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ERES 2013 Conference

Did Specialised REITs outperform

Diversified REITs during the Credit Crunch?

Evidence from the UK

By Leonard Lin

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Contents

Acknowledgements ................................................................................................... 5

Abstract ..................................................................................................................... 6

Introduction .............................................................................................................. 7

Background........................................................................................................ 7

Aims of the Research Project ............................................................................. 9

Literature Review .................................................................................................... 11

Methodologies ........................................................................................................ 16

Data ........................................................................................................................ 20

Statistics Overview ........................................................................................... 25

Regression Analysis/Results ..................................................................................... 32

Portfolio Comparison Analysis/Results..................................................................... 36

Treynor & Jensen’s Analysis/Results......................................................................... 42

Conclusion ............................................................................................................... 45

References............................................................................................................... 48

Appendix ................................................................................................................. 51

Regression Simulations .................................................................................... 52

Portfolio Comparison ....................................................................................... 53

CD Containing All Excel and Eview 7 files .......................................................... 54

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Tables

Table 1 REIT Classification ........................................................................................ 21

Table 2 Summary Statistics – REITs by Sectors .......................................................... 25

Table 3 Performance Statistics for REITs – Equal Weighted Monthly Figures............. 28

Table 4 Return Data Tests for Normality, Heteroskedasticity and Autocorrelation .... 32

Table 5 Summary Statistics for Variables .................................................................. 33

Table 6 Sharpe Ratios (3 Year Period) ....................................................................... 33

Table 7 Regression Results – Sharpe Ratios versus Fund Characteristics ................... 34

Table 8 Value-weighted annual property type diversification proportion on the basis

of Diversified REITs portfolio .................................................................................... 37

Table 9 Equal-weighted annual property type diversification proportion on the basis

of Diversified REITs portfolio .................................................................................... 39

Table 10 Portfolio Performance Summary ................................................................ 40

Table 11 The Yearly Treynor Ratios & Jensen's Alpha for the UK REITs (Period

2007-2011) .............................................................................................................. 42

Figures

Figure 1 Correlation Matrix for the ELUK, FTSE 100, FTSE 200 and FTSE Small Cap

Indices ..................................................................................................................... 26

Figure 2 Correlation Matrix of Specialised REITs, Diversified REITs and FTSE Small Cap

Indices ..................................................................................................................... 27

Figure 3 Historical Value Weighted Monthly Returns (Specialised REITs versus

Diversified REITs) ..................................................................................................... 28

Figure 4 Average Return and Standard Deviation - Diversified versus Specialised REITs

................................................................................................................................ 29

Figure 5 Average Return and Standard Deviation - REITs by Sectors ......................... 30

Figure 6 Average Return and Beta - REITs by Sectors ................................................ 31

Figure 7 Compositions of Diversified REITs portfolio - average market cap (2007-2011)

................................................................................................................................ 36

Figure 8 Value-weighted Diversified REITs ................................................................ 37

Figure 9 Specialised REITs portfolio using the overall property type proportions of the

value-weighted Diversified REITs in Table 8 .............................................................. 38

Figure 10 Equal-weighted Diversified REITs .............................................................. 39

Figure 11 Specialised REITs portfolio using the overall property type proportions of

the equal-weighted Diversified REITs in Table 9 ....................................................... 40

Figure 12 Treynor Ratios .......................................................................................... 43

Figure 13 Jensen’ Alphas ......................................................................................... 44

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Equations

Equation 1 Sharpe ................................................................................................... 16

Equation 2 Multiple Factor Sharpe Ratio Regression ................................................ 16

Equation 3 Treynor .................................................................................................. 18

Equation 4 Jensen's Alpha ....................................................................................... 19

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Acknowledgements

I would like to thank my lecturers Professor Tony Key and Mr Stephen Lee and my

supervisor Dr Fotis Mouzakis for giving me the necessary inspiration, support and

guidance. It has been such a fantastic journey, exploring different methodologies,

self-learning the techniques and completing the research and analysis independently.

I also would like to thank my beloved wife, B. Hsiang, who has supported,

encouraged and believed in me, since I started in the masters program at Cass

Business School. This research is dedicated to her.

* The research dissertation was originally submitted as part of the requirements for the

award of the MSc in Real Estate program, Cass Business School, City University London

(September 2011). The original title for this research project was “Do the property type

Specialised REITs outperform the property type Diversified REITs in the UK?”.

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Abstract

This study looks at the return and risk characteristics of the Diversified and

Specialised REITs in the UK over the last four and half years commencing January

2007. The methodologies used in this study incorporate some simple statistic tools,

multiple factor Sharpe ratio regression, and portfolio construction and use of

efficient frontier models.

In summary, the hypothesis that the Specialised REITs can perform better than the

Diversified counterpart during the credit crunch can be supported. The Diversified

REITs show a moderate return with lower level of volatility. However, the

Specialised REITs track the market more closely.

The Office REITs and Retail REITs produce significant impact on the risk-adjusted

performance. 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.

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Introduction

Background

Real estate investment trusts (REITs) were originally created by the U.S. Congress in

1960 for the purpose of providing small investors an opportunity to invest in real

estate assets and enjoying the same benefits that shareholders have in investment

trusts (Chan et al. 2003). Australia has a similar vehicle established and named

“Listed Property Trust” since 1970’s.

REITs have not been used or invested commonly by institutional investors in the US

until the introduction of the 1993 Revenue Reconciliation Act, where the restriction

of “no more than 50% of a REIT’s stock could be owned by five or fewer persons” was

lifted (Lee 2011a). With the REITs main advantages (tax transparency and liquidity),

it has progressively reached many mature and emerging markets and countries.

There are twenty-one countries that have already established REIT regimes and

approximately six or seven countries that are considering introducing the

establishment of the REITs.

There are three types of REITs in the market (Lee 2011a). Equity REITs invest

directly into real estate, and make returns from rents and property sales, with a debt

level at or around 35%. Mortgage REITs are portfolios of real estate loans with

loan-to-value ratios from 70% to 100%. Hybrid REITs are a mix of the Equity REITs

and Mortgage REITs. Lee further commented that the Equity REITs are being

identified as an effective real estate investment vehicle and representing 90% of the

REIT market. The use of a pure equity REIT sample has become the standard in

more recent years, as a way to reduce potential statistical bias such as

heteroskedasticity (Benefield et al. 2009).

There was also a noticeable shift from property type diversified REITs to property

type specialised (focused or pure-play) REITs in the US. It was found that

property-type diversification increases both property-level cash flows and general

and administrative expenses (including borrowing costs) and decreases liquidity

(Capozza & Seguin 1999).

There are several motivations behind this shift (Geltner & Miller 2001). It was

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suggested that management speciality and cost efficiency can be better achieved by

the specialised REITs. Investors refer to make their own portfolio diversification

decisions with the specialised REITs. From the analysts’ and stock markets’ point of

views, the specialised REITs with one or fewer market segments 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, 2007. To qualify as a REIT in the UK context,

there are a number of structure, activity, asset and income conditions to be met. A

UK REIT should be property rental business, with conditions such as that at least 75%

of its assets must be related to property rental business, and at least 75% of its

accounting profits must be related to property rental business (Deloitte 2010). A

REIT is to be a tax resident in the UK only, a closed-ended company, and listed on a

recongised stock exchange. A REIT must hold at least three properties (no single

property can exceed 40% of the total value of the properties), and must distribute

90% or more of its tax exempt income profit as dividends. If only these conditions

are satisfied, then the REIT will remain in the UK REIT Regime.

According to British Property Federation, there are twenty-three REITs being

recorded on the REITA’s list of UK REITs (REITA.ORG 2011). According to Bloomberg,

there are twenty-two REITs in the UK stock exchange, however, at the time of

conducting this research, there are only twenty-one REITs return data series being

made available on Bloomberg with a market capitalisation of approximately £27.36

billion GBP (Bloomberg 2011). In this instance, the UK REITs to be studied in this

research will be limited to these twenty-one REITs on Bloomberg.

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Aims of the Research Project

The REIT model is slightly different in each country depending on their legal

framework, taxation and reporting structures. REIT has progressively become a

global brand (Rodney 2011). REITs play a role in mixed asset portfolios, in real

estate markets, as well as in the capital market globally.

This research will explore the returns and risks characteristics that the specialised

REITs can offer to the general investors and institutional portfolio investors, in the

time of the credit crunch. The hypothesis is that the Specialised REITs can perform

better than the Diversified counterpart during the credit crunch.

