CORRELATION OF RETURNS BETWEEN STOCKS AND DIRECT REAL ESTATE

Abstract

Equities and real estate constitute a significant portion of many investors’ portfolios. The importance of these two asset classes warrants an investigation of the correlation of returns between the two assets over time. This study therefore seeks to achieve the following objectives, which are to study (1) the long-run homoskedastic and (2) the short-run heteroskedastic correlations of returns between stocks and various sub-markets of direct real estate, and (3) how the correlations and performance of both asset classes vary across different phases of growth cycle and under different levels of inflation and interest rates. It was observed that correlations of direct real estate returns with stocks are generally low and insignificant with the residential sector having the most positive correlation followed by retail, office and industrial real estate in Singapore, the US, Hong Kong and Ireland. The coefficient of variation confirms the existence of the time variation of the covariances of returns between stocks and real estate market. Most covariances fluctuate around their means, with certain periods when the conditional covariances displayed more positive values than the rest of the periods. Therefore, real estate and stocks considered to provide little diversification during times of crisis. Finally, it was found that the correlations of returns between stocks and real estate are not cyclical in that the average correlation differs between each particular phase of growth cycle and that the correlation of the total returns between stocks and real estate changed drastically from one phase to the next.