Is REIT performance still dependent on advisory and
management style?
Amsterdam Business School
Name: C. Schouten Student ID: 10255125
MSc in: Business Economics Specialization: Finance
Supervisor: dr. E. Giambona Completion: August 12th, 2016
Abstract: This study aims to determine to what extent advisory and management style still cause a difference in performance between internally and externally advised/managed REITs. Using data on US Equity REITs from 2002-2015, this research finds that there is still economical and statistical outperformance by internally advised/managed REITs. The research shows that the management style is economically significantly more important to REIT performance than advisory style, especially after controlling for the property types. In addition, this research suggests that there is a penalty on performance for REITs that are both internally advised and managed. Based on this study, a REIT is best of being internally managed but externally advised.
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Statement of Originality
This document is written by Casper Schouten who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
3 Table of Content Statement of Originality 2 Table of Content 3 1. Introduction 4-5 2. Literature overview 5-9 3. Methodology 10-11 4. Data 11-13 5.0 Results 14-16 5.1 Robustness Check 17-18 5.2 Limitations 19 6. Conclusion 20-21 Bibliography 22
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1. Introduction
Over time various studies have been conducted on the differences between externally and internally advised/managed Real Estate Investment Trusts. The National Association of Real Estate Investment Trusts defines a REIT as “a company that owns or finances income-producing real estate”. Currently, Real Estate Investment Trusts are either internally or externally advised. A REIT is externally advised if asset management services (e.g.
investment/disposition decisions) are provided by a separate company that is not a subsidiary (Striewe, Rottke and Zietz,2013). Prior to 1986, REITs were not allowed to make
investment/disposition decisions internally. They were also not allowed to do their own active management of the properties. A property company looking to convert to the REIT status was then facing the risk of losing control of their own property to external advisors. In 1986, the private letter rulings of the Internal Revenue Service allowed REITs to assume responsibility for selecting investment properties and managing their own assets, allowing them to obtain the ‘self-advised’ and ‘self-managed’ status (Ambrose & Linneman 2001). In the past literature there is a general consensus that self-advised/managed companies outperform their externally-advised/managed competitors. The main issue discussed in the literature that accounts for this difference in performance is the agency problem that exists in having external-advisory/management. In general, there is a misalignment between the external management and the shareholders if the compensation scheme of the management is not only dependent on shareholder wealth. In 2013, Striewe, Rottke and Zietz proposed that in the new REIT era, which they believe started in 1993, there is no reason to suspect an agency problem for externally advised REITs. They state that the agency issue is mostly solved because of greater transparency, stabilized financing, higher institutional ownership, more complex capital structures, and greater internal growth. Striewe et all. based their conclusion on a study on the debt levels of REITs. Since the conclusion of their study was rather contrary to the results of earlier research, interest was sparked to look at the current effect of advisory and management style on REIT performance and try to find evidence for the conclusion of Striewe et all. In this research the performance and future growth opportunities of REITs is represented by the Tobin’s Q ratio calculated as the total of the market capitalization of common equity and the book value of total liabilities, divided by total assets. The relationship between advisory and management style is expected to be statistically insignificant based on the findings of Striewe et all. Tobin’s Q is regressed on an advisory-style dummy, a
5 management-style dummy, an interaction variable and control variables for property type, Age, Size and Leverage. Tobin’s Q is used because this ratio demonstrates to what extent there is over or underinvestment and therefore implicitly management performance. The data on Tobin’s Q adds information about the agency problem in external advisory/management to the existing literature over just REIT performance in terms of accounting measures. Contrary to past literature we reviewed both advisory and management style in our study, as this will provide a more detailed insight on this topic. The data used in this research is acquired from the SNL Database on US Equity REITs listed between 2002 and 2015. Companies with incomplete datasets were omitted from the sample.
This thesis first reviews the past literature related to the research on advisory/management style in REITs. After the related literature has been discussed, the methodology of this
research is thoroughly explained. The thesis continues with describing the data used and why this data was chosen. After discussing the data, the main results of this research are presented and the economic interpretation is discussed. A robustness check has been performed to understand the validity of the main results. In addition, the limitations of this research are discussed. Lastly, a conclusion is formulated and future studies are proposed.
