“The overall REIT equity market capitalization has increased tremendously since 1971. The question is, from investors’ point of view, why is there so much interest in REITs? Is it because REITs provide a better risk-return relationship than other securities?
The findings reveal that equity REITs have provided investors with an average abnormal annual return of 2.2 percent with a low time-varying volatility of 0.24, in the context of the conditional capital asset pricing model (CAPM) during this period.”
Insider Ownership and Institutional Investors a Plus for REITs
From “Insider Ownership and Firm Value: Evidence from Real Estate Investment Trusts,” by Bing Han, published in Journal of Real Estate Finance and Economics, 2006.
An Ohio State finance economist, Bing Han, investigated whether insider ownership in listed REITs is associated more strongly with entrenchment that reduces firm value or with alignment of interests that increases firm value. Han found that insider ownership contributed to the value of the firm even at relatively high levels, especially as institutional investment in REITs has increased.
“Agency problems arise within a firm whenever managers have incentives to engage in non-value-maximizing activities such as perquisite-taking and empire-building. Listed REIT data provide a unique laboratory to study this issue. One reason is that the incentive effect of managerial ownership is likely to have a more important effect on the value of REITs.
Other things equal, firm value (measured by Tobin’s Q, the sum of market value of stock plus debt and preferred securities divided by total assets) will increase by 0.13 when insider ownership increases from 0 percent to 5 percent. The relationship between firm value and insider ownership above 25 percent turns negative, although not significantly so.
Using listed REIT data for the 1980s and early 1990s, earlier researchers found that the relationship between market-to-book ratio and insider ownership is positive up to 5 percent and turns negative after that. In comparison, for REITs in 1994-2000, firm value is positively related to insider ownership up to 25 percent. The difference is consistent with reduction in agency costs in modern REITs brought by several recent important changes.
With reduced liquidity, institutional investors with more than a 10 percent stake have more incentive to monitor and influence the firm management. Their presence should reduce agency cost in REITs and may dampen the humped relation between insider ownership and firm value.
For those REITs whose largest institutional investors hold more than 10 percent of the firm, firm value is positively related to insider ownership even at high levels of insider ownership.”
REITs Outshine Commodities and TIPs as Diversifiers
From “Time-Variation in Diversification Benefits of Commodity, REITs, and TIPS,” by Jing-zhi Huang and Zhaodong Zhong, working paper, 2006.
Two Penn State finance economists, Jing-zhi Huang and Zhaodong Zhong, compared the diversification benefits of three asset classes—REITs, commodities, and Treasury inflation-protected securities (TIPS)—for an investment portfolio containing U.S. stocks, foreign stocks, U.S. bonds and foreign bonds. Huang and Zhong found that REITs are more valuable diversifiers than commodities and more valuable than TIPS since mid-2002.
“We can see that the addition of commodities can increase the Sharpe ratio by 0.1 to 0.5 over the sample period. Compared to commodities, REITs provide a larger diversification benefit as it can raise the Sharpe ratio by as high as 1.5 in some periods. While TIPS can increase the Sharpe ratio by as high as 3 early in the same period, the diversification benefits decrease gradually after 2001.”
Another way to look at the time variation in diversification benefits of different asset classes is to examine how their weights in the tangent portfolio change over time. TIPS make up the largest portion of the tangent portfolio at the beginning of the sample period, but the portion becomes smaller in later periods. In contrast, REITs take up a significant weight across the entire sample period. The weights of commodities are relatively stable but are much lower relative to those of REITs and TIPS.”
REIT Stock Repurchases Provide Buy Signal
From “Why Do REITs Repurchase Stock? Extricating the Effect of Managerial Signaling in Open Market Share Repurchase Announcements,” published in Journal of Real Estate Research 28(1):1-23 (January-March 2006).
Two economists from Brigham Young University, James C. Brau and Andrew Holmes, searched REIT stock returns for evidence indicating if managers repurchase stock because their companies are undervalued in the market. They tested the “managerial signaling hypothesis,” which posits that stock repurchases are motivated by market undervaluation, against several competing hypotheses. Brau and Holmes found that REIT stock repurchase decisions do provide a signal to investors that companies are undervalued.
“REIT managers may use repurchases to signal that their firm stands out from the industry and is undervalued relative to other REITs. Specifically, poor stock price performance prior to the announcement may tell management that the stock is undervalued.
Past research documents positive stock price reactions surrounding repurchase announcements and are consistent interpretations with the managerial signaling hypothesis as well as competing hypotheses. Investigation of repurchase announcements by REITs provides a novel approach to isolating the impact of signaling effects from those of the competing hypotheses.
The announcement of a repurchase produces a significant and positive abnormal return in the study. The cumulative abnormal return (CAR) from 10 days prior to the announcement through 10 days following the announcement is significant and positive at +2.07 percent. The significantly negative CAR from day -10 to day -2 (-1.5 percent) is statistical evidence of under-performance in the period immediately prior to the repurchase announcement. The average three-day CAR from day -1 to day +1 equals +2.3 percent and is highly significant.
By eliminating the influence of the competing hypotheses, the REIT sample analysis provides a more focused assessment of the determinants of stock price reaction to a repurchase announcement. The impact of the signaling variables is significant and consistent with the managerial signaling hypothesis and provides an explanation for the repurchase announcement stock price reaction.”
Brad Case is NAREIT’s vice president, research & industry information.
Editor’s Note: Due to the lengthy academic publishing process, many papers are summarized before they are published. Unpublished working papers may achieve the same high quality standards as published papers.
