REIT Returns and Pricing: The Small Cap Value Stock Factor

This study employs a variance decomposition approach to explore the investment characteristics of equity REITs within a multi-factor model relating REIT returns to returns to small capitalization value stocks, small cap growth stocks, large cap stocks, bonds and private real estate. It also examines the changing nature of the return process over time, utilizing a finer partition of the stock market factor than many previous researchers have by distinguishing between small capital growth and small capital value stocks. This decomposition allows the effect of small stocks to be measured more accurately. In addition, this study is unique in that it incorporates a real estate factor at the monthly frequency, constructed from monthly REIT share price premium to NAV estimates. Our results show that REITs have a significant small capital value component, yet also exhibit a large sector-specific component that has increased in importance in recent years. Conversely, REIT return volatility is not highly related to small capital growth stocks, and the contribution of large capital stock drivers to REIT volatility has declined over time. On a monthly level, private real estate returns play only a marginal role in explaining REIT volatility. Our results contribute to an improved understanding of the role played by REITs in portfolios diversified across asset classes.