Location Matters: Local Real Estate Market Risk and Geographic Diversification in REIT Public Debt

Hendrik Jenett, Jakob Kozak, McKay Price and Wolfgang Schäfers

ERES from European Real Estate Society (ERES)

Abstract: This study examines the impact of location based factors specifically local real estate market risk and geographic diversification on the bond risk premia of U.S. Real Estate Investment Trusts (REITs). We hypothesize that REITs operating in more volatile local real estate markets incur higher bond risk premia, reflecting investors' demand for compensation due to heightened risk exposure. Local real estate market risk is quantified using a REIT specific local beta factor, which captures sensitivity to national real estate market shocks. We find a local real estate market risk premium for REIT bonds, indicating that investors seek compensation for the additional risk. Furthermore, we uncover a non linear relationship between geographic diversification and bond risk premia, with a structural break at a Herfindahl Hirschman Index (HHI) of 0.25. For REITs with higher levels of concentration (HHI above 0.25), increased diversification is associated with lower bond risk premia. However, for well diversified REITs (HHI below 0.25), we identify a geographic diversification discount , where further diversification leads to higher bond risk premia, suggesting diminishing benefits from diversification. These findings underscore the important role of real estate location risk in shaping REIT debt costs, offering valuable insights for investors managing bond portfolio risks in the context of market volatility and geographic diversification.

Keywords: Geographic Diversification; Local Beta; REIT Bond; Yield spread (search for similar items in EconPapers)
JEL-codes: R3 (search for similar items in EconPapers)
Date: 2025-01-01
New Economics Papers: this item is included in nep-ure
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