Beyond safe haven: the hidden risk and reward of REITs

Purpose Over time, Real Estate Investment Trusts (REITs) have exhibited a relatively weak correlation with the broader stock market and are often considered a hedge against market volatility. However, empirical evidence does not fully support the classification of REITs as a safety asset. This study seeks to explain this discrepancy by exploring the non-linear relationship between REITs and the overall U.S. equity market. Design/methodology/approach This paper extends the conventional Capital Asset Pricing Model (CAPM) and the Fama-French Three Factor Model by introducing a realized volatility factor, proxied by the square of the market risk premium. Findings The regression analysis reveals that REITs exhibit a negative association with US equity market volatility, implying a concave relationship with respect to market return. As volatility increases, REIT returns tend to experience greater negative correction due to the exposure to this volatility-related risk factor. Including a volatility factor in the CAPM and Fama-French models also yields a statistically significant intercept, which captures excess returns, analogous to Jensen's alpha. Further results suggest REITs differ from other market sectors both in their concave sensitivity to market movements and in their ability to generate persistent excess returns. These findings are robust, as confirmed by dynamic estimation using a Kalman Filter. Originality/value This study contributes to the literature by providing empirical evidence of a concave association of REITs and overall market returns, as well as demonstrating consistent excess returns of REITs. In addition, it highlights that REITs exhibit unique statistical return characteristics distinct from other market sectors.