Do Common Risk Factors in the Returns on Stocks and Bonds Explain Returns on REITs?

The monthly returns on equity and mortgage real estate investment trusts (REITs) are analyzed over the period July 1976 to December 1992. The results indicate that risk premiums on equity REITs are significantly related to risk premiums on a market portfolio of stocks as well as to the returns on mimicking portfolios for size and book-to-market equity factors in common stock returns. Mortgage REIT risk premiums are significantly related to the three stock market factors and two bond market factors in returns. Also, mortgage REIT shares underperform by an average of 6.8% per year.     

Risk and Return on Real Estate: Evidence from Equity REITs

We analyze monthly returns on an equally weighted index of eighteen to twenty-three equity (real property) real estate investment trusts (REITs) that were traded on major stock exchanges over the 1973–87 period. We employ a multifactor Arbitrage Pricing Model using prespecified macroeconomic factors. We also test whether equity REIT returns are related to changes in the discount on closed-end stock funds, which seems plausible given the closed-end nature of REITs.
Three factors, and the percentage change in the discount on closed-end stock funds, consistently drive equity REIT returns: unexpected inflation and changes in the risk and term structures of interest rates. The impacts of these variables on equity REIT returns is around 60% of the impacts on corporate stock returns generally. As expected, the impacts are greater for more heavily levered REITs than for less levered REITs. Real estate, at least as measured by the return performance of equity REITs, is less risky than stocks generally, but does not offer a superior risk-adjusted return and is not a hedge against unexpected inflation.     

REIT Auditor Fees and Financial Market Transparency

This article examines the relationship between overinvestment in audit services, abnormal nonaudit fees paid to the auditor and market-based measures of firm transparency. Because real estate investment trusts (REITs) must distribute 90% of their earnings as dividends, many are repeat participants in the seasoned equity market. Thus, REITs have unusually strong incentives to strive for security market transparency. We find that the capital markets reward REITs that overinvest in audit services with better liquidity as measured by bid-ask spreads. However, firms with abnormally high nonaudit expenditures appear to be penalized with wider spreads, consistent with the notion that such fees may compromise auditor independence.     

Dividend Policies and Dividend Announcement Effects for Real Estate Investment Trusts

Previous research on real estate investment trusts (REITs) assumes that their dividend policies are determined solely by tax regulations. We observe, however, that REITs often pay out more dividends than are required by tax rules. This paper examines the dividend policies of REITs by drawing inferences from agency-cost theory and tests for the determinants of REIT dividend payout ratios. The study also considers whether the stock market responds differently to the dividend announcement effects of equity and mortgage REITs based on asymmetric information. Our results support agency-cost explanations for dividend policy and suggest a differential announcement effect.     

Returns and Information Transmission Dynamics in Public and Private Real Estate Markets

This paper examines U.S. public and private commercial real estate returns at the aggregate level and by the four major property types over the 1994–2012 time period. Returns are carefully adjusted for differences between public and private markets in financial leverage, property type focus and management fees. Unconditionally, we find that passive portfolios of unlevered core real estate investment trusts (REITs) outperformed their private market benchmark by 49 basis points (annualized) over the 1994–2012 sample period. Our baseline vector autoregression results suggest that REIT returns do not embed additional commercial real‐estate‐specific information useful in predicting private market returns. These results strongly suggest that equity REIT returns react to fundamental (latent) asset pricing information more quickly than private market returns given their greater liquidity and price revelation. REITs therefore serve as a fundamental information transmission channel to private market returns when asset pricing variables are omitted.     

The Pricing of Seasoned Equity Offerings: Evidence from REITs

Real estate investment trusts (REITs) have been a very active sector in the capital market over the last few years. This paper examines the pricing of seasoned equity offers by equity REITs during 1991–1996. Consistent with Parsons and Raviv's model, we find that SEOs by REITs are underpriced with respect to both the closing price on the day before and the closing price on the day of the offer. Underpricing depends on the institutional ownership of the firm's common stock. Issues by firms with higher institutional ownership are more underpriced for post-1990 REITs. Further, consistent with the notion that theories of IPO pricing apply to SEOs as well, the underpricing of SEOs is a function of the issue size and of the underwriter's reputation.     

REIT Capital Budgeting and Equity Marginal q

Equity marginal  q  is the change in the market value of a company's equity in response to a one-unit unexpected change in its asset base. Hence, it is a profitability index that evaluates a firm's capital budgeting decisions at the margin. We estimate the equity marginal  q  for real estate–managing public corporations, namely, real estate investment trusts (REITs), in an attempt to understand how the various costs and benefits of being a public corporation play a role in managing this important asset class. Using the universe of equity REITs for the period from 1993 to 2005, we find that REITs with greater idiosyncratic volatility, higher stock turnover and smaller bid-ask spread have a higher equity marginal  q . In addition, both the holdings of institutional investors and their investment horizons are respectively positively related to equity marginal  q.  With these firm characteristics taken into account, firm size is found to be negatively related to equity marginal  q . Our findings are economically important as well, because the equity marginal  q  ratio alone accounts for approximately one-third of the total REIT shareholder wealth change during the study period.     

