This study investigates Real Estate Investment Trusts’ momentum returns in different market states, and explains the momentum phenomenon with a risk-based dividend growth theory of Johnson (Journal of Finance 57:585–608, 2002). Our results show that momentum returns of REITs are higher during up markets. This study finds that winners’ dividend/price ratios are higher than those of losers, and momentum returns are positively correlated with the difference between winners’ and losers’ dividend/price ratios. We also find that momentum returns are higher after the legislation change of REITs in 1992, and that dividend/price ratios of REITs are also higher after 1992, suggesting that a persistent shock to REIT’s dividend/price ratios in 1992 partly explains REITs’ higher momentum returns after 1992. In sum, results of this study suggest that momentum returns of REITs can be jointly explained by a time-varying factor (market state) and a cross-sectional variance in dividend yields.
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Jegadeesh and Titman (1993) defines momentum strategy as shorting stocks with the lowest average returns over a 3–12 month period, using the profits from short-sells to buy stocks with the highest average returns over a 3–12 month period, and holding this zero-cost portfolio for 6–12 months.
Fama (1991) defines a market as weakly efficient if all past price information has been reflected in current stock prices, the market is semi-strong efficient if all public information has been reflected in current stock prices, and it is strongly efficient if all inside and public information has been reflected in current stock prices.
Johnson provides a pricing model where dividend changes signal additional dividend changes in the intermediate but not long-run. His purpose is to show in a theory model that momentum could be the result of intermediate serial correlations in dividend changes which are not forecastable in the short run and which do not persist in the long-run. His model has two key features: one the market is rational in its reaction and thus momentum is associated with a (previously) unobserved risk and these effects do not last—thus, this theory model provides expected outcomes consistent with empirical observations in the momentum literature.
Cochrane sees value stocks as a special case of this class of stocks: those that provide ‘safety’ during economically turbulent times. REITs in the Johnson world would also provide such safety—as such they would experience momentum to the extent that their increased dividends have serial correlation in the intermediate but not long-run. The REITs provide safety in two ways: first, the dividend increases show strength in bad times and these dividends allow investors to disinvest (asset reallocate) without selling and facing immediate price effects.
If the market views stocks that are safer during economic hardship times as ‘better’ stocks and thus bids down their returns, we would expect that REITs might fit into this category.
In 1992, the ‘UPREIT’, or Umbrella Partnership REIT, was developed as a vehicle to enable property owners to defer recognition of taxable capital gains on properties contributed to REITs in exchange for partnership units. UPREITs have accounted for nearly two-thirds of all newly formed REITs since 1992. Up to today, over half of the largest REITs are organized as UPREITs.
Jegadeesh and Titman (1993) use overlapping samples and cumulative average returns (CAR) to measure momentum returns. Because cumulative average returns are known to cause an upward bias, this study does not measure momentum returns in terms of CAR.
The convention of momentum studies is to use a 10% breakpoint. However, due to the smaller size of the REIT sample, this study chooses 30% as breakpoint for winners and losers.
Since momentum returns require zero cost, the computation of momentum return may not be meaningful. This study defines momentum returns as investing one dollar in the winner portfolio and shorting one dollar in the loser portfolio.
Cochrane (1999) argues in a similar manner that unobserved risks may be responsible to momentum returns. In particular, Cochrane argues, “Momentum returns have also not been linked to business or financial cycles in even the informal way that I suggested for price based strategies.” However, Johnston provides such a link from dividend growth to business cycles and momentum returns (particularly) in defensive stocks.
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Hung, S.K., Glascock, J.L. Momentum Profitability and Market Trend: Evidence from REITs. J Real Estate Finan Econ 37, 51–69 (2008). https://doi.org/10.1007/s11146-007-9056-4
- Real Estate Investment Trusts (REIT)
- Momentum predictability
- Market states
- Dividend-growth-rate model