Did Specialised REITs outperform Diversified REITs during the Credit Crunch? Evidence from the UK ERES 2013 Annual Conference, Vienna Austria Prepared by Leonard D. Lin Leonard Lin MRICS,

This research looks at the return and risk characteristics of the Diversified and Specialised REITs during the Credit Crunch (Source: Bloomberg). The methods circulate multiple factor, Sharpe Ratio, Treynor & Jenson’s Alpha, portfolio construction (value weighted and equal weighted), and efficient frontier modelling. The hypothesis: the Specialised REITs can perform better than the Diversified counterpart during the Credit Crunch. Acknowlements: Professor Tony Key, Mr Stephen Lee and Dr Fotis Mouzakis (supervisor) for giving me the inspiration, support and guidance to complete this paper in September 2011, forming part of the requirement for MSc Real Estate at Cass Business School, City University London. ABSTRACT & ACKNOWLEDGEMENT Leonard Lin MRICS,

“Focus” and “Value” are being debated, diversification across property types adversely affects value, not necessarily mean “under performance” (Capozza & Seguin 1999). 75 US REITs data from 1985 to Motivations behind this shift (Geltner & Miller 2001): Management speciality and cost efficiency can be better achieved by the Specialised REITs. Investors make their own portfolio diversification decisions mixing Specialised REITs. For analysts and stock markets, the Specialised REITs are easier to understand and analyse. The UK is relatively young in the development of REITs as the UK REIT Legislation has only come in force on January 1st, In this instance, the scope of the UK REITs surveyed in this research is comprised of 21 REITs (Source: Bloomberg). INTRODUCTION & BACKGROUND Leonard Lin MRICS,

Key past studies: Benefield et al. 2009: 75 US REITs, 1995 – 2006, Diversified REITs did better when the economy/market did well Limited evidence that Specialised REITs would have performed better in the recession periods Ro & Ziobrowski 2009: 100+ US REITs, 1997 – 2006, Diverisfied REITs did better, Specialised REITs have higher market risk Lee & Stevenson 2005: 144 UK observations (not REITs) 1987 – 1998, Diversified funds have superior performance Focused on real estate funds in the UK– “within a region” versus “cross region” Eichholtz et al. 1995: US data 1983 – 1992, retail has more diversification potential across regions than within regions UK data 1977 – 1993, the results suggest full diversification, across property types and regions would be best Investigated the real estate portfolio(s) from “one type in one region”, to “mixed types in one region”, to “mixed types in multiple regions” Retail property investments, diversification across regions is more effective, but US and UK results vary. None of these studies were primarily focusing on the Specialised REITs’ performance in the Recessions. This research takes a closer look at the Specialised REITs’ performance against the Diversified REITs from 2007 to AIM & RESEARCH Leonard Lin MRICS,

Defining a Specialised REIT: a REIT is comprised of 75% of the same property type ( Benefield et al. 2009) Return Data (Jan 2007 – Dec 2011): weekly returns. It has been demonstrated that shorter time periods can be just effective in performance rating (Grinblatt & Titman 1989). Chen & Peiser (1999): Diversified REITs performed poorly compared to the most of the Specialised REITs, by monthly return data from 1993 to Using simple statistical ranking tools such as Mean returns, Standard deviations, correlations and value weighted index Performance ranking methods of Sharpe, Treynor and Jensen’s Alpha Constructing and comparing portfolio performance – Value weighted & equal weighted LITERATURE & METHOLODOGIES Leonard Lin MRICS,

23 REITs on the REITA’s list of UK REITs (REITA.ORG 2011). REITA describes, rather than classifies the sectors that the REITs invest in with terms – diversified, self storage, retail, offices, industrial, residential, and health care. Bloomberg records 21 REITs with return series (Bloomberg 2011). Bloomberg uses classifications more consistently – diversified, storage, office property, warehouse/industrial, retail and health care. The two classify REITs inconsistently. There are 10 conflicted labels after the author cross- referenced the two major sources (see the REIT Classification table below). CLASSIFING REITS Leonard Lin MRICS,

In summary, out of the 21 REITs, there are 10 diversified REITs and 11 specialised REITs. *In this research, a REIT will be labelled as a “specialised” REIT if it is comprised of 75% or more of the same property type with its portfolio, for more than half of the sample period (Benefield et al. 2009). REIT RE-CLASSIFICATION Leonard Lin MRICS,

STATISTICS OVERVIEW REITs portfolios and REIT Indices are conducted on market value & equal weighted basis. On value weighted basis, the Diversified REITs did marginally better with a higher return and a lower standard deviation. On equal weighted basis, the Diversified REITs return is the least attractive, comparing to all REITs. Leonard Lin MRICS,

The finding indicates that the FTSE EPRA/NAREIT UK REIT Index performs more closely to FTSE Small Cap Index with a positive correlation of This is in line with Lee’s view – REITs performing like small caps (Lee 2011a). FTSE EPRA/NAREIT UK REIT INDEX Leonard Lin MRICS,

The correlation statistics show that the Specialised REITs perform more closely and share more systematic risk with the FTSE Small Cap Index, with a positive correlation of CORRELATION MATRICS Leonard Lin MRICS,

The historical monthly returns chart shows some observations of the Specialised REITs especially in the downside periods between Year 2007 and Specialised REITs index was volatile than the counterpart Diversified REITs index in some periods. HISTORICAL VALUE WEIGHTED MONTHLY RETURNS Leonard Lin MRICS,

PORTFOLIO CONSTRUCTION Only six (6) diversified REITs have the yearly break down of the property-type components. These REITs are used to construct the Diversified REIT portfolio. British Land, Land Securities and Hammerson REITs are larger than the other three REITs included in the portfolio. To compensate for the larger REITs in the portfolio, a diversified REITs portfolio on an equal-weighted basis is constructed. Leonard Lin MRICS, Pie chart shows the composition of the six (6) Diversified REITs in terms of the combined market capitalisation.

