Firm location and systematic risk : the real estate channel

Purpose: This paper aims to investigate whether the cyclicality of local real estate prices affects the systematic risk of local firms using a geography-based measure of land availability as a quasi-exogenous proxy for real estate price cyclicality. Design/methodology/approach: This paper uses the geography-based land availability measure as a proxy for the procyclicality of real estate prices and the location of a firm’s headquarters as a proxy for the location of its real estate assets. Four-factor asset pricing model (market, size, value and momentum factors) is used to examine whether firms headquartered in more land-constrained metropolitan statistical areas have higher systematic risks. Findings: The results show that real estate prices are more procyclical in areas with lower land availability and firms headquartered in these areas have higher systematic risk. This effect is more pronounced for firms with higher real estate holdings as a ratio of their tangible assets. Moreover, there are no abnormal returns to trading strategies based on land availability, consistent with stock market betas reflecting this local real estate factor. Research limitations/implications: This paper contributes to the literature on local asset pricing factors, the collateral role of firms’ real estate holdings and the co-movement of security prices of geographically close firms. Practical implications: This paper has important managerial implications by showing that, when firms decide on the location of their buildings (e.g. headquarters building, manufacturing plant and retail outlet), the location’s influence on systematic risk should be part of the decision-making process. Originality/value: This paper is among the first to use a geography-based measure of land availability to study whether the procyclicality of local real estate prices influences firm risk independent of the procyclicality of the local economy. Thus, both the portfolio formed and firm-level analyses provide a more direct evidence of the positive relation between the procyclicality of local real estate prices and firm risk.