REIT Returns and Pricing: Another Look at the Stock Market Factor

The explosive growth in REITs over the past decade suggests that they provide an important alternative investment vehicle. Since REITs are a representation of the real estate market, they should theoretically provide similar diversification benefits of holding direct real estate in a portfolio. Even though in the long run REIT performance may be governed by real estate fundamentals, investigations in the return dynamics of REITs show that they do not necessarily move in tandem with the private real estate market, but rather exhibit properties similar to common stocks. This study examines the return dynamics of REITs using different models. While we find that REIT returns have a significant real estate factor, we show that the most significant determinant of REIT return performance is the returns of small cap value stocks. We also find that REITs behave more like small cap value stocks than small cap growth stocks or large stocks. In addition, we find a decline in the explanatory power of large stocks.