The mainstream corporate finance literatures suggest that diversified investment

vehicles trade at a discount, in comparison to the competing specialised investment

vehicles in the US market (Benefield et al. 2009). The authors tested their

hypothesis based on 75 equity REITs (mixture of specialised and property type

diversified REITs) in the US, between 1995 and 2006. Surprisingly, the authors

found that the property type diversified REITs are better performers, when the

overall economy and market conditions were performing well.

They further addressed that there is very limited evidence that the specialised REITs

would have performed better in the recession period(s). This opens a door of

opportunity for further research on whether the specialised REITs would outperform

the property type diversified REITs in the recessions.

Ro & Ziobrowski also investigated if the specialised REITs outperform property type

diversified REITS, and further compared the performance of specialised versus

diversified REIT portfolios, in the US, between 1997 and 2006 (Ro & Ziobrowski

2009).

They found that diversified REITs outperformed specialised REITs, and the specialised

REITs have higher market risk than diversified REITs. However, the element of the

specialised REITs’ performance was not addressed in the research.

A similar research and discussion were carried out in the UK. The discussion was on

real estate funds, and was on whether it is better to diversify the real estate funds by

a property type across regions or within a region across all the property types (Lee &

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Stevenson 2005). The authors also supported that the funds should be diversified

immediately, as the performance were indeed superior, comparing to the specialised

real estate funds.

Eichholtz attempted to investigate whether there was a benefit to develop the real

estate portfolio(s) from “one property type in one region” to “mixed property types

in one region” or to “mixed property types in multiple regions”. The data was

drawn from both the US and the UK (Eichholtz et al. 1995). The results showed the

nations behave quite differently to the composition of the portfolios. Again the

focuses were more on the population, scale of economy and characters of cities,

rather than performance of these portfolios in economy recessions or booms.

In summary, however, none were primarily focusing on the specialised REITs’

performance in the recessions. This research offers a closer look at the specialised

REITs’ performance against the property type diversified REITs in the recession or so

called “the credit crunch”, between 2007 and 2011.

The reminder of the study will proceed as follows: Section 2 provides relevant

literature reviews. Section 3 provides the methodologies in detail with formulas.

Section 4 provides the data and preliminary statistics overview, and Section 5

provides analysis and results, conclusions, limitation and recommendation for future

research.

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Literature Review

The term of property-type specialised REIT refers to a portfolio with no direct

exposure to any other property type. The term is also commonly referred to and

defined as “pure-play REIT” (Geltner & Kluger 1996). The authors used a term

called “Pure-play portfolio”, and further explained that a pure-play portfolio should

represent returns from a specific sector’s investment without any direct exposure to

other sectors. Some REITs may change strategy of holding a specific sector’s

investment depending on their long term or short term positions. The authors then

suggested analysing the exposure of these REITs from their balance sheets

(accounting data) or from their annual valuation (appraisal values). By doing this,

the REITs’ characters can then be quantitatively characterised. Organisations, for

example, REITA, part of the British Property Federation, describes the existing UK

REITs into REITs by sectors or diversified REITs.

Benefield further defined a specialised REIT as a REIT which is comprised of 75% or

more of the same property type with its portfolio (Benefield et al. 2009). In light of

the conflicted classifications or description of diversified and / or specialised adopted

by the REITA and Bloomberg, each REIT used in this study will be analysed and

rebelled based on Benefield’s definition of the “specialised REIT”.

As the UK REITs have only been established since January 2007, a challenge for this

study will be the shorter return data series. In this study, the weekly return data

series will be adopted for the calculations. It has been demonstrated that the use

of shorter time periods can be just effective in performance rating (Grinblatt &

Titman 1989). Return data from shorter time periods was used in the more recent

studies for the purposes of comparing “old” and “new” REITs. It was reported that

property-type diversified REITs performed poorly compared to the most of the

specialised REIT categories by using monthly return data of a sample of REITs

between 1993 and 1997 (Chen & Peiser 1999).

This study will firstly use some simple statistical tools to draw a picture of what

happened for REITs over the sample period. These statistics include the mean

returns, standard deviations, correlations and the use of market value weighted

index for a close comparison of the performance of “specialised” and “diversified”

REITS. Chen & Peiser (1999) used some simple methods to compare the “new” and

“old” REITs and found the “new” REITs exhibited higher returns.

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This study will then employ the performance ranking methodologies of Sharpe,

Treynor and Jensen’ Alpha, and further draw comparison of the performance of the

diversified and specialised REITs in the stock market, as part of this proposed

research.

Sharpe (1966) adopted a Capital Market model that generates predictions of the

future (in Sharpe’s paper, present data was adopted, instead) performance and risk

of the mutual funds. The author tested on a sample of 34 open-end mutual funds

in the period of 1954 – 1963. It was testing the measure of the net performance

(gross yield less management expenses) which the annual rate of return included the

sum of dividend payments, capital gain distributions and changes in net asset value.

The author then rated the performance by Reward-to-Variability ratio and the

Treynor Index.

Investors demand and receive higher returns with increased variability, suggesting

that variability and risk are related (Lee 2011b). The concept is that a portfolio

should give a return equal or no less than some minimum hurdle rate of return (risk

free investments in Treasury Bills and alike). The risk free rate from the returns will

be stripped out and the risk premium (the remaining return component) will be then

divided by standard deviation. This standard deviation refers to the measure of

variability of returns (Sharpe 1966). A portfolio’s Sharpe ratio being higher than a

benchmark’s Sharpe ratio or the competitor’s Sharpe ratio means the portfolio

manager has outperformed the benchmark or the competitor.

Morri and Lee (2009) studied the performance of Italian real estate mutual funds.

They use the monthly data for seventeen (17) real estate mutual funds, over a 3 year

period from Year 2005 to 2008 (for the purpose of limiting the survivorship bias).

Elements or factors that can affect the return and risk characteristics of a fund are

being discussed and tested in multiple factor Sharpe ratio regressions. These

elements or factors include, but not limited to, risk (by the indicators of beta or

standard deviation), expenses (testing the management efficiency of the funds or in

the context of managing property operationally), size, fund age, regional and

property-type diversification, and the impact of geographical concentration.

Beta and standard deviation indicators are used widely by the researchers to assess

the performance of the equities. Beta measures the systematic risk of a portfolio

compared to the market (Morri & Lee 2009). Higher the beta means that a fund

tracks the market more closely than a fund with lower beta (Chen & Peiser 1999).

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Standard deviation measures the volatility of the return in relation to its mean return,

including both systematic and unsystematic risks. These indicators will be used in

this study (see the later section).

Expenses that Morri and Lee (2009) used were management efficiency (fund

expenses over total assets) and property management (expenses of operating

properties over the number or total value of the properties). Morri and Lee further

explained a common claim that the fund managers who charge higher fees are more

skilled and able to provide higher investment returns. Expenses will be investigated

in this study as the Bloomberg provides the monthly operating expenses and total

asset value data. The limitation of using this data lies at the composition of the

operating expenses is unknown.

Size is suggested as the most significant variable factor in explaining the risk-adjusted

performance of real estate mutual funds (Lin & Yung 2004). Morri and Lee (2009)

suggested that the large mutual funds have advantages over the small ones such as

the economy of scale (cheaper overhead expenses) and superior bargaining and

negotiation positions (for prime investment opportunities). However, the larger

funds cannot grow perpetually as the investment opportunities are restricted by the

size of the market and the returns will eventually decline. Smaller firms can still

perform but the returns are restricted by the small pools of properties they own. Size

of the UK REITs is available on Bloomberg with level of change of total value on

monthly basis. This data will be used in constructing the market value weighted

Diversified and Specialised indices and in the multiple factor Sharpe ratio regression

model in the later section.

Of particular interest, Morri and Lee (2009) also studied the region and property type

diversification factors and looked at their impact on the risk adjusted performance of

the real estate mutual funds. They adopted the portfolio herfindahl index for

property typologies and locations. In this study, the property types will be

represented by dummy variables 1 and 0. A diversified REIT in the regression will

be rewarded “1” in the Diversified variable (DIV) and given “0” in other specialised

sector variables (see the Methodologies section for further details). Regional

diversification wise, the REITs are classified into the UK only, UK & Europe and UK &

Global (including investment in USA). The REITs investing in France will be

rewarded “1” in the variable factor - Europe and investing in California will be

rewarded “1” in the variable factor – Global.

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Leverage factor which was not discussed and included by Morri and Lee (2009) is

incorporated in this study. The preliminary tests for normal distribution of the

monthly return data of each REIT indicated that the REITs which leverage heavily

tend to have non-normal return distribution with significantly higher JB statistics.

