Dreams of lucrative real estate investing for modern Americans are frequent, but realization is rare. Real estate and land of all types are predominantly illiquid assets as buying a house and land has been the “cornerstone” for the American Dream. However, for others who see land as an investing opportunity have demanded a liquid form of investing in land. Real estate investment trusts (REITS) were created in the 1960’s to combat the problem of land being an illiquid asset. Investors pool their capital in hopes to continue to flip, buy, and develop as much property as possible. These REITs have the ability to specialize and focus on specific types of properties such as apartments, self-storage, hospitals, etc. The accessibility for investing in REITs has become easy via the New York Stock Exchange. Investors typically seek REITs because of high dividend yields. The global recession and housing crash in 2008 caused many REITs to take losses in return for months and even years around that time. Cash flows freely into these trusts as investors have continued to invest since 2008; however, dividend yields across all REITs still have not reached pre-2008 levels. The economic impact of these trusts extend beyond financial markets, with REITs being responsible for $3 trillion in gross assets.

Investors, ETFs, and mutual funds find the appeal of real estate investment trusts stemming from their high dividend yields, which reached 7% to 8% dividend yield before the Great Recession. America has seen the housing market recover since 2008 with new residential construction converging towards 2007 totals. The overall positive outlook on the economy has increased as gross domestic investment continues to skyrocket.  Ambrose, Highfield, and Linneman (2005) suggest that REITs are a perfect example of economies of scale. Ambrose, et. al. (2005) state “large REITs are increasing growth prospects while succeeding at lowering costs, leading to a direct relationship between firm profitability and firm size.” So why have these real estate investment trusts continue to pay dividends at rates when returns and net operating incomes are high? Has there been a structural change in the REITs financial market since 2008? Are they filling their balance sheets with additional investment instead of paying out?

There are two categories of REITs: equity REITs and mortgage REITs. Mortgage REITs buy mortgage-backed securities, while equity REITs only invest in property and land. There are REITs that invest in both. Data collected monthly over a twenty-year period from January 1997 until February of 2017 on all equity REITs only. The Great Recession changed financial markets and the housing market. The immense cash flow that REITs received weekly from investors kept these assets from the collapsing magnitude compared to everyday homeowners. Real estate investment trusts have fully recovered in terms of returns and were making profits by 2009. However, I hypothesize that structural changes have been implemented within these trusts as dividend payments have not restored to historical levels. Standard procedure in testing for structural change is running a Chow test. Developed by Greogy Chow in 1960, the Chow test is a nested F-test that categorizes time series data into subgroups based on dates and tests that there is no structural change. If these two subgroups contain structural differences then one will see break lines between these subgroups and see significant differences in slope from subgroup 1 to subgroup 2. The first Chow test I ran was on the returns of these equity REITs to confirm my hypothesis that REITs were not affected drastically by the Great Recession due to their incredible inflow of capital from investors and shareholders. The Chow test confirmed zero break lines with a Bayesian Information criterion value lowest when m equals zero, i.e. no break lines. The second Chow test I ran was on dividends over the longevity of the data sample. This test and graph of dividends over time is below in figure (1). Surprisingly, the Bayesian information criteria was lowest at m=2: i.e. two break lines. The second break line occurred as expected, sometime after 2008, which is why dividends have remained at lower levels than before.  However, the first break line occurs in the later months of 2003. This creates a much more interesting narrative as equity REITs were lowering dividend yields before the Great Recession began. Below the break lines in figure (1) are the 95% confidence intervals for these structural changes. These confidence intervals extend a month or two in each direction.

Figure (1).

Answering the question ‘why real estate investment trusts have stopped paying out dividends’ perhaps is arduous. However, the awareness to understand that there has been a structural change behind these behemoth financial assets can help answer an array of macroeconomic questions concerning the last eight years, such as stagnant 2% growth of the GDP in America.  The current state that most economies worldwide are facing is a lack of investment. Interest rates worldwide have hit historic lows and brought upon experimental negative interest rates, which charges banks for excessive reserves. REITs perhaps can act as a catalyst for growth and development of these economies worldwide. In the last two months, REITs have reached 35 countries with China opening their first “pseudo” REIT. The macroeconomic implications of REITs have structurally changed dividend payouts and can update questions in many different sectors and industries as well. These trusts extend to global economies with global implications, and financially reduce volatility in portfolios, complete asset allocation to stock-heavy investors, and lead to wealth accumulation among all investors.

This post met all five objectives for a graduating senior. It covered the macroeconomic perspective that real estate investment trusts play on an economy, from new construction in America to developing nations worldwide. I briefly mention the affect that REITs play in sectors, subsectors, and individual industries. The Chow test covered any econometric and statistical application or interpretation that was required from an individual graduating along with an extended knowledge in time series.  Finally, this paper gives a conclusion that describes current international and national events affected by this topic.

The Economic Impact of Real Estate Investment Trusts