Compiled by Brad Case
REITs Improve Investment Incentives
From "The Determinants of the Debt Maturity Decision for Real Estate Investment Trusts," by Michael J. Highfield, Kenneth D. Roskelley, and Fang Zhao, published in Journal of Real Estate Research, April-June 2007.
A trio of economists—Michael Highfield of Mississippi State University, Kenneth Roskelley of Louisiana Tech University and Fang Zhao of Siena College—asked what motivates the decisions that REITs make with respect to issuing short or long-term debt. They found that REITs with better growth prospects use short-term debt to correct the alignment of interests between stockholders and debt holders.
"Concerns about liquidity risk, defined as a firm's ability to refinance short-term debt, may lead the firm to issue long-term debt. In terms of liquidity risk, low-rated firms will tend to seek long-term debt due to the high probability that they may be denied financing in the future due to their credit risk.
According to one hypothesis, debt serves as a signal of credit quality. Firms hold information not known to the market, and the choice of maturity serves as a signal to the market about the nature of the asymmetric information. Firms with positive information will issue short-term debt so that they can benefit from the refinancing process by enjoying lower financing costs once the information becomes publicly available. Firms with negative information will issue long-term debt to avoid re-evaluation because the release of negative information will increase the cost of financing. In our findings, there is little evidence that REITs signal information asymmetries by the choice of their debt's maturity.
When debt is included in a firm's capital structure, it may induce managers to forego valuable projects when creditors, instead of stockholders, will capture the project's revenues. Thus, the use of short-term debt may reduce the incentive for firms to underinvest by forcing renegotiation of the debt prior to the exercise date of an implicit real option. This suggests that firms with more growth opportunities should issue short-term debt to control agency problems. There is indeed a negative relation between the maturity of new, incremental debt issues and the market-to-book ratio."
Beta for REITs and Other Listed Property Companies Declined Worldwide
From "Securitized Real Estate and its Link with Financial Assets and Real Estate: An International Analysis" by Martin Hoesli and Camilo Serrano, published in Journal of Real Estate Literature, 2007.
A pair of European economists—Martin Hoesli of Bordeaux Business School and the Universities of Geneva and Aberdeen, and Camilo Serrano of the University of Geneva—investigated changes from 1990 through 2004 in the beta of listed property companies in 16 countries. They found that beta declined in all countries, especially in the United States.
"While a general tendency of decreasing betas is detected in nine countries—Belgium, Canada, France, Japan, the Netherlands, Spain, Sweden, Switzerland and the U.S.—betas appear to be decreasing during the whole period. The most significant reductions from the beginning to the end of the sample occur in Sweden, Canada, Belgium, Spain and the U.S.
A possible explanation for this general decrease is the maturation of the securitized real estate market, which will reduce information asymmetries and lower investors' risk perception of the asset class. Additionally, in France and the U.S., it is the increase in the stock market's standard deviation and the decline in the REIT-stock correlation that explain the decreasing beta."
REIT Liquidity is Related to Managerial Focus, Ease of Valuation
From "The Impact of Property Type Diversification on REIT Liquidity," by Bartley R. Danielsen and David M. Harrison, published in Journal of Real Estate Portfolio Management, October–December 2007.
Two economists—Bartley Danielsen of North Carolina State University and David Harrison of Texas Tech—investigated the factors affecting REIT stock liquidity, measured by quoted bid-ask spreads, effective spreads, or trading volume. They concluded that REITs focusing their investment activities within a single property type sector enjoy enhanced liquidity and ease of valuation.
"The findings suggest that firms holding financial assets are harder to value than firms with direct property investments. In addition, the coefficients suggest that REITs investing exclusively in either debt or equity investments are characterized by lower quoted and effective spreads. REITs focusing their investment activities within a single property type appear to be characterized by lower spreads. Interestingly, storage, health care and retail properties exhibit lower spreads than residential real estate suggesting these properties may be easier to value. On the other hand, lodging, industrial, office and land sectors all exhibit higher spreads than apartments, suggesting these property types may be relatively difficult to value in the marketplace. Finally, smaller firms and more levered firms suffer greater informational opacity than large unlevered firms.
The evidence suggests that within-industry diversification may denote the existence of hard-to-value managerial redeployment options, which are difficult to value and are penalized by the market in the form of reduced market liquidity."
Brad Case is NAREIT's vice president, research & industry information.