Bloomberg provides the leverage data of each REIT.

The REITs monthly return data will be tested for Normality (JB statistics),

Heteroskedasticity (White’s Test) and Serial Correlation (LM’s Test). This is to ensure

that the REITs that are selected for the multiple factor Sharpe ratio regression have

normally distributed return data, efficient and unbiased (see Data section for further

detail).

Ro and Ziobrowski (2009) compared the performance of Specialised REITs and

Diversified REITs by constructing two portfolios. One portfolio was comprised of

property type specialised REITs and the other portfolio was comprised of only

property type diversified REITs. In order to draw a like for like statistical comparison

of the return and risk characteristics of the two portfolios, the authors adjusted for

the balance of the weighting (equal weighted and valued weighted) and property

type mix.

The other two ranking methods which will be used in this study include the Treynor

ratio and Jensen’s Alpha. The Treynor ratio is similar to Sharpe ratio, sharing the

same numerator, however, the denominator is different; the Treynor ratio uses

“systematic risk” which is estimated by the portfolio beta (Lee 2011b).

Jensen (1968) proposed an absolute measure of performance to examine the

forecasting ability of the mutual fund managers in the US, rather than a portfolio’s

efficiency. His model was a form of capital asset pricing models and was taking

explicit account of the effects of “risk” on the returns of portfolios. The paper

highlighted the difference that a superior forecaster (manager or analyst) can make

on a managed portfolio (systematic risk, risk premium, risk on return, etc) as well as

the standard error of estimate of the performance measure.

Any positive or negative alpha can be examined and explained by the fund manager’s

outstanding investment ability or pure luck (Lee 2011b).

Eichholtz used a sample of equity REITs with data from 1990 to 1996 and concluded

that specialised REITs outperform the property-type diversified REITs according to

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Jensen’s Alpha (Eichholtz et al. 2000). The market proxies used were the Standard

& Poor 500 and a REIT index which include the sampled REITs. It was conducted

during the period when the REIT industry was going through transformation. Again,

the study was not carried out for the purposes of measuring the performance of

REITs during the recession, as this is the focus of the study. In this instance, either

the FTSE Small Cap and / or the FTSE UK REIT Indices will be used to determine the

alphas and betas depending on the correlation test result (see in the later section).

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Methodologies

This focus of this study is the performance differences or indifference of

property-type specialised REITs and diversified REITs in the time of the credit crunch.

Methodologies will be the market-based measures of performance which have been

utilised for pension funds, trust funds and mutual funds over years by various

corporate finance researchers.

Sharpe Ratio

𝑆 =R − 𝑅𝑓

σ

Equation 1 Sharpe

𝑆 = Sharpe Ratio on 3 Year Monthly Return Data

R = Monthly Return of a REIT (Return + Dividend)

𝑅𝑓 = Monthly Risk Free Rate of Return (in this case, UK Government Bond 1 Year)

σ = Monthly Standard deviation of the REIT’s Return

Note: Monthly Sharpe Ratio will then be square-rooted by “12” (months), for a yearly

figure.

Sharpe ratio can easily rank funds on risk-adjusted performance. Sharpe ratio does

not depend on indentifying the market portfolio and effectively avoids being

manipulated by leverage. However, the limitation is that Sharpe ratios can be

difficult to interpret and negative Sharpe ratios do not rank funds correctly (Lee

2011b).

Multiple Factor Regression Model (Sharpe Ratio)

𝑆𝑕𝑎𝑟𝑝𝑒 = 𝛼 + 𝛽1𝐴𝑔𝑒 + 𝛽2𝑆𝑖𝑧𝑒 + 𝛽3𝐷𝑒𝑏𝑡 + 𝛽4𝐸𝑓𝑓𝑔𝑖 + 𝛽5𝐷𝑖𝑣 + 𝛽6𝑂𝑓𝑓

+ 𝛽7𝑅𝑒𝑡𝑎𝑖𝑙 + 𝛽8𝐼𝑛𝑑 + 𝛽9𝐻𝑒𝑎𝑙𝑡𝑕 + 𝛽10𝑆𝑡𝑜𝑟𝑎𝑔𝑒 + 𝛽11𝑈𝐾

+ 𝛽12𝐸𝑢𝑟𝑜 + 𝛽13𝐺𝑙𝑜 + 𝜀

Equation 2 Multiple Factor Sharpe Ratio Regression

A 3 year performance period is used in the regressions in the later sector, to limit the

effects of survivorship bias (Morri & Lee 2009).

𝛼 = regression intercept term

𝛽𝑠 = regression coefficients

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ε = the regression error term

the dependent and independent variables are defined in the earlier section (see

Literature Review)

AGE: Majority of the REITs commenced since January 2007 with few exceptions of

REITS started in mid or late 2009 or 2010.

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

With this proposed model, multicollinearity can be the primary concern (Morri & Lee

2009). The most common test, they suggested, is by way of variance inflation factor

(VIF). VIF measures the degree of variance of an estimated coefficient 𝛽𝑠

increases if the independent variables are correlated. They further suggested the

VIF for an individual variable should be 4 or less, for avoiding multicollinearity.

Portfolio Construction and Comparison

The portfolios of the Diversified REITs and the property-type Specialised REITs are

constructed in two ways; first is the value-weighted and the other is equal-weighted.

In this study, six (6) diversified REITs have the yearly break down of the property-type

components and therefore these subjects are used to construct the Diversified REIT

portfolio. The performance of the diversified REITs portfolio will be likely

dominated by the larger REITs on the value-weighted basis. Ro and Ziobrowski

(2009) suggest that to compensate for the larger REITs in the portfolio, it is

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recommended to construct the diversified REITs portfolio on an equal-weighted basis.

In that case, then the larger REITs will become one of the equal components in the

portfolio.

The value-weighted specialised REITs portfolio will be constructed and matched to

the property-type proportions of the diversified REITs portfolio. Ro and Ziobrowski

(2009) suggest constructing a specialised REITs portfolio to match the diversified

REITs portfolio on an equal-weighted basis can best eliminate the disproportionate

size effect that the larger REITs have on the results.

Thirdly and lastly, two other common performance measures are employed in this

study to assess performance of the subject REITS and these include Treynor Ratio

and Jensen’s Alpha.

Treynor Ratio

𝑇𝑅𝑅𝐸𝐼𝑇 =𝑅𝑅𝐸𝐼𝑇 − 𝑅𝑓

𝛽𝑅𝐸𝐼𝑇

Equation 3 Treynor

𝑇𝑅𝑅𝐸𝐼𝑇 = Treynor Ratio on 4.5 Year Monthly Return Data

𝑅𝑅𝐸𝐼𝑇 = Monthly Return of a REIT (Return + Dividend)

𝑅𝑓 = Monthly Risk Free Rate of Return (in this case, UK Government Bond 1 Year)

𝛽𝑅𝐸𝐼𝑇 = Beta of the REIT, derived by regressing the REIT’s returns against the

benchmark’s return (in this case, FTSE Small Cap index)

Note: Monthly Treynor Ratio will then be square-rooted by “12” (months), for a

yearly figure.

This measure shows the excess return per unit of the systematic risk (beta). The

higher the Treynor ratio, the better the investment performance is. Therefore, it is

critical to use the most appropriate market portfolio to determine the beta.

The only difference between the Treynor and Sharpe ratios is the use of beta factor.

Theoretically, if a portfolio is fully diversified with no specific risk, then the Treynor

and Sharpe ratios shall give the same ranking. However, the number of properties

to hold in a portfolio will be large if it wishes to remove all the specific risk (Lee

2011b). Lee expected that the majority of the UK real estate portfolios will contain

high degree of specific risk/unsystematic risk and it will lead to different ranking

results on the Sharpe and Treynor measures.

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Jensen’s Alpha

𝐽𝐴𝑅𝐸𝐼𝑇 = 𝑅𝑅𝐸𝐼𝑇 − [𝑅𝑓 + 𝛽𝑅𝐸𝐼𝑇(𝑅𝑀 − 𝑅𝑓)]

Equation 4 Jensen's Alpha

𝐽𝐴𝑅𝐸𝐼𝑇 = Jensen’s Alpha ratio on 4.5 Year Monthly Return Data

𝑅𝑀 = the return of the market benchmark

𝑅𝑓 = Monthly Risk Free Rate of Return (in this case, UK Government Bond 1 Year)

𝛽𝑅𝐸𝐼𝑇 = Beta of the REIT’s return

Note: Monthly Alpha will then be square-rooted by “12” (months), for a yearly figure.