A Comparative Anatomy of Residential REITs and Private Real Estate Markets: Returns,Risks and Distributional Characteristics

Real Estate Investment Trusts (REITs) are the only truly liquid assets related to residential real estate investments. We study the behavior of U.S. Residential REITs over the past three decades and document their return characteristics. REITs have somewhat less market risk than equity; their betas against a broad market index average about 0.58. Decomposing their covariances into principal components reveals several strong factors. Residential REIT characteristics differ to some extent from those of the S&P/Case‐Shiller (SCS) private real estate markets. This is partly attributable to methods of index construction. Our examination of REITs suggests that investment in residential real estate is far more risky than what might be inferred from the widely followed SCS series. Although the SCS and REITs indicate little support for being able to predict each other, there is strong evidence of self‐predictability for the series.     

An Empirical Study of Derivatives use in the REIT Industry

We examine the use of derivatives in the real estate investment trust (REIT) industry. Tax considerations and speculative motives should not be important factors here, as REITs pay no corporate income tax and their speculative activities are limited by regulations. We find that 41 % of REITs use interest-rate derivatives, although the amount of derivatives on average is not high. Our principal results are that larger REITs and mortgage REITs are more likely to use derivatives. However, in terms of the amount of derivatives, REITs that are smaller and have a larger amount of debt tend to use more derivatives. We interpret the results as evidence supportive of substantial entry costs for hedging and financial-distress costs being a major consideration for the level of hedging. REITs with greater ratio of market to book value of assets also tend to use more derivatives. However, this result is not robust across different sample sets. We therefore view this as weak evidence supporting the agency-cost explanation for hedging. Additional analysis on interest-rate risk and hedging activities finds that mortgage REITs tend to increase their hedging activities when interest rates decrease, while the opposite is true for equity REITs. We interpret this as evidence consistent with prepayment risk being a major factor for mortgage REITs, while equity REITs primarily hedge to control funding costs.     

REIT Stock Price Volatility and the Effects of Leverage

This article sheds light on several puzzling empirical observations. We examine the volatility implications of equity Real Estate Investment Trust (REIT) stock returns over the sample period from January 1985 through October 2012. We find a negative “leverage effect” in the pre‐ and post‐Greenspan era, but not during the Greenspan era (circa 1994–2006). We argue that the positive elasticity of variance with respect to the value of equity during the Greenspan era can be explained by a decline in the spread between the yield on commercial mortgages and 10‐year Treasuries, which triggered a wealth transfer from REIT equity holders to REIT debt holders. We also argue that the declining commercial‐mortgage‐10‐year‐Treasury yield spread during the Greenspan era allowed REITs to take on far more risk than most people realized. We then document that average REIT stock return volatility increased significantly in the 2007–2010 period in the midst of a historic decline in REIT stock prices. The results have significant implications for the good deal of interest and debate in the media over the status of REITs and whether equity REITs have become excessively risky relative to the returns they generate.     

An Analysis of REIT Security Issuance Decisions

This article tests the ability of traditional capital structure theories to explain the issuance decisions of real estate investment trusts (REITs). For issuances made between 1997 and 2006, we find strong support for the market timing theory of capital structure. Controlling for past returns and growth, a REIT is more likely to issue equity when its price-to–net asset value ratio is high. This suggests that REITs issue equity in public markets when the cost of equity capital is lower in the public market than in the private market. Consistent with traditional market timing, REITs are more likely to issue equity after experiencing large price increases. We also find some support for REITs following the trade-off theory of capital structure. REITs are less likely to issue debt when proxies for expected bankruptcy costs are high.     

Does A Firm's Entry or Exit Affect Competitors’ Value? Evidence from the REIT Industry

We analyze 483 entry and 439 exit events of publicly traded real estate investment trusts (REITs) and find that changes in the number of REITs in the market affect rival REITs’ stock performance. We also partition the sample by the modes of entries and exits as well as by REIT asset type in order to disentangle alternative explanations. Overall, our evidence indicates that the supply effect still matters for stock prices even after considering signaling and price pressure explanations.     

Geographic diversification in real estate investment trusts

Whether geographic diversification within property portfolios is ideal remains an open question, with most studies finding either a diversification discount or no evidence of benefits. Using a sample of equity real estate investment trusts (REITs) from 2010 to 2016, we find a nonlinear relation between geographic diversification and firm value. Specifically, geographic diversification is associated with higher REIT values for firms that can be described as being more transparent (i.e., they have high levels of institutional ownership or invest in core property types). Whereas, geographic concentration is associated with higher REIT values for firms that can be described as being less transparent (i.e., they have low levels of institutional ownership or invest in noncore property types). Operating efficiency, at both the property‐ and firm‐levels, are the means by which the diversification value is realized. Operations improve as property portfolios become more geographically diversified for more transparent firms. When the improvements are decomposed into revenue generation and expense efficiency portions, we find revenue generation to be the main operational channel through which the benefits are obtained.     

