What Makes Residential Different from Non-Residential REITs? Evidence from Multi-Factor Asset Pricing Models∗

We use Bayesian methods to estimate a multi-factor linear asset pricing model characterized by structural instability in factor loadings, idiosyncratic variances, and factor risk premia. We use such a framework to investigate the key differences in the pricing mechanism that applies to residential vs. non-residential (such as office space, industrial buildings, retail property) REITs. Under the assumption that the subprime crisis has had its epicentre in the housing/residential sector, we interpret any differential dynamics as indicative of the propagation mechanism of the crisis towards business-oriented segments of the US real estate market. We find important differences in the structure as well as the dynamic evolution of risk factor exposures across residential vs. nonresidential REITs. An analysis of cross-sectional mispricings reveals that only retail, residential, and mortgage-specialized REITs have been over-priced over the initial part of our sample, i.e., 1999-2006. However, the strongest mispricings occurred and may be still persisting in the office and regional mall-specialized REIT subsectors.