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Real Estate for the Long Term: The Effect of Return Predictability on Long-Horizon Allocations

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  • Gregory H. MacKinnon
  • Ashraf Al Zaman
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    Abstract

    We examine how the predictability of real estate returns affects the risk of, and optimal allocations to, real estate for investors of differing investment horizons. Returns to direct real estate are mean reverting, and risk decreases with horizon. This is driven by a tendency for property transaction prices to overshoot inflation. Mean reversion in real estate returns is weaker than that of equities, resulting in real estate having similar risk to equities for long-term investors. However, optimal portfolios have large allocations to direct real estate at all horizons, and the allocation increases with horizon. Finally, we find that real estate investment trusts are a redundant asset class for investors with access to direct real estate as an asset class, but they do have a role in optimal allocations when direct property investment is not feasible. Copyright (c) 2009 American Real Estate and Urban Economics Association.

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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1540-6229.2009.00237.x
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    Article provided by American Real Estate and Urban Economics Association in its journal Real Estate Economics.

    Volume (Year): 37 (2009)
    Issue (Month): 1 ()
    Pages: 117-153

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    Handle: RePEc:bla:reesec:v:37:y:2009:i:1:p:117-153
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    1. Mei, Jianping & Liu, Crocker H, 1994. "The Predictability of Real Estate Returns and Market Timing," The Journal of Real Estate Finance and Economics, Springer, vol. 8(2), pages 115-135, March.
    2. Clayton, Jim & MacKinnon, Greg, 2003. "The Relative Importance of Stock, Bond and Real Estate Factors in Explaining REIT Returns," The Journal of Real Estate Finance and Economics, Springer, vol. 27(1), pages 39-60, July.
    3. Campbell, John Y. & Chan, Yeung Lewis & Viceira, Luis M., 2003. "A multivariate model of strategic asset allocation," Journal of Financial Economics, Elsevier, vol. 67(1), pages 41-80, January.
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    5. Liu, Crocker H & Mei, Jianping, 1992. "The Predictability of Returns on Equity REITs and Their Co-movement with Other Assets," The Journal of Real Estate Finance and Economics, Springer, vol. 5(4), pages 401-418, December.
    6. Timothy J. Riddiough & Mark Moriarty & P.J. Yeatman, 2005. "Privately Versus Publicly Held Asset Investment Performance," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 33(1), pages 121-146, 03.
    7. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    8. David Collett & Colin Lizieri & Charles Ward, 2003. "Timing and the Holding Periods of Institutional Real Estate," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 31(2), pages 205-222, 06.
    9. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2007. "Investing for the Long-run in European Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 34(1), pages 35-80, January.
    10. Ling, David C & Naranjo, Andy & Ryngaert, Michael D, 2000. "The Predictability of Equity REIT Returns: Time Variation and Economic Significance," The Journal of Real Estate Finance and Economics, Springer, vol. 20(2), pages 117-136, March.
    11. Kandel, Shmuel & Stambaugh, Robert F, 1996. " On the Predictability of Stock Returns: An Asset-Allocation Perspective," Journal of Finance, American Finance Association, vol. 51(2), pages 385-424, June.
    12. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
    13. Gregory H. Chun & J. Sa-Aadu & James D. Shilling, 2004. "The Role of Real Estate in an Institutional Investor's Portfolio Revisited," The Journal of Real Estate Finance and Economics, Springer, vol. 29(3), pages 295-320, November.
    14. Hoevenaars, Roy P.M.M. & Molenaar, Roderick D.J. & Schotman, Peter C. & Steenkamp, Tom B.M., 2008. "Strategic asset allocation with liabilities: Beyond stocks and bonds," Journal of Economic Dynamics and Control, Elsevier, vol. 32(9), pages 2939-2970, September.
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    Cited by:

