The debate concerning the economic variables to include in a forecasting model of asset returns is probably endless. An optimal model that remains robust through different time periods, countries, and asset classes, is hardly conceivable.
For securitized real estate, an asset class often described as a hybrid asset (i.e., a hybrid of stocks, bonds and real estate) such a choice of variables may be bypassed. In this paper, we use financial and real estate factors as forecasting variables to proxy for the set of economic variables related to changing economic trends and business conditions that exert an effect on securitized real estate performance. The primary contribution of this paper was to determine whether such financial and real estate factors provided at least as good forecasts for securitized real estate returns as the commonly used economic variables. This was undertaken by identifying and describing the long-run nonlinear relations between securitized real estate and two sets of economic variables on the one hand, and between securitized real estate and financial and real estate factors on the other.
With fractional cointegration analysis, the paper identifies and characterizes the nonlinear relationships that exist between securitized real estate and the
three specifications tested. In fact, we find that the economic variables of Chan, Hendershott and Sanders (1990) generally have no long-run effects on securi-tized real estate as the process is mean reverting. There is some evidence that securitized real estate and the economic variables of Liu and Mei (1992) display short memory, but the strongest linkage is found with financial and real estate factors where a long memory process generally links securitized real estate to these variables.
More accurate securitized real estate return forecasts are obtained with fi-nancial and real estate factors than with economic variables in the U.S. and in Australia, while in the U.K., it is with the economic variables of Liu and Mei (1992) that the best forecasts are made. Such outcomes are economically sig-nificant as they continue to hold when transaction costs are taken into account.
The trading results are also consistent with the long-range dependence found in the U.S. and Australia between securitized real estate and the financial and real estate factors, as well as with the short memory and possible long memory found in the U.K. between securitized real estate and the economic variables of Liu and Mei (1992).
References
Anderson, R., J. Clayton, G. MacKinnon and R. Sharma. 2005. REIT Returns and Pricing: Another Look at the Stock Market Factor. Journal of Property Research 22:4 267-286.
Antoniou, A., I. Garrett and R. Priestley. 1998. Macroeconomic Variables as Common Pervasive Risk Factors and the Empirical Content of the Arbitrage Pricing Theory. Journal of Empirical Finance 5:3 221-240.
Aylward, A. and J. Glen. 2000. Some International Evidence of Stock Prices as Leading Indicators of Economic Activities. Applied Financial Economics10:1 1-14.
Baillie, R.T. and T. Bollerslev. 1994. Cointegration, Fractional Cointegra-tion, and Exchange Rate Dynamics. Journal of Finance 49:2 737-745.
Beenstock, M. and K. Chan. 1986. Testing the Arbitrage Pricing Theory in the United Kingdom. Oxford Bulletin of Economics and Statistics 48:2 121-141.
Bharati, R. and M. Gupta. 1992. Asset Allocation and Predictability of Real Estate Returns. Journal of Real Estate Research 7:4 469-484.
Brooks, C. and S. Tsolacos. 1999. The Impact of Economic and Financial Factors on UK Property Performance. Journal of Property Research 16:2 139-152.
Brooks, C. and S. Tsolacos. 2001. Forecasting Real Estate Returns Using Financial Spreads. Journal of Property Research 18:3 235-248.
Brooks, C. and S. Tsolacos. 2003. International Evidence on the Predictabil-ity of Returns to Securitized Real Estate Assets: Econometric Models versus Neural Networks. Journal of Property Research 20:2 133-155.
Campbell, J.Y. 1987. Stock Returns and the Term Structure. Journal of Financial Economics 18:2 373-399.
Chan, L.K.C. and J. Lakonishok. 1993. Institutional Trades and Intraday Stock Price Behavior. Journal of Financial Economics 33:2 173-199.
Chan, K.C., P.H. Hendershott and A.B. Sanders. 1990. Risk and Return on Real Estate: Evidence from Equity REITs. Real Estate Economics18:4 431-452.
Chen, N.F., R. Roll and S.A. Ross. 1986. Economic Forces and the Stock
Market. Journal of Business 59:3 383-403.
