GLOBAL - Listed real estate stocks tend to lead the underlying property markets by six months and can therefore be used as a leading indicator to enhance real estate investors' returns, according to a study by Cohen & Steers.

The report was commissioned by the European Public Real Estate Association (EPRA) and concluded that the listed sector led the direct market because of greater pricing transparency and quicker information transfer enjoyed by the former.

"We found that listed markets experience higher peaks and lower troughs than the direct markets, which probably relates to the relative degree of leverage used and also the appraisal-based approach to direct real estate valuation that leads to an understatement of true volatility," said Scott Crowe, global portfolio manager at Cohen & Steers, and author of the study.

He added: "Listed property prices immediately incorporate changes in variables which affect asset value from the macroeconomic, such as interest rates and oil prices, to the microeconomic, like expectations for rents and capitalisation rates.

"Valuing direct property is much less transparent because it is valued infrequently and appraisals are based on a small number of transactions. True value is not determined until the property is sold," he continued.

The study found while real estate stocks demonstrate higher levels of risk compared with direct real estate, it is likely that the real risk in the underlying physical market is strongly understated because of the influence of appraisal ‘smoothing'. For example, the measure of risk (standard deviation) of the direct market in the US is only slightly higher than for government bonds while for the UK and Australian direct markets it is lower than sovereign debt.

The research also outlined some implications for asset allocaters, such as the opportunity to arbitrage between listed and direct markets and using listed real estate as a signal to buy or sell in the direct market.

Crowe concluded: "We believe that understanding the relationship between the two markets has useful implications for investors. By using listed property returns as a leading indicator of direct real estate performance, investors can meaningfully improve their asset allocation decisions."