REITs, the stock market and economic activity

Purpose - The purpose of this paper is to investigate the linkages among real estate investment trusts (REITs), the stock market, and real economic activity for the USA for the 1971‐2007 period. In view of the fact that when the economy performs well the equity and REIT markets also do well, it is easy to see why one needs to examine the dynamic interactions among these magnitudes and understand the implications of market movements or policy changes on the returns of REIT. Design/methodology/approach - The empirical investigation is conducted via the vector autoregressive (VAR) methodology coupled with Granger causality and cointegration analyses. VAR analysis permits inferences to be drawn about how a particular variable, say, the stock market, helps to explain a REIT's return and to see how a shock from the same variable affects that return. In other words, the magnitudes which are more relevant in explaining the REIT return can be deduced so as to determine the driving forces behind the return. Finally, some robustness tests are performed and some other relative magnitudes are experimented with so as to have a more comprehensive picture of the dynamic interactions among the three variables. Findings - First, the equity and the mortgage REIT categories display essentially similar patterns with their interactions with the general stock market and/or industrial production movements. Specifically, in the case of the equity REIT, it is revealed that a reciprocal linkage between the two exists, whereas for the mortgage REIT a uni‐directional one run from the REIT to the stock market. Second, when substituting the general stock market returns with two sub index returns (the small‐ and the mid‐cap excess returns) it is found that the two REIT categories are more closely related to a sub index than the general stock market index. Overall, significant short‐run interactions are seen among the three magnitudes since the 1970s. Originality/value - The results are important for investors and policymakers. For investors, the finding of the close relationship between the equity and mortgage REIT categories and the general stock market is that there may not be a profitable reallocation of portfolios within these two asset classes. For policymakers, it can be suggested that they take notice of how changes in monetary policy (via changes in interest rates or money supply) influence REIT investments and what the impact of that would be on the reallocation of such investments by professional investors and managers.