Illiquidity,transaction cost,and optimal holding period for real estate: Theory and application |
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| Authors: | Ping Cheng Zhenguo Lin Yingchun Liu |
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| Institution: | 1. Department of Finance, College of Business, Florida Atlantic University, 777 Glades Road, Boca Raton, FL 33431, USA;2. Department of Finance and Economics, Mississippi State University, Mississippi State, MS 39762, USA;3. Department of Finance, Texas Tech University, Lubbock, TX 79409, USA;1. School of Public Economics & Administration, Shanghai University of Finance and Economics, Shanghai 200433, China;2. Department of Finance, College of Business, Florida Atlantic University, 777 Glades Road, Boca Raton, FL 33431, United States;3. Department of Finance, Mihaylo College of Business and Economics, California State University, Fullerton, CA 92834-6848, United States;4. Department of Finance, Insurance and Real Estate, Laval University, Quebec G1V 0A6, Canada;1. Hanqing Advanced Institute, Renmin University of China, China;2. University of Wisconsin–Madison, United States;3. FRB Minneapolis, United States;4. FRB Chicago, United States;5. NBER, United States;6. University of Leicester, United Kingdom;1. CENTRUM Católica Business School Surco, Lima, Perú;2. INSEAD, NBER and CEPR, Boulevard de Constance, 77305 Fontainebleau, France;3. Bocconi University, Baffi-Carefin Centre and CSEF, Via Roentgen 1, 20136 Milan, Italy;1. Kellogg School of Management, United States;2. Harvard Business School, United States;1. Dept. of Economics, Jinan University, China;2. Dept. of Real Estate and Construction, the University of Hong Kong, China;3. Dept. of Building and Real Estate, the Hong Kong Polytechnic University, China |
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| Abstract: | Choosing the optimal holding period is an important part of real estate investment decisions, because “when to sell” affects “whether to buy”. This paper presents a theoretical model for such decision making. Our model indicates that the optimal holding period is affected by both systematic and non-systematic factors—market conditions (illiquidity and transaction cost) and property performance (return and return volatility). Other things being equal, higher illiquidity and transaction costs lead to longer holding periods, while higher return volatility implies shorter holding periods. Our empirical application suggests that the optimal holding period based on our model is quite consistent with previous empirical findings. In addition, we find that when illiquidity risk is incorporated the true real estate risk is significantly higher than the conventional risk estimate. Therefore, the current practice of real estate valuation, which is naively borrowed from finance theory, substantially underestimates real estate risk. |
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