"The essential question is whether there is any predictability in the cycle length of REIT prices. A finding of positive duration dependence implies that, as the duration of the cycle lengthens, the probability that the cycle will end increases. If so, then the current duration of a cycle provides useful information with which to predict the next turning point.

The hazard models estimated in this paper provide evidence of positive duration dependence, and hence an ability to predict turning points of the cycle, for all samples except mortgage REIT expansions. Consequently, investors with specialized knowledge of real estate may find profitable opportunities in the market for REITs."

Source: J. Payne and T. Zuehlke

UPREIT Organizational Form "Inspired a Global Revolution"

From "The UPREIT Organizational Form: A Rational Expectation Exposition," by M. Shahid Ebrahim, an unpublished working paper, January 2007.

A financial economist from the U.K. studied the organizational form of the Umbrella Partnership REIT (UPREIT), which is often credited with jumpstarting the large-scale movement of assets from private to public management in the early 1990s. Shahid Ebrahim of the University of Nottingham developed a complex mathematical model showing that UPREITs benefit all parties and the economy as a whole.

"REITs coalesce with real estate limited partnerships (RELPs) to the hybrid form of UPREITs to acquire desirable features of the underlying forms. This is designed to move to the most efficient equilibrium. This action alleviates transaction costs stemming from tax as well as non-tax factors inherent in one or both forms. Thus, the overall gains in welfare emanate from meticulous structuring of the UPREIT form, which minimizes administrative costs, bankruptcy costs, illiquidity costs, and taxes; and optimal use of leverage, which minimizes not only taxes but also the endogenous agency costs of debt."

REIT Corporate Governance is Reflected in REIT Share Prices

From "Corporate Governance and Firm Valuation: The REIT-Effect," by Rob Bauer, Piet M.A. Eichholtz and Nils Kok, an unpublished working paper, November 2006.

Three Dutch economists studied the effects of corporate governance on both company value and stock performance of U.S. REITs. Noting that strong corporate governance is typical of the entire U.S. REIT industry, Rob Bauer, Piet Eichholtz and Nils Kok of Maastricht University found that companies with stronger corporate governance are valued more highly.

"The recent global growth of capital inflows in property markets, spurred by institutional and private investors, is allocated to indirect property vehicles such as real estate investment trusts rather than to direct property, which increases the focus on the efficiency of corporate governance mechanisms.

The relationship between corporate governance and firm value is our main significant result and is especially striking because we cannot show that well-governed firms have better equity performance than poorly governed firms over the sample period. This implies that the merits of good corporate governance were recognized by investors before the time of this study. Investors were willing to pay a premium for well-governed REITs, which has immediately been incorporated in the stock price. The governance effect appears in the firm value, but does not appear in the analysis of stock performance any more."

REIT Transparency Translates to Stronger Growth

From "The Effect of Corporate Transparency on Firm Investment: Evidence from Real Estate Investment Trusts," by Heng An, an unpublished manuscript, May 2006.

Heng An, a finance Ph.D. candidate from the University of Alabama, studied the relationship between corporate transparency and investment, finding that transparency makes it easier for REITs to obtain external financing to acquire assets. An uses "stock price synchronicity" to measure corporate transparency, and reaches conclusions consistent with other recent research suggesting that less-transparent firms may fail to grow appropriately.

"I find evidence that corporate transparency, measured by stock price non-synchronicity, has a strong positive effect on REITs' investment. The results suggest that greater transparency mitigates the asymmetric information problem in the capital markets and reduces the information cost of external financing. The magnitude of this effect is larger in the equity market, where the adverse selection problem is more severe, than in the debt market. Greater transparency enables the REIT to raise external capital more easily, thereby relying less on internal cash flow."

REIT Volatility Declining

From NAREIT research conducted by Brad Case in spring 2007.

The volatility of returns to equity REIT investments has been on a downward trend during the 35-year period that data are available, according to research done by Brad Case, NAREIT's vice president, research & industry information. The most commonly used measure of volatility is the standard deviation of monthly returns. This measure of REIT volatility has been declining slightly since 1972.

Equity REITs had an extraordinarily volatile year in 2004. However, volatility declined in the next two years, and in 2006, was below its long-term average.

Another, more informal, measure is the percent of trading days in which each REIT's stock price increased or declined by at least 1 percent. This measure tells the same story: REIT volatility has been on a downward trend during the entire modern REIT era, especially since 1998.

Stocks generally have been slightly more volatile than REITs over the same 35-year period. Stock volatility is more jumpy than REIT volatility, and seems to have hit a trough: 2006 was one of only 13 years in the last 35 when stocks were less volatile than REITs.

Portfolio allocations depend not just on expected returns and expected volatility, but also on expected correlations across different asset classes. According to Case, the average correlation between monthly equity REIT returns and the S&P 500 has been just 29 percent during the modern REIT era (1993–2006), substantially less than the 63 percent during the earlier REIT era (1972–1992).

Declining REIT volatility and sharply declining correlation with other stocks imply that optimal portfolio allocations to REITs may have increased, which is consistent with survey evidence showing five consecutive years of increasing target allocations to real estate among pension funds.

Source: NAREIT data

Editors Note: Due to the lengthy academic publishing process, many papers are summarized before they are published. Unpublished working papers may achieve the same high quality standards as published papers.