The effect of sentiment on commercial real estate returns: investor and occupier perspectives
| DOI | https://doi.org/10.1108/JPIF-01-2020-0010 |
| Published date | 15 January 2021 |
| Date | 15 January 2021 |
| Pages | 561-589 |
| Author | Ka Shing Cheung,Joshua Lee |
The effect of sentiment on
commercial real estate returns:
investor and occupier perspectives
Ka Shing Cheung and Joshua Lee
Department of Property, The University of Auckland, Auckland, New Zealand
Abstract
Purpose –Real estate is an asset that is traded in highly segmented, illiquid and informationally inefficient
local markets. A short sale in real estate is almost infeasible and therefore impedes informed rational
arbitrageurs to trade against mispricing. Thus, real estate returns are prone to sentiment-driven behaviours.
Will the impacts on asset returns be identical for different types of sentiment?
Design/methodology/approach –This study argues that not all sentiment effects are created equal. Using
the bounds test of the autoregressive distributed lag (ARDL) models, this paper examines how occupier
sentiment versus investor sentiment contributes to the short-run and long-run dynamics of commercial real
estate returns in Australia.
Findings –The empirical evidence suggests that investor sentiment and occupier sentiment influence return
asymmetrically after macroeconomic conditions are controlled for.
Practical implications –The sectoral analysis further reveals that sector-specific sentiment plays a
significant role in explaining commercial real estate returns. Furthermore, notable improvement is found in
producing more accurate prediction in returns, given that measures of occupier and investor sentiment are
appropriately specified in the forecast.
Originality/value –This study is novel in the sense that it acknowledges the impacts of occupiers’and
investors’sentiment may be fundamentally different. The unique innovation and contribution of this study to
behavioural finance literature are based on a new dataset from the Royal Institute of Chartered Surveyors
which includes a survey-based measure of investor sentiment and occupier sentiment.
Keywords Occupier sentiment, Investor sentiment, Commercial real estate, Autoregressive distributed lag
(ARDL) models, Bounds tests, Predictability, Behavioural finance
Paper type Research paper
1. Introduction
Many studies have shown that market fundamentals do not fully explain the co-movement of
asset returns (e.g. Chen et al., 2019;Barberis et al., 2005;Pindyck and Rotemberg, 1993;
Schiller, 1989). Market sentiment has been identified as a driver of asset prices. However,
most sentiment-related asset pricing studies in finance overlook a unique asset class, in which
investment and consumption markets coexist, that is the real estate market.The performance
of real estate is related both to the performance of the economy (i.e. occupier demand) and, like
all assets, to the capital markets (i.e. investor demand). As such, this asset class is fascinating,
and its unique status can be exploited, enabling us to understand the role of investors’versus
owner-occupiers’sentiment in the co-movement of assets across and within asset categories,
classes and markets.
When institutional investors trade properties, whose pricing is ultimately driven by
underlying asset values, exposure to the real estate market provides them with an advantage
of information about fundamentals (Graff and Young, 1997). Nevertheless, it also makes them
prone to irrational sentiment, which is recognised to be an essential component of investor
Sentiment
effects:
investors vs
occupiers
561
JEL Classification —G17, R33, R40
The authors would like to acknowledge the Royal Institution of Chartered Surveyors (RICS) to
provide the Australian data on the RICS Occupier Sentiment Index (OSI) and Investment Sentiment
Index (ISI) in their quarterly RICS Global Commercial Property Monitor.
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1463-578X.htm
Received 27 January 2020
Revised 28 August 2020
19 December 2020
Accepted 19 December 2020
Journal of Property Investment &
Finance
Vol. 39 No. 6, 2021
pp. 561-589
© Emerald Publishing Limited
1463-578X
DOI 10.1108/JPIF-01-2020-0010
decision-making in the highly non-transparent, informationally inefficient and segmented
commercial real estate market (Gallimore and Gray, 2002). Furthermore, institutional real
estate investors commonly capitalise in real estate markets via investments in commercial
real estate and publicly traded real estate investment trusts (REITs: Dhar and Goetzmann,
2006;Clayton and MacKinnon, 2003;Ciochetti et al., 2002). Since most REITs lease space to
collect rents on the properties and then distribute a stipulated portion of the income as
dividends to shareholders, this business model makes real estate asset pricing prone not only
to investors’but also to owner-occupiers’sentiment.
In this research, we aim to disentangle the long-run and short-run impacts of occupiers’
sentiment from investors’sentiment in the Australian commercial real estate market.
According to De Long et al. (1990), sentiment is broadly defined as a belief about future cash
flows and investment risks that are not justified by the facts at hand. Intuitively, such belief
has to be fundamentally different between investors (i.e. having the expectation of attaining a
return) and occupiers (i.e. having the intention of space consumption) given the unique dual
nature of the real estate. The inability to short sell further prevents arbitrage (Ling et al., 2014)
and leads to persistent mispricing of real estate assets (Ke and Sieracki, 2019). Given the
peculiarities of real estate markets, these markets are likely prone to sentiment-induced
mispricing.
Using Pesaran and Shin (1999) autoregressive distributed lag (ARDL) model and the
associated bounds tests (Pesaran et al., 2001), this study aims to examine the extent of
occupier sentiment versus investor sentiment in explaining the long-term equilibrium of
investment returns in the Australian commercial real estate market. The source of occupier
sentiment and investor sentiment indices is a survey conducted by the Royal Institute of
Chartered Surveyors (RICS), which is an international professional body that establishes and
enforces standards for the valuation, operation and development of assorted types of
property. Our empirical results suggest that investor sentiment and occupier sentiment
influence commercial real estate returns asymmetrically after the macroeconomic and
financial market conditions are taken into consideration. Analysis reveals that the effect of
sentiment is specific to various sectors. Practically speaking, the distinction between occupier
and investor sentiment can provide additional information to improve forecasting notably,
enabling it to outperform the naı€ve and fundamental forecasting models for all three sectors:
office, industrial and retail.
The Australian commercial real estate market has a representative share of global
commercial real estate investment and is therefore used as an illustrative case. According to
Pramerica Global Investment Management, Australia is one of the top three countries in the
Asia Pacific region in terms of the size of the investable real estate market. Australia remains
the single most popular investment destination, with offshore capital “flowing thick and fast”
into major cities, partly due to the triple-A-rated country status attracting international
institutional investor (PWC and ULI, 2019). Australia is also receiving growing recognition as
having the world’s largest REITs market outside the United States. More than 12% of global
listed property trusts can be found on the Australian Securities Exchange (ASX).
Furthermore, Australia’s maturity and ingrained real estate market provide an intriguing
case to assess sentiment-driven behaviours. Australia ranks as the second most transparent
real estate market in the world, behind only the United Kingdom.
The contribution of this study is threefold. First, to the best of our knowledge, this is the
first research distinguishing the sentiment of investors from occupiers. This study
acknowledges the impacts of occupiers’and investors’sentiment could be fundamentally
different. Second, this study is also distinct from the majority of commercial real estate
studies on sentiment, which has focussed only on the office sector: in contrast, we provide a
comparison of sentiment impact across commercial real estate sectors, including office, retail
and industrial markets. Third, this study is one of few studies which investigate the effect of
JPIF
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