The Hybrid Nature of Real Estate Trusts

Abstract

When do real estate trusts exhibit superior performance, when they mimic the underlying real estate or when they behave like stock? We test whether real estate trusts outperform common stock only when it mimics underlying property fundamentals. We also explore what capital market conditions correspond to and/or contribute to when securitized real estate behaves more like underlying property fundamentals. To explore this issue, we examine the investment performance of real estate trusts over the Great Depression and also the Great Recession. A distinguishing feature of our study is that we are the first to analyze the investment performance of real estate trusts (RETs), the predecessor to modern day real estate investment trusts (REITs), which traded over the late 19th and early 20th century. We compare the behavior and performance of RETs to REITs in the process. We find evidence consistent with the notion that securitized real estate exhibits superior performance only when it mimics the direct real estate market. This performance is fueled in part by cheaper borrowing costs, greater availability of debt and equity financing, and loosening credit standards. With the advent of a crisis, securitized real estate exhibits a greater co-movement with common stock. When this occurs, real estate behaves in a similar fashion to common stock and any abnormal performance disappears. This corresponds to tighter lending conditions and higher borrowing costs. We also show that RETs behave in a similar fashion to REITs.