PORTFOLIO CONSTRUCTION (VALUE- WEIGHTED) Diversified REITs are aggregated and weighted by market capitalisation within a portfolio for the calculation of the sector proportions, i.e. diversifications. The portfolio is then constructed to match the diversified sector weights. The proportions of the Offices, Retail, Industrial and Others within the diversified REIT portfolio are 37%, 48%, 1% and 14% respectively. Leonard Lin MRICS,

PORTFOLIO CONSTRUCTION (EQUAL- WEIGHTED) Under the equal-weighted basis, the retail component drops 20%, whilst the industrial component increases to 20%. The office component stays much the same in both the value- weighted and equal-weighted basis. The proportions of the Offices, Retail, Industrial and Others within the diversified REIT portfolio are 36%, 33%, 20% and 11% respectively. Leonard Lin MRICS,

The sample of the returns and standard deviations are all calculated for the time period commencing January 2007 (ending July 2011), with fifty- three (53) months of monthly return data. PORTFOLIO PERFORMANCE RESULTS As the results from the efficient frontier suggest, the performance of the diversified REITs and specialised REITs under the value-weighted basis is of only a marginal difference. At a similar level of the monthly return, the specialised REITs portfolio produces the return with less volatility. The specialised REITs portfolio under the equal-weighted construction produces a better mean return at a similar level of the volatility. Portfolio Performance Summary Leonard Lin MRICS,

TREYNOR & JENSON’S ALPHA RATIOS Treynor and Jensen measures take into account of the correlation between the market index (FTSE Small Cap index) and the respective REIT’s return. Overall, the Specialised REITs outperform the Diversified REITs by showing better average fund managers’ management abilities and by showing better average fund managers’ forecasting abilities. Portfolio Performance Summary Leonard Lin MRICS, Period 2007 – 2011, UK REITs

REGRESSION ANALYSIS Leonard Lin MRICS,

RETURN DATA TESTED Leonard Lin MRICS, Only 8 REITs which their monthly return data pass the normality, heteroskedasticity and autocorrelation tests. *It appears that the REITs that have higher leverage (DEBT) ratio also have the non normal return data.

REGRESSION ANALYSIS Summary Statistics for Variables Leonard Lin MRICS, AGE: Majority of the REITs commenced since January 2007 with few exceptions of REITS started in mid or late 2009 or SIZE: each REIT is given a rating proportionately (the market cap of the REIT over the entire REIT market cap) DEBT: based on the total debt / total asset ratio provided by Bloomberg (3 year average) EFFIG: Management efficiency measured by the operating expenses over the total assets (3 year average) DIV: dummy variable, “1” rewarded for a Diversified REIT OFF: dummy variable, “1” rewarded for an Office REIT RETAIL: dummy variable, “1” rewarded for a Retail REIT IND: dummy variable, “1” rewarded for an Industrial REIT HEALTH: dummy variable, “1” rewarded for a Healthcare REIT STORAGE: dummy variable, “1” rewarded for a Storage REIT UK: dummy variable, “1” rewarded for REITs investing in the UK EURO: dummy variable, “1” rewarded for REITs investing in Europe GLO: dummy variable, “1” rewarded for REITs investing anywhere outside of the UK and Europe Variables

SHARPE RATIOS VS FUND CHARACTERISTICS Leonard Lin MRICS, All possible models tested & consideredBest outcome with five (5) variables

The best outcome is displayed in Table 7 with five (5) variables – DIV, OFF, RETAIL, IND and EURO. An average VIF of 2.43 is achieved, indicating the multicollinearity problem is being attended and minimised. In addition, the R-squared is and the Adjusted R- squared is indicting that these variables individually or combined are significantly related to the excess return performance. The outcome suggests that over the last three (3) years, the property type specialised REITs (namely the Office and Retail Sectors) and regional diversified REITs (namely the REITs which invest in Germany, France, etc) produce higher risk-adjusted performance. REGRESSION RESULTS Leonard Lin MRICS,

SUMMARY The Specialised REITs track the market more closely. The Diversified REIT had a low return, comparing to all other REITs. The Specialised REITs portfolio under the equal-weighted portfolio construction produces a better mean return at a similar level of the volatility, than the Diversified REITs portfolio. The Office REITs and Retail REITs produce significant impact on the risk-adjusted performance. In conclusion, the hypothesis that the Specialised REITs can perform better than the Diversified counterpart during the Credit Crunch is supported. Leonard Lin MRICS,

Thank you Leonard Lin Chartered Surveyor Leonard Lin MRICS,