A Comparative Anatomy of REITs and Residential Real Estate Indexes: Returns, Risks and Distributional Characteristics

TL;DR

This paper compares REITs and residential real estate indexes, analyzing their return characteristics, risks, and predictive relationships, revealing REITs are more risky but better predictors of residential index returns.

Contribution

It provides a detailed comparison of REITs and residential real estate indexes, highlighting differences in risk, characteristics, and their predictive power for residential index returns.

Findings

REITs have lower market risk than equities with an average beta of 0.65.

REITs are more risky than SCS residential indexes.

REITs can reasonably predict SCS index returns.

Abstract

Real Estate Investment Trusts (REITs) are the only truly liquid assets related to real estate investments. We study the behavior of U.S. REITs over the past three decades and document their return characteristics. REITs have somewhat less market risk than equity; their betas against a broad market index average about .65. Decomposing their covariances into principal components reveals several strong factors. REIT characteristics differ to some extent from those of the S&P/Case-Shiller (SCS) residential real estate indexes. This is partly attributable to methods of index construction. Our examination of REITs suggests that investment in real estate is far more risky than what might be inferred from the widely-followed SCS series. REITs, unlike SCS series are forward looking, and this helps them in the prediction of SCS returns. REIT forecasts of SCS returns are reasonably precise over a number of periods.