Asset Productivity, Local information Diffusion, and Commercial Real Estate Returns

The geography of a firm’s assets is an important determinant of its investment decisions and productivity, which, in turn, drives stock returns. We construct a novel measure of the returns earned by private market investors in the metropolitan areas where each equity REIT owns properties. We then risk-adjust this geographically weighted proxy for each REIT’s property portfolio return (PPR) by regressing it against the sensitivity of the REIT’s returns to systematic risk factors. We find that this risk-adjusted property portfolio return (αPPR) predicts the cross-section of returns in the public REIT market, suggesting a slow diffusion of asset-level information into stock returns. Our findings also suggest it is the slow diffusion of information about “local” prices changes, not current rental income or local liquidity, that predicts REIT returns. Moreover, the αPPRs associated with REIT allocations to major “gateway” markets are more predictive of REIT returns than the property portfolio returns produced by allocations to secondary and tertiary markets. This study improves our understanding of the extent to which “local” information about the productivity of a firm’s assets is capitalized into stock prices and the speed at which it is capitalized. This study also contributes to the literature on the predictability of REIT returns and the relation between private and public CRE returns using firm-level, instead of index level, returns.