the impact of noise trading on the nav spread in reit pricing evidence from the new pan eu reit...

The Impact of Noise Trading on the NAV Spread in REIT PricingEvidence from the New Pan EU REIT Market

ERES – European Real Estate Society18th Annual Conference Eindhoven, Netherlands, June 15 - 18, 2011

Michael G. Mueller

2

Agenda

June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

1. Introduction

2. Data

3. Empirical Evidence

4. Conclusions

3

1. Introduction Problem Definition


1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

-40%

-20%

0%

40%

20%

30%

10%

-30%

-50%

-10%

NAV spread REITs/REOCs Europe (based on EPRA (2010))NAV spread REITs USA (based on Green Street Advisors (2011))

The predominant explanation to NAV spreads (i. e. premia/dicounts) implicates an effect of company-specific factors (e. g. size, leverage, focus) on the valuation of REITs

Although this assertion is able to reason NAV spreads, it can only hardly reason the following characteristics:

- radical changes (like 2007/2008)

- continuous alternation

- homgeneous trend

The Noise Trader Model (NTM) of De Long et al. (1990) has the potential to reason these char-acteristics but

- has not gained too much attention in research regarding REITs NAV spreads and

- its empirical evidence "is not overwhelming" (Barkham/Ward (1999)).

4

1. Introduction Purpose of the Study


1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

-40%

-20%

0%

40%

20%

30%

10%

-30%

-50%

-10%

NAV spread REITs/REOCs Europe (based on EPRA (2010))NAV spread REITs USA (based on Green Street Advisors (2011))

This study examines to what extent empirical evidence actually supports noise trading as an alternative assertion for NAV spreads

To attain more unambiguous results than previous studies, the investigation period covers the financial crisis, which is regarded as a period of high (negative) noise trader sentiment

The study concentrates on the new pan EU REIT market, which is barely investigated in contrast to the large body of research regarding NAV spreads of US REITs

5

1. Introduction The Noise Trader Model (NTM) in Brief


The noise trader hypothesis assumes two different categories of market participants: rational investors and irrational investors (noise traders).

De Long et al. (1990) base the accordant NTM on four assumptions. Rational investors are:

(1) risk averse and have

(2) finite investment horizons.

While noise trader sentiment is:

(3) stochastic and

(4) the consequential noise trader risk is systematic

A fifth assumption is amended by Lee/ Shlei fer/ Thaler (1991):

(5) Noise traders are predominantly invested indirectly, while rational investors prefer the (underlying) direct investments.

The NTM reasons long-term mispricing as well as the continued existence of noise traders in asset markets.

NTM – empirically revisable implications

Taken together, the NTM results to five revisable implications:

(1) equity issues in premium-periods,

(2) mean reversion,

(3) negative long-term average,

(4) homogeneity of sentiment,

(5) correlation with other indicators of sentiment.

The implications are the foundation of the following analysis.

Based on a literature review, minor irregularities regarding the systematic effect of noise trader sentiment have to be expected (i. e. implication 3, 4 and 5).

6

2. Data Overview – the Pan EU REIT Market


Year1) State Abbr. REIT Name Abbr. No.2)

1969 Netherlands NL Fiscale Beleggingsinstelling FBI 6

1995 Belgium BE Société d'Investissement à Capital Fixe en Immobilière

SICAFI 15

1999 Greece GR Real Estate Investement Company3)

REIC3) 4

2003 France FR Sociétés d'Investissements Immobiliers Cotées4)

SIIC4) 42

2003 Lithuania LT Collective Investment Undertakings3)

CIU3) -

2004 Bulgaria BG Special Purpose Investment Companies3)

SPIC3) 19

2007 Germany GE German Real Estate Investment Trust

G-REIT 3

2007 United Kingdom

UK UK Real Estate Investment Trust5) UK-REIT5) 21

2007 Italy IT Società di Investimento Immobiliare Quotate

SIIQ 1

2009 Finland FI Real Estate Investment Trust REIT -

2009 Spain ES Sociedad Cotizada de Inversión en el Mercado Inmobiliario

SOCIMI -

1)

2)

3)

4)

5)

Year of national REIT legislation coming into effect. Number of companies at the end of period Q4/2010.Due to better intelligibility, the original REIT nomenclature of Greece, Lithuania and Bulgaria in Cyrillic, Hellenic and Lithuanian have been replaced by the internationally established nomenclature in English.Companies suspended from SIIC status not taken into account.Channel Islands not taken into account.

