Do informed REIT market participants respond to property sector mispricing?

ABSTRACT

Sector mispricing represents the deviation of current and long-run sector fundamentals indicating either over- or undervaluation. We focus on the response of informed market participants to property sector mispricing in the context of equity REITs. We argue that REIT market participants such as institutional REIT investors and analysts have an informational advantage due to their access to commercial real estate market data. As a result, they are expected to respond to property sector mispricing. Using a sample of 2,637 firm-quarters of pure play equity REITs over the period of 1993 to 2020, we find that sector mispricing indeed impacts the decision-making of informed REIT market participants. The more overvalued (undervalued) a property sector is, the more institutional investors behave as net sellers (buyers) for REITs with the respective property type specialisation in the next quarter. Similarly, property sector overvaluation (undervaluation) results in lower (higher) net buy recommendations by analysts for REITs in the respective sector in the next quarter. However, our results are driven by smaller REITs and REITs with higher growth options. The sensitivity of institutional REIT investors and analysts to property sector mispricing also varies across different states of trading and recommendations respectively.

KEYWORDS:

• Asset pricing
• Reits
• sector mispricing
• institutional investors
• analysts

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. RKRV’s method is applied in multiple scenarios: Merger and acquisition (Ben-Davidet al., 2015; Nguyen et al., 2012; Rhodes-Kropf et al., 2005) and seasoned equity offerings (Hertzel & Li, 2010). There are other ways of determining mispricing using different valuation models, however, our focus is on capturing property sector level mispricing, and therefore we use the RKRV misvaluation measure, which is theoretically motivated and empirically robust.

2. The first model in RKRV (2005) includes only book value; the second model includes book value and net income.

3. We analyse whether buy/sell decisions could be impacted by further lagged mispricing measures as well. We find that the effect is significant across first 3 quarter lags, but the magnitude is decreasing with the second and the third lag significantly dropping in its magnitude. We also test the cumulative 3 quarter lag impact and find that to be higher than the first lag impact albeit by a small number. All the results are robust using either first lag or the cumulative impact of 3 lags.

4. We acknowledge the presence of a potential endogeneity where capital flows could impact future mispricing and therefore, we conduct robustness checks to examine if institutional investors’ buy-sell decisions have a significant impact on future mispricing. We do not find statistical evidence of feedback effects caused by institutional investors’ decisions to buy and sell REITs on property sector mispricing.

5. Available on request.

6. https://www.nber.org/research/business-cycle-dating

7. Tables available on request.

Additional information

Notes on contributors

Ramya Aroul

Ramya Aroul: She received her Ph.D. specializing in finance and real estate from the University of Texas at Arlington in 2014. Her primary research interests include ESG and its valuation in asset markets, sentiment in real estate markets, sustainability in residential real estate markets, endogeneity and simultaneity issues in hedonic valuation. Her work has been published in journals such as Real Estate Economics, the Journal of Real Estate Research, Journal of Property Research, Journal of Real Estate Finance and Economics and Journal of Housing Research.

Julia Freybote

Julia Freybote: She holds a PhD in Business Administration (Real Estate) from Georgia State University and has published in journals such as Real Estate Economics, the Journal of Real Estate Research, Journal of Property Research, Journal of Real Estate Finance and Economics and Journal of Housing Research. Her research interests include real estate finance and investment, ESG, climate risk, PropTech/FinTech and behavioural real estate.

Anh Nguyen

Anh Nguyen: He received his Ph.D. degree in Finance from the University of Texas at Arlington (UTA) in 2022. His research focuses on mutual fund flows, international investment, REITs, and public pension funds.