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Did Real Estate Professionals Anticipate the 2007-2008 Financial Crisis? Evidence from Insider Trading in the REITs

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Abstract

This research examines whether real estate professionals detected the property bubble and foresaw the consequent financial crisis of 2007-2008. By analysing the insider trading activities within REITs from 1996 to 2010, we find that REIT insiders reduced their holdings significantly during the real estate boom period as early as 2004, before the financial crisis. Difference-in-difference analysis reveals that REIT insiders cashed out their positions more aggressively than insiders in real estate and construction firms. The findings support the informed trader hypothesis that managers and employees in REITs anticipated the burst of the real estate bubble and the imminent financial crisis, and shifted their wealth away from the real estate market to avoid potential losses. We find no evidence to support the biased belief hypothesis (Cheng et al., 2014) that REIT insiders were over-optimistic during the real estate boom period or that their inside trading behaviour was affected by local market performance.

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Notes

  1. Following previous studies in the literature of insider trading (e.g., Seyhun, 1986; Rozeff and Zaman, 1988), we take the trades by directors, managers and employees within their own firms as insider trading. The trades by the insiders are not necessarily illegal practice as would be trades based on non-public and material information.

  2. Because of active management skills and experience in real estate valuation, REIT insiders could be more informed about the market than some real estate professionals such as agents and operators. We take REIT insiders as sophisticated real estate professionals who have superior knowledge of the property market and systemic risk in that market. They also have significant personal wealth in the form of equity holdings in their managed REITs.

  3. Some researchers had already warned the market about the existence of the real estate bubble before its collapse (e.g., Case and Shiller, 2003; Himmelberg et al., 2005; Laing, 2005; Krugman, 2005; Shiller 2006, 2007; Mayer, 2006; Smith and Smith, 2006)

  4. The literature has shown that insiders possess private information on their managed firms (Jaffe, 1974; Finnerty, 1976a, 1976b; Rozeff and Zaman, 1988). Insiders in REITs have superior information about the fundamental value of properties and act on it through informed trading (Damodaran and Liu, 1993; Cline et al., 2014). Active management within REITs requires managers to select, manage and operate properties to create value for shareholders (Ambrose and Linneman, 1998, 2001), which brings an information advantage to REIT insiders in the evolution of the real estate market.

  5. Some cities in the US have experienced persistently large growth rates in house prices over a long period (Himmelberg et al., 2005; Gyourko et al., 2013). Buyers in these markets might form expectations of continued high growth rates in the future (Sinai and Souleles, 2005; Gyourko et al., 2013).

  6. The insiders are required to report their open-market trades under the Securities and Exchange Act of 1934. Insiders include officers, directors, affiliates, and beneficial owners in a firm. Thomson Reuter collects the insider trading data from SEC filings. The data are widely used in studies reported in the literature (e.g., Gao et al., 2014; Ali and Hirshleifer, 2017; Tang and Xin, 2017; Fu et al., 2019).

  7. The sample period covers the real estate boom period 2004-2006, the pre-crisis period 2006-2007 and the crisis period 2007-2008. Our results are robust to different sample periods.

  8. Following Fama-French 48 industry classifications, construction stocks are defined as the firms with SIC codes as 1500-1511, 1520-1549, 1600-1799, and real estate stocks are the firms with SIC codes as 6500, 6510, 6512-6515, 6517-6532, 6540-6541, 6550-6553, 6590-6599 and 6610-6611.

  9. The remaining firms did not have reported insider transactions during the sample period.

  10. The 20 major metropolitan areas include Phoenix Metropolitan Area, Greater Los Angeles, San Diego County, San Francisco, Denver-Aurora Metropolitan Area, Washington Metropolitan Area, South Florida Metropolitan Area, Tampa Bay Area, Atlanta Metropolitan Area, Chicago Metropolitan Area, Greater Boston, Metro Detroit, Minneapolis-Saint Paul, Charlotte Metropolitan Area, Las Vegas Metropolitan Area, New York Metropolitan Area, Greater Cleveland, Greater Portland, Dallas–Fort Worth Metroplex and Seattle Metropolitan Area. The index of 100 applies to January 1996. Housing index movements for the leading and non-leading groups are shown in Figure 2.

  11. The leading group includes Las Vegas Metropolitan Area, Greater Los Angeles, South Florida Metropolitan Area, Washington Metropolitan Area, Phoenix Metropolitan Area and Tampa Bay Area. The remaining 14 areas are classified among the non-leading group.

  12. The housing returns calculated from the Case-Shiller U.S. National Index are highly related to the REIT market returns measured by the CRSP Ziman REIT Value Weighted Index. The results remain similar if we include the REIT market returns or the returns for sub-markets based on the property types in the regressions.

  13. Cziraki (2018) does not give evidence on abnormal insider sales observed during the real estate boom period. Our findings show that REIT insiders significantly reduced their exposure to the real estate market when the housing price was still on a rising trend.

  14. Appendix 2 gives the sample of real estate stocks in Panel A and the summary statistics in the sample in Panel B. Panel C indicates that insiders in real estate firms also anticipated the burst of the real estate bubble and reduced the real estate exposure by selling their company stocks.

  15. Gyourko et al. (2013) define the superstar cities as the cities in metropolitan statistical areas with a high demand for housings but inelastic and limited supply. The superstar cities have a persistently larger growth rate of home price and price-to-rent ratio than other cities.

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Acknowledgment

Shen acknowledges a research grant (P0030199) from the Hong Kong Polytechnic University. The authors thank the editor, Professor John Glascock, and a referee for their insightful comments and Professor Michael Anson for his editorial work

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Authors and Affiliations

  1. Department of Building and Real Estate, The Hong Kong Polytechnic University, Hum Hong, Hong Kong

    Jianfu Shen, Eddie C.M. Hui & Kwokyuen Fan

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  1. Jianfu Shen
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Appendix A

Appendix A

Table 6 Brief explanation of variable definition
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Table 7 The results for real estate and construction companies
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Shen, J., Hui, E.C. & Fan, K. Did Real Estate Professionals Anticipate the 2007-2008 Financial Crisis? Evidence from Insider Trading in the REITs. J Real Estate Finan Econ 63, 122–142 (2021). https://doi.org/10.1007/s11146-020-09763-8

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