REIT Momentum and the Performance of Real Estate Mutual Funds

REITs exhibit a strong and prevalent momentum effect that is not captured by conventional factor models. This REIT momentum anomaly hampers proper judgments about the performance of actively managed REIT portfolios. In contrast, a REIT momentum factor adds incremental explanatory power to performance attribution models for REIT portfolios. Using this factor, this study finds that REIT momentum explains a great deal of the abnormal returns that actively managed REIT mutual funds earn in aggregate. Accounting for exposure to REIT momentum also materially influences cross-sectional comparisons of the performances of REIT mutual funds. This study has important implications for performance evaluation, alpha–beta separation, and manager selection and compensation. Managers of such real estate portfolios as real estate mutual funds are compensated for the returns they produce on their portfolios relative to a benchmark portfolio’s return. This study focuses on the REIT industry to illustrate that momentum effects in U.S. REIT returns can affect portfolio performance attribution. We first confirmed that the presence of a strong and prevalent momentum effect in REIT returns poses a challenge to performance attribution based on common factors. A REIT momentum strategy, which buys REITs with the highest past return and sells short REITs with the lowest past return, produces a return that is economically larger than that of a common-stock momentum strategy. The common-stock momentum factor, which is explicitly designed to capture momentum effects, does not suffice to capture the REIT momentum anomaly. Instead, return differences among portfolios with different REIT momentum characteristics are best captured by a REIT momentum factor. To gauge the practical implications of the REIT momentum anomaly, we demonstrated how the inclusion of our REIT-specific momentum factor in performance attribution models affects estimates of the value added by active REIT portfolio managers. Using a sample of U.S. REIT mutual funds, we found that REIT momentum explains a great deal of the abnormal returns that such mutual funds earn according to studies that did not account for REIT momentum. Consistent with our expectations, REIT mutual fund returns are better explained by a REIT momentum factor than by the conventional common-stock momentum factor. The positive alphas that REIT funds deliver under conventional factor models dissipate under a model that includes the three Fama–French factors and a REIT momentum factor. Finally, we showed that a consideration of REIT momentum affects our understanding of cross-sectional variation in the performance of REIT funds. Specifically, REIT mutual funds with relatively high past returns continue to earn higher returns than the competition because of greater exposure to the REIT momentum factor. Moreover, the common-stock factor model and the factor model proposed in this study substantially disagree about the rankings of REIT mutual funds by their alphas. These results imply that factoring REIT momentum into performance attribution has important implications for REIT performance evaluation and manager selection and compensation.