Can the Textual Tone in REIT Financial Statements Improve the Information Environment for Commercial Real Estate Investors? An Investigation

Abstract

The SEC requires publicly traded REITs to discuss commercial real estate market conditions in their financial statements in order to provide REIT investors with decision-relevant information. We investigate whether the textual tone in REIT financial statements (10-K/10-Q) can be used to predict future commercial real estate returns. In our empirical investigation, we focus on forward-looking tone, i.e., tone that cannot be explained by a REIT’s past performance. We extract textual tone from quarterly REIT financial statements over the period from 2002 to 2017 by using both a generic finance dictionary and a new, REIT-specific dictionary. We then employ a regime-switching methodology to assess the informative value of forward-looking tone for commercial real estate returns in the next quarter. We find that in periods of poorly performing real estate markets the forward-looking tone in REIT financial statements predicts total returns in the next quarter. This effect is driven by capital returns and is most pronounced for apartment and retail. Our findings suggest that the tone in REIT financial statements can help improve the information environment for commercial real estate investors.