At the end of period Q4/2010:

Eleven of the 27 EU member states have established the legal conditions for a national REIT vehicle

Starting 2003, a continuous increase of national REIT laws has been noted

The total amount of REITs in EU member states accumulates to 111 companies

In Lithuania, Finland and Spain there have been no conversions to the according national REIT status, i. e. these countries have no national REIT market

The sample is constrained to the western EU member states with an established REIT market (i. e. the Netherlands, Belgium, France, Germany, United Kingdom and Italy)

7

2. Data Sample Coverage


State/REIT Number of REITs Market capitalization1)

market sample perc. market2) sample2) perc.

NL FBI 6 6 100% 9,201 9,201 100%

BE SICAFI 15 15 100% 5,255 5,255 100%

GR REIC 4 0 0% 1,498 0 0%

FR SIIC 42 39 93% 45,002 44,625 99%

LT CIU - - - - - -

BG SPIC 19 0 0% 727 0 0%

GE G-REIT 3 3 100% 957 957 100%

UK UK-REIT 21 18 86% 28,082 27,211 97%

IT SIIQ 1 1 100% 452 452 100%

FI REIT - - - - - -

ES SOCIMI - - - - - -

Total 111 82 74% 91,174 87,701 96%

1)

2)

End of period Q4/2010 in 1,000,000 EUR (mEUR), based on Thomson Financials and company reports.Due to international inter-REIT interests (e. g. REIT subsidiaries in foreign countries), the total market capitalization is less than the aggregated figures and amounts to 90,571 mEUR (87,097 mEUR in sample).

The total market capitalization of all 111 REITs in EU member states amounts to 90,571 mEUR

The sample covers

- 82 of 111 REITs (74 percent) and

- 96 percent of the total market capitalization.

France and the United Kingdom represent the biggest markets

Germany and Italy are of minor size (together only four REITs)

The investigation period 2005 to 2010 covers the entire financial crisis

The total number of observations is about 800

8

3. Empirical Evidence 1st Implication – Equity Issues in Premium-Periods


-30% -20% -10% 0% 10%-40% NAVspread

20%

1,800 mEUR

1,600 mEUR

1,400 mEUR

1,200 mEUR

200 mEUR

2,000 mEUR

1,000 mEUR

400 mEUR

600 mEUR

800 mEUR

Quarterly IPO/SEO volume (mEUR).Trendline.

In the period from Q4/2005 to Q4/2010, over 400 single transactions affecting share capital are reported for the selected REIT sample.

The data is constrained to the quarterly mEUR volume of IPOs and SEOs

The trend line suggests an additional emission of ten mEUR for every percent of quarterly increase in the NAV spread.

Outliers at discounts of about 20 to 30 percent result from SEOs in the first half of 2009 (in this period of exceptionally difficult credit availability and decreasing real estate values, REIT's valuation related banking covenants and tax exempt status have been threatened)

Results: in line with the NTM, apart from the reasonable outliers

9

3. Empirical Evidence 2nd Implication – Mean Reversion


0.75

-0.75

0.50

-0.50

- 1 - - 2 - - 3 - - 4 - - 5 - - 6 - Lags- 7 - - 8 - - 9 -0.00

95% confidence level.

Results: in line with the NTM

Test for serially autocorrelation with nine time lags

The sample shows a typical pattern of mean reversion:

- positive autocorrelation regarding short time lags and

- negative autocorrelation regarding longer time lags

The first, fourth and fifth lag show significance at the 95 percent confidence level

10

3. Empirical Evidence 3rd Implication – Negative Long-Term Average


2005Q4 2006Q4 2007Q4 2008Q4 2009Q4 2010Q4

-20%

0%

30%

20%

10%

-30%

-40%

-10%

-4.62%

NAV spread.Average 2005 – 2010.

The average NAV spread for the entire sample amounts to -4.6 percent.

The single national markets show a broad range of average NAV spreads (from -43.03% regarding the IT SIIQ to 2.54% regarding the BE SICAFI)

The irregular results regarding the single national markets can be reasoned since

- company specific factors affect the valuation of REITs, i. e. noise trader risk is only one factor among others that affects the valuation level

- average values depend significantly on the selected period of investigation

Results: - entire sample: in line with the NTM- separate national markets: mixed results, but reasonable

11

3. Empirical Evidence 4th Implication – Homogeneity (1)


-40% -30% -20% 10% 0%-50% Average NAV spread

30%

05%

25%

10%

15%

20%

GE

UK

FR

NL

BEIT

Vo

latil

ity

Established REIT market.Young REIT market.

The systematic effect of noise trader sentiment suggests a homogenous impact on national NAV spreads, i. e. a:

homogenous valuation level (measured by the average NAV spread),

homogenous fluctuation (measured by volatility) and a

homogenous trend of the national NAV spreads (measured by the pairwise correlations of the national markets)

The evidence reveals

divergent valuation levels (reasonable according to the 3rd implication) and

divergent fluctuation levels

but a homogenous trend among NAV spreads since...

