Interest rate sensitivities of externally and internally managed Australian REITs

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Yong, Jaime L; Singh, Abhay
The Modelling and Simulation Society of Australia and New Zealand Inc
REITs; financial leverage; interest rate risk; panel quantile regressions; Finance and Financial Management
conference paper description
Real Estate Investment Trusts (REITs) in Australia experienced tremendous growth and investor interest following the crash of unlisted property funds in the 1990s. Since 2001, management structures have shifted from external property management to an internally advised model. The sector’s returns had been notably rewarding up till the Global Financial Crisis but rising costs of debt and years of aggressive borrowing to fund expansions have eroded the values of REITs. Externally managed trusts had relatively higher levels of debt than their internally managed counterparts thus increasing the sensitivities to interest rate risks. Yet internally managed REITs engage in a wider set of operating activities which compound exposures to market and financial risks. Using panel regressions, this paper aims to examine the joint impact of financial leverage and management structure on REIT returns in terms of their sensitivities towards stock market returns and changes to yields of 10-year bonds and 90-day bank accepted bills. We utilise a sample period of monthly data from January 1980 to March 2013. Panel quantile regressions are also employed to analyse how sensitivities to market risks, short and long-term interest rate risks vary at different parts of an economic cycle. Our study finds that REITs are positively related to the stock market and the effect is greater for REITs with greater financial leverage as well as stapled trusts. REITs are only negatively affected by short-term interest rates at the lowest 5 per cent quantile of returns. Long-term interest rates have an inverse effect on REITs only at the upper 75 and 95 per cent quantiles. We consider the possibilities that rental yields and inflationary expectations may offset the influences of financing costs. Internal management appears to compound market and interest rate risks. These have implications on investors looking to select REITs as substitutes of direct property investments.