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

1. Determinants of Risk-Adjusted REIT Performance - Evidence from US Equity REITs Kai-Magnus Schulte ERES Stockholm, Session 4-C, 26. June 2009

2. Agenda • Motivation & Purpose of the Study • Sample • Dependent & Independent Variables • Data & Methodology • Empirical Results • Summary & Conclusion

3. Motivation & Purpose of the Study Motivation of the Study Four Sources of Motivation Performance Asset Pricing • 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 • 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 Cyclicality Segmentation • 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) • 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

4. Motivation & Purpose of the Study Purpose of the Study Three Questions • Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs? • Does the impact and/or significance vary over time, esp. over boom and bust phases? • Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors?

5. Sample 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

6. Dependent & Independent Variables Dependent Variables

7. Dependent & Independent Variables Independent Variables

8. Data & Methodology Data • 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 Methodology • Unbalanced Panel • Least-Squares Dummy Variable Regression (fixed cross-section effects) • Question 1: • Question 2: • Question 3:

9. Empirical Results (1) • Question 1: Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs?

10. Empirical Results (2) • Question 1: Which are the fundamental, continuing drivers of the risk-adjusted performance of REITs? • Five firm-specific factors, namely size (-), BTMV (+), leverage (-), dividend yield (+) & FFO payout ratio (-), drive the risk-adjusted performance of equity 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

11. Empirical Results (3) • Question 2: Does the impact and/or significance vary over time, esp. over boom and bust phases?

12. Empirical Results (4) • Question 2: Does the impact and/or significance vary over time, esp. over boom and bust phases? • 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

13. Empirical Results (5) • Question 2: Does the impact and/or significance vary over time, esp. over boom and bust phases? • 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

14. Empirical Results (6) • Question 3: Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors?

15. Empirical Results (7) • Question 3: Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors?

16. Empirical Results (8) • Question 3: Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors? • 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 ?

17. Empirical Results (9) • Question 3: Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors? • 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

18. Summary & Conclusion Summary • 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 Conclusion • 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

19. Thank you for your attention 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: Kai-Magnus.Schulte@irebs.de www.irebs.de

20. BACKUP (1) Dependent 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