Local Beta: Have Location Risks Been Priced in REIT Returns?

Abstract

This paper studies the pricing of the risk associated with the location of the assets. The location risk is measured by ‘local beta’, which combines the systematic risk of local property markets and the property allocation strategy of real estate firms. The empirical results confirm a higher equity return for a firm with higher exposure to the most volatile property markets, particularly for REITs which are more geographically concentrated. For REITs with highly diversified assets, location risks are reflected in REIT returns. For those REITs with most concentrated assets, a one standard deviation increase in the local beta will lead to a 4.5% increase in the annual return. Investors can use REITs’ location risk as an information tool to construct a long-short investment portfolio of real estate firms and can achieve a significant non-market performance of 6% per annum.

Keywords: geographic asset location, real estate returns, location risks, diversification

JEL Classification: G12, R3