Do informed REIT market participants respond to property sector mispricing?

ABSTRACT Sector mispricing represents the deviation of current and long-run sector fundamentals indicating either over- or undervaluation. We focus on the response of informed market participants to property sector mispricing in the context of equity REITs. We argue that REIT market participants such as institutional REIT investors and analysts have an informational advantage due to their access to commercial real estate market data. As a result, they are expected to respond to property sector mispricing. Using a sample of 2,637 firm-quarters of pure play equity REITs over the period of 1993 to 2020, we find that sector mispricing indeed impacts the decision-making of informed REIT market participants. The more overvalued (undervalued) a property sector is, the more institutional investors behave as net sellers (buyers) for REITs with the respective property type specialisation in the next quarter. Similarly, property sector overvaluation (undervaluation) results in lower (higher) net buy recommendations by analysts for REITs in the respective sector in the next quarter. However, our results are driven by smaller REITs and REITs with higher growth options. The sensitivity of institutional REIT investors and analysts to property sector mispricing also varies across different states of trading and recommendations respectively.