2. Literature overview
This study aims to identify whether advisory style is a significant determinant for performance and future growth opportunities of REITs. The general consensus in the literature is that that internally advised REITs outperform the externally advised REITs because of conflicts of interest between the advisor and the shareholders in advisor’s
compensation existing in the external advisory-structure. Size and capital structure seem to be relevant variables to control for as size affects the economies of scope and, because of the cost of capital, the optimal capital structure is different for internally and externally-advised
REITs.
In the past decades, a significant amount of research has been done on the differences between internally advised and externally advised REITs. Before 1986, REITs were only allowed to be externally advised. A REIT is externally advised if asset management services (e.g. investment/disposition decisions) are provided by a separate company that is not a subsidiary (Striewe, Rottke and Zietz, 2013). In 1986 the Internal Revenue Service allowed REITs to become internally advised. This means that REITs could now take on responsibility for selecting investment properties and managing their own assets, allowing them to obtain the ‘self-advised’ and ‘self-managed’ status (Ambrose & Linneman 2001). Self-management
6 is defined as doing the property management internally. When the IRS allowed REITs to become internally advised, many REITs changed from external to internal advisory as they believed having external advisors exposed the REIT to agency risk as advisor’s compensation depended on asset size rather than fund performance. The agency risk is believed to decrease firm performance and future growth opportunities. In the recent literature there has been empirical evidence on the underperformance of externally advised REITs compared to
Internally Advised REITs linked to agency costs, advisor compensation and capital structure. Golec (1992) states that REITs pay their advisors using either a fixed formula or salaries and bonuses adjusted for performance. He elaborates by explaining that most firms’ formula-based compensation plans define only the maximum compensation pool available to firm managers, leaving boards of directors the discretion to pay out less than the maximum. By contrast, formula REIT advisors are legally separate from their REITs and
formula-determined compensation is paid in full. He uses Compustat data from 1962-1987 on price, dividends and earnings and focuses his data analysis on whether the payment structure determines the REIT performance. Results show that REITs using fixed formulas to
determine management’s compensation have greater dividend yields and poorer total return performance on average than REITs that compensate based on the board of director’s discretion.
More recently, Pattitony et all (2012) finds that in Italian REITs that pay performance fees based on market values better align the management and the shareholder interest. This paper confirms that the performance of a REIT is dependent on the incentives scheme for
management.
In their paper “Corporate Governance and the Leverage of REITs: The impact of the Advisor structure” Striewe, Rottke and Zietz (2013) explain possible conflicts of interest that may exist between shareholders and external advisors and their economical meaning. They state four basic types of agency conflicts that are relevant to the advisor structure: (1) the desire of managers to keep their job at all cost, (2) to maximize compensation, (3) to concentrate control over the company, and (4) to avoid risk. They continue explaining that at first, managers may act opportunistically to retain their jobs even though a replacement of the management team may maximize shareholder value in certain circumstances. Second, managers may put personal wealth maximization before the company’s health in their day to day decision making. Third, managers can try to increase their control over the company using different capital structures. Lastly, managers are likely to be exposed to cluster risks because personally they are overinvested in their company and they have done many firm
7 specific investments in terms of human capital (Fama, 1980). This can cause the managers to make investment decisions that may favour personal wealth but can be detrimental to
shareholder wealth. The above explanation by Striewe, Rottke and Zietz (2013) helps to understand the conflict of interest between investors and advisors in a more intuitive way. In their paper, they also explain how REITs, their management and their company characteristics have changed over time. From 1981 to 1992 have been identified as the “old” REIT era with “sleepy and slow-growth companies” by Ott, Riddiough and Yi (2005). During these years many externally-advised REITs converted to internally advised and internally managed firms. REITs also changed with respect to an operating characteristic: one finds greater
transparency, stabilized financing, higher institutional ownership, more complex capital structures, and greater internal growth (Striewe, Rottke and Zietz, 2013). The REIT
Modernization Act of 1999 brought about further structural changes affecting the way REITs are operated and financed. This act was implemented in 2001 and reduced the pay-out ratio from 95% to 90%. The Act also introduced the Taxable REIT Subsidiary (TRS), which allows a REIT to offer a more complete range of services to its tenants without jeopardizing its status as a REIT. The REIT Modernization Act (RMA) also denied tax deductions for interest on loans from parent REIT’s to TRS’s in cases of excessive leverage (Matheson, 2001)
https://www.irs.gov/pub/irs-soi/01reit.pdf . Striewe, Rottke and Zietz (2013) pose that in the new REIT era, there is no reason to suspect an agency problem for externally advised REITs. In their research on leverage levels in REITs they contradict the existing literature on the old REIT era (1985-1992). In the old REIT era, externally-advised REITs have been more opportunistic and have taken on significantly more debt compared to internally-advised REITs. This behavior arose from misalignment in the compensation scheme. Striewe, Rottke and Zietz (2013) found evidence that in the new REIT era, the compensation style of
externally-advised REITs no longer appear to lead to opportunistic behavior resulting in lower leverage levels. They even find that in the new REIT era externally-advised REITs choose lower leverage levels compared to their internally-advised counterparts. Because issuing debt is generally more expensive for externally-advised REITs, these results make sense in terms of optimal capital structure.
