The Relative Importance of Stock, Bond and Real Estate Factors in Explaining REIT Returns

Abstract

This papers offers a new approach to answering the question, "how much of a REIT's return is driven by real estate market influences, and how much by stock and bond factors?" Specifically, we develop a method that allows for the decomposition of the volatility of REIT returns into stock market, bond market, real estate market and idiosyncratic effects. Our results show that from 1978 to 1998, the REIT market has gone from being driven mostly by large cap stocks to being driven by both a small cap stock factor and a real estate factor. There is also a steady increase over time in the proportion of volatility not accounted for by any stock, bond or real estate factors. The analysis indicates that some of this this unaccounted for volatility is due to a REIT sector factor that is common to most REITs but independent of the stock, bond and real estate markets. Attempts to explain cross-sectional differences in the volatility determinants for different REITs meets with only limited success, although it seems that REITs with larger market capitalization are more like stocks.

JEL Classification: G12