Academic journal article The Journal of Real Estate Research

Are Real Estate IPOs a Different Species? Evidence from Hong Kong IPOs

Academic journal article The Journal of Real Estate Research

Are Real Estate IPOs a Different Species? Evidence from Hong Kong IPOs

Article excerpt


It is well documented that in the United States, real estate investment trust (REIT) initial public offerings (IPOs) have an abnormally low initial-day return when compared to that of industrial firm IPOs. Researchers suspect that the abnormal return pattern of REIT IPOs is caused by their unique real estate holdings. Examination of 399 IPOs issued in Hong Kong during the 1986-1997 period reveals strong evidence that suggests that underlying real estate holdings cannot be the sole reason for the observed low initial-day return of REIT IPOs. This investigation indicates that there is a need to re-think the current explanations for the abnormal performance of REIT IPOs.


One of the most puzzling phenomena in the finance literature is the pricing behavior of initial public offerings (IPOs) of equity securities. In the United States, investors who participate in the IPOs of industrial firms earn about a 16% gain during the first trading day, on average. This first trading day return is even higher in some other countries. Just as puzzling is the fact that the IPO firms tend to underperform the market for a period of up to three years. These empirical regularities lead to two important questions. First, why do the original (non-public) equityholders offer new shares that are consistently underpriced? If the shares had been priced "rationally," the original equityholders would have had 16% more capital after the first trading day. Second, why do IPO firms underperform the market over the longer-run, given that the initial prospects seem so positive? While various answers to these questions have been suggested, they can be grouped into two types of explanations. The first group of explanations are variants of the "winner's curse" theory, according to which underwriters rationally price IPOs below their market value in order to achieve an economic equilibrium. The second group includes the "fad" or "hot market" theories, which simply state that those who purchase shares on the first day of trading of the IPO stocks pay too much for the shares. From this perspective, the price run-up during the first trading day is not rational, while the longer-run price decline restores rationality.' Although empirical evidence exists to support both types of explanations, it is quite clear that the underlying theories are not comprehensive. For example, in spite of the spectacular initial-day return for industrial firm IPOs, there is also anomalous evidence from the IPOs for real estate investment trusts (REITs), master limited partnerships (MLPs) and closed-end mutual funds. The IPOs of those units tend either to be overpriced or at least significantly less underpriced than the typical industrial firm IPOs.

Wang, Chan and Gau (1992) report that REIT IPOs from 1971 to 1988 were overpriced, while Weiss (1989) and Peavy (1990) show that IPOs of closed-end funds are not significantly different from zero. Ling and Ryngaert (1997) extend Wang, Chan and Gau's study to a more recent period, finding that REIT IPOs issued in the 1990s have a positive and significant average initial-day return. However, this return is extremely small when compared to industrial firm IPOs. In addition, Muscarella (1988) and Michaely and Shaw (1994) also find that MLP IPOs (including real estate related IPOs) are not as significantly underpriced as industrial firm IPOs. The evidence derived from IPOs of mutual funds, REITs and MLPs casts some doubt on the completeness of the existing theories of IPO underpricing as an equilibrium phenomenon.

To address this puzzle, Wang, Chan and Gau (1992) suggest that REIT IPOs may behave differently from industrial firm IPOs for three reasons. First, REITs, at least in the pre-1990s, have more uninformed investors subscribing to the IPOs when compared to industrial firms; a characteristic also true for mutual fund and MLP IPOs. Second, REITs during the pre-1990s were not operating companies. …

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