Modeling Long Memory in REITs

One stylized feature of financial volatility impacting the modeling process is long memory. This article examines long memory for alternative risk measures, observed absolute and squared returns for Daily Equity real estate investment trust (REITs) and compares the findings for a market equity index. The article utilizes a variety of tests for long memory finding evidence that REIT volatility does display persistence. Trading volume is found to be strongly associated with long memory. Results suggest differences in the findings with regard to REITs in comparison to the broader equity sector.     

Real Estate Investment Trusts, Small Stocks and Bid-ask Spreads

This study examines the liquidity of Real Estate Investment Trusts (REITs), as measured by their bid-ask spread. We find that REIT spreads have increased over the period 1986–1990, are inversely related to market capitalization, and are similar in magnitude to spreads on other stocks of comparable size. Analysis of variance tests indicate that REIT spreads are similar across equity, mortgage and hybrid asset types. Multivariate regression results indicate that market capitalization is the primary determinant of REIT bid-ask spreads, and spreads are larger for National Association of Securities Dealers Automated Quotations (NASDAQ) REITs than for New York Stock Exchange (NYSE) REITs. The regression results also indicate that spreads are lower for equity REITs than for mortgage or hybrid REITs, and are inversely related to the fraction of the REIT's shares held by institutional investors. The similarity between REIT spreads and those of other common stocks holds in both bull and bear real estate markets and suggests that, from a liquidity perspective, REITs are similar to other common stocks.     

Asset Growth and Stock Performance: Evidence from REITs

In this article, we examine the impact of asset growth rates on the future stock performance of 308 publicly traded real estate investment trusts (REITs). We observe that fast‐growing REITs tend to underperform slow growing REITs. However, we find evidence that the growth effect is significantly less negative for REITs selling at a premium to net asset value. In addition, we observe the asset growth effect only in the subsample of REITs that engages in equity issuance over the next 12 months. The combined evidence suggests contemporaneous equity dilution, which has not been considered in previous studies, may provide an explanation for the underperformance of fast‐growing firms.     

Real Estate and Economies of Scale: The Case of REITs

Building on past research in the economies-of-scale debate, we test for scale economies in real estate investment trusts (REITs) by examining growth prospects, revenue and expense measures, profitability ratios, systematic risk and capital costs. Overall, we find that large REITs are increasing growth prospects while succeeding at lowering costs, leading to a direct relationship between firm profitability and firm size. Additionally, we find an inverse relationship between equity betas and firm size, and for all cost of capital measures we find significant scale economies. Further evidence from the stochastic frontier analysis suggests efficiency opportunities appear possible through continued growth and consolidation in REITs.     

How Do Firms Finance Nonprimary Market Investments? Evidence from REITs

This study explores the impact of investment characteristics, mainly investment location relative to the firm's primary market, on financing choices by real estate investment trusts (REITs). Using a large sample of commercial property acquisitions, we show that REITs are 4–8% less likely to use secured (mortgage) debt when acquiring properties in their primary markets than elsewhere. The documented evidence supports a demand‐side story for the relation between investment characteristics and financing. Moreover, the evidence is consistent with the hypothesis that REITs avoid mortgage financing in their primary markets to preserve operational flexibility in those markets.     

Industrial tail exposure risk and asset price: Evidence from US REITs

In this study, we investigate the impact of industry-based tail dependence risk on the cross-section of stock returns. To this end, we propose a novel tail risk dependence measure (industrial tail exposure risk [ITER]), which captures the tail risk exposure of individual stocks to multiple industries. Using US equity real estate investment trusts (REITs) data from 1993 to 2020, we document that stocks in the highest ITER portfolio outperform stocks in the lowest ITER portfolio by 8.40% per annum. This positive return spread is significant even after controlling for well-known firm characteristics. The return premium of ITER is stronger for small, value, and highly levered stocks and is substantially high during recession periods. Finally, the effects of ITER are cross-sectionally more associated with REITs that have greater degrees of the following factors: bivariate tail exposure risks of major industries, exposure to local industry tail risk, geographical concentration, and ownership of home-biased investors. Overall, our results suggest that REIT investors are indeed averse to tail risks that are associated with various sectors.     

They Would If They Could: Assessing the Bindingness of the Property Holding Constraints for REITs

This study examines the bindingness of the property holding constraints which Real Estate Investment Trusts (REITs) face on their portfolios (the dealer rule), and illustrates how these constraints hinder REITs from exploiting opportunities to time the property market. I first simulate a set of filter‐based market timing strategies, which outperform a buy‐and‐hold strategy out of sample, and show that imposing a four‐year (or even the newer two‐year) holding constraint significantly reduces the excess returns the strategies generate. I then analyze actual holding periods of properties in REIT portfolios and find that there seems to exist a large degree of demand for short property holding periods and that the trades generated by the filter strategy generally resemble actual REIT trading activity, validating the relevance of the simulation results. A direct test for the constraint reveals that REITs' propensity to hold a property beyond the minimum period increases, the higher the profit from the transaction, consistent with the asymmetric nature in which the rule is enforced. By contrast, this effect is insignificant for Umbrella‐Partnership REITs (UPREITs), which are not as affected by the constraint. I further show that UPREITs overall achieve significantly better ex‐post market timing performance than non‐UPREITs. I thus find that overall REITs are limited by the dealer rule.