Chen, S.-J., C.-H. Hsieh and B.D. Jordan. 1997. Real Estate and the Arbitrage Pricing Theory: Macrovariables vs. Derived Factors. Real Estate Economics 25:3 505-523.
Chen, S.-J., C. Hsieh, T.W. Vines and S.-N. Chiou. 1998. Macroeconomic Variables, Firm-Specific Variables and Returns to REIT.Journal of Real Estate Research 16:3 269-277.
Cheng, A.C.S. 1995. The UK Stock Market and Economic Factors: A New Approach. Journal of Business Finance and Accounting 22:1 129-142.
Cheung, Y.-W. and K.S. Lai. 1993. A Fractional Cointegration Analysis of Purchasing Power Parity. Journal of Business and Economic Statistics 11:1 103-112.
Cheung, Y.-W. and K.S. Lai. 1998. Macroeconomic Determinants of Long-Term Stock Market Comovements Among Major EMS Countries. Applied Fi-nancial Economics 9:1 73-85.
Cheung, Y. and L.K. Ng. 1998. International Evidence on the Stock Market and Aggregate Economic Activity. Journal of Empirical Finance 5:3 281-296.
Clare, A.D. and S.H. Thomas. 1994. Macroeconomic Factors, the APT and the UK Stock Market. Journal of Business Finance and Accounting 21:3 309-330.
Clayton, J. and G. MacKinnon. 2001. The Time-Varying Nature of the Link between REIT, Real Estate and Financial Asset Returns. Journal of Real Estate Portfolio Management 7:1 43-54.
Clayton, J. and G. MacKinnon. 2003. The Relative Importance of Stock, Bond and Real Estate Factors in Explaining REIT Returns. Journal of Real Estate Finance and Economics 27:1 39-60.
Diacogiannis, G.P. 1986. Arbitrage Pricing Model: A Critical Examination of its Empirical Applicability for the London Stock Exchange. Journal of Busi-ness Finance and Accounting 13:4 489-504.
Engle, R.F. and C.W.J. Granger. 1987. Co-Integration and Error Correc-tion: Representation, Estimation, and Testing. Econometrica55:2 251-276.
Ewing, B. and J.E. Payne. 2005. The Response of Real Estate Investment Trust Returns to Macroeconomic Shocks. Journal of Business Research 58:3
293-300.
Fama, E.F. and K.R. French. 1989. Business Conditions and Expected Re-turns on Stocks and Bonds. Journal of Financial Economics 25:1 23-49.
Fama, E.F. and M.R. Gibbons. 1984. A Comparison of Inflation Forecasts.
Journal of Monetary Economics 13:3 327-348.
Fifield, S.G.M., D.M. Power and C.D. Sinclair. 2002. Macroeconomic Fac-tors and Share Returns: An Analysis Using Emerging Market Data. Interna-tional Journal of Finance and Economics 7:1 51?62.
Fisher, J.D., D.M. Geltner and R.B. Webb. 1994. Value Indices of Com-mercial Real Estate: A Comparison of Index Construction Methods. Journal of Real Estate Finance and Economics 9:2 137-164.
Geltner, D.M. 1993. Estimating Market Values from Appraisal Values with-out Assuming an Efficient Market. Journal of Real Estate Research8:3 325-346.
Geweke, J. and S. Porter-Hudak. 1983. The Estimation and Application of Long-Memory Time Series Models. Journal of Time Series Analysis 4:4 221-238.
Giliberto, M. 1990. Equity Real Estate Investment Trusts and Real Estate Returns. Journal of Real Estate Research 5:2 259-263.
Glascock, J.L., C. Lu and R. So. 2000. Further Evidence on the Integration of REIT, Bond, and Stock Returns. Journal of Real Estate Finance and Eco-nomics 20:2 177-194.
Groenewold, N. and P. Fraser. 1997. Share Prices and Macroeconomic Fac-tors. Journal of Business Finance and Accounting 24:9-10 1367-1383.
