REIT Performance during Hurricanes

By Sah, Vivek; Ziobrowski, Alan J. et al. | Journal of Real Estate Portfolio Management, January-March 2008 | Go to article overview

REIT Performance during Hurricanes

Sah, Vivek, Ziobrowski, Alan J., Ziobrowski, Brigitte J., Journal of Real Estate Portfolio Management

Executive Summary.

This paper examines the impact of hurricanes on the pricing of real estate investment trusts (REITs) listed on the New York Stock Exchange, American Stock Exchange, and NASDAQ using an event study methodology. The findings reveal that the REIT markets are generally efficient with respect to hurricanes. There is no evidence of abnormal returns associated with REITs concentrated along the southeastern coast during the time of the hurricanes. Furthermore, when REITs were analyzed corresponding to the hurricanes that made landfall in the state in which they had the maximum exposure, the results did not change.

There are on average six Atlantic hurricanes each year. Over any three-year period, approximately five hurricanes strike the United States coastline from Texas to Maine. The Atlantic hurricane season begins June 1 and ends November 30 with peak activity occurring July through September. When hurricanes move across land, the heavy rain, strong winds, and high waves can severely damage property. The high waves, commonly called storm surge, are very dangerous and are the major cause of property damage. The SaffirSimpson Hurricane Scale is a 1-5 rating based on the hurricane's intensity. Wind speed is the determining factor in the scale, as the storm surge is highly dependent on the wind speed, the slope of the continental shelf and the shape of the coastline at the point of landfall. From 2003 to 2005, nine hurricanes with a rating of 3 or higher hit the U.S. coastline causing damage of more than $169 billion. Exhibit 1 gives the total damages done by tropical storms in the last ten years. The year 2005 recorded the highest damage to date when Hurricane Katrina alone caused damage of more than $80 billion.

The damage done to properties can be a big loss to owners. Many of these owners are real estate investment trusts (REITs). The damage inflicted by the hurricanes frequently cannot be mitigated or repaired within a short period of time. This potential loss may be reflected in the prices of REITs as the hurricanes approach landfall. As hurricanes are forecast way before they hit the mainland, markets may reflect the uncertainty with respect to the damage that could be done by the hurricane. This may lead to abnormal returns in the time surrounding the event. The effect on the prices should be seen particularly for REITs having substantial property holdings in the states that experience the greatest hurricane activity.

On the other hand, an efficient market should already consider the public information regarding the probability of losses from hurricanes into REIT prices. Public information regarding the history of damage from hurricanes and forecasts for hurricanes are available to the market. Hence, if the markets are efficient, then there will not be any abnormal returns because the price would have already captured this catastrophic risk associated with the upcoming hurricanes and the anticipated damage. Besides this, hurricanes are largely predictable in terms of their frequency and severity, and professional real estate companies such as REITs are equipped to handle the effects of hurricanes. REITs having properties in the hurricane belt tend to buy adequate insurance coverage against the possible damage caused by hurricanes. These costs are impounded into the equilibrium rental rates and are borne ultimately by the lessee of the properties. As a result, a hurricane landfall may have no effect on REIT prices.

A study by Thompson, Zaman, and Kirmani (AFIR Colloquium, April 1994) examined the impact natural catastrophes have on share prices of publicly traded property/casualty insurers in the U.S. between 1970 and 1992. They found some evidence of abnormal returns around catastrophic events.

The current study measures the abnormal returns associated with hurricanes on the performance of REITs using an event study methodology. An efficient market should already factor the public information related to the hurricanes into the price. …

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