Bubbles in US hotel/lodging real estate investment trusts

Publication Date05 March 2018
Date05 March 2018
AuthorFahad Almudhaf
SubjectProperty management & built environment,Real estate & property,Property valuation & finance
Bubbles in US hotel/lodging real
estate investment trusts
Fahad Almudhaf
Department of Finance and Financial Institutions, Kuwait University, Kuwait
Purpose The purpose of this paper is to test for the presence of bubbles in the US lodging/hotel real estate
investment trust (REIT) subsector from 1994 to 2016. It also compares the profitability of a buy-and-hold
strategy with several technical trading rules when applied to lodging REITs.
Design/methodology/approach To investigate speculative bubbles, the sequential right-sided unit root
tests of Phillips, Shi and Yu (2015a, b) are used.
Findings The results confirm the possibility of the existence of multiple bubbles and explosive behavior in
prices and the price-dividend ratio. One of the detected bubbles coincides with the financial economic crisis of
2008 using both measures. In addition, several technical rules are found to be superior to a naïve buy-and-hold
strategy even after adjusting for risk.
Practical implications These findings will be of interest to policy makers, who can use such models as an
early alert to take anticipative action to avoid bursting of bubbles and consequent negative effects on the
economy. The findings also provide important information to investors attempting to devise trading rules
that utilize the signals from bubble detection, as well as to hotel executives devising policies aimed at
reducing risk and creating more firm value to maximize shareholder wealth. Moreover, valuation and bubbles
are important to lenders and creditors who use assets as collaterals for financing hotel REITs.
Originality/value Hotels are a unique hybrid of retail and housing that combine operating business with
real estate. This paper is the first to investigate speculative bubbles in lodging REITs.
Keywords Technical analysis, Real estate investment trusts, Bubble, Hospitality REIT, Hotel REIT,
Lodging REIT
Paper type Research paper
According to the National Association of Real Estate Investment Trusts (NAREIT), the market
capitalization of lodging/resort real estate investment trusts (REITs) as of January 2017
is approximately $49 billion, representing 5 percent of the NAREIT equity index. In the
USA, 53,432 hotels generated $176 billion in revenues in 2015 (American Hotel and Lodging
Association, 2015). Hotels are a unique hybrid of retail and housing that combine an operating
business with real estate. As noted by Liu an d Manning et al. (2015), further research efforts are
needed to understand the hotel and lodging real estate sec tor.
Lodging REITs have grown remarkably in both number and market capitalization since
1993, and are cyclical and sensitive to economic conditions. Ro and Ziobrowski (2011)
document that lodging REITs exhibit higher volatility than other types of REITs, consistent
with Jackson (2008b). Lodging is the most volatile equity subsector as measured by
standard deviation. This volatility is the result of shorter leases, construction time and
tenant improvements (Anderson et al., 2012). In addition, hotel REITs feature high
unsystematic risk (unique, firm-specific risk) (Kim et al., 2002). Kim et al. (2012) document
that an average of 86 percent of the risk of hotel C-corps is due to unsystematic risk.
Although systematic (market) risk is strongly related to firm value, unsystematic risk comes
into play when investors determine the intrinsic (fair) value of lodging REITs. Deviations of
market prices from intrinsic values for long time periods are unsustainable and can result in
bubble bursts and market panics and crashes. Journal of Property Investment &
Vol. 36 No. 2, 2018
pp. 171-190
© Emerald PublishingLimited
DOI 10.1108/JPIF-03-2017-0025
Received 31 March 2017
Revised 8 July 2017
Accepted 10 July 2017
The current issue and full text archive of this journal is available on Emerald Insight at:
The Project was Funded Partially by Kuwait Foundation for the Advancement of Sciences under
project code: P116-17IM-02.
US hotel/
lodging REITs
The intrinsic (fair) value of an REIT is the present value of expected cash flows,
especially when using funds from operations cash flow (FFO) (Graham and Knight, 2000).
Investors may be willing to pay higher prices than the suggested fundamental value when
purchasing REITs, which is rational if they anticipate selling the REITs at higher prices in
the future. Speculative bubbles occur when there is an enduring deviation between the
fundamental values of assets and actual market prices. As long as expectations hold, REIT
prices will continue to increase and reach excessive levels. However, once investors believe
the increase in prices is no longer sustainable, any bad news could cause a panic that bursts
the bubble. Rallies and busts of prices have occurred in all asset classes in several time
periods. Jirasakuldech et al. (2006) list multiple reasons that REITs are vulnerable to pricing
bubbles, including limited short selling, restrictions on SEOs and a lack of advanced
derivative markets on REIT indices. Therefore, investors have limited reactions even if they
believe that the market or sector is overvalued (Lim, 2011). Anderson et al. (2011) argue that
bubbles in REITs can also be caused by overconfidence, myopia and excess optimism of
investors in the general stock market.
The financial economic crisis (FEC) of 2008 impacted the risk aversion of investors in all
asset classes, and the burst of the housing bubble will likely resonate with investors in
the future. During such events, some investors prefer dividend-paying assets to offset the
downsideof losses. However, investorsseek to acquire such assets at or below theirfair values
rather than purchase overvalued properties. Jain et al. (2017) show that intraday trading in
hotel REITs increased significantlyafter the 2008 FEC, and hotel REITs became less volatile.
Previous studies have focused on the general equity REIT market; by contrast, the
lodging/hotel REIT subsector is a highly volatile subsector, thus providing a new context
for further examination. This paper is the first to utilize the model of Phillips et al. (2015a, b)
to test for bubbles in lodging/hotel REITs. This method allows for break mechanisms and
non-linear structure and can detect, locate and date the origination and collapse of multiple
bubbles (if any). The profitability and performance of several technical trading rules are
compared with that of a naïve buy-and-hold strategy after adjusting for risk and transaction
costs. This study contributes to the strands of literature on investing, performance
and market timing of hotel REITs as well as the pricing and efficiency of lodging REITs.
The main aim is to fill the void in the literature noted above and provide a detailed empirical
assessment of speculative bubbles in lodging REITs.
The results of this study will be of interest to practitioners and investors attempting to
develop tradingrules based on bubble detection. Thefindings will also be of interest to policy
makers, who can use suchmodels as an early alert to take anticipative action to avoidbursts
and consequent negative effects on the economy. Moreover, this study has important
implications for executives in the hotel industry. When bubbles burst and hotel prices
collapse, investors typically cut costs(e.g. decrease the number of employees)to boost profits
and offset the decline in hotel fixed-asset market prices. Jackson (2008a) points to the
importanceof valuation knowledgeto lodging managers as stakeholderswho will suffer from
the consequences of a negative impact. In addition, investors are interested in maximizing
their wealth by increasing the long-term intrinsic value of their REIT holdings. Detecting
bubbles could give such investors an early exit signal. Finally, valuation and bubbles are
importantto lenders and creditors who usesuch assets as collateral for financing hotel REITs.
Evidence of explosiveness is observed in the price-dividend ratios of hotel REITs and
lodging/resort REITs (adjusting for fundamentals) in two to four subsamples. Such evidence
suggests the existence of bubbles. In addition, several technical rules are shown to be
superior to the naïve buy-and-hold strategy even after adjusting for risk. In an attempt to
better understand the factors potentially related to bubbles in lodging REITs, dividends are
related to several sentiment variables previously related to bubbles in the general stock
market. Dividends are selected for analysis because REITs distribute at least 95 percent of

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