THE INDIRECT REAL ESTATE INVESTMENT DILEMMA

Abstract

Real Estate Investment Trust (REIT) can be seen as one of the most successful financial instrument that has revolutionized the way real estate is owned and held. While REITs offer investors an attractive avenue for indirect real estate investment, another popular instrument to attain this goal is to invest through a Real Estate Mutual Fund (REMF). Both industries was observed to have grown rapidly only in the 1990s period. Hence, given the easy access and popularity of such instruments, the question of their relative financial performance arises. Specifically, do such securities exhibit risk-return characteristics that outperform the other? The results will have implications in the context of portfolio management related to employing real estate investments so as to derive diversification benefits. This study analyses a sample of 123 equity REITs and 86 REMFs over the same period from January 2000 through December 2004, using 60 continuous monthly data. Based on the Fama-French model, REMFs is found to be significantly more sensitive than REITs to broad market indices. However both are observed to exhibit similar behavior toward common risk factor related to book-to-market ratio. Risk factor related to size is significant in explaining excess returns for REITs but not REMFs. Subsequently, analysis of firm specific characteristics reveals that size is the only significant factor in explaining risk-adjusted returns for REITs while no consistent evidence was documented for REMFs. In contrast to what is hypothesized, risk-adjusted performance for REITs slightly out-performed that of the REMFs, while maintaining similar volatility in their returns. While cointegration test yields no evidence of a long-run relationship between them, the Granger Causality test does reveal some form of one-way causal relationship where it is observed that REITs is often the ‘causal’ factor. This implies that one will derive limited additional benefits in holding both instruments in the same portfolio.