Illiquidity, Transaction Cost, and Optimal Holding Period for Real Estate: Theory and Application

28 Pages Posted: 30 Mar 2010 Last revised: 12 Feb 2011

See all articles by Ping Cheng

Ping Cheng

Florida Atlantic University - Finance

Zhenguo (Len) Lin

Florida International University (FIU) - Hollo School of Real Estate

Yingchun Liu

Dept. of Finance, Insurance, Real Estate and Law, University of North Texas

Date Written: March 29, 2010

Abstract

Choosing the optimal holding period is an important part of real estate investment decisions, because “when to sell” affects “whether to buy.” This paper presents a theoretical model for such decision making. Our model indicates that the optimal holding period is affected by both systematic and non-systematic factors - market conditions (illiquidity and transaction cost) and property performance (return and return volatility). Other things being equal, higher illiquidity and transaction costs lead to longer holding periods, while higher return volatility implies shorter holding periods. Our empirical application suggests that the optimal holding period based on our model is quite consistent with previous empirical findings. In addition, we find that when illiquidity risk is incorporated the true real estate risk is significantly higher than the conventional risk estimate. Therefore, the current practice of real estate valuation, which is naively borrowed from finance theory, substantially underestimates real estate risk.

Suggested Citation

Cheng, Ping and Lin, Zhenguo and Liu, Yingchun, Illiquidity, Transaction Cost, and Optimal Holding Period for Real Estate: Theory and Application (March 29, 2010). Journal of Housing Economics, Vol. 19, 121-130, 2010, Available at SSRN: https://ssrn.com/abstract=1580134

Ping Cheng

Florida Atlantic University - Finance ( email )

777 Glades Rd
Boca Raton, FL 33431
United States
561-297-3456 (Phone)
561-297-3686 (Fax)

Zhenguo Lin (Contact Author)

Florida International University (FIU) - Hollo School of Real Estate ( email )

Miami, FL 33199
United States
3057799248 (Phone)

Yingchun Liu

Dept. of Finance, Insurance, Real Estate and Law, University of North Texas ( email )

1155 Union Circle #305340
Denton, TX 76203
United States

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