Despite continued scepticism from parts of the real estate investment community, REITs have become a significant - and still growing - global force. New research reviews the past 50 years and reveals regional focus and size of REIT among the key performance drivers as authors Dirk Brounen and Sjoerd de Koning report
In 1960 the US Congress passed the Real Estate Investment Trust (REIT) Act, in order to expand the traditional investment universe beyond stocks and bonds. Fifty years later, this REIT standard has been adopted in 34 different countries and has fuelled the evolution of a mature global asset category that currently consists of 537 different companies, representing a sum total of well over €500bn. A good moment to look back, reflect and learn from the years that have gone by.*
The early years
The 1960 REIT Act was the product of a tactical lobby of investment bankers. It recognised that the time was right to design new investment products for retail investors, and lobbied for the REIT to enhance the supply of investments. In the early years, however, few investors shared the enthusiasm of the bankers.
But suddenly during the early 1990s, a rare combination of unrelated favourable circumstances caused a tidal wave in US REIT capitalisation. At a time when interest rates were low and real estate prices ‘cheap' (just after the overbuilding crisis in the late 1980s), regulators suddenly opened up the REIT market to institutional investors, and enhanced the appeal of REIT vehicles through a series of favourable tax reforms. In a matter of four years, the US REIT market tripled in size and turned into a success that was soon discovered by authorities around the globe.
During the past two decades, the REIT regime went on tour, causing waves of REIT introductions first in Asia, and in more recent years in Europe, with the UK and Germany as the latest adopters. Today, the REIT regime is present in financial markets around the world. Figure 1 plots the evolution of the total market capitalisation of REIT markets in our sample, across continents.
In 1990, the global REIT market equalled a sum total of only €25bn. By 1997, after the US REIT boom this number quadrupled to €100bn, and 10 years later peaked at €600bn. Since the trough of the recent financial crisis, REIT markets around the world have again doubled in value, and today matured into a solid asset class.
REIT performance, important lessons from the past
Celebrating a 50-year jubilee also calls for a review of the past. The most relevant REIT period to consider here relates to the past two decades, when the REIT market effectively matured. We analysed the return dynamics of 210 REITs in Asia, Europe, and North America for the period 1990-2010 and searched for outperformance. The annualised alpha of REITs ranged from -3% (for the Netherlands) to 15% (for Canada) and averaged at 4% for our full sample. This means that, after controlling for risk, REITs on average outperformed common equity by 4% a year. Figure 2 shows that most of that outperformance was found in Europe and North America. The Asian markets performed weakly at times.
To identify the factors and strategies that are key to REIT outperformance, we also performed additional regression analysis in which we relate individual REIT alphas to a set of firm characteristics and portfolio strategies. We correct for continental variations and find that REIT alpha is highest among large REITs that manage geographically focused portfolios. Evidently, focus and size are key when it comes to REIT performance.
Large REITs outperform smaller ones by almost 4% a year, and regional focus enhances the annual return by yet another 2%. Also regarding portfolio spread across property type, we find evidence that specialist REITs do better. Figure 3 shows also shows that participations in real estate development projects reduced the performance of REITs during the past two decades.
When considering the systematic risk (beta) of REITs, we find that continental variations still tend to be vast. Asian REITs exhibit a risk profile that exceeds the US market by over 10%, while European REITs have the lowest betas. Individual REIT betas are mainly a function of leverage, with high betas for REITs with a lot of debt, also well before the credit crisis.
A bright future ahead?
REITs have matured and are now an asset class with appeal to investors, both institutional and retail. Listed real estate markets have been around for almost a century now, with firms such as Brixton Estate (now Brixton plc), which listed its shares in London in 1924. But the REIT regime has been around for 50 years today, and has brought listed real estate to a new level, especially in recent years. The ease of trading listed REIT stocks and the competitive risk-return ratio has given it a place in today's well diversified investment portfolios.
The regulatory criteria that prescribe a high dividend payout policy, cap leverage levels and limit non-real estate investments have ensured that REITs qualify as a transparent and low-risk investment. The next 50 years will be hard to predict, but with societies ageing, we are likely to move into an era in which the older investor community will appreciate high yielding investments.
* The full paper of this analysis is available as a free download EPRA Research Report at www.epra.com
Dirk Brounen (left) is professor of real estate, Tilburg University; Sjoerd de Koning, consultant, Boston Consulting Group