The macroeconomic forces that drive REIT returns in Australia

Real Estate Investment Trusts (REITs) represent a viable alternative to direct property investments. They offer enhanced liquidity and risk diversification. In addition, the securitisation process provides a level of governance not typically offered in direct property markets. However, as an openly traded security, it experiences risk exposures inherent to equities such as interest rate risk, default risk, inflation and so on. This study explores the nature and magnitude of various macroeconomic risk factors that drive REIT performance. Utilising data from the Australian market over a 20 year period spanning multiple economic cycles, REITs were found to have an adverse relationship to unexpected inflation and default risk suggesting that REITs are not an effective hedge against inflation. On the other hand, increasing spreads in the yield curve and changes to expected inflation and were found to correlate positively with fund performance. The latter effect possibly being due to higher expected rents. These effects are greater for highly leveraged funds and those that adopt a stapled trust structure. This is expected given their greater reliance on debt and the wider set of operating activities which compound exposures to market and financial risk. These funds also exhibited a greater overall exposure to market risk. Size risk was also considered with small cap funds exhibiting greater exposure to the risk factors than medium and large funds. The practical implications for asset allocation strategies is that portfolio managers and other investors seeking to take a long position may select highly leveraged funds with a stapled trust structure operating in a low interest environmental with higher expected inflation; whole those wishing to adopt a more defensive stance may consider less heavily geared funds with external management.