Abstract/Summary

Institutional investors such as pension funds or insurance companies commonly invest in the unsecuritized and securitized real estate market. We investigate how institutional investor sentiment in the inefficient commercial real estate market affects institutional trading behavior in the REIT market and subsequently asset pricing. In particular, we test two alternative theories - flight to liquidity and style investing theory - to explain the sentiment induced trading behavior of institutional investors in the REIT market for the pre-crisis (2002-2006), crisis (2007-2009) and post-crisis (2010-2012) period. We find that the applicability of either theory depends on economic conditions. In the pre-crisis period institutional investors switched capital in and out of REITs based on their sentiment in the private market (style investing). However, in the crisis period institutional investors switched capital from the illiquid private market to the more liquid REIT market (flight to liquidity). The flight to liquid REITs continues into the post-crisis to a lesser extent and suggests that the financial crisis has changed institutional investment behavior. Our findings hold across different groups of REITs (e.g. high and low institutional ownership, S&P and non-S&P REITs) and property types. We also find that institutional real estate investor sentiment introduces a non-fundamental component into REIT pricing.