Academic journal article Real Estate Economics

Measuring and Explaining Changes in REIT Liquidity: Moving beyond the Bid-Ask Spread

Academic journal article Real Estate Economics

Measuring and Explaining Changes in REIT Liquidity: Moving beyond the Bid-Ask Spread

Article excerpt

Jim Clayton [*]

Greg MacKinnon [**]

This paper investigates changes in REIT liquidity since the REIT boom of 1993. We use trade-by-trade data for REITs traded on the major U.S. exchanges to estimate and compare Kyle's (1985) measure of inverse liquidity for the 1993 and 1996 time periods. For our full sample of equity REITs, there is a significant increase in REIT liquidity in terms of the median price impact of trades. The increasing importance of the self-advised, self-managed organizational structure is found to be a major factor driving increased REIT liquidity. Our results imply a decline in the asymmetric information faced by market-makers. Our investigation of the changes in the size distribution and resulting price impacts of REIT trades over the 1993-1996 period yields evidence of increased importance of informed traders to REIT price dynamics. Our findings of increased liquidity indicate that the increase in adverse-selection costs due to the presence of more informed traders is more than offset by the increase in market thickness as a result of an increase in the number of uninformed (liquidity) traders.

The REIT industry has undergone tremendous growth in recent years, increasing from a market capitalization of just under $11 billion at the end of 1992 to nearly $100 billion at the end of 1997 (Ziering, Winograd and McIntosh 1997). A shortage of capital from traditional lenders, low interest rates and the desire by institutional investors for a more liquid way in which to invest in (illiquid) real estate assets have combined to generate a boom in REITs (Ling and Ryngaert 1997).

Much of the growth in REIT market capitalization is the result of increased institutional involvement. Public-market real estate investment by institutions has become more of an accepted practice. Many institutional investors were unable to dispose of properties at "fair market value" in the latest real estate downturn; real estate liquidity dried up. Investors who became disenchanted with private (direct) property investments looked to the public markets (REITs) for a more liquid way to participate in the real estate recovery.

Anecdotal evidence indicates that as a result of the REIT boom many individual REITs have reached market capitalizations that institutional investors feel comfortable with. Historically, REITs were too small for institutional investors to hold large blocks of shares (Lieblich and Pagliari 1997). Even though REIT shares trade on organized exchanges, and therefore in theory are liquid, the small capitalizations of REITs in the past meant that it was essentially impossible for investors to sell off large blocks of REIT shares either quickly or with little price impact; the investors were better off owning the underlying properties themselves. Hence, it seems that market participants believe REITs are now a more liquid investment vehicle than they were five years ago.

In support of this claim, a number of recent papers report that the REIT market microstructure has changed dramatically since the early 1990s. In particular, REIT liquidity as measured by bid-ask spreads has increased significantly (spreads have decreased) over time. [1] In their paper, Below, Kiley and McIntosh (1996) report that bid--ask spreads declined significantly between 1992 and 1994 for NYSE-listed REITs. [2] They find that spreads declined even after controlling for trading volume, institutional ownership and REIT price variability, which might indicate a structural shift in the way REITs are priced. Consistent with this hypothesis, they also find a significant change in REIT market microstructure relative to a sample of similar non-REIT stocks. Specifically, in an earlier study of NYSE-listed REITs in 1991, Below, Kiely and McIntosh (1995) document a significant differential between REIT and non-REIT stock bid--ask spreads. Based on their 1994 sample, Below, Kiely and McIntosh (1996) find that the spread differential between REITs and non-REITs decreased by about one-half over the 1991--1994 period. …

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