Ambrose & Linneman (2001) hypothesize that, due to their superior ability to resolve the agency problems, and the misalignment of interest between advisor and shareholders,
internally-advised REITs will dominate the externally-advised REITs. They also test if larger REITs enjoy significant advantages over smaller REITs with respect to economies of scale in revenues, expenses and capital. The data sample of their research consists of 139 equity
8 REITs trading between 1990-1996. They do not find strong evidence that their internally advised REITs outperform their advised competitors. They do state that externally-advised REITs are responding to market pressures to become more like internally-externally-advised REITs. More relevant to this research they find that larger REITs do have higher profit margins and rental revenue ratios and lower implied cap rates. In addition, they did find that larger REITs enjoy significantly lower costs of capital. Firm size is therefore an important variable to include in this research.
Capozza & Seguin (2000) look at the effect of the different advisory-styles on fund
performance. They show that, between 1985 and 1992, externally-advised REITs consistently under-perform internally-advised REITs. They state that the key distinction between the two managerial arrangements is not the existence or absence of an arm's-length relationship between the manager and shareholders but rather a prevalence of contracts that compensate external advisors based on metrics other than shareholder wealth. Therefore, misalignment of incentives occurs when advisor’s compensation is not solely based on shareholder wealth. In their analysis, they show that on a property level the revenues are not significantly different but that at a corporate level the expenses, in particular the interest expenses, are significantly higher for externally-advised REITs. They argue that this is explained by the fact that
external-advisors tend to seek higher leverage but face higher yields when attracting external financing. Capozza &Seguin´s findings are used as motivation to control for debt levels in this study.
Sagalyn (1996), looking from a different perspective, studies the surge in REIT IPO’s between 1993-1994. He argues that there is a misalignment of incentives for externally managed REITs and that the efficient markets incorporate the implied agency costs in the stock price. Sagalyn raises an important point relevant to this research. In this research we consider Tobin’s Q as a measure of profitability and future growth potential. Tobin’s Q is preferred as a performance measure over Return on Assets because ROA is not a risk-adjusted performance measure. Another argument to use Tobin’s Q is the fact that it is used as a
measure to identify overinvestment (Lang and Litzenberger, 1989). They explain that
overinvestment occurs if management invests in negative NPV projects. In this case the firm is better off to not invest at all rather than invest in negative NPV projects. Q ratios between 0 and 1 indicate that there are agency issues.
As Tobin’s Q contains the market capitalization value of the outstanding equity, the share price is a determinant of Q. If the misalignment of incentives is incorporated by the efficient
9 markets, we are supposed to see lower values for Q in our results.
