https://orcid.org/0000-0001-7781-4107
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Abstract
The extent to which a real estate investment trust’s (REIT’s) physical growth is related to market valuation and performance is examined. Using a sample of U.S. equity REITs over the 1995–2020 period, we measure a REIT’s growth as the growth of its total area in square feet (or, alternatively, its number of properties) and find that fast-growing REITs, while able to increase cash flows, are unable to increase such cash flows with equal proportionality with the expansion of their physical footprint. In essence, the growth in cash flow while positive is lower than the growth in square feet or number of properties. Moreover, we find no evidence that growth alone is associated with stock performance. However, we show that rapidly growing REITs are associated with higher market valuation, measured by capitalization rates, Price/FFO ratio, and firm Q. These findings suggest that capital structure, managerial actions and potential for improved property level performance associated with scale rather than physical growth alone play major roles in REIT valuation. Overall, our findings are aligned with expectations for market efficiency in a highly transparent asset group such as equity REITs.
Disclosure Statement
No potential conflict of interest was reported by the author(s).
Notes
1 In the past two decades, REIT market capitalization as well as the number of property holdings expanded dramatically. In 2016, the equity market capitalization of REITs reached $1 trillion. REITs own about 500,000 properties across the U.S. For more details, see a NAREIT article, titled “REITs by the Numbers”, at https://www.reit.com/data-research/data/reits-numbers.
2 When a REIT grows, there are potential benefits of economies of scale in its real estate operations (Highfield et al., Citation2021).
3 Tangentially, Ambrose and Steiner (Citation2022) look at CAPEX, which is related to capital investment in an existing asset and conclude impact is mostly reflected in a change in value.
4 The 2018 CBECS can be found in https://www.eia.gov/consumption/commercial/; In the US Office Outlook – Q2 2022, US Office Market Statistics, Trends & Outlook, reported by JLL on July 12, 2022, the three highlights are all about space in square feet. They are provided in the below.
• “Transaction volume was relatively flat over the quarter at 47.2 million square feet as tenants both large and small put expansion plans on hold amid macroeconomic uncertainty”.
• “Flight to quality accelerated in the second quarter: since the onset of the pandemic, new supply has registered net occupancy growth of 86.8 million square feet”.
• “11.8 million square feet of new space was delivered in Q2, bringing year-to-date completions to 26.5 million square feet, on track to repeat 2021’s more than 50 million square feet of new space”.
For details, see https://www.us.jll.com/en/trends-and-insights/research/office-market-statistics-trends; Also, when discussing the United States Properties holdings in the 2021 annual report (10K), Simon Property Group, Inc. (SPG) states: “Our U.S. properties primarily consist of malls, Premium Outlets, The Mills, lifestyle centers and other retail properties. These properties contain an aggregate of approximately 175.3 million square feet of gross leasable area, or GLA.”
5 Aggregate property count of in-service owned assets as of the end of the period as reported by the company. This is the number of wholly in-service owned, joint venture, and operated/leased properties in which the company has an equity interest and does not include franchised or managed-only properties.
6 Total area is measured in square feet for the aggregate properties owned by each REIT as of the end of the period.
7 Kenneth R. French’s Data Library: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.
8 FFO is a widely used cashflow metric when analyzing REITs. NOI is the traditional property-level real estate measure of cashflow. NOI is also a proxy for property-level cash flow (Capozza & Seguin, 1999; Eichholtz & Yönder, 2015), which equals the sum of FFO, general and administrative expenses, and interest expenses; The changes in NOI and FFO that are greater (or less) than 100% (that is, the NOI and FFO double in a year) are replaced with missing values.
9 All other things equal, a higher capitalization rate indicates a lower market valuation.
10 Negative CAP, price/FFO and firm Q are replaced with missing values since negative values for these measures are not meaningful.
11 We use the IBES Analyst Median Forecast “medest” in the IBES database in our analysis. For robustness, we also tried IBES Analyst Mean Forecast “meanest”, the results are consistent.
12 In Beracha et al. (Citation2019a, Citation2019b), it is called the operating efficiency ratio.
13 The median of REIT Growth and total assets growth are 2.2% and 5.7%, respectively.
14 Again, we evaluate physical growth (square footage and number of properties, as example’s).
15 A Hausman test is also conducted in order to justify the fixed effects rather than the random effects model.
16 For robustness purposes, we have explored the Price-to-NAV ratio as an alternative valuation measure. This supplementary analysis, accessible upon request, reinforces our conclusions and provides additional insights into REIT valuation dynamics.
17 We are unable to provide a similar analysis using net operating income (NOI) because analysts normally do not forecast one-year-ahead NOI per share for firms.