REITs provide an important diversification benefit to investors based on their low correlation to other asset classes; this has been the focus of many academic studies. The structure was approved in 1960 and as an indirect form of property investment it experienced explosive growth throughout the 1990s; in particular equity REITs. The latter contain many of the advantages of property company shares in terms of lot size, liquidity, public trading and price information, with the added advantage of tax transparency. Although generally outperforming both direct property investments and real estate operating companies, they exhibit higher volatility than the direct market (Ball, Lizieri & MacGregor 2001).
Researchers at SNL Financial (2000) maintain that the weak pricing of the REIT industry during the 90s was due to the scarcity of capital and investors engaged in other asset classes. However, REITs have demonstrated an ability to stabilise real estate markets throughout property cycles and thereby the defensive properties of the asset class to market swings. This relationship has important implications for portfolio managers in terms of the diversification potential of REITs; it is assumed that more and more investors will include such stable income-oriented stocks in their portfolios as time goes on.
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