Financial Leverage,CEO Compensation,and Corporate Hedging: Evidence from Real Estate Investment Trusts

This paper studies the determinants of corporate hedging practices in the REIT industry between 1999 and 2001. We find a positive significant relation between hedging and financial leverage, indicating the financial distress costs motive for using derivatives in the REIT industry. Using estimates of the Black–Scholes sensitivity of CEO’s stock option portfolios to stock return volatility and the sensitivity of CEO’s stock and stock option portfolios to stock price, we find evidence to support managerial risk aversion motive for corporate hedging in the REIT industry. Our results indicate that CEO’s cash compensation and the CEO’s wealth sensitivity to stock return volatility are significant determinants of derivative use in REITs. We also document a significant positive relation between institutional ownership and hedging activity. Further, we find that probability of hedging is related to economies of scale in hedging costs.

Correlation and Volatility Dynamics in International Real Estate Securities Markets

We study international correlation and volatility dynamics of publicly traded real estate securities using monthly returns from 1984 and 2006. We also examine, for comparison, the correlations among the corresponding stock markets. A multivariate dynamic conditional correlation model captures the time-varying correlation within the full period. We confirm lower correlations between all real estate securities market returns than those between the stock market returns themselves. Some significant variations and structural changes in the correlation structure happened within the sample period. We detect a strong and positive connection between real estate securities market correlations and their conditional volatilities. We also find the international correlation structure of real estate securities and the broader stock market are linked to each other. Our results have economic motivations regarding the potential integration of international real estate securities markets and the possibility of including information on changing correlations and volatilities to design more optimal portfolios for international real estate securities.

Discovering REIT Price Discovery: A New Data Setting

This study decomposes real estate investment trust (REIT) returns into two components: (1) real returns, and (2) public returns. The real returns are based on the changes in the private, appraisal-based net asset values of REITs, whereas the public returns are measured by the variations in REITs’ premiums/discounts. This study then investigates the price discovery of REIT prices. The results indicate that lagged public returns are useful in predicting real returns. In addition, the study documents concurrent factor exposures for public returns and lagged factor exposures for private returns under a variety of asset pricing models. Overall, the results are consistent with the notion that public markets are more efficient in processing information.

The Long-Horizon Performance of REIT Mergers

We study long-horizon shareholder returns in a comprehensive sample of Real Estate Investment Trust (REIT) mergers, to test whether or not the anomaly of post-merger underperformance observed in conventional firms applies to the case of REITs. Constructing synthetic benchmark portfolios controlling for firm size and for book-to-market value ratio, we find that 60-month buy-and-hold abnormal returns for REIT acquirers are significantly negative at approximately −10%, supporting the position that REIT merger acquirers underperform non-merging REITs in the long run. We find no evidence to challenge previous studies reporting positive announcement period returns for acquirers when the target is privately held, but we do find evidence that these positive returns do not persist. The long term performance of acquiring REITs is approximately the same whether the target is public or private.

Mortgage Put Options and Real Estate Markets

In this paper we offer direct evidence that financial intermediation does impact underlying asset markets. We develop a specific observable symptom of a banking system that underprices the put option imbedded in non-recourse asset-backed lending. Using a dataset for 19 countries and over 500 real estate investment trusts, we find that, following a negative demand shock, the “underpricing” economies experience far deeper asset market crashes than economies in which the put option is correctly priced.

REIT IPOs and the Cost of Going Public

We examine Initial Public Offerings (IPOs) of Real Estate Investment Trusts (REITs) that went public between 1986 and 2004. Consistent with previous studies, we find that REIT IPOs are associated with lower levels of underpricing relative to traditional issues. We also find that REITs are associated with smaller file price revisions. Both findings are potentially attributable to the lower level of uncertainty associated with pricing REITs. In contrast, using an alternative measure of issuance costs that incorporates the share retention decision by preexisting owners, we find no significant difference between REIT and non-REIT issues, suggesting the results of previous studies are not robust to various specifications of issuance cost and that preexisting owners do not necessarily benefit from the lower level of underpricing. Additionally, we find no difference in the issuance costs of equity versus mortgage REITs, particularly once we control for the use of umbrella partnerships.

The Inflation Hedging Characteristics of US and UK Investments: A Multi-Factor Error Correction Approach

Historic analysis of the inflation hedging properties of stocks has produced anomalous results, with stocks often appearing to offer a perverse hedge. This has been attributed to the impact of real and monetary shocks to the economy, which influence both inflation and asset returns. It has been argued that real estate should provide a better hedge: however, empirical results have been mixed. This paper explores the relationship between commercial real estate returns and economic, fiscal and monetary factors and inflation for US and UK markets. Comparative analysis of general equity and small capitalization stock returns is carried out with inflation divided into expected and unexpected components. The analyses are undertaken using an error correction approach. In the long run, once real and monetary variables are included, asset returns are positively linked to anticipated inflation but not to inflation shocks. Adjustment processes are, however, gradual and not within period. Real estate returns, particularly private market returns, exhibit characteristics that differ from those of stocks.