Jensen’s alpha computes the difference between the average return to the fund and

the average return to the market portfolio whose systematic risk (𝛽𝑝) is identical to

that of the fund (Jensen 1968). Hence this return can be attributed purely to the

fund manager’s selection ability (Lee 2011b).

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Data

British Property Federation website records total number of twenty-three (23) REITs

on the REITA’s list of UK REITs (REITA.ORG 2011). Bloomberg on the other hand

records twenty-two (22) REITs in the UK stock exchange, however, at the time of

conducting this research, there are only twenty-one (21) REITs return data series

being made available on Bloomberg, excluding Vector Hospitality (Bloomberg 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. In

some cases, REITA uses the term “diversified” in one instance (British Land), and use

description such as “retail, offices, industrial” for REITs that invest in multiple sectors

(see Glenstone Property Group’s and Hammerson’s descriptions). Of the

twenty-one (21) REITs, REITA described seven (7) REITs as “diversified” and fourteen

(14) REITS as “non-diversified”.

Bloomberg uses the classifications more consistently on the other hand.

Bloomberg adopts the terms – diversified, storage, office property,

warehouse/industrial, retail and health care. It is clear that the REITs labelled as

“diversified” are indeed diversifying across some or all sectors and the REITs labelled

as “office property” are indeed specialising in one sector only. Of the twenty-one

(21) REITs, Bloomberg labels fourteen (14) REITs as “diversified” and five (5) REITs as

“specialised in a specific sector”, whilst two (2) REITs were not labelled.

The two sources above clearly use the terms and description of the REITs’

classification inconsistently. Before analysing the REITs in question and their

performance, it is logical to review the composition of these twenty-one (21) REITs

individually and classify these REITs independently in light of the seeing the

inconsistent classification of the REITs. In question, there are ten (10) conflicted

labels by cross-referencing the two major sources (see the REIT Classification table

below).

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21

Table 1 REIT Classification

In this study, 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). Bloomberg provides the summary of the total assets

that each REIT currently holds or has held from the accounting periods beginning in

March / April 2007 till March / April 2011.

Capital Shopping Centre was a REIT with conflicting labelling and description shown

as “Retail” in REITA.ORG but as “Diversified” in Bloomberg. Screening the past

annual reports available online (Capital Shopping Centres 2011), the retail

component within the portfolio indeed has been in excess of 75% consistently over

the sample period. Therefore, it is labelled as “Retail” in this study.

Derwent London REIT has been classified by Bloomberg as a Diversified REIT without

a clear disclosure of the composition of the assets, for three accounting periods

commencing December 2008. The composition of Derwent’s portfolio is

predominately of commercial properties and residential properties in London, and a

small number of shopping centres located in Scotland (Derwent London 2011). A

further investigation has been carried out by reviewing the balance sheet reports

from its website backdated to Year 2007, however, the available financial reports

online also do not disclose the allocation of the assets, sector wise. The reports

only referred to their assets as “trading properties” and did not classify any further in

REIT Name Sector Label by REITA.ORG Sector Label by Bloomberg Label for Proposed Research

1 Big Yellow Group Self Storage Storage Storages

2 British Land Diversified Diversified Diversified

3 Caiptal Shopping Retail Diversified Retail

4 Derwent London Offices Diversified Diversified

5 *Glenstone Property Group Retail, offices, industrial n/a n/a (no return data available)

6 Great Portland Estates Offices Office Property Offices

7 Hammerson Retail, offices Diversified Diversified

8 Hansteen Industrial Warehouse/Industrial Industrial

9 Highcroft Investments Diversified Closed-end funds Diversified

10 Land Securities Diversified Diversified Diversified

11 Local Shopping REIT Retail Diversified Retail

12 London & Stamford Property Offices, Retail Diversified Diversified

13 McKay Securities Offices Diversified Offices

14 Metric Property Investments Retail Diversified Retail

15 Mucklow (A & J) Group Offices, Industrial Diversified Diversified

16 NewRiver REIT Retail n/a Retail

17 *Pineapple corporation Residential, Industrial n/a n/a (no return data available)

18 Primary Health Group Health Care Health Care Healthcare

19 Shaftesbury Retail Diversified Diversified

20 Segro PLC Industrial Diversified Industrial

21 Town Centre Securities Retail Diversified Retail

22 Warner Estate Retail Diversified Diversified

23 Workspace Group Offices, Industrial Office Property Diversified

24 *Vector Hopsitality n/a Hotels and Motels Hotels (no return data available)

Diversified Labels 7 14 10

Non Diversified Labels 14 5 11

No Labels 2

Total 21 21 21

Note: * refers to these return data not made available on Bloomberg

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detail. The indicator which it is used to classify Derwent London REIT as a

“diversified” REIT for this study is by screening at the properties on the website in

conjunction of the REIT’s description listed on Bloomberg.

Great Portland Estates has been classified by REITA.ORG and Bloomberg as “Offices”

REITs, however, the annual reports indicated that the REIT invests in both offices and

retail assets and there are three out of five sample periods showed the office

component in excess of 75%. This REIT is on the border line between “diversified”

and “specialised” as a REIT, however, it still fits in the “specialised” benchmark and

will be treated as “specialised” in this study.

McKay Securities showed a conflicted classification as it was classified as “diversified”

in the Bloomberg and as “specialised/offices” in the REITA.ORG. The annual reports

starting from 2007 and ending 2011 were studied and it was found that the McKay

Securities consistently invested in offices in excess of 75% over the sample period

(McKay Securities 2011). It is therefore classified as “specialised” in this study.

Metric Property Investment PLC REIT only commenced in April 2010. Metric was

described by REITA.ORG as “Retail” and by Bloomberg as “Diversified”. According

the portfolio description provided (Metric Property Investments 2011), all the assets

are retail parks and supermarkets and it is appropriately described as

“Retail/Specialised” by REITA.ORG.

Of interest, Mucklow A & J Group PLC was labelled as a “diversified” REIT investing

across industrial, office and retail sectors (Mucklow A & J Group PLC 2011). It was

however showed a consistency of owning in excess of 70% in industrial sector across

the sample period. Its performance will indeed be reviewed closely in this study.

Sergo PLC was labelled as “diversified” in Bloomberg but as “industrial” in REITA.

After reviewing its published property analysis over the sample period, the industrial

sector assets indeed have been consistently in excess of 75%. Therefore it will be

labelled as “specialised” in this study.

Shaftsbury PLC was labelled as “diversified” in Bloomberg but as “retail” in REITA.

Shaftsbury have 7 portfolios which the majority are wholly owned portfolios with

one joint venture (Longmartin). Their annual reports disclose the total square

footage of their shops, restaurants & leisure, offices and residential, however the

estimate asset values of their assets by sector are not made available. It is

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understandable that labelling of this REIT without transparent and publically made

available data is difficult. In this case, Bloomberg’s label will used in this study.

Town Centre Securities annual reports indicated that it has owned in excess of 75% of

retail assets consistently over the sample period and it is therefore being labelled as

“retail” in our study (Town Centre Securities PLC 2011). It was labelled previously

by Bloomberg as “diversified”.

Workspace Group was another REIT with conflicted labelling. The sources available

from the online annual reports and Bloomberg do not provide indication of the

allocation of its sector diversification (Workspace Group 2011). However,

Workspace Group offers a variety of spaces to its tenants including, but not limited to,

storage spaces, yard space, retail space, offices and industrial units. This REIT is

labelled as “diversified” in this study, which matches REITA’s classification of

Workspace Group (REITA.ORG 2011).

Warner Estate’s annual reports showed that no single property type has had

dominated the portfolio for over 75% over the sample period (Warner Estate 2011).

REITA.ORG described the REIT more correctly than Bloomberg. This REIT will be

classified as “diversified” in this study.

In summary, out of the twenty-one (21) REITs, there are ten (10) diversified REITs and

eleven (11) specialised REITs. Note: In some calculations, two Retail REITs with

short data trend will be removed from calculation to avoid any biased or distorted

results. Removal of the two Retail REITs will be clearly identified in the later

sections.

As the study focuses on the market-based measures of performance, REITs included

in the analysis should the ones traded publically, with the price information available

from Bloomberg. The data used is the monthly “last price” including non trading

days and it will then be converted into the appropriate returns and indices for this

research. Government bond (1 year) data will be used as Risk Free rate for the

calculations of Sharpe ratios, Treynor and Jensen’s Alpha ratios. The sample period

is from January 2007 to June 2011.