The past literature agrees that the main difference in performance between external and internal REITs is caused by the agency conflicts. Striewe, Rottke and Zietz (2013) believe that there is no more opportunistic behaviour in externally advised REITs and that the agency problems are less severe than they used to be in the old REIT era. Ambrose & Linneman (2001) also argue that externally-advised REITs are responding to market pressures to become more similar to internally-advised REITs. In my research, I would like to verify that in the new REIT era, the agency costs are indeed no longer of significant importance which would mean that there should be no significant difference in performance between internally and externally advised and or managed REITs. In this thesis Tobin’s Q is used as a measure of performance and the market’s expectations on future growth and investment opportunities. I hypothesize that in the new REIT era, there is no difference in performance between
internally and externally advised REITs. This hypothesis is tested by regressing Tobin’s Q on an advisory and management dummy using OLS. Contrary to past literature we make a distinction between advisory (acquisition/disposition decisions) and management (property management). This is relevant because different REITs focus on different property types that may benefit from different advisory/management styles. The different property types are included in the regression as control variables. In addition, we control for relevant company characteristics discussed in the literature; Age, Size, and Leverage. The results of this thesis will help to understand if there is still a significant difference in the performance of REITs based on advisory and management style. This research is also more able to accurately pinpoint the true determinant of the difference; advisory or management style.
3. Methodology
This research tries to find evidence for the advisory and management style in equity REITs as a significant determinant of the firm’s performance and future growth opportunities. Quarterly data on equity REITs traded on US stock markets in years 2002-2015 has been acquired from the SNL Database. A cross-section analysis is performed using ordinary least squares
estimation. Tobin’s Q has been used as a performance measure that not only tells something about the current performance of a company but also the market’s expectation on future growth opportunities. Tobin’s Q has been calculated as the total of the market capitalization of common equity and the book value of total liabilities, divided by total assets.
10 𝑇𝑜𝑏𝑖𝑛′𝑠 𝑄 =Market Capitalization + Total Liabilities
Total Assets
This research will regress Tobin’s Q on three variables of interest: Internally-Advised, Internally-Managed and an interaction variable of Internally-Advised*Internally-Managed. Internally-Advised is a dummy variable which equals one if the REIT takes investment and or divestment decisions internally. In other words, for these decisions the REIT is not advised by an external third party. Internally-Managed is a dummy variable which equals one if the REIT performs its own property management. The interaction variable equals one only if the REIT is both Internally-Advised and Internally-Managed.
To enhance the quality of the model, several control variables have been admitted. Age, Size, Leverage and the different Property types are included. Age tells how long the REIT has been trading on a stock exchange. Size is calculated using total assets and is admitted as a control variable because Ambrose & Linneman (2001) found that larger REITs enjoy significantly lower costs of capital. Leverage is admitted in the model as the book value of debt over the book value of equity. Leverage is included in the model as a control variable to control for the different capital structures different REITs have. Capozza & Seguin (2000) state the
importance of leverage in REITs since internally-advised and or managed REITs on average have lower interest expenses than their externally advised and or managed competition. Lastly, we control for the different property types. Different property types demand different strategies in terms of advisory and management, controlling for the property specific effects will increase the quality of the estimations on the variables of interest. The resulting model if given in Model 1.
Model 1: The main OLS model
𝑇𝑜𝑏𝑖𝑛′𝑠 𝑄 = 𝛼 + 𝐼𝑛𝑡𝑒𝑟𝑛𝑎𝑙𝑙𝑦 𝐴𝑑𝑣𝑖𝑠𝑒𝑑 + 𝐼𝑛𝑡𝑒𝑟𝑛𝑎𝑙𝑙𝑦 𝑀𝑎𝑛𝑎𝑔𝑒𝑑 + 𝐼𝑛𝑡𝑒𝑟𝑎𝑐𝑡𝑖𝑜𝑛 + 𝐴𝑔𝑒
+ 𝑆𝑖𝑧𝑒 + 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 + 𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑇𝑦𝑝𝑒 + 𝜀
This model is designed to get estimates as precise as possible using ordinary least squares estimation. Based on the hypothesis, Internally Advised, Internally Managed and the interaction variable are all expected to be insignificant and close to zero. We expect this because in the literature there is some evidence that externally advised or managed companies, in the new REIT era, feel market pressure to behave as internally advised or
11 managed REITs which in terms mitigates the agency cost issue for external advisory and or management (Ambrose & Linneman 2001). In addition, Striewe, Rottke and Zietz (2013) state that externally advised REITs now act less opportunistically and issue less debt than their internally advised competitors resulting in lower differences in performance between the advisory styles. The estimates on the variables of interest in the main model of this research will provide insight on to what extent there is still a difference in performance of externally and internally advised companies. This research makes the distinction between advisory and management since REITs own many different property types that all need different strategies and management.
