IMPACT OF 9/11 ON US REIT RETURNS: FUNDAMENTAL OR FINANCIAL?, THE

International Journal of Strategic Property Management, 2006 by Gheno, Andrea, Lee, Stephen L

ABSTRACT. Following the attack on the World Trade Center on 9/11 volatility of daily returns of the US stock market rose sharply. This increase in volatility may reflect fundamental changes in the economic determinants of prices such as expected earnings, interest rates, real growth and inflation. Alternatively, the increase in volatility may simply reflect the effects of increased uncertainty in the financial markets. This study therefore sets out to determine if the effects of the attack on the World Trade Center on 9/11 had a fundamental or purely financial impact on US real estate returns. In order to do this we compare preand post-9/11 crisis returns for a number of US REIT indexes and in general we find that the effect of the attack on the World Trade Center on 9/11 had only a financial effect on REIT returns and therefore was transitory.

KEYWORDS: 9/11; REITs; Fundamental or financial effects

1. INTRODUCTION

The volatility of daily returns of the US stock market rose sharply following the terrorist attack on the World Trade Center. This increase in volatility may reflect changes in the fundamental economic determinants of stock prices such as expected earnings, interest rates, real growth and inflation. Alternatively, the increase in market volatility after the 9/11 terrorist attacks may simply reflect the effects of increased uncertainty in the financial markets.

For instance, Baen (2003) argues that the terrorist attack added another dimension to property investment risk in the US that is likely to have serious implications for the future capital values and net operating income (NOI) to institutional, investment-grade real estate. Indeed, Kelly (2001) argues that the impact of 9/11 on real estate markets would be felt across the whole of America. This suggests that the effects of the attack on the World Trade center are likely to be fundamental and long lasting for real estate securities.

In contrast, in an analysis of the causes of large daily price changes, Kaminsky and Schmukler (1999) argue that the largest daily changes seem to be driven in part by herding or an overreaction to bad news. While, Wrolstad and Kreuger (2003) find that, as expected, when catastrophic events such as the attack on the World Trade Center, occur, investor risk aversion increases dramatically but that the increase was only short lived as within a month the market had regained the losses incurred immediately after the 9/11 events. In other words, the 9/11 attacks had only a financial impact on real estate security returns and was therefore short lived as the assessment by investors of the effects of the terrorist action on the economic prospects of the economy evolved. In support of this view Miller et al (2003) find that there was no significant increase in vacancy rates in tall and trophy buildings across the major cities of the US, even though New York showed modest and negative effects on vacancy rates. While, survey evidence reported by Miller et al (2003) indicated that the impact on tall and trophy buildings should show little lasting effects, although the truly famous buildings have suffered as a consequence of 9/11 (Dermisi, 2005).

In order to sort out whether the effects of the attack on the World Trade Center on 9/11 had a fundamental or purely financial impact on US real estate securities we compare preand post-9/11 crisis returns for the US Real Estate Investment Trusts (REITs) using an approach suggested by French and Roll (1986), as extended by Tuluca et al (2003). In general, we find evidence that the effects of 9/11 did not have a fundamental effect on real estate stock prices. In other words, the effect of the terrorist attack was financial and so transitory.

The remainder of the paper is organised as follows. The next section discusses the economic impact of the attack on the World Trade Center had on the US in general and real estate markets in particular. Section 3 describes the methodology and data used in this study to test whether the effect of 9/11 on REITs was fundamental or purely financial. Section 4 reports the empirical findings and Section 5 concludes the study.

2. THE IMPACT 9/11 ON REAL ESTATE MARKETS

On the morning of Tuesday 11 September 2001, the United States was hit by a set of unprecedented terrorist attacks, calculated to inflict massive civilian casualties and damage. Four hijacked commercial jets crashed, into the World Trade Center towers in Manhattan, which collapsed shortly thereafter, one on the Pentagon in Washington DC, and the last one in Pennsylvania. Over 3,000 people were killed, including hundreds of rescue personnel, Lenain et al (2002).

The 9/11 attacks inflicted casualties and material damages on a far greater scale than any terrorist aggression in recent history. The destruction of physical assets was estimated in the national accounts to amount to $14 billion for private businesses, $1.5 billion for State and local government enterprises and $0.7 billion for Federal government. Rescue, cleanup and related costs have been estimated to amount to at least $11 billion. Lower Manhattan lost approximately 30 percent of its office space and scores of businesses disappeared. Close to 200,000 jobs were destroyed or relocated out of New York City, at least temporarily (DRI-WEFA (2002)).