    1. Hoesli, Martin & Oikarinen, Elias, 2012. "Are REITs real estate? Evidence from international sector level data," Journal of International Money and Finance, Elsevier, vol. 31(7), pages 1823-1850.
    2. William Mingyan Cheung & James Chicheong Lei & Desmond Tsang, 2016. "Does Property Transaction Matter in the Price Discovery of Real Estate Markets?," International Real Estate Review, Asian Real Estate Society, vol. 19(1), pages 27-49.
    3. Nazlioglu, Saban & Gormus, N. Alper & Soytas, Uğur, 2016. "Oil prices and real estate investment trusts (REITs): Gradual-shift causality and volatility transmission analysis," Energy Economics, Elsevier, vol. 60(C), pages 168-175.
    4. David Ho & Kwame Addae-Dapaah & John Glascock, 2015. "International Direct Real Estate Risk Premiums in a Multi-Factor Estimation Model," The Journal of Real Estate Finance and Economics, Springer, vol. 51(1), pages 52-85, July.
    5. Ghysels, Eric & Plazzi, Alberto & Valkanov, Rossen & Torous, Walter, 2013. "Forecasting Real Estate Prices," Handbook of Economic Forecasting, Elsevier.
    6. Radu Tunaru, 2015. "Model Risk in Financial Markets:From Financial Engineering to Risk Management," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 9524, July.
    7. Sum, Vichet, 2014. "Dynamic effects of financial stress on the U.S. real estate market performance," Journal of Economics and Business, Elsevier, vol. 75(C), pages 80-92.
    8. Ranajit Kumar Bairagi, 2012. "The direct costs of raising external equity capital for US REIT IPOs," Journal of Property Investment & Finance, Emerald Group Publishing, vol. 30(6), pages 538-562, September.
    9. S. Price & Dean Gatzlaff & C. Sirmans, 2012. "Information Uncertainty and the Post-Earnings-Announcement Drift Anomaly: Insights from REITs," The Journal of Real Estate Finance and Economics, Springer, vol. 44(1), pages 250-274, January.
    10. Christian Rehring, 2012. "Real Estate in a Mixed‐Asset Portfolio: The Role of the Investment Horizon," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 40(1), pages 65-95, 03.
    11. Carolina Fugazza & Massimo Guidolin & Giovanna Nicodano, 2010. "1/N and long run optimal portfolios: results for mixed asset menus," Working Papers 2010-003, Federal Reserve Bank of St. Louis.
    12. Walter Boudry & N. Coulson & Jarl Kallberg & Crocker Liu, 2013. "On Indexing Commercial Real Estate Properties and Portfolios," The Journal of Real Estate Finance and Economics, Springer, vol. 47(4), pages 617-639, November.
    13. Ranajit Kumar Bairagi & William Dimovski, 2010. "The underpricing of US REIT IPOs: 1996--2010," Journal of Property Research, Taylor & Francis Journals, vol. 28(3), pages 233-248, December.
    14. Paul M Anglin & Yanmin Gao, 2011. "Integrating Illiquid Assets into the Portfolio Decision Process," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 39(2), pages 277-311, 06.
    15. Caporale, Guglielmo Maria & Sousa, Ricardo M., 2016. "Consumption, wealth, stock and housing returns: Evidence from emerging markets," Research in International Business and Finance, Elsevier, vol. 36(C), pages 562-578.
    16. Martin Hoesli & Kustrim Reka, 2013. "Volatility Spillovers, Comovements and Contagion in Securitized Real Estate Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 47(1), pages 1-35, July.
    17. Mingyan Cheung & Chicheong Lei, 2014. "Does Property Transaction Matter in Price Discovery in Real Estate Markets? Evidence from International Firm Level Data," ERES eres2014_195, European Real Estate Society (ERES).
    18. Daniele Bianchi & Massimo Guidolin, 2014. "Can Linear Predictability Models Time Bull and Bear Real Estate Markets? Out-of-Sample Evidence from REIT Portfolios," The Journal of Real Estate Finance and Economics, Springer, vol. 49(1), pages 116-164, July.
    19. Muhammad Najib Razali, 2011. "Portfolio Optimisation Model for Malaysian Property Market," ERES eres2011_131, European Real Estate Society (ERES).

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