Optimum Realty, Optimal Timing: How Credit Markets Shape REIT Stock Correlations in the U.S. (1990-2024)

Abstract

Real Estate Investment Trusts (REITs) have provided investors with commercial real estate exposure while retaining the liquidity benefits of traditional equities. Relatively low correlations between REITs and the broader equity market have historically provided portfolio diversification; however, recent studies have shown rising correlations between the asset classes. This study investigates the relationship between credit market conditions and REIT-stock return correlations on a sector level from 1990 to 2024. Identifying the impact of changing credit market conditions and market volatility on REIT-stock return correlations is important for equity investors who seek diversification benefits from REITs amidst tightening credit markets. The REIT sectors examined in this study include healthcare, industrial/office, lodging/resorts, residential, retail, and self-storage. A comprehensive dataset is created using data from the CRSP/Ziman Real Estate Database, Finaeon, and Federal Reserve Economic Data. This study focuses on the effect of the default spread, term spread, mortgage spread, and VIX on sector REIT-stock return correlations. The empirical results suggest that the default spread, term spread, and VIX have the strongest explanatory power for REIT-stock return correlations across all sectors. While sector-specific sensitivities vary, widening default spreads and narrowing term spreads both increase correlations across all sectors. Additionally, when VIX levels spike, correlations increase for all REIT sectors except self-storage, whose correlations decrease. This study offers insights into the dynamic relationship between credit market conditions and REIT-stock return correlations, with implications for portfolio allocation and diversification.