Since their inception in 2001, Japanese REITs (J-REITs) have experienced rapid growth both in terms of a number of entities and total market capitalization. Investors are attracted to JREITs due to their liquidity, transparency, and simplicity in terms of management, but do these advantages come at a cost? In this paper, we assess the diversification potential of REITs for stock market investors and investors in direct real estate assets. We develop a novel methodology for deriving the correlation between the cumulative returns of assets over different time horizons from a framework that accounts both for their long-run relationship and short-run dynamics. We establish a link between cointegration and correlation analysis by adapting long-run equilibrium analysis to the standard mean-variance framework of modern portfolio theory. This allows us to study the portfolio implications of investors holding cointegrated assets. We find that J-REITs and direct real estate assets are positively correlated; their correlation increases in the time horizon and approaches unity for holding periods of ten or more years. The correlation between J-REITs and the stock market is non- monotonic and turns negative for some sector and holding periods. Nevertheless, despite the findings on cointegration and correlation indicate REITs be a close substitute to direct real estate, we contend that their substitutability in the long-run is deemed to be limited due to their high level of volatility.