Determinants of Risk-Adjusted REIT Performance - Evidence from US Equity REITs

Determinants of Risk-Adjusted REIT Performance - Evidence from US Equity REITs

Kai-Magnus Schulte ERES Stockholm, Session 4-C, 26. June 2009

Agenda

1. Motivation & Purpose of the Study

2. Sample

3. Dependent & Independent Variables

4. Data & Methodology

5. Empirical Results

6. Summary & Conclusion

2

Motivation of the StudyMotivation of the Study

REITs evolved as a distinct asset class

US Equity REITs offered both superior total and risk-adjusted returns over at least 15 years

Ongoing adoption of REIT legislations around the world

Motivation & Purpose of the Study

Four Sources of Motivation

The CAPM has dominated asset pricing theories for decades (Fama & MacBeth, 1973)

Growing consent that the single index CAPM is mis-specified (Fama & French, 1992)

The sole “beta” is incapable of explaining REIT returns

REIT market experienced two boom (1992:1997 & 2001:2007) and two bust phases (1998:2000, 2008:now)

Countering results concerning the influence of pricing factors depending on the study period

PerformancePerformance

CyclicalityCyclicality

Asset PricingAsset Pricing

REIT market is segmented into distinct property type sectors

Each sector shows distinct risk/return characteristics (Chen & Peiser, 1999)

Although increasing over time, REIT property type sectors are not perfectly correlated & integrated (Young, 2000)

SegmentationSegmentation

3

Purpose of the StudyPurpose of the Study

1. Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs?

Motivation & Purpose of the Study

2. Does the impact and/or significance vary over time, esp. over boom and bust phases?

3. Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors?

Three QuestionsThree Questions

4

SampleSample

Sample

Based on the NAREIT & FTSE/NAREIT All REIT Index

All REITs traded on NYSE, ASE & NASDAQ

Property focus reported

Sample corrected for

Mortgage & Hybrid REITs

REITs with no available / insufficient data

Sample Size

275 REITs in total

On average 135 REITs/year

Maximum of 2,034 observations

Study Period: 1993-2008

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Dependent VariablesDependent Variables

Dependent & Independent Variables

Sharpe Ratio

Sharpei ,t TRi ,t RFRt

StDevi ,t

StDevi ,t 1

TTRi ,t i

t1

T

2

Sortino Ratio

SemiStDevi ,t 1

Tmin TRi ,t RFRt ,0

t1

T

2

Sortinoi ,t TRi ,t RFRt

SemiStDevi ,t

6

Independent VariablesIndependent Variables

Dependent & Independent Variables

Variable Proxy Literature

Size (-)(LN_MARCAP)

Ln(Market Capitalisation) Colwell/Park (1990), McIntosh/Liang/Tompkins (1991), Chen et al. (1998), Hamelink/Hoesli (2004), ...

Leverage (-)(LEVERAGE)

Total debt / market capitalisation

Chan/Hendershott/Sanders (1990), Redman/Manakyan (1995), Ooi/Liow (2004), ...

Book-to-Market Value (+)(BTMV)

Book value of equity / market value of equity

Chen et al. (1998), Chui/Titman/Wei (2003), Ooi/Liow (2004), Ooi/Webb/Zhou (2007), ...

Dividend Yield (+)(DY)

Dividend per share / share price (in %)

Sanders (1996), Ling/Naranjo (1998), Ooi/Liow (2004), ...

FFO Payout Ratio (?)(FFOPR)

Dividend per share / FFO per share (in %)

Fama/French (2002), McManus/Gwilym/Thomas (2004), Zhou/Ruland (2007), ...

Sector Specialisation (+)(FOCUSED, ...)

Binary variable; FTSE/NAREIT (2006, 2008)

Chen/Peiser (1999), Eichholtz/Op‘t Veld/Schweitzer (2000), Boer/Brounen/Op‘t Veld (2005), ...

Market Environment (+)(MARKET RETURN)

Continuous return of the MSCI US Broad Market

Ling/Naranjo (1998), Ooi/Liow (2004), Glascock/Lu/So (2006), ...

Interest Rate Changes (-)(INTEREST RATE)

First difference in FED effective interest rates

Allen/Madura/Springer (2000), Devaney (2001), Ooi/Liow (2004), ...

Boom/Bust Phases (+/-)(D1993_1997, ...)

Binary variable Ooi/Liow (2004), Glascock/Lu/So (2006), ...

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Data & Methodology

MethodologyMethodology

Unbalanced Panel

Least-Squares Dummy Variable Regression (fixed cross-section effects)

Question 1:

Question 2:

Question 3:

Yi ,t ai Fi ,t Si ,t M t Dt ui ,t

Yi ,t ai Fi ,t Dt Si ,t Dt

M t Dt ui ,t

Yi ,t ai Fi ,t Si ,t M t Si ,t

Si ,t Dt ui ,t

DataData

Accounting data collected at end of year t

Contemporaneously available data collected at end of June year t

Sharpe / Sortino Ratio calculated from July year t to June year t+1

Data extracted from SNL Financial & Datastream

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Question 1: Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs? Question 1: Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs?

