An Investigation into the Substitutability of Equity and Mortgage REITs in Real Estate Portfolios

This paper reconciles the controversy regarding the substitutability between equity REITs (EREITs) and mortgage REITs (MREITs) in existing literature. Using CRSP/Ziman data from 1992 to 2011, we show that the driving economic factors on EREIT returns are different from those driving MREIT returns, which rejects the substitutability hypothesis. Additional tests confirm that causality runs unilaterally from EREITs to MREITs, implying the leading (subordinate) role of EREITs (MREITs). Finally, EREITs and MREITs possess disparate risk and return profiles under the full and sub-periods. In sum, strong evidence reveals that EREITs and MREITs are in fact not substitutable.