What effect did the BREXIT have on the abnormal stock returns of REITs and how do different firm characteristics affect this relationship Bachelor thesis at the University of Amsterdam Thesis supervisor: Mario Bersem Bachelor student: Koen Spelde Student number: 10819606 BsC Economie & Bedrijfskunde Field: Finance & Economics Statement of Originality This document is written by Koen Martijn Spelde who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used creating it. The Faculty of Economics and Business responsible solely for the supervision of completion of the work, not for the contents. 2 Contents: 1. Introduction 5 2. Literature overview 7 3. Methodology 11 3.1 Event study methodology 11 3.2 Regression analysis methodolgy 15 4. Data 18 5. Results 19 5.1 Event study results 19 5.2 Regression analysis results 23 6. Conclusion 24 7. Appendix 25 8. References 32 3 Abstract: The Brexit outcome affected the stock market on almost every sector both domestically as internationally. In this paper the effect of the Brexit on the real estate sector of the UK is examined. This is done by conducting an event study to test how UK REITS performed during the Brexit. The model used is the market adjusted model and found a negative overall effect of cumulative abnormal returns for the REIT sector and negative significant cumulative abnormal returns for 35 of the 39 REITS. Thereafter a regression analysis is provided to test the relation between the cumulative abnormal return and the market capitalization of the REITS. Besides the market capitalization, the leverage ratio, book to market ratio and the dummy variable for the FTSE100 and FTSE250 are included as control variables. The regression analysis found a negative relationship between the CAR and the market capitalization. In increase in market capitalization resulted in a further decrease of the negative cumulative abnormal return. 4 1. Introduction: On June 24 in 2016, the United Kingdom voted to exit the European Union in a referendum. Of all participants, 51,9% voted in favor to leave the EU (The Guardian, 2016). This outcome was unexpected because the bookmakers expected a 90 percent chance that the UK would remain within the EU (Bloomberg, 2016). This outcome, the so-called Brexit, had many consequences on both domestic and international levels and caused many concerns on the political, social and economical level. Dhingra, Ottaviano, Samson & van Rheenen et al. (2016) found that in case the Brexit would happen, stock prices on the London stock Exchange would be negatively affected. The Brexit affected the returns in different sector types on both domestic and international stock markets. The day after the outcome the FTSE250 fell almost 12 percent in dollar terms. Moreover, an economic consequence is that 63% of UK export goods and services go to EU membership states. When the UK is no longer part of the EU, the UK will face trade tariffs because they cannot oblige to the EU trade agreement anymore. Dhingra et al. (2017) concluded that of all scenarios, the Brexit will reduce the welfare of the average UK citizen. In addition, a political consequence is that the position of EU residents who are living and working in the U.K. became uncertain. Monfared & Pavlov (2017) found prove that many EU residents left the London area due to the in 4 months’ time after the outcome of the referendum. Subsequently, real estate prices dropped between a range of 1,9% to 3%. Real estate and stocks are major components in valuing assets. Zeckhauser and Silverman (1983) found at least 25 percent of the value of corporate firms is associated with real estate. Gyourko and Keim (1992) published a paper and found prove that the real estate market is integrated in the stock market. Therefore, the stock market contains relevant and appropriate knowledge of the real estate market. Both stocks and real estate prices are subject to changes in the economy. Real estate and stocks are important investment vehicles of both individual and large institutional investors. A decrease in stock prices will result in a decrease in personal wealth, but research varies on how the Brexit influenced stock markets and different sectors in the UK. Most of the research was done for multiple sectors at once. Research 5 regarding the Brexit and the performance of real estate investment trusts (REITs) is only shortly mentioned in the paper of Ramiah, Pham & Moosa, (2016). Ramiah et al. (2016) researched the effect of the Brexit respecting different sectors of the UK. This was done calculating the abnormal returns of a 10-day event window regarding the Brexit. However, they found consistent results according to the paper of Dhingra et al. (2016). Moreover, market efficiency showed quick price adjustments of stock prices in 3 days after the outcome Oehler et al, (2017). Therefore, central in this thesis is to re-examine the abnormal returns of real estate stocks which