The Long-Run Dynamics between Direct and Securitized Real Estate by Elias Oikarinen, Martin Hoesli, and Camilo Serrano 2011

There is a lot of debate about how effective securitized real estate (REITs) is as a substitute for direct real estate (buying property), and over short time scales the two do not track each other very well. This paper investigates the question of whether "the NAREIT [index for securitized REITs] and NCREIF [index for direct real estate] returns reflect the same ‘‘real estate factor’’ in the long run and to examine the predictability of the overall NAREIT and overall NCREIF returns." The paper applies a variety of time-series statistical methods to argue that the two show a strong long-term cointegral relationship with each other.

Overall I find the argument pretty convincing, though I didn't follow all of the statistics. One weakness with the paper is that the time series aren't that long (40 years or so), and there's a significant episode of deviation in the 1990s ("new REIT era") that gets explained away as a one-off. But explaining away 1/8 of your dataset as a one-off is kind of iffy. And the paper also does something of a similar dance about the 2008 financial crisis (with the advantage of hindsight from 2019, this hand wave looks pretty good, as REITs and direct real estate both recovered in tandem, with REITs leading direct real estate as predicted by the paper).

I wonder if there is some kind of arbitrage opportunity here between securitized vs. direct real estate investments. This is the kind of thing where there are significant barriers to arbitrage trades -- non-commoditized investment vehicles, large minimum transaction sizes, large transaction costs, etc. You would need a ton of money and a long time horizon to be able to make a good go at it.

Abstract: This study presents evidence of cointegration between securitized (NAREIT) and direct (NCREIF) real estate total return indices. Since the two real estate indices are cointegrated with one another but not with the stock market, real estate investment trusts (REITs) and direct real estate are likely to have similar long-term diversification benefits in a stock portfolio. Only direct real estate is found to currently adjust towards the cointegrating relation, with NAREIT returns leading NCREIF returns. However, the results show evidence of the predictability of NAREIT returns during the 1980s. Additionally, a large and long-lasting deviation from the long-run relation between NAREIT and NCREIF is identified at the beginning of the ‘‘new REIT era.’’