Agency, Ownership, and Returns on Real Assets

Institutions commonly purchase fully utilized, prime properties of “institutional quality,” while other investors buy both underutilized and subprime properties. Managers of institutions with well diversified, liquid portfolios claim to be averse to the additional risk and illiquidity of noninstitutional assets. This behavior and its puzzling explanation are predicted by this dynamic model of clienteles. Here, only institutions have separate owners and managers and thereby an agency problem. Institutions trade prime properties with noninstitutional investors, buying fully utilized assets and eventually selling underutilized assets. Across assets average returns are increasing in both risk, either diversifiable or not, and illiquidity. This result reflects the segmentation of markets in equilibrium produced by the agency problem, rather than compensation for either risk or illiquidity. Also, both risk and liquidity are determined endogeneously. The predicted trading patterns are consistent with observed transactions of industrial and office buildings in suburban San Diego during 1993–2000. Minor modifications of the model yield similar results for subprime properties and underutilized assets, like land, and that require intensive investigation or management.