4. Data
The SNL Financial database has provided the data used in this thesis. During the course of the research, SNL Financial has been taken over by S&P Global. Currently the database used in this research is known as the S&P Global Market Intelligence database. The time period this research covers are the years from Q1 2002 to Q4 2015. This timeframe has been chosen based on the changes in REIT regulation over the years. Since the 1980’s, REITs have changed because of the IRS allowing REITs to become internally advised and managed, the REIT modernization act implemented in 2001 and the introduction of the Taxable REIT Subsidiaries. All of these changes changed REITs with respect to operating characteristics: one finds greater transparency, stabilized financing, higher institutional ownership, more complex capital structures, and greater internal growth (Striewe, Rottke and Zietz,2013). Because this research wants to identify to what extent modern day REITs face less agency costs and therefore realize smaller differences in performance and future growth
opportunities, the year 2002, one year after implementation of the REIT modernization act, is the starting point of the data analysis. Data used are quarterly. To gain a general insight on the differences between Internally and Externally-Advised/Managed REITs table one has been created. In table one the mean statistics grouped for Self-Advised, Self-Managed, Externally-Advised and Externally-Managed are calculated. The entire sample consists of 143 equity REIT companies. The sample contains 127 Self-Advised companies and 16 Externally-Advised companies. Looking at the management style the sample contains 109 Self-Managed companies and 34 Externally-Managed companies. Based on these findings, it appears that making investment/divestment decisions and doing property management internally is still preferred by REITs. In the last two columns of table one the T-Statistics for the differences between company characteristics and accounting measures are provided. The table shows all
12 variables differ significantly. We see that Tobin’s Q is significantly higher for Self-Advised and Self-Managed companies. We also see that on average, Self-Advised/Managed REITs have twice as many assets and issue twice as much debt compared to
Externally-Advised/Managed REITs. The debt to equity ratios are less extreme and are still significantly different. In general, the mean statistics seem to be in line with the literature.
Self-Advised/Managed companies take on more debt because they are able to finance more cost effectively. Because they are able to issue more debt they can acquire more assets. Looking at performance, we see that the average Tobin’s Q for Self-Advised/Managed companies are significantly higher, indicating outperformance.
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5.0 Results
The main results of this research are provided in table two. Eight models are estimated to provide information on the causal inference of advisory (investment/divestment decisions) and management style (property management) on Tobin’s Q. For all eight models it holds that Tobin’s Q is a dependent variable.
In model 1 through 3 Tobin’s Q is regressed on Advised, Managed, both Self-Advised and Self-Managed respectively. In model 4 the interaction variable is introduced for REITs that are both self-advised and self-managed. Even though individually the effects of being internally advised or internally managed are positive, if a REIT has both internal-advisory and management there is a penalty. The first four models show that there may be statistical evidence that advisory and management style have a significant influence on Tobin’s Q. The magnitude of the estimates show that the causality is strong and worth researching. In models 5 to 8 the first four models are estimated again although include the control variables: Age, Assets, Leverage and the various property types. Age tells how long the REIT has been trading on a stock exchange. Size is calculated using total asset. Leverage is included in the model as the book value of debt over the book value of equity. Lastly, in models 5 to 8 time fixed effects have been admitted in the model. Time fixed effect have been admitted to capture the influence of aggregate (time-series) trends.