The stock market return indices such as FTSE EPRA/NAREIT UK REIT Index (ELUK),

FTSE 100 Index (UKX), FTSE 250 Index (MCX), FTSE 350 Index (NMX), FTSE Small Cap

Index (SMX) and FTSE All-Shares Index (ASX) are also collected from Bloomberg, for

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24

the purpose of comparing the return and risk characteristics of the UK REITS.

The prices of the REITs traded on weekly basis are extracted from Bloomberg,

depending on the commencement of each REIT on the stock exchange. Majority of

REITs commenced trading in January 2007 and three (London & Stamford Property,

Metric Property Investment and NewRiver REIT) only joined the UK REIT regimes in

late 2007 and or between 2009 and 2010.

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Statistics Overview

The returns (including dividends) and standard deviations for the Specialised REITs

and Diversified REITs are examined. The portfolios of the Specialised and

Diversified REITs and Property Type Specialised REIT Indices are conducted both on

market value weighted average monthly return and equal weighted (unweighted)

average monthly return basis. Table 2 below shows the summary statistics of the

data series. During the sample period from January 2007 to July 2011, the number

of the Diversified REITs in the sample is 10 with an average market capitalisation of

£1.3 billion. The Specialised Property REIT Portfolio, Office REIT, Retail REIT,

Industrial REIT and other REIT types are all smaller than the Diversified REITs in terms

of the market capitalisation.

Table 2 Summary Statistics – REITs by Sectors

The Diversified REIT return is right-skewed; however, the Diversified REIT return is

less extreme on the value weighted basis. In terms of excess kurtosis (K-3), the

Diversified REIT returns on both value and equal weighted basis are leptokurtic (peak

around the mean and flatter at the tails); however, the value weighted diversified

REITs return is less leptokurtic than the equal weighted diversified REITs. On value

weighted basis, the Diversified REITs outperformed the Specialised REITs (Portfolio

wise) with a higher return and a lower standard deviation. However, on equal

weighted basis, the result is noticeably an opposite outcome. When returns are

equal weighted, the Diversified REITs return is the least attractive and its volatility sits

in the middle of all other REIT types. This exhibits a different result from Ro &

Ziobrowski’s result finding in their survey in 2009, which suggests that the Diversified

REITs exhibit the least risk than their specialised counterparts.

The result also indicates that the Health REIT had the lowest volatility on both value

Period (2007 - 2011)

Sector# of

REITs

Market Cap

(£m) Return St. Dev Skewness Kurtosis Return St. Dev Skewness Kurtosis

Diversified Property REIT Portfolio 10 1335.30 -0.47% 7.98% 0.16 3.90 -0.87% 7.60% 0.73 6.81

Specialsed Property REIT Portfolio 9 585.07 -0.66% 9.08% -0.19 4.75 -0.53% 7.39% 0.78 6.40

Office REIT Index 2 85.56 0.11% 8.01% 0.43 3.95 -0.58% 8.01% 1.13 6.25

Retail REIT Index 3 261.20 -0.86% 9.37% -0.38 3.57 -0.72% 9.38% 0.55 6.75

Industrial REIT Index 2 189.96 -0.85% 12.17% 0.03 5.31 -0.49% 10.03% 0.44 6.24

Healthcare REIT Index 1 13.12 -0.19% 2.09% 0.49 2.24 -0.19% 2.09% 0.49 2.24

Storage REIT Index 1 35.23 -0.62% 10.88% 0.95 7.60 -0.62% 10.88% 0.95 7.60

Note: The number of REIT indicates the number of REITs used to construct each porfolio or index. All data are on monthly basis. Two Retail

REITs that started in 2009 and 2010 were removed from this analysis due to short data trend.

Value Weighted Equal WeightedAverage Monthly

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26

and equal weighted basis. Industrial REITs are the most volatile on value weighted

basis.

Figure 1 (below) shows index return data that are collected from Bloomberg and

indices include FTSE EPRA/NAREIT UK REIT Index (ELUK), FTSE 100 Index (UKX), FTSE

250 Index (MCX), FTSE 350 Index (NMX), FTSE Small Cap Index (SMX) and FTSE

All-Shares Index (ASX). The index returns have been re-based at 1 January 2007

(from January 2007 to July 2011, the sample period).

Figure 1 Correlation Matrix for the ELUK, FTSE 100, FTSE 200 and FTSE Small Cap Indices

Although FTSE 100 Index is more commonly used as a benchmark for investment

analysis, the finding indicates that the FTSE EPRA/NAREIT UK REIT Index performs

more closely to FTSE Small Cap Index with a positive correlation of 0.83. This is in

line with Lee’s view of REITs performing like small caps (Lee 2011a).

The ten (10) diversified REITs and nine (9) specialised REITs of the twenty-one (21)

REITs selected for this study have been separated and computed into two separate

indices – Diversified REIT Index (DivIndex) and Specialised REIT Index (SpecIndex).

This is of a monthly return index based on market value weighted average return

(including dividend) of the respective REITs type. With this information, it allows to

further look at the performance of the DivIndex & SpecIndex against FTSE Small Cap

Index (SMXIndex).

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Figure 2 Correlation Matrix of Specialised REITs, Diversified REITs and FTSE Small Cap Indices

The correlation statistics (above) show that the Specialised REITs perform more

closely and share more systematic risk with the FTSE Small Cap Index, with a positive

correlation of 0.71. Diversified REITs and Specialised REITs share a strong

correlation of 0.90 with each other.

Covariance Analysis: Ordinary

Date: 08/18/11 Time: 12:36

Sample (adjusted): 2007M02 2011M06

Included observations: 53 after adjustments

Balanced sample (listwise missing value deletion)

Covariance

Correlation DIVRETURN SPECRETURN SMXRETURN

DIVRETURN 0.006247

1

SPECRETURN 0.006431 0.008082

0.904963 1

SMXRETURN 0.003647 0.00424 0.004428

0.69346 0.708684 1

Note: Two Retail REITs (METP & NRR) with short data trend are removed

from this calculations.

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Figure 3 Historical Value Weighted Monthly Returns (Specialised REITs versus Diversified REITs)

The change in volatility of both Diversified and Specialised REITs is shown in Figure 3

above. The historical monthly returns chart shows some observations of the

Specialised REITs especially in the downside periods between Year 2007 and 2010.

Specialised REITs index has been indeed more volatile than the counterpart

Diversified REITs index.

Table 3 Performance Statistics for REITs – Equal Weighted Monthly Figures

Table 3 (above) displays the average monthly returns, beta and standard deviations

for the Diversified REITs, Specialised REITs, REITs by sectors and FTSE Small Cap Index.

Period (2007 - 2011)

Sector Return Beta St. Dev

Diversified Property REIT Portfolio -0.87% 0.31 7.60%

Specialsed Property REIT Portfolio -0.53% 0.39 7.39%

Office REIT Index -0.58% 0.34 8.01%

Retail REIT Index -0.72% 0.56 9.38%

Industrial REIT Index -0.49% 0.40 10.03%

Healthcare REIT Index -0.19% -0.03 2.09%

Storage REIT Index -0.62% 0.33 10.88%

FTSE Small Cap Index -0.13% 1.00 6.72%

Equal Weighted

Average Monthly

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Note: Warner Estates is removed from the calculation as this is one of the most

extreme outliers with non-normal return data.

The figures provided above are not adjusted by the market capitalisation and

therefore are equal weighted (un-weighted). The figures excluding the extreme

outliers provide a better statistical estimate (Chen & Peiser 1999). Chen & Peiser

suggest that un-weighted figures can be a more effective indicator for comparing the

performance of REITs in different sectors.

Betas for the Specialised REITs are higher than the Diversified counterparts, except

the Healthcare REIT. Most of the REITs betas had a low average – between 0.30 and

0.35, indicating that the correlation between REITs and the FTSE Small Cap Index is

not very strong.

Standard deviations for industrial, retail and storage are very high. The Diversified

REITs performed poorly against the non diversified REITs in this study as the

Diversified REIT had a low return, comparing to all other REITs. This suggests that

the market did not value the diversified REITs as much as they value the more

specialised REITs. This finding is in line with Chen & Peiser’s observation of the

Diversified REITs (1999).

Figure 4 Average Return and Standard Deviation - Diversified versus Specialised REITs

Figure 4 (above) exhibits that the Diversified REITs had a lower average return and a

Diversified REITs

Specialised REITs

FTSE Small Cap Index

-1.00%

-0.90%

-0.80%

-0.70%

-0.60%

-0.50%

-0.40%

-0.30%

-0.20%

-0.10%

0.00%

6.60% 6.70% 6.80% 6.90% 7.00% 7.10% 7.20% 7.30% 7.40% 7.50% 7.60% 7.70%

Average Return and Standard Deviation Jan 07 - Jul 11

Ave

rage

Mo

nth

ly R

etu

rn

Standard Deviation

Average Return and Standard Deviation

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30

greater volatility than the Specialised REITs. However, the Specialised REITs had a

higher beta than its counterpart REITs and it means that they track the market

performance more closely than its counterpart REITs.

