Do taxable REIT subsidiary spell risk for REITs? An empirical examination
| Published date | 04 July 2016 |
| Date | 04 July 2016 |
| DOI | https://doi.org/10.1108/JPIF-09-2015-0066 |
| Pages | 387-406 |
| Author | Juan C. Cardona |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
Do taxable REIT subsidiary
spell risk for REITs?
An empirical examination
Juan C. Cardona
Department of Business Administration,
University of Puerto Rico, Bayamon, Puerto Rico, USA
Abstract
Purpose –The purpose of this paper is to employ a unique data sample to study the relationship
between risk and the use of taxable real estate investment trusts (REITs) subsidiary (TRS).
Design/methodology/approach –Total volatility is decomposed into systematic risk and
idiosyncratic risk in order to examine whether cross-sectional variations in REITs’risk are related to
use of TRS. The relation between REITs risk and REITs liquidity is also explored in this paper by
using three liquidity measures: percentage spread, dollar volume and price impact. GMM regressions
are used to explore diversification and risk-adjusted returns.
Findings –The evidence, using GMM regressions, suggests that: REITs increased in firm risk during
the years 2002-2011; REITs with TRS are more liquid than REITs with non-TRS; TRS-REITs’prices
becomes more volatile than the broader market after year 2007 –S&P500 index is used as benchmark;
and TRS-REITs’portfolios requires a larger number of securities to obtain similar levels of
diversification as non-TRS portfolio.
Practical implications –TRS-REITs’portfolio is riskier (systematic risk) than non-TRS-REITs, its
assets are the more demanded (liquid) among investor, meaning that when necessary those assets can
be easier converted to cash without affecting to much its prices. When S&P500 is used as benchmark
the TRS-REITs’portfolio requires a larger number of securities to obtain similar levels of
diversification as non-TRS portfolio.
Originality/value –This paper employs a unique data sample to study the relationship between risk
and the use of TRS in the USA. Although the relationship between risk and returns has been largely
studied in the finance field, still there is a gap in REIT literature about the relation between REIT
return volatility and the use of TRS’s.
Keywords Diversification, REITs, Idiosyncratic risk, Risk, Systematic risk, Liquidity
Paper type Research paper
1. Introduction
This paper employs a unique data sample to study the relationship between risk and
the use of taxable real estate investment trust (REITs) subsidiary (TRS) in the USA.
Although the relationship between risk and returns has been largely studied in the
finance field, still there is a gap in REIT literature understanding the relation between
REIT return volatility and the use of TRS’s.
The REIT industry has been evolving since its creation in 1960, when the Congress
of the USA authorized the organizational form of REITs to make the income-producing
real estate accessible to common investors. The objective of the industry leaders and its
regulators has been to retain the trust form while eliminating the competitive
constrains. During the 1970s President Ford signed into law the Tax Reform Act which Journal of Property Investment &
Finance
Vol. 34 No. 4, 2016
pp. 387-406
©Emerald Group Publis hing Limited
1463-578X
DOI 10.1108/JPIF-09-2015-0066
Received 21 September 2015
Revised7May2016
Accepted7May2016
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
JEL Classification —G10, G11, G12, F15
The author thank Nick French (the editor) and two anonymous referees for their helpful
suggestions.
387
Taxable REIT
subsidiary
spell risk
for REITs
included the simplification amendments that allowed REITs to be established as
corporations in addition to business trusts. A decade later, President Reagan signed the
Tax Reform Act of 1986 that, among other provisions, allowed REITs to be internally
advised and managed. This is considered as one of the most important changes in
REIT’s structure during the 1980s. In 1993, as part of the Omnibus Budget
Reconciliation Act, President Clinton signed into law a change to the “five or fewer”rule
in order to make it easier for pension plans to include REITs on their portfolios.
The year 1993 became a landmark among researchers for the study of REITs
performance and risk (see, e.g. Li and Wang, 1995; Scott et al., 1996; Glascock et al.,
2000; Mueller and Anikeeff, 2001; Clayton and MacKinnon, 2001) as the enactment open
the way for private REIT to have access to liquidity (see, e.g. Clayton and MacKinnon,
2000; Benveniste et al., 2001; Chan et al., 2002). The 1990s closed with another important
provision for REITs with the enactment of the REIT Modernization Act (RMA) that
was signed into law at the end of year 1999 but came into effect in 2001. This enactment
produced another significant change in REIT structure: now REIT’s were allowed to
own up to 100 percent of a taxable REIT subsidiary (TRS) in order to provide a more
complete range of services to their tenants without jeopardizing their status as REIT’s.
Nevertheless, health care was excluded from the RMA provision and they had to wait
until 2007 when, by the REIT Investment Diversification and Empowerment Act
(RIDEA), they were allowed to own TRSs. Although real estate professionals welcomed
RMA and attributed them the power to change and to bring modernization to the
industry, there is a great need on empirical studies to help us understand the impact
that TRS has on REITs industry.
According to Matheson (2008), during its first four years the US TRS
sector presented an increase of 406 percent in total assets (from $16.8 billion to
$68.2 billion) and a 235 percent in total income (from $6.9 billion to $16.2 billion).
These numbers are far superior when contrasted with the 193 percent increase in REIT
market capitalization reported by NAREIT during the first four years of TRS creation
(2001-2004)[1]. These statistics are evidence in favor to what NAREIT expected to
happen in REITs industry by the creation of TRS’s: “NAREIT strongly supported the
REIT Modernization Act and worked closely with policy makers to obtain its Passage
[…] These changes are necessary to revitalize the REIT structure to better serve REIT
investors and the American economy for the next 40 years of the REITs’charter[2].”
Howe and Jain (2004) came out with a study about TRS impact on REITs, and their
results showed a modest positive wealth outcome associated with the two effects of the
passage of the RMA and a significant decline in the systematic risk of REITs as well.
But, their evidence does not suggest that this decline in systematic risk was
attributable to RMA. Thornton Matheson (2005) reported a descriptive study that
covered the first year of TRS operation. In his study he showed that during the year
2001, 404 TRS were established –154 of which were newly created firms and the
remaining 250 were pre-existing entities. –afterward, Matheson (2008) documented
that the number of TRS increased steadily to 704 during the years 2001-2004. He also
reported that the total TRS assets grew from $16.8 billion to $68.2 billion and that the
total TRS net income turned from negative to positive during this period (from −$190
million to $1.2 billion).
Cardona and Rodriguez (2014) studied the long-run performance of those REITs that
kept the same policy to own or not a TRS during the period 2001-2009. In their study
they reported that both groups obtained positive daily performance, but the annual
difference was just 0.19 percent. They also reported that firms with TRS presented the
388
JPIF
34,4
To continue reading
Request your trial