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Ex-ante performance of REIT portfolios

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Abstract

The Real Estate Investment Trust (REIT) market has become an increasingly important vehicle for alternative investment for equity investors. While existing research examining the cross-section of REIT returns usually employs standard risk factors in the in-sample models, it can only show the ex-post performance of REIT portfolios. The goal of our paper is to examine the ex-ante performance of REIT portfolios (i.e., the ability of investors to earn abnormal returns in real time). We employ the out-of-sample methodology of Cooper, Gutierrez, and Marcum (2005), and show that ex-ante performance of REIT portfolios is rather weak. For about half of our 19-year sample over the period of 1999 to 2017, the portfolio performances of REITs chosen ex-ante do not beat the performances of the FTSE-NAREIT or the CRSP Equal-Weighted index. After adjusting for transaction costs, the REIT portfolios significantly further underperform their benchmarks. Overall, our findings suggest that the market is relatively efficient in the REIT sector, and it is difficult for investors to devise trading strategies that improve the ex-ante performance of REIT portfolios, based on standard risk factors.

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Data availability

Standard data sources used, as disclosed in the main body of manuscript.

Code availability

May be made available upon request.

Notes

  1. For instance, REITs have to follow strict regulations regarding investment and income distribution to remain qualified as REITs and to keep their tax-exempt status, as they are required to distribute at least 90% of their taxable income as dividends and to generate at least 75% of their gross income from real estate related sources.

  2. https://www.reit.com/investing/investment-benefits-reits/reits-and-dividend-income.

  3. Similarly to Cooper et al. (2005), we rely on a portfolio sorting approach instead of any regression-based approach. We do this to minimize the number of assumptions a real-time investor may have, since, for instance, regressions would impose a linear relationship between REIT returns and risk factors.

  4. As a robustness check, we also select top 5% and bottom 5% as LONG and SHORT portfolios, respectively. The results remained the same.

  5. Ling et al. (2000) look into the determinants of REIT returns, with two important differences from our study. First, they examine an earlier period of 1980 to 1996, which mostly consists of the pre-modern era in the REIT market. Second, they use a regression-based approach, developed by Pesaran and Timmermann (1995), to relate risk factors to REIT returns. Stevenson (2002) investigates the ex-ante performance of the NAREIT indices with a portfolio sorting approach based on the indices’ historical returns over the period of 1994 to 2002. However, he does not consider any firm-specific risk factors or individual REIT firms. While Ling et al. (2000) find no superior performance of REIT returns ex-ante, Stevenson (2002) shows that there exists superior performance ex-ante for NAREIT index portfolios.

  6. www.reit.com/news/reit-magazine/november-december-2013/beginnings-era.

  7. We run a number of robustness checks with alternative intervals for both in-sample and out-of-sample, including matching intervals for both (e.g. 3 and 5 years for both in- and out-of-sample windows). We find similar results. Results areavailable upon request.

  8. Our first 10-year in-sample period is from July 1989 to June 1999. To form the 66 portfolios for the year of 1989, we calculate beta using July 1987 to June 1989 returns. To calculate out-of-sample returns, we use the mean monthly returns for the year immediately following the in-sample period. Since the last 10-year in-sample period is from July 2007 to June 2017, we use the mean monthly return for the year of July 2017 to June 2018 to calculate our out-of-sample returns.

  9. The impact of survivorship bias should not be significant as we conduct portfolio-based tests.

  10. In an unreported robustness check, we also adopt the methodology of Stambaugh, Yu, and Yuan (2015) to construct the portfolios. The results are similar to those generated with our original method.

  11. The last out-of-sample year, July 2017 to June 2018 is labeled as “2017” in tables and graphs.

  12. Note that the Jensen’s Alpha criterion is called Terminal Wealth criterion in Cooper et al. (2005).

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Acknowledgements

We thank Cheng-Few Lee (Editor), two anonymous referees, and participants at the Real Estate Markets and Capital Markets (ReCapNet) Conference, the American Real Estate Society (ARES) Research Symposium, the European Real Estate Society (ERES) Annual Conference, the Southern Finance Association Annual Meetings for helpful comments. The views expressed in the paper are solely those of the authors and do not necessarily represent the views of the institutions to which the authors are affiliated. This paper was previously circulated under the title “Ex Ante Predictability of REIT Returns.” The authors would like to thank the participants at the 13th Real Estate and Capital Markets Conference 2021 in Stockholm Sweden, The American Real Estate Society Fall 2021 Research Symposium in Las Vegas NV, 2019 Southern Finance Association Meetings in Orlando, FL and two anonymous referees for their helpful comments and suggestions.

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Authors and Affiliations

  1. Department of Finance, School of Business, Southern Connecticut State University, New Haven, CT, USA

    Gene Birz, Sandip Dutta & Khoa Nguyen

  2. Department of Economics and Finance, College of Business Administration, University of Texas at El Paso, El Paso, TX, USA

    Erik Devos

  3. School of Hotel and Tourism Management, Chinese University of Hong Kong Business School, Shatin, NT, Hong Kong

    Desmond Tsang

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  1. Gene Birz
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  2. Erik Devos
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  3. Sandip Dutta
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  4. Khoa Nguyen
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  5. Desmond Tsang
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Correspondence to Sandip Dutta.

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Appendices

Appendix A1

See Table 7.

Table 7 Distribution of REITs by Year and Month
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Appendix A2

See Table 8.

Table 8 Distribution of REITs by Year and Property Type
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Birz, G., Devos, E., Dutta, S. et al. Ex-ante performance of REIT portfolios. Rev Quant Finan Acc 59, 995–1018 (2022). https://doi.org/10.1007/s11156-022-01068-6

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