Figure 5 Average Return and Standard Deviation - REITs by Sectors

Figure 5 (above) plots the return/risk position of the REITs by Sectors. It can be

seen that Diversified REITs had the lowest return comparing to all other REITs by

sectors, with a standard deviation sitting in the middle of the range (close to office

REIT and FTSE Small Cap). It is noticed that the Healthcare REIT had a high return

and a lower standard deviation than the rest of the REIT sectors, largely due to high

dividend pay-out.

All REIT sectors show a higher risk than the FTSE Small Cap Index.

Diversified

Healthcare

Industrial

Office

Retail

Storage

FTSE Small Cap Index

-1.00%

-0.90%

-0.80%

-0.70%

-0.60%

-0.50%

-0.40%

-0.30%

-0.20%

-0.10%

0.00%

0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%

Average Return and Standard Deviation

Average Return and Standard Deviation Jan 07 - Jul 11Standard Deviation

Ave

rage

Mo

nth

ly R

etu

rn

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Figure 6 Average Return and Beta - REITs by Sectors

Figure 6 (above) displays the average returns and betas for the Diversified REITs,

Specialised REITs, the REITs by Sectors, and the FTSE Small Cap Index.

Retail REITs had the highest beta of 0.56, which means they track the market

performance more closely than the Diversified REITs and other REITs by Sectors.

Healthcare REITs had a negative beta and a positive return. It can be seen that

industrial REITs, office REITs and storage REITs scattered relatively closed to each

other, meaning they share a reasonably matched average return and beta figure.

Diversified

Healthcare

Industrial

Office

Retail

Storage

FTSE Small Cap Index

Specialised

-1.00%

-0.90%

-0.80%

-0.70%

-0.60%

-0.50%

-0.40%

-0.30%

-0.20%

-0.10%

0.00%

-0.20 0.00 0.20 0.40 0.60 0.80 1.00 1.20

Average Return and Beta Jan 07 - Jul 11Beta

Ave

rage

Mo

nth

ly R

etu

rn

Average Return and Beta

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Regression Analysis/Results

Last prices and dividend of the individual REIT on monthly basis are extracted from

Bloomberg and are used to derive the monthly returns of the REITs. These monthly

returns are then being input into calculations of Sharpe ratios and other performance

ranking measures (see the later section). Return data are being tested for normality,

heteroskedasticity and autocorrelation.

Table 4 Return Data Tests for Normality, Heteroskedasticity and Autocorrelation

Apart from the absence of the return data of GPG, PC and VNY and a shorter period

return data (less than 3 years) for NRR, the reminder of the REITs show a mixture of

results for normality, White’s test and LM’s test. It appears that the REITs that have

higher leverage (DEBT) ratio also have the non normal return data. By using only

the REITs that pass all three tests, there will be only a handful of REITs for running the

regression. Possibilities of using the nonparametric regression or quantile

regression will be further discussed in the conclusion as a recommendation for

further research.

In this study, the following observations, which were recorded from screening the

characteristics of the sample REITs, will be incorporated in the regression studies.

Ticker3 year

SharpeAge Size Debt EFFGI

Monthly Return for

Normality (JB test)

Heteroskedasticity White's

Test (P-value)

Autocorrelation LM's Test (P-

value)

BYG 0.27 4.55 0.01 0.36 0.00 22.6155 0.5239 0.0894

BLND 1.37 4.55 0.19 0.38 0.00 0.1232 0.6669 0.1835

CSCG -0.44 4.55 0.11 0.52 0.01 2.4746 0.3716 0.7440

DLN 2.77 4.55 0.06 0.38 0.05 19.9018 0.0204 0.0877

GPG na na na na

GPOR 3.07 4.55 0.05 0.27 0.00 2.6877 0.6662 0.2404

HMSO 0.42 4.55 0.12 0.42 0.01 5.0191 0.0718 0.7252

HSTN 1.07 4.55 0.02 0.46 0.01 22.6108 0.0901 0.3105

HCFT 1.02 4.55 0.00 0.01 0.07 26.9570 0.0002 0.0074

LAND 0.31 4.55 0.24 0.38 0.01 0.7501 0.5475 0.1560

LSR 2.72 4.30 0.00 0.61 0.01 3.8404 0.6441 0.4928

LSP 2.86 3.72 0.03 0.20 0.01 14.3907 0.6998 0.7883

MCKS 0.23 4.55 0.00 0.47 0.01 28.2433 0.4254 0.5136

METP na 1.30 0.01 0.00 0.02 1.2092 0.8641 0.0069

MKLW 1.56 4.55 0.01 0.18 0.01 15.8450 0.6124 0.0048

NRR na 1.88 0.00 0.65 0.02 8.6167 0.4303 0.6454

PC na na na na

PHP 5.24 4.55 0.01 0.57 NA 2.2033 0.1739 0.6130

SHB 2.86 4.55 0.05 0.46 0.00 6.6037 0.8384 0.0472

SGRO 0.06 4.55 0.08 0.46 0.01 2.3288 0.3455 0.9575

TCSC 1.46 4.55 0.00 0.51 0.01 18.7239 0.2725 0.1275

WNER -1.82 4.55 0.00 0.59 0.02 100.7816 0.0002 0.7430

WKP 0.92 4.55 0.01 0.52 0.01 11.4372 0.9502 0.0618

VNY na NA na na na

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Table 5 Summary Statistics for Variables

Variables that are to be incorporated in the regression present some features of

interest. The mean Sharpe ratio (for the 3 year period) is 1.37 with six REITs

outperforming the mean Sharpe ratio (see Table 6 below).

Table 6 Sharpe Ratios (3 Year Period)

Secondly, most of the REITs started since the introduction of the REITs regulation in

January 2007. Thirdly, the average total debt / total debt ratio for the UK REITs is

0.41. Half of the REITs in the UK are “Diversified”. Most of the UK REITs invest

locally and only a small number of REITs invest internationally. Lastly, the

management efficiency (EFFGI) is not strongly correlated with the Sharpe ratios,

Variables Mean Max Min Corr p

SHARPE3 1.37 5.24 -1.82

AGE 4.49 4.55 3.72 -0.28 0.25

SIZE 0.05 0.24 0.00 -0.20 0.42

DEBT 0.41 0.61 0.01 -0.09 0.70

EFFGI 0.01 0.07 0.00 0.00 0.70

DIV 0.53 1.00 0.00 -0.09 0.70

OFF 0.11 1.00 0.00 0.06 0.80

RETAIL 0.16 1.00 0.00 -0.03 0.89

IND 0.11 1.00 0.00 -0.18 0.47

HEALTH 0.05 1.00 0.00 0.59 0.01

STORAGE 0.05 1.00 0.00 -0.17 0.50

UK 1.00 1.00 1.00 NA NA

EURO 0.16 1.00 0.00 -0.24 0.33

GLO 0.05 1.00 0.00 0.21 0.38

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

3 Year Sharpe Ratios

3 Year Sharpe

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34

which is contradictory to Morri & Lee’s findings. The accuracy of the data extracted

from Bloomberg is therefore challenged.

Table 7 Regression Results – Sharpe Ratios versus Fund Characteristics

The initial regression model on the left hand side of Table 7 incorporates the 19 REITs

that have the return data longer than three years. This model includes the majority

of the variables allowed (excluding Storage & UK) as restricted by the size of the

sample included. This model is mainly for purpose of illustrating that all possible

regression models are considered and tested. Given that a number of the REITs’

monthly return data fail the normality tests, the model (left) will not likely to capture

the impact that the variables will have on the REITs’ performance. It has been

suggested that Quantile regression will be more robust to deal with large return data

outliers.

A later regression model on the right hand side of Table 7 incorporates only the 8

REITs which their monthly return data pass the normality, heteroskedasticity and

autocorrelation tests. It is understood that a regression model incorporating a

small number of samples faces risks of having biased or inaccurate results or makes

the results not greatly convincing.

A number of the possible regressions (see appendix) has been tested out based on

the later regression model with 8 REIT samples. All fourteen (14) variables are

mixed and tested and a number of variables showing huge errors or excessively high

VIFs, failing t-statistics or being insignificant are eliminated.

