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REIT Returns Tied to Tenants

The health of tenants not only is an important factor for commercial real estate landlords' profits; it is also closely tied to their stock prices.

New research from Bank of America shows that the stocks of office real estate investment trusts are generally correlated to the stocks of financial-related companies, which tend to make up a good portion of their tenant bases.

In addition, retail REITs, which own malls and shopping centers, are well correlated to retailer stocks, according to the report from analyst Christy McElroy.

Over a three-year and five-year period, the correlation between office REITs and the S&P IBK/Brokerage and Financial indices is around 0.95.

In measuring correlation, a reading of 1.0 suggests the two sectors' stock prices move in the same direction at all times. Thus, the 0.95 reading means that office REITs and financial stocks are nearly always moving in lockstep fashion.

The caveat, McElroy says, is that the year-to-date correlations have been skewed by the sharp rise in office REIT prices earlier this year. But during any time interval over the past 10 years, the correlation between office REITs and financial stocks has been 0.84 to 0.96, the analyst says.

How is this information useful to investors? Well, for one, it shows how owning stocks in both sectors reduces diversification. It also suggests that investors can develop long/short trading strategies by using stocks and exchange-traded funds to hedge against losses.

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