Abstract
AbstractThis paper studies the pricing of the risk associated with the location of the assets. The local real estate market risk is measured by ‘local beta’, which combines the systematic risk of local property markets and the property allocation strategy of real estate firms. The empirical results confirm a higher equity return for a firm with higher exposure to the most volatile property markets, particularly for REITs which are more geographically concentrated. For REITs with highly diversified assets, local real estate risks are not reflected in REIT returns. For those REITs with most concentrated assets, a one standard deviation increase in the local beta will lead to a 4.7% increase in the annual return. Investors can use REITs’ local real estate risk as an information tool to construct a long-short investment portfolio of real estate firms and can achieve a significant non-market performance of 4.9% per annum.
Highlights
I, t is one of the following K firm characteristics: the change in SIZE, defined as the log-differenced firm’s aggregate market capitalization; market to book ratio (M/B), defined as the market value of assets divided by the book value of assets; LEV, defined as total debt divided by the book value of equity; and RE Invest, the real estate investment growth
By comparing γRE local and γStock Mrkt, we identify changes in the REIT price triggered by the systematic risks from direct real estate market and equity markets
This paper studies the role of geography on equity performance from the point of local real estate market risks
Summary
The importance of location on property investment has been highlighted in the literature. This paper proposes a new location risk factor – the “beta risk” of the local property markets where REITs allocate their assets It captures the sensitivity of the underlying property markets to any aggregate shocks. It reflects the systematic risk and cyclicality of the local real estate markets. The systematic risk of local real estate markets is priced in REIT equity returns, geographic diversification allows REITs to limit their exposure to the high beta markets. This topic has been intensively studied, most prior literature has focused on time variation in the aggregated risk and return of the real estate, stock, and REIT investments. Extending prior work, this study finds that the sensitivity to local real estate market risk varies across REITs according to their spatial diversification strategy.
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