They Would if They Could : Assessing the Bindingness of the Property Holding Constraints for REITs

This study examines the bindingness of the property holding constraints which REITs face on their portfolios, and illustrates how these constraints hinder REITs from exploiting opportunities to time the property market and thereby generate profits by taking advantage of the market's predictability. I first simulate a filter-based market timing strategy, which I show outperforms a buy-and-hold strategy out of sample over a wide range of levels of transaction costs. I further show that this strategy requires a substantial number of transactions with holding periods that are shorter than four years, and that imposing a four-year holding constraint significantly reduces the excess returns the strategy generates. I then analyze actual holding periods of properties in REIT portfolios and find that there seems to exist a large degree of demand for short property holding periods, and that thus the four-year constraint is quite binding. I proceed to model holding period as a function of current market performance, finding that REITs are more likely to hold a property beyond four years the higher the profit from the transaction, since this longer holding period is necessary in order for them to retain these capital gains. By contrast, this effect is insignificant for UPREITs, which, I argue, are not affected by the constraint, implying that those firms which are allowed to sell properties before four years to realize capital gains often do so. The results thus give strong support to my hypothesis that REITs are severely bound by this holding constraint, and further illustrate why REITs are unable to realize short-term property appreciation profits, as shown in Muhlhofer (2008)