European REITs NAV Discount: market sentiment and fundamental factors

This paper analyzes the NAV discount of European REITs listed in France, in the Netherlands and in the United Kingdom between 2003 and 2014 considering both the “rational” and the “noise trader” approaches. The analysis examines the hypothesis that discounts (premiums) are the result of leverage, size, liquidity, risk, performance, investment activity and sentiment. The results on traditional NAV discount are compared with those obtained using an unlevered NAV discount formula introduced by Morri, et al. (2005) that cleans for the bias generated by the level of gearing. Among the main conclusions emerge that REITs in different markets have different behavior. Moreover, the relationship that leverage has with the traditional NAV discount is positive for England and France based REITs, while it is negative for the Netherlands based REITs. When the discount is adjusted to remove the bias due to the level of debt, the relationship between leverage and unlevered discount became less pronounced in all cases. Higher liquidity commands lower discounts for French REITs, while Dutch and British REITs, which trade in markets that are characterized by a higher number of average daily transactions, do not seem to suffer discounts (premiums) derived from liquidity. Operational risk and performance are for all the three samples significant to explain the NAV discount, the first having a positive relationship with the discount, and the second having a negative relationship with it. Later a new formula that adjusts the NAV discount for the investor sentiment is introduced with the aim of identifying better firm specific factors that contribute to the discount in order to clean possible distortions induced by sentiment. Sentiment, when measured using the average sector discount, deeply affects the discount, accounting alone for 10% to 15% of the explicative power of the model considered. The results confirm the findings obtained using non-sentiment adjusted regressions, even if reaching a lower level of R-squared. Changes of behavior between growth periods and during crises are also investigated. A further analysis of the NAV discount in phases of upswing and downturn allows to say that, while fundamental factors are more relevant and stable when the market is growing, price fluctuations during periods of recession are heavily influenced by market sentiment, and fundamentals do not describe the dynamics of the NAV discount in a satisfactory way.