2014-06: Identifying REITs Asset-pricing Bubbles: A Modified CCAPM Approach

This paper develops a model for the pricing of US Equity Real Estate Investment Trusts (REIT’s), based upon economic fundamentals. The analysis compares the theoretical price generated by our model with actual prices in order to examine the existence of REIT’s pricing bubbles. Our price modeling employs a novel approach by applying a special case of the CCAPM, inclusive of stochastic taxation, to derive the price dividend ratio as a function of the parameters of the log normal distribution of the rate of growth of after-tax dividends, stochastic dividend taxation, and the coefficient of relative risk aversion. We find that Equity REITs, during our sample period, 1972-2013, were overvalued for a substantial portion of the time period. During this forty-two year span, Equity REITs were underpriced according to our model for only nine years. More surprisingly, contrary to a popular belief, during and after the so-called, “Great Recession,” 2008-2013, equity REITs were underpriced for only one year (i.e., 2008).