“Finally, in the case of REITs, the returns are more correlated with equity while other types of real estate investment are less correlated with equity…”
I googled the topic, and I got the following link - if you read through, the statement basically states the opposite, namely that correlation is low. Now, is that because there is a mistake in the Schweser text, or because the correlation has changed throughout the years. If the latter, then why might this be the case?
Well, that article is very liberal when describing “low correlation with equity”. The guy mentions IYR, which has 0.758 correlation with SPX. That’s pretty high correlation, if you ask me…
the articles continues and concludes that the correlation isnt that low (as you basically said). but then why the first sentence where he obviously quotes an outdated opinion that REIT have low correlation…
doest matter. conclusion is that correlation is not low. makes sense to me intuitively.
Because REITs trade on the exchanges, they’ll tend to move more in sync with equity markets. For an example, look what happened to REITS in late 2008. Conversely, direct real estate investments which are valued mainly by appraisals, are not nearly as correlated to equity markets.
As compared to other equity asset classes, REITS have generally lower correlection to broad equity markets and offer diversification benefits.
There’s a better explanation in the CFAI book – probably a chart as well – that will explain this for you.
Funny: When I studied for L1 and L2, I only used the CFAI books and everyone said - are you crazy. And for L3 I decided to only use Schweser - which turns out to be quite scant in many aspect - see my other new posts to follow.
The key is Real Estate is correlated with the economy. If the economy improves, typically, RE prices go up and hence REITS also do well. The catch is that RE has some idiosyncratic variables and is also affected differently by economic factors like interest rates hence the correlation is high(er) than direct investments. Page 19 of the CFA book clearly explains this and I guess for the exam that is all matters !!