Empirical Results (1)

Yi ,t ai Fi ,t Si ,t M t Dt ui ,t

9


Five firm-specific factors, namely size (-), BTMV (+), leverage (-), dividend yield (+) & FFO payout ratio (-), drive the risk-adjusted performance of equity REITs

Question 1: Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs? Question 1: Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs?

Leverage

Negatively related to the Sharpe Ratio (higher risk)

Insignificant when only downside risk is penalised

FFO Payout

Negatively related to the Sharpe and Sortino Ratio

Earnings growth / Free cash flow / Overinvesting / Agency cost

Differential information (Signalling / Information asymmetry)

Sector Specialisation

Focused REITs do not outperform

Inclusion of market phase variables

Three macroeconomic factors, namely interest rate changes (-), market environment (+) & market phases (+), drive the risk-adjusted performance of equity REITs

10

Question 2: Does the impact and/or significance vary over time, esp. over boom and bust phases? Question 2: Does the impact and/or significance vary over time, esp. over boom and bust phases?


Yi ,t ai Fi ,t Dt Si ,t Dt

M t Dt ui ,t

11


Yes, it does !

Size effect only consistent driver of the risk-adjusted performance of equity REITs


BTMV

Insignificant 1993:1997 & 2008; significant 1998:2000 & 2001:2007

Little valuation uncertainty

Immature market

Irrational market

Leverage

Insignificant 1993:1997 & 1998:2000; significant 2001:2008

Increased utilisation of debt

Dividend Yield

Insignificant 1998:2000 & 2008; significant 1993:1997 & 2001:2007

Higher scope for contrarian investment strategy following bust phases

12


FFO Payout

Only significant in 2001:2007

Increased risk of overinvesting ?


Sector Specialisation

Focused REITs never outperformed their counterparts

Interest Rate Changes

Now insignificant when only downside risk is penalised

13

Question 3: Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors?




Si ,t Dt ui ,t

14





Si ,t Dt ui ,t

15


Yes, it does !

Size effect only consistent driver of the risk-adjusted performance of equity REITs



BTMV

Insignificant for retail and diversified REITs

Valuation ?

Leverage

Insignificant for retail & residential REITs

Positive for diversified REITs

More stable cash flows / higher leverage ?

Dividend Yield

Insignificant for residential & niche REITs, also diversified REITs (Sortino)

Reason ?

16


FFO Payout

Insignificant for residential, niche & diversified REITs

Less prone to overinvesting ?



Interest Rate Changes

Insignificant for industrial/office, residential & diversified REITs

Negative for retail REITs, positive for niche REITs

Linkage interest rates – consumer spending ?

Market Environment

Insignificant for niche REITs when only downside risk is penalised

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Summary & Conclusion

Question 1: Five firm-specific (size, BTMV, leverage, dividend yield & FFO payout ratio) and three macroeconomic (interest rate changes, market environment & market phases) factors drive the risk-adjusted performance of equity REITs

Question 2: For most, the significance varies over market phase

Question 3: For most, the significance varies over property sectors

Some explanations were yielded, other remain unexplored as an area of further research

SummarySummary

ConclusionConclusion

While the initial analysis revealed that several factors - on average - drive the risk-adjusted performance of equity REITs, this effect largely stems from distinct time periods and distinct property sectors

Investors need to be aware of both the current market phase and property sector before deciding which attribute they want to take into consideration in their investment decision

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Kai-Magnus Schulte

Research Assistant

Chair of Real Estate Management

IRE│BS International Real Estate Business School

University of Regensburg

Building PT, Room 50-007

Phone: +49 (0) 941 – 943 5075

Fax: +49 (0) 941 – 943 5072

Email: [email protected]

www.irebs.de

Thank you for your attention19

Dependent VariablesDependent Variables

Systematic risk may not capture all the risk inherent in REITs (Redman & Manakyan, 1995)

In segmented markets (Westerheide, 2006), volatility is a more appropriate measure of risk (Bekaert et al., 1997)

Importance of normalizing returns (Capozza & Seguin, 2000)

Especially appropriate for investors who do not hold a perfectly diversified portfolio (Glascock & Davidson, 1995)

Downside-risk framework more adequately captures the risk perception of investors

BACKUP (1)

Sharpe Ratio

Sharpei ,t TRi ,t RFRt

StDevi ,t

StDevi ,t 1

TTRi ,t i

t1

T

2

Sortino Ratio

SemiStDevi ,t 1

Tmin TRi ,t RFRt ,0

t1

T

2

Sortinoi ,t TRi ,t RFRt

SemiStDevi ,t

20

Documents

Determinants of Risk-Adjusted REIT Performance - Evidence from US Equity REITs