Does asset liquidity matter? Evidence from real estate stock markets

Purpose - The purpose of this paper in this context is to examine the impact of asset liquidity on real estate equity returns, after taking well-documented systematic risk factors into account. Due to their unique characteristics, real estate equities constitute an inherently low degree of underlying asset liquidity. Design/methodology/approach - Following the Fama-French time-series regression approach, the authors extend the conventional asset pricing model by a real estate-specific asset liquidity factor (ALF), using a sample of 244 real estate equities. Findings - The results, based on monthly data for the period 1999-2012, reveal that asset liquidity is a relevant pricing factor which contributes to explaining return variations in real estate equity markets. Accordingly, investors expect a risk premium from listed real estate companies with a low degree of asset liquidity, which is especially the case for companies facing financial constraints and during economic downturns. Furthermore, an investment strategy exploiting differences in the underlying asset liquidity yields considerable average excess returns of upto 8.04 per cent p. a. Practical implications - Considering the findings presented in this paper, asset liquidity should receive special attention from investors, as well as from the management boards of listed real estate companies. While investors who ignore the magnitude of asset liquidity may systematically misprice real estate equities, management can influence the firm's cost of capital by adjusting the underlying asset liquidity. Originality/value - This is the first study to examine the role of an ALF in a real estate asset pricing framework.