Gyourko, J. and D.B. Keim. 1992. What Does the Stock Market Tell Us About Real Estate Returns? Journal of the American Real Estate and Urban Economics Association 20:3 457-485.
Hargreaves, C.P. 1994. Nonstationary Time Series Analysis and Cointegra-tion, Oxford, U.K.: Oxford University.
Hoesli, M. and C. Serrano. 2007. Securitized Real Estate and its Link with Financial Assets and Real Estate: An International Analysis. Journal of Real Estate Literature 15:1 59-84.
Hosking, J.R.M. 1981. Fractional Differencing. Biometrika 68:1 165-176.
Johansen, S. 1988. Statistical Analysis of Cointegrating Vector. Journal of Economic Dynamics and Control 12:2-3 231-254.
Johansen, S. 1991. Estimation and Hypothesis Testing of Cointegration Vec-tors in Gaussian Vector Autoregressive Models. Econometrica 59:6 1551-1580.
Karolyi, G.A. and A.B. Sanders. 1998. The Variation of Economic Risk Pre-miums in Real Estate Returns. Journal of Real Estate Finance and Economics 17:3 245-262.
Keim, D.B. and R.F. Stambaugh. 1986. Predicting Returns in the Stock and Bond Markets. Journal of Financial Economics 17:2 357-390.
Laopodis, N.T. 2006. Dynamic Interactions Among the Stock Market, Fed-eral Funds Rate, Inflation, and Economic Activity. Financial Review 41:4 513-545.
Lawrence, C. and A. Siow. 1985. Interest Rates and Investment Spending:
Some Empirical Evidence for Postwar U.S. Producer Equipment, 1947-1980.
Journal of Business 58:4 359-375.
Ling, D.C. and A. Naranjo. 1997. Economic Risk Factors and Commercial Real Estate Returns. Journal of Real Estate Finance and Economics 15:3 283-307.
Ling, D.C. and A. Naranjo. 1999. The Integration of Commercial Real Es-tate Markets and Stock Markets. Real Estate Economics 27:3 483-515.
Liow, K.H. and J.R. Webb. Forthcoming. Common Factors in International Securitized Real Estate Markets. Review of Financial Economics.
Liow, K.H. and H. Yang. 2005. Long-Term Co-Memories and Short-Run Adjustment: Securitized Real Estate and Stock Markets. Journal of Real Es-tate Finance and Economics31:3 283-300.
Liu, C.H. and J. Mei. 1992. The Predictability of Returns on Equity REITs and Their Co-Movement with Other Assets. Journal of Real Estate Finance and Economics 5:4 401-418.
McCue, T.E. and J.L. Kling. 1994. Real Estate Returns and the Macroe-conomy: Some Empirical Evidence from Real Estate Investment Trust Data, 1972-1991. Journal of Real Estate Research 9:3 277-287.
Mei, J. and A. Lee. 1994. Is There a Real Estate Factor Premium? Journal of Real Estate Finance and Economics9:2 113-126.
Mei, J. and C.H. Liu. 1994. The Predictability of Real Estate Returns and Market Timing. Journal of Real Estate Finance and Economics8:2 115-135.
Pagliari, J.L., K.A. Scherer and R.T. Monopoli. 2005. Public Versus Private Real Estate Equities: A More Refined, Long-Term Comparison. Real Estate Economics 33:1 147-187.
Payne, J.E. 2003. Shocks to Macroeconomic State Variables and the Risk Premium of REITs. Applied Economics Letters 10:11 671-677.
Peterson, J. and C. Hsieh. 1997. Do Common Risk Factors in the Returns on Stocks and Bonds Explain Returns on REITs? Real Estate Economics 25:2 321-345.
Poon, S. and S.J. Taylor. 1991. Macroeconomic Factors and the UK Stock Market. Journal of Business Finance and Accounting 18:5 619-636.
Priestley, R. 1996. The Arbitrage Pricing Theory, Macroeconomic and Fi-nancial Factors, and Expectations Generating Processes. Journal of Banking and Finance 20:5 869-890.
Roll, R. and S.A. Ross. 1980. An Empirical Investigation of the Arbitrage Pricing Theory. Journal of Finance 35:5 1073-1103.
