Abstract
We study how short selling activity of REITs can be used to hedge real estate risk and how it affects price efficiency in the real estate markets. We propose a dynamic equilibrium model in which two agents (an owner and a landlord) trade real estate assets and stocks of REITs. The model accounts for two relevant frictions of the real estate assets: (i) they cannot be sold short; and (ii) their purchase or sale involve transaction costs. We show that these frictions lead to periods of high REIT short selling activity and predictability in real estate prices. Furthermore, we use proprietary data on equity lending supply, loan fees and quantities for the short selling activity of 197 REITs between 2005 and 2009 in order to test the main implications of the model. We find that an increase of 1% in the lending supply of REITs anticipates a decrease of 0.05% in real estate prices.
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