Real Estate Investment Trusts
Structure, Performance and Investment Opportunities
Su Han Chan, John Erickson and Ko Wang
v The only book that provides a systematic and comprehensive look at the REITs industry. here are currently around 200 publicly traded Real Estate Investment Trusts (REITs) operating in the United States and their equity values total about $160 billion. Originating just a little over a century ago, most analysts would agree that REITs have proven their eligibility as a good way for investors to diversify their portfolios. They were, in fact, created to allow institutional and individual investors to invest in real estate via a corporate entity. While they trade like stocks, their market path most often tracks in a different direction - often outperforming the stock market in tough times and declining over the term of aggressive equity bull markets. REAL ESTATE INVESTMENT TRUSTS: Structure, Performance and Investment Opportunities analyzes and synthesizes the existing scholarly research on REITs in a way that will enable managers to improve their investment decisions and the operating performance of their REITs portfolios. This book is designed to help investors evaluate REITs and identify those with the greatest investment potential. It also provides the investing public, real estate practitioners, regulators, and real estate and finance academics with up-to-date information on what modern scholarly research tells us about REITs. Also included is up-to-date original research on REITs based on the authors’ own database, which is the most extensive data base available on REITs that is free of survivorship bias. As well as offering a broad understanding of the evolution of this important industry, this book discusses the likely future prospects of this unique investment vehicle. This book is one of the newest additions to the Financial Management Association's (FMA) Survey and Synthesis Series. AVAILABLE OCTOBER 2002 x 9-1/4 copyright 2003; 352 pp., 6-1/8 0-19-515534-3 $45.00 The Authors Su Han Chan is a Professor of Finance at California State University-Fullerton and a Visiting Professor at the School of Business, University of Hong Kong. She has published in the leading finance and real estate journals on various topics including REITs and co-authored 19 teaching cases. She currently serves on the editorial board of the Financial Management Association’s Survey and Synthesis Series, the Journal of Real Estate Research and the International Real Estate Review. John Erickson is a Professor and the Chair of Finance at California State University-Fullerton. He has published articles on REITs in Real Estate Economics and the Journal of Real Estate Research. He has also published in the Journal of Finance and the Journal of Law and Economics. Ko Wang is a Professor of Real Estate and Finance at California State University-Fullerton and an Honorary Professor at the Chinese University of Hong Kong. He has published extensively in the leading real estate and finance journals on various topics including REITs, co-edited a monograph on real estate valuation theory, and coauthored 19 teaching cases. He is the editor of the Journal of Real Estate Research, the founding executive editor of International Real Estate Review, and an associate editor of seven other journals.
S. Erickson." Sheridan Titman McAllister Centenial Chair in Financial Services Department of Finance University of Texas
"Most previous treatises on REITs suffer from their excessive focus on institutional and legal structure alone.”
Glenn R. and Wang provide an excellent comprehensive analysis of the REIT market that is sure to be a valuable resource for stock market investors interested in diversification opportunities and real estate professionals interested in REITs as funding vehicles. devoid of the broader existence of REITs within the real estate and capital markets. with a timely and interesting integration of academic knowledge and the frontier of practitioner activities.
. It is the first effort to integrate the latest academic insights from the economics and finance literature with the relevant applied issues faced by investment professionals to create a truly useful text -.an invaluable reference guide that will become the standard against which all subsequent efforts will be judged. Erickson. and abroad. Edelstein Chairholder. Vandell Tiefenthaler Chair in Real Estate and Urban Land Economics Director. yet. Fisher Center for Real Estate & Urban Economics Haas School of Business University of California at Berkeley
“Authors Chan. pragmatic real estate activities. University of Pennsylvania
“The REIT industry has changed dramatically over the last decade. The use of this investment vehicle is likely to continue to grow. The book provides an unusually balanced presentation among analytic-theoretic issues. As finance investors have begun to recognize the enormous profit opportunities in inner cites and distressed communities. and Real Estate Investment Trusts provides the most up-to-date view of industry available today. This book will also help investors understand a REIT analyst's thought process and better interpret their reports. Chan.”
