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The Impact of Noise Trading on the NAV Spread in REIT Pricing

The Impact of Noise Trading on the NAV Spread in REIT Pricing Evidence from the New Pan EU REIT Market. ERES – European Real Estate Society 18th Annual Conference Eindhoven , Netherlands, June 15 - 18, 2011 Michael G. Mueller. Agenda. 1. Introduction. 2. Data.

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The Impact of Noise Trading on the NAV Spread in REIT Pricing

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  1. The Impact of Noise Trading on the NAV Spread in REIT Pricing Evidence from the New Pan EU REIT Market ERES – European Real Estate Society 18th Annual Conference Eindhoven, Netherlands, June 15 - 18, 2011 Michael G. Mueller

  2. Agenda 1. Introduction 2. Data 3. EmpiricalEvidence 4. Conclusions June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  3. 1. IntroductionProblem Definition • 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)). 40% NAV spread REITs/REOCs Europe (based on EPRA (2010)) NAV spread REITs USA (based on Green Street Advisors (2011)) 30% 20% June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration 10% 0% -10% -20% -30% -40% -50% 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

  4. 1. IntroductionPurposeofthe Study • 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 40% NAV spread REITs/REOCs Europe (based on EPRA (2010)) NAV spread REITs USA (based on Green Street Advisors (2011)) 30% 20% June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration 10% 0% -10% -20% -30% -40% -50% 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

  5. 1. IntroductionThe 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: • risk averse and have • finite investment horizons. • While noise trader sentiment is: • stochastic and • the consequential noise trader risk is systematic • A fifth assumption is amended by Lee/‌Shlei­fer/‌Thaler(1991): • 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: • equity issues in premium-periods, • meanreversion, • negative long-term average, • homogeneity of sentiment, • 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). June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  6. 2. Data Overview – thePan EU REIT Market • 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) June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  7. 2. Data Sample Coverage • 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 June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  8. 3. EmpiricalEvidence1st Implication – Equity Issues in Premium-Periods 2,000 mEUR 1,800 mEUR 1,600 mEUR 1,400 mEUR 1,200 mEUR 1,000 mEUR • 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) 800 mEUR 600 mEUR 400 mEUR 200 mEUR -40% -30% -20% -10% 0% 10% 20% NAV spread Results: in line with the NTM, apart from the reasonable outliers Quarterly IPO/SEO volume (mEUR). Trendline. June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  9. 3. EmpiricalEvidence2nd Implication – Mean Reversion • 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 0.75 0.50 0.00 - 1 - - 2 - - 3 - - 4 - - 5 - - 6 - - 7 - - 8 - - 9 - Lags -0.50 -0.75 Results: in line with the NTM 95% confidence level. June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  10. 3. EmpiricalEvidence3rd Implication – Negative Long-Term Average • 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 30% 20% 10% 0% -4.62% -10% -20% -30% -40% 2005Q4 2006Q4 2007Q4 2008Q4 2009Q4 2010Q4 Results: - entire sample: in line with the NTM - separate national markets: mixed results, but reasonable NAV spread. Average 2005 – 2010. June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  11. 3. EmpiricalEvidence4th Implication – Homogeneity (1) • 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 • homogenoustrend 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... Volatility FR 30% GE NL 25% UK 20% BE IT 15% 10% 05% -50% -40% -30% -20% 10% 0% Average NAV spread Established REIT market. Young REIT market. June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  12. 3. EmpiricalEvidence4th Implication – Homogeneity (2) • …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 theparticular shareholder structure Results: in line with recent adjustments regard- ing the systematic character of noise trader sentiment June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

  13. 3. EmpiricalEvidence5th Implication – Correlation with Sentiment-Indicators • 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 June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

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

  15. Contact Thanksforyourattention! Darmstadt University of Technology Michael G. Mueller Research Center for Real Estate Business Administration Hochschulstraße 1 64289 Darmstadt • Phone: + 49 (0) 221/ 99 37 87 24 Email: michael.mueller@bwl.tu-darmstadt.de Web: www.immobilien-forschung.de June 17th 2011 | Mueller | TU Darmstadt | Research Center for Real Estate Business Administration

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