The Other Side of Value: The Effect of Quality on Price and Return in Real Estate

Abstract

We examine the effect of quality on price and return in real estate. Quality real estate stocks generally trade at higher prices. However, similar to findings in the aggregate stock market (Asness et al. 2013), quality in listed real estate is not fully reflected in price. A long quality, short junk portfolio (QMJ) is found to produce average risk-adjusted returns of 3.6 % per quarter (14.4 % annually). QMJ has a significantly positive coefficient when added as a dependent variable to a 4-factor model explaining U.S. real estate excess returns, including market, size, value and momentum factors, and leads to a small improvement in the overall fit of the model. Further investigation of the components of quality shows that profitability has a consistently positive relationship with real estate excess returns, while higher dividend payout is consistently associated with lower returns, in contrast to findings for conventional firms.

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Notes

  1. 1.

    The analysis is conducted on a quarterly basis, as quality data is only available quarterly.

  2. 2.

    Quality scores are based on Asness et al. (2013) and described in detail in the Data & Variables section. Portfolios are formed with a one quarter lag to account for the delays in reporting and data availability as of the end of the quarter.

  3. 3.

    Payout is excluded here as it is not directly related to successful property investment and management, but is rather a byproduct.

  4. 4.

    There are several benefits of using log returns (log of the price relative). Assuming that prices are log-normally distributed, log returns are normally distributed. When returns are small (as in our case) ln(1 + r) ≈ r.

  5. 5.

    http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

  6. 6.

    For detailed description of the method, see Altman (1968), Ang et al. (2006), Daniel and Titman (2006); Penman et al. (2007); Campbell et al. (2008), Novy-Marx (2013); Frazzini and Pedersen (2014), and Asness et al. (2012).

  7. 7.

    The negative sign signifies that leverage contributes negatively to the safety measure.

  8. 8.

    The 1-year standard deviation of ROE was also calculated for comparison and indicated an aggregate mean of less than half that of the 3-year. However, once incorporated into the overall safety score and used in regressions, the resulting safety coefficients were not substantially different from those associated with the 3-yr. standard deviation.

  9. 9.

    This is also the basis of the quality minus junk (QMJ) factor, which will be described in greater detail later on.

  10. 10.

    The NYSE’s average and median market capitalizations are $8.9 billion and $1.9 billion, respectively (NYSE 2014). In contrast, the real estate sample has an average and median market capitalization of $1.867 billion and $755 million, respectively, with a 75th percentile of $2 billion.

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Correspondence to Milena Petrova.

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Anzinger, S.K., Ghosh, C. & Petrova, M. The Other Side of Value: The Effect of Quality on Price and Return in Real Estate. J Real Estate Finan Econ 54, 429–457 (2017). https://doi.org/10.1007/s11146-016-9574-z

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Keywords

  • Quality attributes
  • Firm performance
  • Real estate prices
  • Real estate returns