By Christopher M. Wright

NAME: Andrew C. Spieler TITLE: Associate Professor of Finance, Frank G. Zarb School of Business, Hofstra University BORN: 1970 EXPERIENCE: Spieler holds a Ph.D. in finance from the State University of New York (SUNY) at Binghamton. He has published in several academic journals and received awards for best paper in “Real Estate Valuation” and best paper in “REITs” from the American Real Estate Society. Spieler has earned the Chartered Financial Analyst (CFA) and Financial Risk Manager (FRM) professional designations.

Analysts matter. That's why a lack of analyst coverage can make it difficult for small-cap REITs to attract capital or get the attention of institutional investors. A paucity of anticipated coverage has been known to deter private companies from going public, for fear that raising further capital would be exceedingly difficult without an analyst following the company. It's often said in reference to many types of firms that, without analyst coverage, a company will remain unknown, keeping its share price stuck in neutral.

Therefore, it seems intuitive that analyst coverage would increase REIT value, and now there's academic documentation for that assertion. Andrew C. Spieler, associate professor of finance at Hofstra University, and his research colleagues found increases in REIT value that they attribute to publicly distributed earnings forecasts from sell-side securities analysts.

Portfolio caught up with Spieler to discuss his team's findings as well as their other research on REITs.

Portfolio: What was the main finding of your study of REIT analyst activity over 20 years?

Spieler: Analyst coverage increases the value of REITs, something investors would be keen to know. We studied analyst activity at 247 equity, mortgage and hybrid REITs between the years 1985 and 2004. By coverage, we mean analysts following the company and issuing public earnings forecasts.

When we say value, we don't mean the immediate reaction of the stock price to the announcement of an analyst's earnings forecast. We're talking about long-term trends as measured by Tobin's Q, which has several definitions. However, it is basically the ratio between the value of the company as the market sees it versus the value of the company's underlying assets—market value over book value in short. Premium or discount to net asset value (NAV), which analysts commonly use, conveys the same idea, but we were not confident that NAV data are accurate, i.e., that NAV estimates fairly reflect the intrinsic worth of the assets. NAV may be easier for analysts to use but we find Tobin's Q data to be more reliable.

Moreover, Tobin's Q is a forward-looking market assessment. A value greater than one means that the capital markets expect the company to grow in the future and is therefore worth more than current asset value.

Portfolio: What do you think accounts for your findings?

Spieler: As in all empirical economics and finance research, we have to infer the reasons for the results we obtain. Here, the reason could simply be that having analysts reduces uncertainty about the company and its future returns. Academics call this investor recognition: investors recognize and get more comfortable with a company when an analyst has performed due diligence on it. Investors reward reduced uncertainty with a higher valuation. Another explanation could be what we call monitoring: investors are more confident when they know that analysts are scrutinizing management's actions.

A less important reason is liquidity. A covered company has a more prominent "brand name," so more people get interested in buying and selling the stock. Volume goes up and transaction costs (the bid-ask spread) come down. We call this the microstructure view, and it increases the value of the firm. It's like selling your home, but you pay a lower commission putting more money in your pocket. Lower bid-ask spreads increase the value of the firm because they lower investors' required rate of return.

Portfolio: How many analysts does it take to produce these effects, and is there a point of diminishing returns?

Spieler: We didn't study that directly. The number of analysts that follow REITs is small compared to industrial firms. In the data we used, we saw about two analysts per REIT, which is much less than the 20 to 40 that might follow a Microsoft. I would think that the key is having at least one analyst following the company at all, and that adding a second or third analyst would not have nearly the same impact.

Portfolio: Are there any important limitations to your study?

Spieler: We studied sell-side analysts only. Analysts on the buy-side don't make their forecasts public so we didn't include them. We used earnings forecasts instead of funds from operations (FFO) because the data are more accessible.

Because we controlled for some other factors such as firm size (small companies tend to outperform), debt and trading volume that might have caused the results, we feel comfortable concluding that there is causality here, not just a correlation—that analyst forecasts really do cause REIT values to go up. However, the slim possibility remains that some other variable we didn't control for actually accounts for the results.

Portfolio: What were some of your other findings?

Spieler: REIT analyst forecasts became more accurate after the year 2000. That's when real estate securities came into public view and people started including them in their portfolios, not just stocks and bonds.

Demand for real estate [investments] increased after the tech bubble burst, so REIT shares began to rise. Additionally, there were more REIT IPOs and investors demanded more research. With more analysts following the space, more knowledge was developed and forecasts became more accurate.

We also found that analyst forecasts about mortgage REITs are more accurate than for equity REITs because they are more transparent. It's easier to predict aggregate mortgage default rates than it is to value underlying properties or gauge the earnings prospects of an equity REIT. I don't see anything on the horizon that would change any of our findings, at least for the foreseeable future.

Portfolio: Tell us about some of your other REIT-related research.

Spieler: My co-authors and I have found that analysts are too optimistic about REIT IPOs. They make forecasts that turn out to be too high. We're currently studying whether analysts created artificial demand by going too far in recommending REIT IPOs after 2000, the way analysts were pumping new tech companies in the late 1990s.

We published another paper on bank lines of credit. Industrial firms have been known to draw down their lines of credit when they couldn't meet their obligations. We found it's completely different for REITs, which, by virtue of their tax status, have to distribute at least 90 percent of their earnings in dividends, so they don't have cash on hand to pursue a great investment that might come up. Issuing equity and debt takes too long, so REITs have to reserve their lines of credit for these kinds of opportunities. It's sort of like using a credit card. By the time the bill comes, you've raised other money to pay it back.

Our finding is that REITs use lines of credit correctly, generally speaking, whereas for traditional firms, you have to worry about bank credit being used for ordinary expenses. We had a follow-up paper finding that it's good for REITs to be cash-constrained because it means that they have to ensure they're making profitable investments. That rounds out the picture: REITs use both their cash and lines of credit judiciously.

Portfolio: One study found, contrary to popular belief, that stocks of high dividend-paying companies go up more than companies that don't pay dividends at all. The theory is that companies that pay high dividends don't have a lot of extra cash sitting around to blow on extraneous projects. They have to be more disciplined in taking on new activities and must make better choices when it comes to net present value and internal rates of return (IRR).

Spieler: Yes, that's very well accepted within the finance community now. Take the tobacco firms in the 1980s, they had lots of money. What did they do? Buy Nabisco.

Debt imposes even more discipline than paying dividends. Management has discretion to cut the dividend. Maybe the stock price will take a hit, but the firm won't go bankrupt. With debt, however, the company is staring fixed interest payments in the face every month. It's more of a high-wire act.

Portfolio: What research are you currently working on?

Spieler: We're working on a paper where we follow particular REIT analysts and their recommendations. We want to know the degree to which they exhibit herding behavior. It's safer to stick with the crowd and make middle-of-the-road estimates than it is to stick your neck out. If an analyst is wrong, people think they're an idiot, so analysts tend to follow the herd. That's a typical problem with earnings forecasts, and we want to see if the same dynamic is at work among REIT analysts.

So far, the data are showing that analyst estimates at the bigger investment banks, such as Morgan Stanley and Goldman Sachs, are more accurate, perhaps because a ding to their reputation from being systematically over-optimistic would eventually cost the firm more in absolute dollars from loss of future business than at a smaller bank.