formulate the following research question: What effect did the BREXIT have on the abnormal stock returns of REITs and how do different firm characteristics affect this relationship In this thesis, both the interest upon UK REITs and their performance after the Brexit outcome are considered. This is done by conducting an event study. The purpose of this thesis is to indicate abnormal returns for the REITs sector using a smaller event window than the research of Mackinlay, (1997). The aim of this thesis is to provide investors with insights, as they often consider real estate to diversify their portfolio. In addition, real estate is considered to be a relatively stable investment in someone’s overall portfolio. Therefore, it is interesting to consider what effect the Brexit had on these relatively stable stocks. The event study of this thesis calculates the abnormal returns, which will be based on the market-adjusted model. After this, the average t-test statistic is formulated to calculate the overall effect of het performance of UK REITS. Thereafter, a t-test is conducted for every REIT separately to establish their performance compared with the market return. In line with other research respecting abnormal returns and the Brexit, the results of the abnormal returns show a negative relation with the Brexit. After this event study was carried out, multiple regressions were performed. This was done with the use of STATA. Here, the relationship between the cumulative abnormal return and the market capitalization of the REITs was examined. In section 2, the literature overview will be described. The relation between the stock market and the Brexit will be discussed as well as what research was already 6 conducted with respect to the real estate market and the stock market. Thereafter, the first hypotheses will be formed. Moreover, the relation between stock returns and market capitalization will be described. After that, the firm characteristics which were chosen for the regression are explained. This is followed by the second hypothesis. In section 3, the event methodology is described. Then, the assumptions of a multiple regression are defined. In section 4, the collected data will be analyzed, which will be followed by some descriptive statistics. In the last section the results will be discussed, together with a conclusion based on these results. 2. Literature review Brexit and stock markets Research varies on how the Brexit affected the stock returns. Alkhatib & Harasheh, (2018) published an article on how global financial markets experienced this shock. They found significant positive abnormal returns from US T-bonds on the event date. Moreover, Ramiah et al. (2016) wrote a paper where they conducted research on what impact the Brexit referendum outcome had on different sectors of the British Economy. By measuring abnormal returns, an event study over the period June-July in 2016 was conducted and the results showed that the banking sector and leisure sector were affected the most. The short-term market risk was adjusted by the Bank of England, which resulted in negative abnormal returns and higher risk for this sector. Besides that, the Financial Times wrote that banks will leave the UK when the outcome results in leaving the EU, which would eventually lead to depreciation of the pound. In addition, for UK residents, holidays became more expensive which resulted in the negative abnormal return of the leisure sector. This is consistent with the research of Bonchev and Penchava (2017), who focused on the abnormal returns of bank stocks in Europe and found significant negative abnormal returns. They also concluded that bank size matters in the level of negative abnormal return. Oehler, Horn and Wendt (2016) researched short term price effects of different sectors, and analyzed how the FTSE100 reacted after the Brexit referendum. This was done by taking the abnormal returns of the first 3 days after the FTSE100 opened. The results (figure 1) show that large and medium cap-prices and returns were very volatile for the first 3 days after the Brexit. For example, from June 24 to June 27 the FTSE100 7 ranged between 5798 – 6117 points. This research provided equally weighted mean values from the market capitalization and the standard deviation from the firms of the FTSE100. The statistical t – test of the abnormal and cumulative abnormal returns were found to have significant results at a 1 percent level. The abnormal returns of firms with a higher domestic operating degree were found to have a larger negatively affected return, in comparison to the companies that operate more internationally. Figure 1: The FTSE100 index from 23/6/2016 – 30/6/2016 Definition of REITs: A REIT is a company or corporation which use the combined investments of all types of investors to purchase real estate property, Before REITs were created this was only available for large and wealthy individuals.