The Changing Importance of Sector and Regional Factors in Real Estate Returns: 1987–2002

Stephen Lee · Steven P. Devaney

22 citations0/0 files storedJournal of Property Research

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Financial Markets and Investment Strategies Housing Market and Economics Real estate and construction management

Abstract

A stylized fact in the real estate diversification literature is that sector (property type) effects are relatively more important than regional (geographical) factors in determining property returns. Thus, for those portfolio managers who follow a top‐down approach to portfolio management, they should first choose which sectors to invest in and then select the best properties in each market. However, the question arises as to whether the dominance of sector effects over regional effects is constant. If not, property fund managers will need to take account of regional effects in developing their portfolio strategy. Using monthly returns data for individual properties over the period 1987:1 to 2002:12, this paper investigates the influence of sector and regional factors on commercial real estate performance, first by adopting the dummy variable approach of Heston and Rouwenhorst (1994 Heston, S. L. and Rouwenhorst, K. G. 1994. Does industrial structure explain the benefits of international diversification?. Journal of Financial Economics, 36: 3–27. [Crossref], [Web of Science ®] , [Google Scholar], 1995 Heston, S. L. and Rouwenhorst, K. G. 1995. Industry and country effects in international stock returns. The Journal of Portfolio Management, Spring: 53–58. [Google Scholar]) and then by using the notion of cross‐sectional dispersion introduced by Solnik and Roulet (2000 Solnik, B. and Roulet, J. 2000. Dispersion as cross‐sectional correlation. Financial Analysts Journal, January/February: 54–61. [Google Scholar]). The results show that sector‐specific dominate region‐specific factors for the majority of the time and, in particular, during volatile periods of the real estate cycle. However, during calmer periods, sector and regional effects appear to be of equal importance. Overall, sector effects are still the most important aspect in the development of an active portfolio strategy.

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1997Postwar U.S. Business Cycles: An Empirical Investigation 1982Trends and random walks in macroeconmic time series 1988Trends and random walks in macroeconomic time series 1990Business Cycles: Real Facts and a Monetary Myth 1994Does industrial structure explain the benefits of international diversification?1981Post-War U.S. Business Cycles: An Empirical Investigation 2000The Increasing Importance of Industry Factors 1998Another look at the role of the industrial structure of markets for international diversification strategies1We are especially grateful to Pat Casey and Virge Cavalli at Dow Jones for providing the Dow Jones World Stock Index data and for their assistance with numerous queries. We gratefully acknowledge the comments of Geert Bekaert, William Brigham, Shane Corwin, Steve Foerster, Jeff Harris, Steve Heston, Ajay Khorana, David Mayers, John Persons, René Stulz, and particularly, the referee (Geert Rouwenhorst) and editor (John Long). We also thank participants at the University of Alberta, University of Toronto and Ohio State University, the 1996 UBC Global Investment Conference (Whistler), 1996 International Finance Conference (Georgia Tech), 1996 Western Finance Association Conference, and 1996 Financial Management Association Conference for helpful suggestions. Karolyi thanks the Dice Center for Financial Economics and the Social Sciences and Humanities Research Council of Canada for financial support.1

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