12

3. Empirical Evidence 4th Implication – Homogeneity (2)


State/REIT1)

NLFBI

BESICAFI

FRSIIC

UKUK-REIT

EUSample

NLFBI

Correlation (Pearson) 01 00.947** 00.974** 0.652* 00.927**Significance (one sd.) 00.000 00.000 0.028 00.000N 11 11 11 9 11

BESICAFI

Correlation (Pearson) 00.947** 01 00.973** 0.581 00.933**Significance (one sd.) 00.000 00.000 0.050 00.000N 11 11 11 9 11

FR Correlation (Pearson) 00.974** 00.973** 01 0.722* 00.974**SIIC Significance (one sd.) 00.000 00.000 0.014 00.000 N 11 11 11 9 11UKUK-REIT

Correlation (Pearson) 00.652* 00.581 00.722* 1 00.859**Significance (one sd.) 00.028 00.050 00.014 00.002N 09 09 09 9 09

EUSample

Correlation (Pearson) 00.927** 00.933** 00.974** 0.859** 01Significance (one sd.) 00.000 00.000 00.000 0.002 N 11 11 11 9 11

***1)

Significant at the 0.05 level (one sided).Significant at the 0.01 level (one sided).Germany and Italy not taken into account (due to minor market size)

…all four markets show a close correlation (at least 86 percent) with the EU sample at the highest levels of significance

The established markets indicate a very close pairwise correlation (about 95 percent or higher) and are highly significant

The results regarding the UK (young market) show a lesser but still unambiguous extent of positive correlation (between 58 and 72 percent)

Altogether: NAV spreads follow the same trend (i. e. increase/decrease homogenously) with different intensity (i. e. a heterogeneous gradient)

This is in line with results from aligned fields of research (CEFs/DLCs) that reason these irregular-ities by the particular shareholder structure

Results: in line with recent adjustments regard-ing the systematic character of noise trader sentiment

13

3. Empirical Evidence 5th Implication – Correlation with Sentiment-Indicators


State/REIT

IFOEC EA1)

STXEI EA2)

EC ESI EA3)

EUSample

Correlation (Pearson) 00.704** 00.730** 00.706**Significance (one sd.) 00.008 00.005 00.008N 11 11 11

State/REIT

EC ESI NL4)

EC ESI BE4)

EC ESI FR4)

EC ESI UK4)

NLFBI

Correlation (Pearson) 00.830** 00.846** 00.839** 00.860**Significance (one sd.) 00.001 00.001 00.001 00.001N 11 11 11 11

BESICAFI


FRSIIC


UKUK-REIT

Correlation (Pearson) 00.196 00.292 00.295 00.352Significance (one sd.) 00.306 00.223 00.221 00.177N 09 09 09 09

** Significant at the 0.01 level (one sided).1) Ifo Economic Climate (Euro area).2) Sentix Economic Index (Euro area).3) European Commission's Economic Sentiment Indicator (Euro area).4) European Commission's Economic Sentiment Indicator (national sentiment).

Three different sentiment indices regarding the general economic development are selected.

The EU sample is highly correlated with all three indices (at least 70 percent) at the highest level of significance, i. e. NAV spreads are highly reflective of the general economic sentiment

The national NAV spreads (established REIT markets) reveal a high correlation with the national sentiment indices (between about 75 and 83 percent) and are highly significant.

The results regarding UK (young REIT market) are less distinct, but anyhow do not contradict the NTM (potentially an effect of the exceptional circumstances accompanying the market launch of the UK-REIT)

Results: in line with the NTM

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4. Conclusions


The study supports noise trader sentiment as an alternative assertion for NAV spreads

The results of the empirical analysis are compliant with the models implications and feature a high statistical significance

Identified irregularities can be reasoned sufficiently, however minor refinements regarding the systematic effect of noise trader sentiment need to be considered

Since the sample period relates to the financial crisis, the regular impact of sentiment on NAV spreads may be lesser

Both the predominant "rational" explanation and noise trader sentiment contribute to explain NAV spreads

Implication

1. Equity issues in premium-periods compliant

2. Mean reversion compliant

3. Negative long-term average compliant, with adjustments

4. Homogeneity of sentiment compliant, with adjustments

5. Correlation with other indicators of sentiment compliant

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Contact


Michael G. Mueller

Hochschulstraße 164289 Darmstadt

Phone: + 49 (0) 221 / 99 37 87 24

Web: www.immobilien-forschung.de

Darmstadt

University of

Technology

Research Center for Real Estate Business Administration

[email protected]:

Thanks for your attention!

the impact of noise trading on the nav spread in reit pricing evidence from the new pan eu reit...

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