Agency Costs and Inefficiency in Commercial Real Estate

Executive Summary. Persistence in partially disaggregated NCREIF returns suggests that the institutional real estate market is inefficient and that the most significant source of market inefficiency is agency cost. A major structural distinction between the stock and real estate markets is the imposition of an agency cost control mechanism on stock portfolio managers by the existence of continuous price discovery in the stock market. Persistence in extreme return behavior distinguishes the effect of multiyear agency cost amortization on real estate returns from the effect of market dynamics subsequent to asset acquisition. The application of persistence tests to real estate return series can form the basis for substitute portfolio controls to compensate partially for the absence of continuous price discovery from the real estate market.