The nature of listed real estate companies: property or equity market?

This paper addresses the question of whether shares of public real estate companies should be treated as real estate or as equity investments. Because theoretical considerations do not suffice for making such a classification, we empirically investigate correlation structures and cointegration relationships of private and public real estate and equity markets for the United States and the United Kingdom. Our results suggest that public real estate stocks show similarities to the general stock market with regard to short-term return co-movements. For long-term investment horizons, the interdependence between direct and securitized real estate is much stronger. However, in the latter case, real estate stocks substantially lead the private property markets.

How Does the Market for Corporate Control Function for Property Companies?

We investigate 95 takeovers of property companies all over the world and find that only two of those are hostile. To determine the effectiveness of the market for corporate control, we first study characteristics of targets and acquirers compared to a control sample, using the complete global universe of listed property companies during the most recent takeover wave (1999–2004). We find that the inefficient management hypothesis holds for both REITs and non-REITs, as targets exhibit significant underperformance before takeovers. In the second part of this study, we investigate shareholder wealth effects following takeovers and confirm previous findings that abnormal returns for targets and bidders are distinctly different for the real estate sector. Moreover, we show that this difference not only holds for REIT-to-REIT mergers, but also for mergers of real estate firms without a REIT-status.

Optimal Time to Sell in Real Estate Portfolio Management

This paper examines the properties of optimal times to sell a diversified real estate portfolio. The portfolio value is supposed to be the sum of the discounted free cash flows and the discounted terminal value (the discounted selling price). According to Baroni et al. (Journal of Property Investment and Finance 25(6):603–625, 2007b), we assume that the terminal value corresponds to the real estate index. The optimization problem corresponds to the maximization of a quasi-linear utility function. We consider three cases. The first one assumes that the investor knows the probability distribution of the real estate index. However, at the initial time, he has to choose one deterministic optimal time to sell. The second one considers an investor who is perfectly informed about the market dynamics. Whatever the random event that generates the path, he knows the entire path from the beginning. Then, given the realization of the random variable, the path is deterministic for this investor. Therefore, at the initial time, he can determine the optimal time to sell for each path of the index. Finally, the last case is devoted to the analysis of the intertemporal optimization, based on the American option approach. We compute the optimal solution for each of these three cases and compare their properties. The comparison is also made with the buy-and-hold strategy.

Commercial Real Estate Valuation: Fundamentals Versus Investor Sentiment

This paper investigates the role of fundamentals and investor sentiment in commercial real estate valuation. In real estate markets, heterogeneous properties trade in illiquid, highly segmented and informationally inefficient local markets. Moreover, the inability to short sell private real estate restricts the ability of sophisticated traders to enter the market and eliminate mispricing. These characteristics would seem to render private real estate markets highly susceptible to sentiment-induced mispricing. Using error correction models to carefully model potential lags in the adjustment process, this paper extends previous work on cap rate dynamics by examining the extent to which fundamentals and investor sentiment help to explain the time-series variation in national-level cap rates. We find evidence that investor sentiment impacts pricing, even after controlling for changes in expected rental growth, equity risk premiums, T-bond yields, and lagged adjustments from long run equilibrium.

Fundamental Real Estate Prices: An Empirical Estimation with International Data

We propose two alternative models to estimate fundamental prices on real estate markets. The first model is based on a no-arbitrage condition between renting and buying. The second model interprets the period costs as the result of market equilibrium between housing demand and supply. We estimate both models for the USA, the UK, Japan, Switzerland, and the Netherlands. We find that observed prices deviate substantially and for long periods from their estimated fundamental values. However, we find some evidence that, in the long-run, actual prices tend to return to their fundamental values progressively. This result is due to both impulse–response functions and forecast analyses. In particular, we find that using the fundamental price significantly increases the accuracy of out-of-sample long-term forecasts of the price.

The Effect of Reputation and Competition on the Advice of Real Estate Agents

We study a two-period bargaining game where buyers and sellers employ real estate agents to help them determine the sales price of a house. We find that agents are less likely to provide aggressive bargaining advice to their client when they receive percentage commissions and when they work for the buyer. In addition, we find that agents are less likely to suggest aggressive bargaining strategies when there is little market competition, the gains to trade are large, in markets where housing values appreciate slowly, and when dual agency is permitted. More importantly, we show that an agent is more likely to bargain aggressively and capture a portion of the gains to trade for a client when the house’s sales price is closely related to the agent’s reputation and future business (referrals).