Dependent Variable: SHARPE3 Dependent Variable: SHARPE3

Sample: 19 REITs Sample: 8 REITs

Variable Coeff SE T-Stat VIF Variable Coeff SE T-Stat VIF

C 7.612 8.757 0.869 NA C 5.240 1.667 3.144 NA

AGE -1.094 2.012 -0.544 1.41

SIZE -4.290 5.804 -0.739 1.45

DEBT -5.873 3.438 -1.708 2.54

EFFGI -49.774 33.414 -1.490 2.84

DIV 1.411 1.626 0.868 6.34 DIV -4.400 2.041 -2.156 2.81

OFF 1.630 1.730 0.942 2.71 OFF -2.170 2.357 -0.921 1.75

RETAIL 2.260 1.839 1.229 4.32 RETAIL -4.100 2.041 -2.009 2.25

IND 1.550 2.342 0.662 4.96 IND -4.760 3.118 -1.527 3.06

HEALTH 6.519 2.173 3.000 2.26

EURO -0.218 1.531 -0.142 2.99 EURO -0.420 2.041 -0.206 2.25

GLO 3.645 1.873 1.946 1.68

R-squared 0.701 R-squared 0.789

Adjusted R-squared 0.230 Adjusted R-squared 0.261

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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 0.789 and

the Adjusted R-squared is 0.261 indicting that these variables individually or

combined are significantly related to the excess return performance.

This outcome suggest 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.

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Portfolio Comparison Analysis/Results

The portfolios of the Diversified REITs and the property-type Specialised REITs are

constructed in two ways; first is the value-weighted and the other is equal-weighted.

In this study, only six (6) out of the ten (10) diversified REITs having the yearly break

down of the property-type components are used to construct the Diversified REIT

portfolio. The following pie chart shows the composition of the six (6) Diversified

REITs in terms of the combined market capitalisation.

Figure 7 Compositions of Diversified REITs portfolio - average market cap (2007-2011)

As the figures indicate above, British Land, Land Securities and Hammerson REITs are

larger than the other three REITs included in the portfolio. The performance of the

diversified REITs portfolio will be likely dominated by the three larger REITs on the

value-weighted basis. Ro and Ziobrowski (2009) suggest that to compensate for the

BLND 34.22%

WNER 0.36%

MKLW 1.38%

HCFT 0.20%

LAND 42.36%

HMSO 21.49%

Compositions of diversified REIT portfolio

BLND

WNER

MKLW

HCFT

LAND

HMSO

REIT Name Ticker

2007 - 2011

Average Market

Cap (£m)

Percentage

British Land BLND 4388.44 34.22%

Warner Estate WNER 45.63 0.36%

Mucklow (A & J) Group MKLW 176.76 1.38%

Highcroft Investments HCFT 25.40 0.20%

Land Securities LAND 5432.06 42.36%

Hammerson HMSO 2756.14 21.49%

Total 12824.42 100.00%

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larger REITs in the portfolio, it is recommended to construct the diversified REITs

portfolio on an equal-weighted basis. In that case, then the larger REITs will

become one of the equal components in the portfolio.

The value-weighted specialised REITs portfolio will be constructed and matched to

the property-type proportions of the diversified REITs portfolio shown in the

following chart.

Figure 8 Value-weighted Diversified REITs

Table 8 Value-weighted annual property type diversification proportion on the basis of Diversified REITs

portfolio

Initially, all available diversified REITs are aggregated and weighted by their own

market capitalisation within a portfolio for the calculation of the overall

property-type proportions. The table above shows the property type composition

of the diversified REITs portfolio on a value-weighted basis. The average

proportions of offices and retail dominate nearly 80% of the portfolio.

0.00 1000.00 2000.00 3000.00 4000.00 5000.00 6000.00

BLND

HCFT

HMSO

LAND

MKLW

WNER

Offices

Retail

Industrial

Shopping

Residential

Others

Value Weighted diversified REITs

Panel A: Value Weighted

Year Offices Retail Industrial Shopping Residential Others Total

2007 40% 40% 1% 6% 0% 13% 100%

2008 41% 39% 1% 6% 0% 12% 100%

2009 39% 42% 1% 0% 0% 18% 100%

2010 35% 50% 1% 0% 0% 13% 100%

2011 36% 52% 1% 0% 0% 11% 100%

Mean 37% 46% 1% 2% 0% 14% 100%

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The proportions are then matched to the weight of each property-type specialised

REIT index within the specialised REIT portfolio as shown below.

Figure 9 Specialised REITs portfolio using the overall property type proportions of the value-weighted

Diversified REITs in Table 8

For the comparison, the proportions of the Offices, Retail, Industrial and Others

within the diversified REIT portfolio are 37%, 48%, 1% and 14% respectively. The

specialised REIT will match with the above quoted percentages. Note: Retail and

Shopping Centre components are combined. Residential which is of a smaller

portion will be combined with the “Others”. Others include other specialised REITs

such as Healthcare and Storage REITs.

Ro and Ziobrowski (2009) suggest constructing a specialised REITs portfolio to match

the diversified REITs portfolio on an equal-weighted basis can best eliminate the

disproportionate size effect that the larger REITs have on the results.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Offices Retail Industrial Shopping Residential Others

Specialised REIT portfolio usign the overall property type %

Offices

Retail

Industrial

Shopping

Residential

Others

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Figure 10 Equal-weighted Diversified REITs

Table 9 Equal-weighted annual property type diversification proportion on the basis of Diversified REITs

portfolio

The table above shows the property type composition of the diversified REITs

portfolio on an equal-weighted basis. Under the equal-weighted basis, the retail

component drops 20% comparing to the value-weighted counterpart (shown in

Figure 9), whilst the industrial component increases to 20%. The office component

stays in a fairly similar level under both the value-weighted and equal-weighted basis.

Note: the residential proportion is very small in the UK instance as the residential

REITs are still not available in the UK stock exchange. This makes the mix of the

portfolios significantly different from the portfolios that Ro & Ziobrowski (2009) and

Benefield et al. (2009) structure, where the residential components are at least 30%.

0 1000 2000 3000 4000 5000

BLND

HCFT

HMSO

LAND

MKLW

WNER

Offices

Retail

Industrial

Shopping

Residential

Others

Equal Weighted diversified REITs

Panel B: Equal Weighted

Year Offices Retail Industrial Shopping Residential Others Total

2007 39% 23% 16% 12% 1% 9% 100%

2008 39% 22% 17% 12% 1% 9% 100%

2009 35% 25% 21% 6% 1% 13% 100%

2010 34% 29% 22% 3% 1% 10% 100%

2011 35% 30% 22% 3% 1% 9% 100%

Mean 36% 26% 20% 7% 1% 10% 100%

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Figure 11 Specialised REITs portfolio using the overall property type proportions of the equal-weighted

Diversified REITs in Table 9

For the comparison, the proportions of the Offices, Retail, Industrial and Others

within the diversified REIT portfolio are 36%, 33%, 20% and 11% respectively. The

same process is then repeated to create a specialised REIT portfolio.

After completing the construction of the specialised REITs portfolios under both

value-weighted and equal-weighted basis, the value-weighted and equal-weighted

specialised REITs index returns are then being input into the efficient frontier models

(monthly return basis) respectively, based on the property-type proportions

calculated earlier.

Table 10 Portfolio Performance Summary

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.

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

0%

5%

10%

15%

20%

25%

30%

35%

40%

Offices Retail Industrial Shopping Residential Others

Specialised REIT portfolio usign the overall property type %

Offices

Retail

Industrial

Shopping

Residential

Others

Average

Monthly

Div REIT

Portfolio

Spec REIT

Portfolio

Div REIT

Portfolio

Spec REIT

Portfolio

Mean -0.63% -0.60% -1.21% -0.67%

Std. Dev. 8.36% 7.48% 8.04% 7.63%

Value Weighted Equal Weighted

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difference. At a similar level of the monthly return, the specialised REITs portfolio

produces the return with less volatility.

On the other hand, the specialised REITs portfolio under the equal-weighted

construction produces a better mean return at a similar level of the volatility. This

calculation, however, ignores the leverage element, which in Ro and Ziobrowski’s

view, may potentially bias the findings.

