Real Estate Investment Trusts: An Industry Analysis With A Special Focus On Recessions and COVID-19

Bergur Løkke Rasmussen & Alessandro Daffré

Student thesis: Master thesis


Since their creation in 1960, Real Estate Investment Trusts have experienced a long and troublesome development. It was not until the late 1990s that REITs received the essential adjustments that made them the unique and valuable investment vehicle that they are today. With the REIT Modernization Act in 1999, the modern REIT was born. Therefore, the last twenty years provides the most significant time period for the analysis of REITs.
REITs are subjected to several regulations that safeguard the philosophy behind them. With the development of REITs, small investors were provided with the opportunity to invest in real estate. The regulations require that REITs’ real properties account for at least 75% of their taxable income. In addition, REITs are pass-through investment vehicles and are thus required to distribute at least 90% of their taxable income to shareholders through dividends. Because of these unique requirements, REITs exhibit certain characteristics. With a majority of REIT investments being in hard assets, REITs show a high potential for portfolio diversification in the form of low correlation to other asset types. The total return provided by REITs include, due to high dividend payout requirements, a significant income return that historically has provided superior inflation protection compared to other asset classes. Depending on the average lease-terms and the nature of the underlying property assets, different REIT sectors show significantly different volatilities. For example, short average-lease terms, high portfolio rollover and cyclical property types will result in higher volatility.
We analyzed the performance of REITs in the last twenty years and found that short term holdings of REITs have performed worse than other assets and major indices. However, extending the timeframe to the whole twenty year period, we find that REITs show greater total returns than all other assets in the long run. Adjusting the total returns for asset volatility, REITs demonstrate the second best risk-adjusted return among all asset classes considered. Segregating the analysis into various REIT sectors, this paper finds that these vary significantly in fundamentals, but in general follow the same trends as the industry in general. Since some types of REITs are more cyclical, we found that different REIT sectors have varying volatility in the short term, but in the long term show positive performance. Furthermore, the study found that tech-related REITs currently perform significantly better than the industry average. We conclude that this is due to the technological development continuing regardless of economic cycles.
After analysing the macroeconomic factors that relate to REITs, this study arrived at five main conclusions: (1) Rising unemployment rate and low GDP expectations have a crucial impact on the overall industry. (2) Demographic structure is a valuable indicator of performance for certain REIT sectors. (3) Interest rate movements negatively affect REIT prices in the short term. (4) REITs demonstrate a consistent inflation hedge over time. (5) Average lease term and portfolio rollover are precious indicators for the sensitivity of REITs to market fundamentals.
Furthermore, the study explored the four main interactions between fundamental drivers and REITs: (1) Treasury bond yields serve as effective indicators for REIT performance. Findings showed a strong negative correlation between 10-year Treasury yields and REIT stock prices. (2) The importance of NOI growth in REIT valuation. (3) Corporate bond yields and corporate bond yield spread are negatively correlated with REIT cash flow multiples. (4) Low leverage ratios and high debt cover ratios help REIT management to maintain a high level of financial flexibility.
Through an analysis on REITs and the performance of various REIT sectors during recessions, this study found that, although recessions are unique, they share three main factors that provide a framework for understanding different situations. By analysing the (1) type of recession, (2) macroeconomic elements and (3) REIT fundamentals, a more holistic understanding of certain economic situations can be achieved. The study found that, overall, REITs perform worse than other assets in the short term. However, when including the period of recovery, REITs perform much better than other types of assets in times of recession. This is due to their underlying hard assets and the significant income component. Through the lense of historical recessions, the study attempted to understand REITs in the current COVID-19 crisis. The findings were in line with the expectations and showed that REITs currently perform the second worst of the major indices in the analysis. Both in the previous recessions and during the current COVID-19 crisis, the study found that tech-related REITs show above average total returns compared to other REIT sectors.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2020
Number of pages131
SupervisorsJens Lunde