Quality in the Selection of REITs

16 Pages Posted: 16 May 2019

See all articles by Bill Hughes

Bill Hughes

Colony Capital, Inc.

Sean Kedrowski

Colony Capital, Inc.

Farouk Jivraj

Fidelity Investments, Inc. - Fidelity Management & Research; Imperial College Business School

Andrew Abramczyk

Barclays Investment Bank

Date Written: March 6, 2019

Abstract

Quality real estate has historically offered an attractive return, but that return sits behind high barriers to entry. Physical property is costly to own and illiquid to trade. Publicly listed real estate investment trusts (REITs) were conceived as a means for shareholders to own property in a more divisible and tradable way. Over time, REIT shares have grown into a more than trillion dollar market. Historically, REIT shares have tracked long term real estate returns while also outperforming the stock market. They have combined bond-like regular payouts with the capital appreciation aspects of ordinary stocks. As such, they offer a long-term diversification benefit versus other traditional asset classes. However, REIT investing comes with two specific risk characteristics. One: an asymmetric risk profile, i.e. stable revenue and an absence of windfall profit possibilities limit the reward for taking incremental risk. Two: a high debt burden relative to companies in other sectors.

In this paper, we investigate quality-based characteristics that can improve the risk-return profile of REIT investing. Specifically, we study portfolios of REITs formed based on four characteristics: profitability, leverage, valuation and yield. We find that a portfolio that removes low quality REITs has historically outperformed the broad REIT benchmark. We highlight an approach of using these four characteristics to build a broad, statistically robust REIT portfolio, with each characteristic being additive to the REIT selection process. Importantly, the approach is based on fundamental real estate investment principles.

Keywords: Real Estate Investment Trusts (REITs), Quality Factor, Smart Beta

JEL Classification: G12, R30

Suggested Citation

Hughes, Bill and Kedrowski, Sean and Jivraj, Farouk and Abramczyk, Andrew, Quality in the Selection of REITs (March 6, 2019). Available at SSRN: https://ssrn.com/abstract=3351781 or http://dx.doi.org/10.2139/ssrn.3351781

Bill Hughes

Colony Capital, Inc. ( email )

515 South Flower Street
44th Floor
Lots Angeles, CA 90071
United States

Sean Kedrowski

Colony Capital, Inc. ( email )

515 South Flower Street
44th Floor
Lots Angeles, CA 90071
United States

Farouk Jivraj (Contact Author)

Fidelity Investments, Inc. - Fidelity Management & Research ( email )

1 St. Martins Le Grand
London, EC1A 4AS
United Kingdom

Imperial College Business School ( email )

South Kensington campus
London, SW7 2AZ
United Kingdom

Andrew Abramczyk

Barclays Investment Bank ( email )

5 The North Colonnade
London, Canary Wharf E14 4BB
United Kingdom

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