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Treynor & Jensen’s Analysis/Results

Table 11 The Yearly Treynor Ratios & Jensen's Alpha for the UK REITs (Period 2007-2011)

Treynor and Jensen measures, on the other hand, take into account of the

correlation between the market index (FTSE Small Cap index) and the respective

REIT’s return. The table above displays the yearly Treynor ratios and Jensen’s Alpha

for seventeen (17) REITs that have the return data series commencing since January

2007. This includes nice (9) Diversified REITs and eight (8) Specialised REITs.

Ticker Sector Treynor Ratio Jensen's Alpha Avearge Treynor Jensen's

BLND Divr -0.52 0.01 Div -0.42 0.09

DLN Divr 0.07 0.33 Spec -0.36 0.17

HCFT Divr -0.01 0.32 All -0.40 0.13

HMSO Divr -0.20 0.15

LAND Divr -0.52 0.01

MKLW Divr -0.06 -0.21

SHB Divr 0.13 0.21

WKP Divr -0.12 0.52

WNER Divr -2.60 -0.51

PHP Healthcare -1.82 0.04

HSTN Ind 0.01 0.18

SGRO Ind -0.24 0.17

GPOR Offices 0.03 0.26

MCKS Offices -0.51 0.02

CSCG Retail -0.23 0.18

TCSC Retail -0.09 0.36

BYG Storage -0.08 0.16

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Figure 12 Treynor Ratios

Managers have complete control over the property stocks he or she chooses to trade,

buy or sell, despite the controls or restrictions which the senior management may lay

on. If it wasn’t a market related risk, it would then be a managerial problem,

instead (Treynor 1965).

Figure 12 shows that individually the two Diversified REITs – Derwent London and

Shaftsbury have positive ratios (0.07 and 0.13), which are higher than the two

Specialised REITs – Hansteen and Great Poland Estates (0.01 and 0.03).

The average yearly Treynor ratio for all seventeen (17) UK REITs is -0.40 over the

period from January 2007 to July 2011. The average Treynor ratio for the

Specialised REITs is -0.36 and for the Diversified REITs is -0.42. Overall, the

Specialised REITs outperform the Diversified REITs by showing better average fund

managers’ management abilities.

-3.00

-2.50

-2.00

-1.50

-1.00

-0.50

0.00

0.50

Treynor Ratio

Treynor Ratio

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Figure 13 Jensen’ Alphas

Jensen’s alpha examines the forecasting ability of the mutual fund managers, rather

than a portfolio’s efficiency (Jensen 1968). Jensen’s model is a form of capital asset

pricing models and is taking explicit account of the effects of “risk” on the returns of

portfolios. Jensen’s paper highlights the difference a superior forecaster can make

on a managed portfolio.

Figure 13 shows that individually a number of the Diversified REITs (DLN, HCFT, SHB &

WKP) have an alpha of 0.21 and / or higher and a number of the Specialised REITs

(GPOR & TCSC) have an alpha of 0.26 and / or higher. Workspace Group (WKP)

demonstrates the highest Alpha of 0.52 (within the Diversified REITs), whilst Town

Centre Securities (TCSC) shows the highest Alpha of 0.36 (within the Specialised

REITs).

The average Jensen’s Alpha on the seventeen (17) REITs is 0.13 with the average

Alpha on the Diversified REITs being 0.09 and the Specialised REITs being 0.17. In

summary, the Specialised REITs outperform the Diversified REITs by showing better

average fund managers’ forecasting abilities.

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

Jensen's Alpha

Jensen's Alpha

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Conclusion

This study looks at the return and risk characteristics of the Diversified and

Specialised REITs in the UK over the last four and half years commencing January

2007, which experienced the credit crisis and great economy uncertainty. The

twenty-one (21) REITs are screened, assessed and compared on group, individual and

portfolio basis.

The methodologies used in this study incorporate some simple statistic tools

(correlation & index comparison used by Chen & Peiser), multiple factor Sharpe ratio

regression (with some variation and with inspiration of Morri & Lee’s work on Italian

Real Estate Mutual Funds), and portfolio construction and use of efficient frontier

models (with some variation and with great influence from Ro & Ziobrowski).

Initially, the statistical finding indicates that the FTSE EPRA/NAREIT UK REIT Index

perform more closely to FTSE Small Cap Index with a positive correlation of 0.83.

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 0.71.

In terms of the change in volatility of the both Diversified and Specialised REITs (as

shown in Figure 3), the historical monthly returns chart shows some observations of

the Specialised REITs especially in the downside periods between Year 2007 and 2010.

Specialised REITs index has been indeed more volatile than the counterpart

Diversified REITs index.

The Diversified REITs perform poorly against the non diversified REITs in this study as

the Diversified REIT had a low return, comparing to all other REITs. This suggests

that the market did not value the diversified REITs as much as they value the more

specialised REITs.

The multiple factor Sharpe ratio regression 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.

Subsequently, the results from the portfolio comparison and efficient frontier models

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46

suggest that 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 a marginally

lesser volatility.

On the other hand, the specialised REITs portfolio under the equal-weighted

portfolio construction produces a better mean return at a similar level of the

volatility.

In terms of the Treynor ratio ranking methodology, the Specialised REITs, overall,

outperform the Diversified REITs by showing better average fund managers’

management abilities. However, it is worth noting that individually Derwent

London and Shaftsbury have highest positive ratios (0.07 and 0.13) among all other

individual REITs.

In terms of the Jensen’s Alpha ranking methodology, the Specialised REITs

outperform the Diversified REITs by displaying better average fund managers’

forecasting abilities. As a note, Workspace Group (WKP) demonstrates the highest

Alpha of 0.52 (within the Diversified REITs), whilst Town Centre Securities (TCSC)

shows the highest Alpha of 0.36 (within the Specialised REITs).

In conclusion, the hypothesis that the Specialised REITs can perform better than the

Diversified counterpart during the credit crunch is supported. The Diversified REITs

show a moderate return with lower level of volatility. However, the Specialised

REITs track the market more closely. The Office REITs and Retail REITs produce

significant impact on the risk-adjusted performance. 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.

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Limitation and Future Research

One of the shortcomings of the study on the performance of the UK REITs is the short

return data trend. Majority of the REITs commenced since January 1st, 2007 which

leave only 53 observation months of monthly return data for the analysis. This

opens a window of opportunity for further research incorporating the return data of

the same securities (prior to becoming the UK REITs) into the regression models and

portfolio analysis. This may offer the investors and practitioners an in-depth

understanding of the performance of REITs before and after becoming REITs.

Having a longer time period return trend also allows the study of the performance

into multiple sub periods by the use of Chow test (structural break, see Benefield et

al.).

Another shortcoming of the study is the fact of having relatively small number of the

REITs. There are twenty-one (21) REITs that Bloomberg provides monthly return

data trend. However, given the requirement of the normality test and other

statistical restriction, there are only eight (8) REITs that can be incorporated into a

multiple factor Sharpe ratio regression. This opens a window of opportunity for

carrying out the regression testing in the nonparametric format or quantile

regression format.

The multiple factor Sharpe ratio regression can be further improved by adopting

variables such as the fund management efficiency, property management efficiency

and the portfolio herfindahl indices for property typologies and locations. The

efficiency (EFFGI) variable calculated from the Bloomberg database show a great

standard error and a weak correlation with the Sharpe ratios, indicating that the

validity of the data is questionable. It is advisable that the future researchers can

get in touch with the fund managers of the REITs directly and obtain the most

accurate efficiency data for the similar regression testing.

Words: 10,191

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48

References

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Appendix

1. Regression Simulations

19 REIT Samples

8 REIT Samples

2. Portfolio Comparison

Tables

Value-weighted

Equal-weighted

3. CD Containing All Excel and Eview 7 files

Method 1-Diversified versus Specialised Indices

Method 1-Performance Statistics for individual REITs

Method 2-Regression Models with Dividend (and Results)

Method 2-REIT Monthly Sharpe, Treynor and Jensen’s Alpha

Method 3-Diversified REITs – Property Type Components Value vs Equal

Method 3-Portfolio Construction Spec. Value & Equal

Method 3-Specialised 4x Funds Value versus Equal Weighted

Method 3-Specialised 4x Optimised Portfolio

Eview 7 files

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Regression Simulations

19 REIT Samples

8 REIT Samples

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Portfolio Comparison

Tables

Value-weighted

Equal-weighted

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54

CD Containing All Excel and Eview 7 files

Method 1-Diversified versus Specialised Indices

Method 1-Performance Statistics for individual REITs

Method 2-Regression Models with Dividend (and Results)

Method 2-REIT Monthly Sharpe, Treynor and Jensen’s Alpha

Method 3-Diversified REITs – Property Type Components Value vs Equal

Method 3-Portfolio Construction Spec. Value & Equal

Method 3-Specialised 4x Funds Value versus Equal Weighted

Method 3-Specialised 4x Optimised Portfolio

Eview 7 files