Isaac Megbolugbe Vice President of Fannie Mae Foundation's Office of Research & Adjunct Professor of City and Regional Planning.Advance Praise for Real Estate Investment Trusts:
"REITs provide a convenient and liquid structure that allows investors to hold a diversified portfolio of commercial real estate. and public markets behavior. Authors Chan."
Robert H. Chan. The book demonstrates a special sensitivity about how the United States' experience with real estate investment trusts may parallel and extend the inexorable trend towards the real estate securitization throughout the world. and Wang have created a first-class book about Real Estate Investment Trusts. Center for Urban Land Economics Research University of Wisconsin-Madison
"Mssrs. The book is informative and analytic. Real Estate Development Professorship Co-chair. both in the U.”
Kerry D. and Wang stands out in this regard. thus Real Estate Investment Trusts is a must for any investor interested in REITs. Mueller Professor at Johns Hopkins University Real Estate Institute and Real Estate Investment Strategist on Legg Mason's REIT Research Team. Understanding the complexities and nuances of modern REITs is very important to making good investment decisions. Erickson. quite readable for the sophisticated lay-audience. and Wang have done a masterful job of explaining the world of REITs from the perspective of a very experienced financial analyst but in a fashion that less experienced reader can easily follow and understand. REIT is one vehicle that both community development professions and Wall Street analysts are examining to help bring private capital to distressed communities. Erickson.
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To Order. McAllister Centennial Chair in Financial Services.00 352pp. visit www. Department of Finance. Erickson and Wang provide an excellent and comprehensive analysis of the REITs market that is sure to be a valuable resource for stock market investors interested in diversification opportunities and real estate professionals interested in REITs as funding vehicles. systematic and comprehensive look at the REIT industry • Shows how to invest in REITs • Helps identify those REITs with the greatest investment potential • Includes authors’ exclusive database which tracks REITs performance • Contains original research never before published on REITs security offerings and the role REITs play in countries outside the USA • Looks at the future of REITs-likely trends.O x f o r d U n i v e r s i t y Pre s s Announces
Real Estate Investment Trusts
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3.2 Factors in the Growth of the REIT Industry 2.3 The REIT Simplification Act and the REIT Modernization Act The Modern REIT The Future of the REIT Concept References Organizational Structure The Costs of Being a REIT 3.5 Conversion Costs The Net Effect of the REIT Organizational Form 3.3 Non-Mortgage REITs During the 1970s 2.2
Chan.2.1 2.6 Tax Reform Changes REITs Once More The 1990s: Growth and Change .3.1.4 The Problem of Market Timing 3.4 Where We are Headed 1.2.1 Increasing REIT IPO Activities 1.1.1 The Tradeoff between Tax Benefits and Flotation Costs 22.214.171.124.1 Reduced Benefits of Using Debt 3.3 Issues of Interest 1.2.2 Managing REITs 1.1 The REIT Boom 126.96.36.199.2.1 Survey and Synthesis of Evidence 1.2 Reduced Growth Potential 3.CONTENTS
Preface Acknowledgments Chapter 1 Introduction 1. Erickson.2 REITs are Different from Other Stocks 1.3.5 A Book for Wiser Decision-Making 1.2 A Comprehensive Database 1.6 Chapter 3 3.5 2.1 Understanding REITs 1.Again 2.3
2.2.2 Bringing the Evidence Together 1.1 The 1960s: REITs Attract Investor Attention 188.8.131.52 The 1970s: Rough Times for REITs 2.5 The 1980s: A Changing Market Environment 2.2.2 The Origins and Evolution of Real Estate Investment Trusts The History of the REIT Concept REITs in the 1960s-80s 2.2 Changes in Organizational Structure
2.4 The Tax Reform Act of 1976 2.6 References Chapter 2 2.3. and Wang
.3.3 Conflict of Interest between Shareholders and Managers 3.2.4 2.1.3 Investing in REITs 1.1 Why REITs Deserve Our Attention 1.1.
