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Contribution Details

Type Master's Thesis
Scope Discipline-based scholarship
Title The Risk and Return Relation of Direct Real Estate and REITs - Evidence from European Markets
Organization Unit
  • Zhizhi Li
  • Thorsten Hens
  • Dr. Syz Juerg
  • English
Institution University of Zurich
Faculty Faculty of Business, Economics and Informatics
Number of Pages 72
Date January 2018
Zusammenfassung There has been a long discussion by industry practitioners and academics on the performance characteristics of REITs compared to direct real estate investments. The connection of the two asset classes has not been clear since the implementation of the REIT regime. In the recent ten years, REITs have been developing at a rapid pace. The potential role REITs could play in a mixed-asset portfolio draw investors’ attention. However, due to the relatively short history of the European REITs market, comprehensive empirical research on the investment vehicle is limited. In this thesis, the relationship between the direct real estate and REITs returns will be examined with European market data between 1996 to 2016, the period during that the European REIT market started to expand and boom. The essential question is whether listed real estate has the same performance characteristics of the underlying property market and whether REITs could provide the same exposure and diversification effect as direct real estate investments. So far most studies focus on quarterly returns and hence implicitly show results which are valid for short-term investors with a quarterly investment horizon. This thesis aims to investigate further whether the link between direct and listed real estate is dependent on the investment horizon. Before the performance of listed and direct real estate can be compared, the differences of the two data sets like leverage, appraisal smoothing, sector compositions and management fees need to be taken into account (Pagliari, Scherer, & Monopoli, 2005). Further on, the relationship of listed real estate returns with other asset classes including equity, bond and direct real estate returns is analysed with a multi-factor regression model following (Clayton & MacKinnon, 2003). The analysis confirms that the variation of listed real estate returns is predominantly driven by general stock market factors and idiosyncratic components over short investment horizons. However, over the long run, REITs performance is highly correlated to the underlying property market. The exception is the German listed real estate market which seems to be largely unrelated to the German direct property market. The risk of direct and listed real estate is further investigated by conducting tests for equality of variances, but it cannot be confirmed that volatilities are the same. However, the results are greatly influenced by the parameter estimation for de-smoothing direct real estate returns. On the other hand, correlations of the direct real estate with equity markets increase significantly with a lengthening of the investment horizon and converge to the correlations of listed real estate with equities. In a next step, the fundamental macroeconomic exposure of REITs and direct property markets is analysed. Real GDP growth has been identified as a fundamental macroeconomic variable which has the most significant effect on real estate performance. The results are consistent across European listed and direct real estate markets. On the other hand, the reaction towards anticipated and unanticipated inflation is mixed across markets. Some markets provide a hedge against inflation while other markets seem to be negatively affected both by expected and unexpected inflation. However, it can be stated that direct real estate seems to offer better inflation hedging capabilities than listed real estate and inflation protection tends to work best for expected inflation over the long run. The long-run evidence for a co-movement of REITs and direct property returns has important implications for practitioners, regulators and academics. It suggests that listed real estate gives exposure to the underlying direct property market, and hence REITs serve as good substitutes for investors with an investment horizon longer than 1 year. However, the substitution cannot be applied to all markets as the empirical results for Germany show. The institutional setup of a market influences the behaviour of its submarkets greatly and might lead to disentangled behaviour.
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