An Analysis of Real Estate Investment Trust: Dynamic Correlations with Stock, Bond, Real Estate and Consumption

Abstract

This paper investigates the relationship between real estate investment trusts (REITs) in the United States and five asset classes, including large cap stock, small cap stock, bond, unsecuritized real estate, and consumption, referred to as benchmark asset classes in this paper, from the period 1979 to 2015. We explore the nature of the conditional correlations between REIT and each of the benchmark asset classes by examining three subperiods: pre-modern REIT era, REIT market boom, and mature REIT era. Using DCC-GARCH model, we find that REIT's conditional correlation with each asset class is time varying. In addition, small cap stock remains the most correlated asset with REIT during the entire period of study. The conditional correlation between REIT and large cap stock increases significantly from pre-modern REIT era to REIT market boom, and then from REIT market boom to mature REIT era. The relationships of REIT with bond, unsecuritized real estate, and consumption remain weak with fluctuations. Using the factor-adjusted model, we take a closer look at the relationship between REIT and large cap stock in the United States. During each subperiod, we observe a siginificant drop in the conditional correlation between REIT and large cap stock after we remove the impacts of the other four assets in the benchmark asset classes. Furthermore, we discover that the conditional correlation between REIT and large cap stock during financial crisis varies based on the nature of the crisis. Our study also shows that REIT experiences significant decrease in its ability to diversify risk in the most recent financial crisis. Compared to the cases in pre-modern REIT era, REIT tends to have a higher conditional correlation with large cap stock in modern REIT era market turbulences.