REITs smell like real estate, look like bonds and walk like equity — a casual check in Hong Kong
[updated on Feb 23, 2019 — added a correlation chart]
Greg Whyte, an Analyst of Morgan Stanley once said, “REITs smell like real estate, look like bonds and walk like equity”.
Since a REIT runs a business on real estate and its incomes must be directly from real estate rental incomes, it is tenable to argue that it performs like direct real estate. However, as it is stipulated by laws to distribute a fixed high proportion (say 90% in Hong Kong) of its income to the shareholders, it works like a bond, even though a REIT is not a debt instrument. Lastly, as a REIT is traded in a stock exchange market, it has been found to perform like a stock of real estate operating company (REOC).
Let’s check it one by one in Hong Kong:
- Whether a REIT performs like a REOC stock?
Figure 1 below shows the annual rates of return of a REIT and a REOC, they seem to track each other quite closely.
If we compare the past 12-month monthly rates of return of the two, the similarity and differences between the two would be clearly depicted (Figure 2). They are closely tracking each other. The average monthly rates of return and the standard deviations of the REITs and the REOC are of 2.6% and 0.04% (both positive returns, but REIT’s return was much higher) and 4.5% and 5.5% (both of similar magnitude) respectively.
Figure 3 however shows the scatter plot of the rates of return of the REIT vs the REOC and the best fit line. Both the correlation coefficient of 52% and the R-squared of 27% are not really high. Of course, it may simply due to the peculiarities of these particular 2 companies in the past 12-month performance, and they do not represent the peers. For example, it is reported the yield rates of the REIT and the REOC were much lower than its peers average (2.80% vs 5.65%) and (3.48% vs 4.59%) (data from AASTOCS ).
2. Whether a REIT performs like Direct Real Estate Investment?
If we compare the monthly rate of return of a REIT focused on retail and the overall retail property price index of the DRE market in Hong Kong, the REIT’s volatility is much higher than the direct real estate market, as shown in Figure 4. The average monthly rates of return of the REIT and the DRE are 2.2% and 0.2% respectively in the period, and their standard deviations are 3.9% and 0.5% respectively.
3. Whether a REIT performs like a Bond?
If we compare the monthly rate of return of a REIT and a Government Bond in Hong Kong, the REIT’s volatility is much higher than the Government Bond, as shown in Figure 4. The average monthly rates of return of the REIT and the Bond are 2.2% and -0.2% respectively in the period, and their standard deviations are 3.9% and 0.3% respectively.
As a casual check, REIT’s performance seems to come closer to REOC’s rather than that of a Bond or Direct Real Estate in Hong Kong. It may reflect the fact that investors take REITs as an investment of a public real estate operating company (REOC). Yet, since it is not a robust empirical study and the time series are relatively short, the findings cannot make any conclusions.
- Yahoo Finance (2019) Historical Data of Stocks, retrieved on Feb 22. https://finance.yahoo.com/quote/0016.HK/history?p=0012.HK
- Rating and Valuation Department (2019) Retail Price Index, retrieved on Feb 22. https://www.rvd.gov.hk/en/property_market_statistics/index.html
- HKSAR Government (2019) Government Bonds Prices and Yields, retrieved on Feb 22. https://www.hkgb.gov.hk/en/statistics/closing.html
- AASTOCS (2019) Dividend History, retrieved on Feb 23. http://www.aastocks.com/en/stocks/analysis/company-fundamental/dividend-history?symbol=00016