Returns and Information Transmission Dynamics in Public and Private Real Estate Markets

This paper examines U.S. public and private commercial real estate returns at the aggregate level and by the four major property types over the 1994–2012 time period. Returns are carefully adjusted for differences between public and private markets in financial leverage, property type focus and management fees. Unconditionally, we find that passive portfolios of unlevered core real estate investment trusts (REITs) outperformed their private market benchmark by 49 basis points (annualized) over the 1994–2012 sample period. Our baseline vector autoregression results suggest that REIT returns do not embed additional commercial real-estate-specific information useful in predicting private market returns. These results strongly suggest that equity REIT returns react to fundamental (latent) asset pricing information more quickly than private market returns given their greater liquidity and price revelation. REITs therefore serve as a fundamental information transmission channel to private market returns when asset pricing variables are omitted. Investors can hold ownership positions in commercial real estate (CRE) both through direct private investment and public real estate securities. Purchasing individual properties directly in the private market gives investors complete control of the asset: who leases it, who manages it, how much debt financing is used and when it is sold. With publicly traded real estate securities, individuals andinstitutionsinvestcapitalinarealestatecompanywhich,inturn,purchases, manages and holds title to the real estate. In contrast to private real estate markets, exchange-traded real estate securities provide investors with a relatively high degree of liquidity and transparency and relatively low transaction costs. Nevertheless, returns in both private and public CRE markets should be driven, at least in the long run, by the net cash flows derived from leasing space to tenants in local property markets.