Swedroe: Real Estate Isn’t Special

April 30, 2018

Many investors think of real estate investment trusts (REITs) as a distinct asset class because, in aggregate, they historically have had relatively low correlation with stocks and bonds. In addition, their returns were not well-explained by the single-factor CAPM.

For example, during the period January 1978 through December 2017, the monthly correlation of the Dow Jones U.S. Select REIT Index with the S&P 500 Index was 0.58, and with five-year Treasuries it was just 0.07.

Real Estate Return/Risk Behaviors

Peter Mladina contributes to the literature on REITs as an asset class with the study “Real Estate Betas and the Implications for Asset Allocation,” which appears in the Spring 2018 issue of The Journal of Investing. In it, he sought to answer the question: Does the real estate asset class offer different return and risk behaviors than conventional stocks and bonds?

Mladina used a modified version of the Fama-French five-factor model to evaluate how well the returns and risks of publicly traded equity REITs and private real estate investments are explained by common stock and bond factors.

The five factors Mladina used in his model are the Fama-French market beta, size and value factors plus the term (the return of the Barclays U.S. Treasury Index minus the return of one-month Treasury bills) and default (the return of the Barclays U.S. Corporate High Yield Index minus the return of the Barclays U.S. Treasury Index) factors.

He modified the original Fama-French five-factor model to account for research finding that, because there is no real-time market price for illiquid private assets, returns are appraisal-based and subject to manager judgment. The result is that public REIT returns lead private real estate returns, with the lag of private real estate returns being statistically significant for up to four quarters.

Mladina’s database included:

  • The FTSE NAREIT Equity REITs Index, which contains 157 publicly traded REITs (as of 2016) that span commercial real estate in the United States, excluding timber and infrastructure REITs.
  • The NCREIF Property Index (NPI), the industry-standard, private-market index for core real estate. NPI returns are appraisal-based, unleveraged and gross of fees. The index is constructed from data collected from 79 contributors (as of 2015).
  • The NCREIF Open-End Diversified Core Equity Index (ODCE), constructed from data provided by 33 open-end commingled funds (as of 2015) pursuing a core strategy.
  • The Cambridge Real Estate Index, compiled from about 860 value-added and opportunistic private real estate funds formed between 1986 and 2015 that report net of fees.

His data covered the period January 1986 to December 2015. Following is a summary of Mladina’s findings:



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