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Illiquidity, transaction cost, and optimal holding period for real estate: Theory and application

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  • Cheng, Ping
  • Lin, Zhenguo
  • Liu, Yingchun

Abstract

Choosing the optimal holding period is an important part of real estate investment decisions, because "when to sell" affects "whether to buy". This paper presents a theoretical model for such decision making. Our model indicates that the optimal holding period is affected by both systematic and non-systematic factors--market conditions (illiquidity and transaction cost) and property performance (return and return volatility). Other things being equal, higher illiquidity and transaction costs lead to longer holding periods, while higher return volatility implies shorter holding periods. Our empirical application suggests that the optimal holding period based on our model is quite consistent with previous empirical findings. In addition, we find that when illiquidity risk is incorporated the true real estate risk is significantly higher than the conventional risk estimate. Therefore, the current practice of real estate valuation, which is naively borrowed from finance theory, substantially underestimates real estate risk.

Suggested Citation

  • Cheng, Ping & Lin, Zhenguo & Liu, Yingchun, 2010. "Illiquidity, transaction cost, and optimal holding period for real estate: Theory and application," Journal of Housing Economics, Elsevier, vol. 19(2), pages 109-118, June.
    • Handle: RePEc:eee:jhouse:v:19:y:2010:i:2:p:109-118
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    Cited by:

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    2. Mei, Bin, 2015. "Illiquidity and risk of commercial timberland assets in the United States," Journal of Forest Economics, Elsevier, vol. 21(2), pages 67-78.
    3. Amédée-Manesme, Charles-Olivier & Barthélémy, Fabrice & Prigent, Jean-Luc, 2016. "Real estate investment: Market volatility and optimal holding period under risk aversion," Economic Modelling, Elsevier, vol. 58(C), pages 543-555.
    4. Annika Hegemann & Angela Kunoth & Kristina Rupp & Caren Sureth-Sloane, 2017. "Hold or sell? How capital gains taxation affects holding decisions," Review of Managerial Science, Springer, vol. 11(3), pages 571-603, July.
    5. Bond, Shaun A. & Chang, Qingqing, 2012. "Liquidity dynamics across public and private markets," Journal of International Money and Finance, Elsevier, vol. 31(7), pages 1890-1910.
    6. Steven Devaney & David Scofield, 2015. "Liquidity and the drivers of search, due diligence and transaction times for UK commercial real estate investments," Journal of Property Research, Taylor & Francis Journals, vol. 32(4), pages 362-383, December.
    7. Gianluca Marcato, 2018. "Liquidity Pricing of Illiquid Assets," ERES eres2018_215, European Real Estate Society (ERES).
    8. Hui, Eddie C.M. & Chan, Ka Kwan Kevin, 2019. "Alternative trading strategies to beat “buy-and-hold”," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 534(C).

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