Real estate investment trusts have outperformed property investments since pension funds were allowed to invest in REITs in 1994 — but REITs are riskier than real estate, according to research by the Pension Real Estate Association.
And even though a dollar invested in REITs in 1994 produced more income than a dollar invested in property, equity real estate outperformed when returns were adjusted for the added risk, the research paper stated.
“REITs had higher returns, but higher volatility,” Greg MacKinnon, director of research, said in an interview.
PREA, Hartford, Conn., used returns of the FTSE/NAREIT Equity REIT indexes vs. returns of private real estate as measured by the MIT Center for Real Estate's Transaction Based Index for its research.
According to the research, REIT returns have bested equity real estate returns by 159 basis points per year between the second quarter of 1994 and the second quarter of 2010.
However, REIT volatility reduces returns, Mr. MacKinnon said. The average REIT return per quarter of the study period was 3.14%, but the volatility of returns was 11.37%.
For equity real estate, the average return per quarter was 2.13%, while the volatility of returns was 3.58%, Mr. MacKinnon said.
The Sharpe measure, which represents the excess return earned per unit of volatility, was 0.35 for private real estate but 0.20 for REITs, according to the paper.
And dashing a widely held belief, Mr. MacKinnon said, PREA's research showed REITs are not a proxy for equity real estate.
According to the paper, REITs are more closely related to equities, corporate bonds and hedge funds than they are to equity real estate.
Transparency and liquidity do make REITs look better, he said.
“One argument is that there is more volatility in the short run, but in the long run that all washes out ...” Mr. MacKinnon said. “But keep in mind as soon as you say you are worried about liquidity, you are thinking there is some chance you will sell on short notice, which is to say that you should worry about short-term volatility.”
But the folks at the National Association of Real Estate Investment Trusts beg to differ. They say not only do REITs outperform equity real estate investments, but they also are safer.