Sephton, P.S. 2002. Fractional Cointegration: Monte Carlo Estimates of Critical Values, with an Application. Applied Financial Economics 12:5 331-335.
Serrano, C. and M. Hoesli. 2007. Forecasting EREIT Returns. Journal of Real Estate Portfolio Management 13:4 293-309.
Serrano, C. and M. Hoesli. Forthcoming. Are Securitized Real Estate Re-turns more Predictable than Stock ReRe-turns? Journal of Real Estate Finance and Economics.
Titman, S. and A. Warga. 1986. Risk and the Performance of Real Estate Investment Trusts: A Multiple Index Approach. AREUEA Journal 14:3 414-431.
Wilson, P.J. and J. Okunev. 1999. Long-Term Dependencies and Long Run Non-Periodic Co-Cycles: Real Estate and Stock Markets. Journal of Real Es-tate Research18:2 257-278.
Wongbangpo, P. and S.C. Sharma. 2002. Stock Market and Macroeconomic Fundamental Dynamic Interactions: ASEAN-5 Countries. Journal of Asian
Economics 13:1 27-51.
Yao, J., J. Gao and L. Alles. 2005. Dynamic Investigation into the Pre-dictability of Australian Industrial Stock Returns: Using Financial and Eco-nomic Information. Pacific-Basin Finance Journal 13:2 225-245.
Table1:SetsofVariablesExamined SymbolVariableDataSourceorMeasurement PanelA:RawEconomicSeriesandSources ItInflationConsumerpriceindex TBtTreasury-billrate3-monthTreasury-billrateintheU.S.andtheU.K.,and 3-monthInterbankmiddlerateinAustralia BtLong-termgovernmentbondsDatastream’s10-yeartotalreturngovernmentbondindex AAAtCorporateAAAbondsCitigroup’scorporateAAA/AAbondindex BBBtCorporateBBBbondsCitigroup’scorporateBBBbondindex PanelB:EconomicVariables Chan,HendershottandSanders(1990) ∆TStChangeintermstructureBt-TBt ∆RPtChangeinriskpremiumBBBt-AAAt EItExpectedinflationFamaandGibbons(1984) ∆EItChangeinexpectedinflationEIt+1-EIt UItUnexpectedinflationIt-EIt LiuandMei(1992) TBtTreasury-billrate3-monthTreasury-billrateintheU.S.andtheU.K.,and 3-monthInterbankmiddlerateinAustralia YStYieldspreadAAAt-TBt DYtStocksdividendyieldDatastream’sstock’sdividendyieldindex CRtREITsCap.RateFTSE/NAREITAllREITsdividendyieldindexinthe U.S.andGPRGeneraldividendyieldindexintheU.K. andAustralia PanelC:FinancialandRealEstateFactors StStockfactorDatastream’stotalreturnstockindex BtBondfactorDatastream’s10-yeartotalreturngovernmentbondindex REtRealestatefactorNCREIFPropertyIndex(NPI)intheU.S.,IPDindex intheU.K.,andMercer’sUnlistedPropertyFundIndex (MUPFI)inAustralia Notes: ForAustraliatheTreasury-billrateisnotavailableforthewholeperiodsotheInterbank3-month middlerateisused.Theircorrelationovertheshortercommontimeperiodforwhichbothvariables areavailable(1986Q2-2002Q2)is0.97. InvestmentgradebondsdataarenotavailableintheU.K.andAustraliaforthewholeperiod,sothese variablesareproxiedusingU.S.data.ThecorrelationbetweenU.S.andU.K.AAAbondsis0.75,while thecorrelationis0.62forBBBbonds.InAustralia,thesecorrelationsare0.79and0.48,respectively. AsdonebyChan,HendershottandSanders(1990),expectedinflationiscalculatedusingFamaand Gibbons(1984),i.e.,EIt=TBt−1−1 12
Pt−12 s=t−1[TBs−1−Is].
