Betting Against the Sentiment in REIT NAV Premiums

Abstract

We dissect REIT NAV premiums and examine their relation to expected returns. More than half of the cross-sectional variation in NAV premiums can be explained by readily observable company characteristics, such as size, property type, location, leverage, and profitability. We empirically decompose NAV premiums into characteristics-driven (fitted) and sentiment-driven (orthogonalized) components. The transient, sentiment-driven component of NAV premiums is strongly negatively related to future returns, whereas the stable, characteristics-driven component is a very weak positive predictor of returns. A long-short investment strategy that purchases (sells short) REITs with the lowest (highest) sentiment- driven NAV premiums generates 9% per year, which is 3% per year more than a strategy based on the raw NAV premium. These results shed light on the role of investor sentiment in REIT pricing and have important implications for REIT active investment management.