolio-level, whereby
fund managers may identify which weightings of office, retail and industrial assets work best
when combined. However, there are limitations in the short-run utility of this research as it
does not take into account the risk profiles of the subgroups present within each commercial
sector, which may vary in their influence on a portfolios short-run efficiency.
As such, the above studies are extended by taking the methodologies used on sector-level
returns (that enable portfolio-level decision-making) and utilising them on prime and
secondary grade property returns within each commercial sector (referred to as subsectors)
and comparing these to A-REIT returns; this in turn enables acquisition-level
decision-making whereby fund managers can target and acquire specific asset grades
within commercial sectors that may best optimise a portfolios efficiency, given each
subsector embodies its own behaviour and relationship with A-REITs.
It is acknowledged that the A-REIT market is not entirely diversified in itself, given
A-REITs make up less than 10% of the largest 200 companies on the ASX by market
capitalisation (S&P/ASX200, 2019). This is why this study uses the S&P/ASX 200 A-REIT
index to allow for an as balanced as possible combination of A-REIT returns across the
various commercial sectors and subsectors.
The rest of the paper is organised as follows: Section 2 presents a brief literature review,
Section 3 describes the data used for analysis, Section 4 presents the methodology, Section 5
discusses results, Section 6 outlines the practical implications and lastly, Section 7 concludes
the discussion.
2. Literature review
REIT and real estate dynamics have been widely studied, with the bulk of existing research
focussing on the US and UK markets. However, this myriad of research contains conflicting
findings due to the varying use of data, methodology and differential interpretation of results.
Below is a summary of the existing research covering both the long and short-run dynamics
of REITs and real estates.
Many research papers have identified a significant long-run relationship between REITs
and direct real estate returns (Giliberto, 1990;Mei and Lee, 1994;Geltner and Kluger, 1998;
JPIF
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