Conditional Volatility of Equity Real Estate Investment Trust Returns: A Pre- and Post-1993 Comparison

We examine the dynamic behavior of Equity Real Estate Investment Trust (EREIT) volatility in a GARCH context 1972–2006 using monthly EREIT returns, and comparing volatility performance for “early” Equity REITs 1972–1992 with that of “modern” EREITs 1993–2006. Consistent with findings for conventional firms, we find that EREIT conditional volatility is time-varying, persistent, and predictable. There is a positive relationship between expected return and expected risk in EREIT stocks pre-1993, but the relationship disappears after 1993. We find no evidence that negative shocks affect EREIT volatility differently from positive ones in either time period. Different from reported results for conventional firms, we find that changes in the conditional volatility of fundamental macroeconomic variables have strong explanatory value for future changes in EREIT volatility. Finally, comparing EREIT volatility performance with volatility in the Russell 2000 Index, a proxy for small stocks, we find that EREIT volatility behaves differently from that of small stocks in many respects, indicating that risks in the small stock index cannot effectively proxy for risks in the EREIT market.

Volatility Transmission in the Real Estate Spot and Forward Markets

How shocks in one market influence the returns and volatility of other markets has been an important question for portfolio managers. In the finance literature, many studies found evidence of volatility spillovers across international markets, as well as between spot and futures markets. Although real estate is often regarded as a good vehicle for diversification, the dynamics of its volatility transmission have been largely ignored. This paper provides the first study to examine volatility spillovers between the spot and forward (pre-sale) index returns of the Hong Kong real estate market through a bivariate GARCH model. Transaction-based indices were used so that our volatility modelling was free from any smoothing problem. Our results showed that real estate returns exhibited volatility clustering, and the volatility of the forward market was more sensitive to shocks than the spot market. Moreover, volatility was mainly transmitted from the forward market to the spot market, but not vice versa.

Hedging House Price Risk with CME Futures Contracts: The Case of Las Vegas Residential Real Estate

Until the recent introduction of real estate futures on the Chicago Mercantile Exchange (CME), there have been few opportunities to manage house price risk. This paper examines whether house price risk can be effectively hedged in Las Vegas, one of the CME contract cities. The analysis considers hedging from the viewpoint of real estate investment groups, mortgage portfolio investors, builder/developers and individual homeowners. For investment groups and mortgage holders holding a mix of new and existing home assets, CME futures would have reduced house price risk by more than 88% over the 1994–2006 period. Similarly, homeowners implicitly hedging price volatility of existing homes also would have fared well over the sample period. However, builder/developers worried about new home price appreciation would have been much less successful in managing their risk. One important caveat, minimum variance hedge ratios change over time and may cause hedge performance to suffer.

Calendar Anomalies: The Case of International Property Shares

In this paper we analyze the price dynamics of international property shares for the ten most prominent markets from around the world plus South-Africa. We focus on the presence of calendar effects in daily and monthly price returns and examine these effects both over time and across countries. For the daily returns we find price anomalies for Fridays and Mondays in all markets. Friday returns tend to be the highest of the week, while Mondays are weakest. We find that these patterns were most prominent during the 1980s and early 1990s and in the smaller markets in our sample. For the monthly returns we found little evidence for price irregularities. In most cases January was superior to most other months, but these differences lacked statistical significance. More interesting was the sell in May effect that seemed to be present in ten out of 11 markets. Price returns during the winter season outperformed the summer months and in five countries these difference were both economically and statistically significant. Finally, we looked at firm level returns to isolate the drivers of these infamous calendar effects. The day-of-the-week effect appears to be most pronounced among small and young firms that have little or no institutional investors. Large and long-established listed real estate firms with a large portion of loyal block-holders experience no significant price patterns during the trading week.

Marketing Period Risk in a Portfolio Context: Comment and Extension

This paper re-examines and extends the findings of Bond et al., Journal of Real Estate Finance and Economics, 34, 447–461, (2007) who consider the theoretical model of Lin and Vandell, Real Estate Economics, 35, 291–330, (2007) to determine the extent to which individual real estate asset return characteristics caused by marketing period risk disappear in a large, diversified real estate portfolio. The effects of marketing period risk are found to disappear in the limit with growth in the size of the portfolio, with ex ante variance approaching ex post variance, but only if the portfolio consists of nonsystematic risk alone, in which case both approach zero. The marketing period risk factor (MPRF), representing the ratio of ex ante to ex post variance, however, does not in general approach zero in the limit, in fact could increase or decrease depending upon the illiquidity characteristics of the individual assets and the magnitude and degree of correlation among individual property returns and marketing periods. The results suggest that even large institutional real estate portfolio managers must consider the illiquidity present in their portfolios and cannot assume that its effect will be diversified away.

Analyst Activity and Firm Value: Evidence from the REIT Sector

This paper is the first to examine (1) properties of analyst forecasts and (2) effects of analyst following on firm value for all REITs on CRSP, Compustat and I/B/E/S. Our results suggest that REITs operate in an information environment that has changed over time. We find that for periods when the REIT industry was either in the developmental stage (pre-1992), or after other structural changes in the industry (post-2000), more analysts cover REITs and forecasts are more accurate and less biased. Further, we find that mortgage REITs are more transparent than other REIT structures and exhibit properties of analyst behavior that are different from other types of REITs. Our investigation into the effect of analyst coverage on REIT value suggests that analyst coverage increases REIT value (as measured by Tobin’s q) and that the causality does not run the opposite way.