Linkages Between Direct and Indirect Real Estate Returns

Contemporaneous correlation between the returns of direct and indirect real estate investments is generally found to be weak. However, direct and securitized real estate returns are expected to be cointegrated over the long run, since securitized real estate returns are derived from direct real estate assets. Cointegration between direct and indirect return indices implies that the correlation between the returns converges to one as the investment horizon increases. The relative inefficiency of the direct real estate market suggests that securitized real estate prices react faster to shocks in the fundamentals than direct real estate prices. As such, securitized real estate returns are conceived as a leading indicator of direct real estate returns. Nevertheless, the opposite may also hold due to the speculative, nonfundamental related noise embedded in securitized real estate prices in the short run. This paper examines the dynamic relation between direct and indirect real estate returns in the U.S. for the period 1977Q42008Q2. It contributes to the literature by depicting the linkages between direct and indirect real estate returns, as well as by identifying the response speeds and magnitudes of direct and indirect real estate returns to shocks in the market fundamentals. The response speeds are estimated with vector error correction models.