Real Estate Investments, Product Market Competition, and Stock Returns

Abstract

This paper theoretically and empirically examines the effect of product market competition on the relation between real estate investments and stock returns. By limiting operating flexibility in the event of negative demand shocks, real estate assets are found to increase firm risk. This study introduces product market competition as a critical determinant of the relation between real estate investments and stock returns. As part of capacity strategies, these investments are generally associated with increased market power, which reduces cash flow volatility through its effect on equilibrium market prices and potential market entry. We present a simple model of oligopolistic competitive equilibrium showing a negative relation between real estate and firm beta and empirically confirm this prediction for a large sample of firms from 1973 to 2010. This study shows that controlling for product market competition enhances identification of the endogenous relation between real estate investments and stock returns.

Keywords: Real Estate Investments, Systematic Risk, Stock Returns, Product Market Competition, Oligopolistic Competition

JEL Classification: G11, G31, L11, L13