Table 2: Summary Statistics, 1980-2008Q2 for the U.S. and 1987-2008Q2 for the U.K. and Australia (Quarterly Data)
United States United Kingdom Australia
(%) (%) (%)
Securitized Real Estate Mean 3.12 2.08 3.24
Std. Dev. 7.37 10.50 6.96
Stocks Mean 3.46 2.49 3.12
Std. Dev. 7.95 8.08 8.00
Bonds Mean 2.28 2.06 2.57
Std. Dev. 4.78 3.60 3.87
Direct Real Estate Mean 2.22 2.19 2.29
(Unsmoothed) Std. Dev. 3.81 8.62 6.69
T-Bill Mean 1.38 1.68 1.81
Std. Dev. 0.72 0.75 0.79
Yield Spread Mean 1.01 0.19 0.00
Std. Dev. 4.05 2.40 2.52
Dividend Yield Stocks Mean 2.83 3.67 3.76
Std. Dev. 1.40 0.80 0.76
Dividend Yield Mean 7.87 0.44 0.62
Securitized Real Estate Std. Dev. 1.83 0.41 0.76
Change in Term Mean 0.90 0.38 0.75
Structure Std. Dev. 4.80 3.60 3.83
Change in Risk Mean 0.13 0.08 0.08
Premium Std. Dev. 1.19 1.15 1.15
Expected Inflation Mean 1.24 1.34 1.49
Std. Dev. 0.69 0.65 0.73
Change in Expected Mean -0.03 -0.02 -0.04
Inflation Std. Dev. 0.27 0.19 0.27
Unexpected Inflation Mean -0.35 -0.66 -0.66
Std. Dev. 0.49 0.74 0.65
Table3:EstimatedFractionalCointegrationCoefficients Chan,HendershottandSanders(1990)LiuandMei(1992)FinancialandRealEstateFactors d95%ConfidenceIntervald95%ConfidenceIntervald95%ConfidenceInterval UnitedStates µ=0.550.92[0.221.62]-0.28[-1.040.47]0.08[-0.530.69] µ=0.5750.94[0.341.54]-0.07[-0.840.69]0.25[-0.350.85] µ=0.601.08[0.431.72]0.01[-0.670.69]0.30[-0.220.82] UnitedKingdom µ=0.550.59[-0.371.55]-0.62[-1.540.30]0.81[0.241.39] µ=0.5750.60[-0.261.46]-0.46[-1.420.50]0.80[0.291.32] µ=0.600.64[-0.081.35]-0.22[-1.150.70]0.69[0.221.16] Australia µ=0.550.31[0.080.54]-0.52[-1.230.18]0.05[-0.560.65] µ=0.5750.44[0.010.88]-0.39[-1.130.36]0.09[-0.460.64] µ=0.600.49[0.120.86]-0.26[-0.930.41]0.19[-0.300.67] Notes: Thistableshowsthefractionalcointegrationcoefficientsestimatedwithequation(4),ln(Iu(ωj))=α+βln(4sin2 (ωj/2))+εt.Three setsofvariablesareconsidered:theonesusedbyChan,HendershottandSanders(1990),thoseofLiuandMei(1992),andfinancial andrealestatefactors.Thetablealsoreportsthe95%confidenceintervals.Forthesamplesizefunctionn=Tµ ,wereportresults forµ=0.55,0.575,and0.60.
Table 4: Trading Strategy Results
United States United Kingdom Australia
Annual Round-Trip Annual Round-Trip Annual Round-Trip Return Transaction Return Transaction Return Transaction
(%) Costs (bp) (%) Costs (bp) (%) Costs (bp)
Chan, Hendershott 8.49 0 7.47 0 11.28 171
and Sanders (1990) Variables
Liu and Mei (1992) 13.44 0 11.42 506 9.48 0
Variables
Financial and Real 15.57 302 5.92 0 15.84 1328
Estate Factors
Buy-and-Hold 14.32 8.73 10.16
Investment Notes:
This table shows the annual returns on the active trading strategies with the three forecasting specifications, as well as the buy-and-hold strategy. Transaction costs which would render the active strategy equivalent to the passive one are also shown.