The role of sentiment in the real estate market

In Neoclassical finance theory, there is no role for investor sentiment in valuation, markets are efficient and all movements in stock prices rationally reflect changes in cash flows or discount rates. In sharp contrast, the behavioral finance literature posits that investor sentiment and limits to arbitrage play a role in the determination of asset prices which is independent of market fundamentals. Real Estate Investment Trusts (REITs) are unique in that the pricing of the asset class parallels two markets. Specifically, a dual asset market situation exist for trading real estate assets in the private real estate market, trading properties directly, and the public real estate market for trading REIT shares that provides ownership of underlying properties indirectly. The contribution of this analysis to the existing literature of REIT pricing dynamic is twofold. First, this analysis address the question of whether REITs suffer from stock market sentiment following the presence of noise traders or the real market sentiment is an important force in REIT pricing. To this extent this work aims to disentangle the driving forces leading to sentiment as “rational” sentiment, related to fundamental changes and “irrational” stock market sentiment. Secondly, this analysis is one of the first attempts to investigate how REIT-specific characteristics are related to their sensitivity to investor sentiment (“sentiment beta”), focusing the attention on the role played by the institutional investors that are usually view as rational traders by the literature.