.3.4.1 The Net Effect of the UPREIT and DOWNREIT What Have We Learned? Will the REIT Structure Survive? References Advisor Puzzle The Evolution The Problems with Using External Advisors 184.108.40.206 4.1 The Potential Costs 4.3 Size and Net Asset Value of REITs 5.8 Chapter 5 5.5 5.2 Self-dealing 4.4 What Can We Conclude? The Future of Big Consolidations 5.1.3 3.4 3.1 4.2 Merging to Become Bigger? What Have We Learned? What Does the Future Hold for the Size of REITs? The Impact of Institutional Investors The Roles of Institutional Investors 220.127.116.11.5 4.1.1 Stock Performance 4.1 Monitoring Management’s Decisions 6.1
5.2 Operating Performance Issues Complicated by Compensation Schemes What Have We Learned? What is the Future Direction? References REIT Economies of Scale Arguments in Favor of Large REITs 5.6 Chapter 6 6.1
Chan. Erickson.1 Size and Stock Returns 5.2 Size and Stock Performance of REITs 5.2.2
3.2 Other Benefits of Size Arguments Against Large REITs Net Results of the Evidence 5.3 Whether to Take Advantage of the REIT Structure A Comparison with the MLP and Corporation Structures New Structures: The UPREIT and DOWNREIT 3.4
4.6 4.7 Chapter 4 18.104.22.168.3.1.6 3.1 Economies of Scale 5.1 Revenue Allocation 22.214.171.124.5 3.4
5.7 4.2 Setting Stock Prices 6.3 The Worst Case Scenario: Captive REITs The Problem of Using Internal Advisors Which One to Use: External or Internal? 4.2.2 5.2.1 Empirical Evidence on REIT Mergers 5.2.2 Poor Stock Performance 4.3 The Reputation Effect
Erickson.3.3 To Signal the Volatility of Future Cash Flows 8.1 To Reduce Agency Costs 8.1 REIT Initial Public Offerings 6.1 Evidence from the Real Estate Market 8.5 7.3.2
126.96.36.199 7.5 6.3.1 Is REIT Type Correlated with the Property Market? 7.6.3 A Note of Caution Stock Performance and Institutional Investors 6.2 188.8.131.52
Chan.5.3.1 8.1 Against the Diversification Strategy 7.3
8.4 6.1 Market Reaction to Announcements by Industrial Firms 8.2 Does Property Type Matter in Determining REIT Returns? 7.3
Institutional Investors in the REIT market 6.3 Who are the Winners. and Wang
8.3.2 Institutional Holdings of REIT Stocks 6.7 Chapter 8 184.108.40.206.3 The Verdict Three Related Questions on the Diversification Issue 7. and Should We Care? The New Evidence and a New Argument What Have We Learned? Conclusions Dividends and Debt Policies of REITs Constraints on REITs’ Dividend Policies No One Seems to Care about the Constraint Why REITs Pay Such High Dividends 8.6.1 Gathering Institutional Data 6.2 Market Reactions to REIT Announcements
7.6 6.3.2 The Monday Effect 6.3 General Performance Relationship with Financial Analysts Other Kinds of Informed Investors What Have We Learned? The Future of Institutional Investment in REITs Diversification versus Focus What the Industry People Say? The Function of REIT Managers To Diversify or Not to Diversify: The Pros and Cons 7.2.2 Evidence from the REIT Market Is There a Consensus View in the Market? 220.127.116.11
7.2 For the Diversification Strategy 7.2 To Signal Private Information 8.7 Chapter 7 18.104.22.168 7.2 Argument for the Use of Debt Practices in the Field 8.5 To Attract Investors Constraints on REIT Debt Policies 8.2.1 Arguments Against the Use of Debt 8.2 8.3
