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Stock Market Rotations and REIT Valuation

Working paper #441
Robert Falzon

This article confirms what many people in the industry already accept about real estate stocks: they are both real estate and stocks. The strong relationship between REIT perform-ance and market sentiment toward small cap value and small cap growth stocks provides valuable insights into the often puzzling disconnect between the public real estate market and the private property markets. While public real estate companies afford investors access to the investment characteristics of private real estate—and most important, high and relatively sta-ble yields—they represent a very small sector of the public equities market. Because of the small size of the sector, capital flows in the public equities market can and often do easily overwhelm the private market property characteristics of real estate stocks when these char-acteristics are either in or out of favor. As shown in this article, REITs have traded at premi-ums to net asset value (NAV) when value investing is in favor, and at discounts to NAV when growth investing is in favor. Since sentiments in the stock market change much faster and less predictably than property market cycles, the stock market gyration dominantly delineates the cycles of REITs trading at premiums or discounts to NAVs.

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