8.4 To Reduce Information Asymmetry 8.
3 Is There a General Consensus? 10.2 Evidence for Partial or No Integration 10.7.2.2.1.3.2
Chan.7.2 IPO Activities 9.3 Which Types of REITs Should Use SEOs? Link between IPOs and SEOs What Have We Learned? Conclusions The Performance of REIT Stocks REIT Stocks and Unsecuritized Real Estate 10.4.3 Pricing of REIT IPOs Factors Determining the Initial-Day Return 9.2.2 Performance by Subperiod 10.1.2.5 9.2
9. and Wang
.3.1.3 The Distribution Method 9.2 Ownership of REIT Shares The Lesson We Learned Price Performance Following IPOs Secondary Offerings of REIT Securities 9.1 Changes in Organizational Structure 22.214.171.124 Is There a Compromise? The Risk and Return Characteristics of REITs 10.3
9.4 Valuation Uncertainty 9.1 Evidence for Integration 10.8 9.9 9.4
9.1 Underwriter and Stock Listing 9.8 Chapter 9 9.1.1 REIT Stocks versus the Stock Market 10.2.2.and Post-1990 9.1.10 Chapter 10 10.1. Erickson.126.96.36.199 Secondary-Offering Activities 9.3 Overall REIT Performance 10.5 Fund Duration The Changing Nature of REITs: Pre.3 The Fund-Like Organizational Structure Empirical Evidence on REIT IPOs 188.8.131.52 The Buyers of REIT IPOs 9.1
What Have We Learned? Conclusions REIT Security Offerings What Is Unique About REIT IPOs? 184.108.40.206.7
9.2 Performance of REIT SEOs 220.127.116.11.3 Market Factors Affecting REIT Stocks
9.1 Common Factors 10.3.7 8.1 Data Collection 9.1 The General Trend of the Evidence 10.6 9.2 REITs and Asset Type 10.7.1
10.2 Unique Factors 10.2 Institutional Investors 18.104.22.168 Uncertainty About the Value of the Properties 9.
1 Domestic REITs Investing Abroad 12.3 Be Wary of REITs with no Growth Potential 10.4 What Can We Say about Growth? What Have We Learned? Conclusions The Predictability of the REIT Stock Market Possible Reasons for REIT Stock Market Inefficiency Evidence of REIT-Return Predictability Trading Strategies Based on Predictability Trading Strategies Based on Stock Price Reversals Momentum Trading in REITs What Have We Learned? Conclusions The Future of REITs Why REITs Will Always Stay with Us Operating Company Versus Mutual Fund Non-Real Estate Products The Changes Ahead 12.3 11.4.3
10.4.2 Diversification Potential Other Forms of Securitized Real Estate 10.6
12.4 The Verdict REITs As Growth Stocks 10.4.6 11. Erickson.7 Chapter 11 11.4
10.4.1 Inflation-Hedging Potential 10.2 12.4
10.2 REITs as Income Stocks 10.4.2 22.214.171.124 Adoption of the REIT Concept Abroad The Fittest Survive Concluding Remarks
12.5.3 Relative Performance When Compared to Real Estate MLPs 10.3.5.5.5 11.8
Appendix 1 Stock Returns and Performance Index of Publicly Traded REITs (19622000 and 2001-2002)
Chan.7 Chapter 12 12.1 Relative Performance When Compared to CREFs 10.5 12.4 Interest Rates and Stocks Factors Inflation-Hedging and Diversification Benefits 10.4. and Wang
.6.1 Use of Alliances and Joint Ventures 12.1 11.6.4 11.1 12.5
10.2 Relative Performance When Compared to REOCs 10.2 Increased Use of Technology Going Private and Increasing Debt Usage Globalization of the REIT Concept 12.7 12.6 10.3.3 12.1 Limitations on Growth 10.10.