In Model 5 Tobin’s Q is regressed on Self-Advised and the control variables. This model tells us that if REITs are self-advised the Tobin’s Q ratio will on average be 0,0685 higher than externally-advised REITs. If we compare Model 5 with Model 1 we can conclude that the estimate of Model 1 is overestimated because of omitted variables. In model 6 Tobin’s Q is regressed on Self-Managed and the control variables. This model tells us that if REITs are self-managed the Tobin’s Q ratio will on average be 0,0795 higher than externally-managed REITs. If we compare Model 6 with Model 2 we can conclude that the estimate of Model one is underestimated because of omitted variables. Based on Model 7, it appears that on average, a REIT is much better at making their own investment/divestment decisions and providing property management services internally. In other words, a REIT is better of being Self-Advised and Self-Managed. Model 8 contradict this conclusion. When the interaction variable is introduced the estimators of the model change dramatically. First we notice that the
interaction variable is statistically significant and has a relatively large but negative relation to Tobin’s Q. To explain further, there is a penalty for REITs being both internally advised and managed. Another interesting phenomenon is the change in the Self-Managed coefficient. We see that compared to Model 7 this coefficient nearly triples in magnitude, yet there is still
15 statistical significance. Another interesting finding in this research comes from comparing Model 4 and Model 8. We notice that after controlling for property types and other control variables, the Self-Managed coefficient increases dramatically. Economically, this makes sense given the fact that all of the different property types require different management intensities. It then makes sense that the coefficient increases in magnitude after controlling for property type. Based on this research, it seems that for REITs it is a lot more important to do their property management internally than being internally-advised. Following Model 8, a REIT is better of being externally-advised and internally-managed opposed to being both internally-advised and managed.
The results of the research do not confirm the hypothesis that in the modern REIT era there are no longer significant differences between internally and externally managed REITs. The research shows that there are still large differences. New insights are provided that the differences between external and internal are mostly caused by management style. Another interesting discovery is that there is a penalty in being both internally advised and managed. One explanation could be that within a firm, providing both advisory and
self-management is a very broad scope and therefore self-management intensive. It appears that doing both at the same time harms the company’s performance. Based Model 8, a REIT should focus on doing the property management internally and be advised externally over investment/divestment decisions.
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5.1 Robustness check
Within the timeframe of this study lies the 2008 financial crisis in the USA. In this research, the end of the financial crisis is marked by the introduction of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The financial distress index of the Federal Reserve Bank supports this assumption (Chang, 2011). The index shows that in 2010, the financial distress index returns to pre-crisis levels. In the robustness check the post-crisis timeframe is used to clear the data sample of the major effects the financial crisis had on the average performance and volatility of all public USA markets. The post-crisis, instead of the pre-crisis timeframe, has been chosen because this study tries to estimate the most current status in REIT equality in terms of advisory and management style. It is interesting to understand how the results of the 2002-2015 timeframe compare to a Q3 2010 – Q4 2015 timeframe. Table 3 provides the same overview of the same models used in the results of this research but limited to the Q3 2010- Q4 2015 timeframe. Comparing the main results to the robustness check several remarks can be made. The first results that differ from the main results is the statistically significant negative relation between being self-advised and Tobin’s Q. In the main results the relation between being self-advised and Tobin’s Q was positive. By itself this is an interesting finding and further research should determine why the positive relation, although small, over the 2002-2015 timeframe is positive but in the post-crisis timeframe negative. One explanation might be that after the crisis investor’s perception of REITs and their expertise in making investment/divestment decisions had changed. Another explanation could be that the modern governance rules limited the internal advisors in their day to day business. More qualitative research is necessary to determine the true cause of this change. We do find consistent evidence for the Self-Managed variable. There is again a positive relationship between being self-managed and Tobin’s Q. Self-Managed also again has a larger coefficient implying a greater economic significance in explaining Tobin’s Q. For the
interaction variable we again find a negative relationship with Tobin’s Q. However, in the estimation results over the 2010-2015 timeframe the relationship is not statistically
significant. Lastly, we notice that the r-square statistic is higher for the 2010-2015 timeframe compared to the 2002-2015 timeframe. One can therefore argue that in the most recent timeframe, the advisory and management style is more important in explaining Tobin’s Q than in the larger timeframe.
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5.2 Limitations
As with all linear regression models, the results of this research are likely to suffer from endogeneity. Some limitations in this study are caused by the estimation method. OLS is a relatively simple estimation method that often suffers from omitted variable bias. Even though in this research there are several control variables admitted in the main model to reduce this bias, there may still be some variables that have a relationship with Tobin’s Q but have not been admitted into the model. Related to the agency costs in external management, there may very well be a relation between Tobin’s Q and the firm’s corporate governance structure.
Another limitation in this research is that the sample is rather unbalanced between external and internal advised/managed firms. We see that there are significantly more internally advised/managed firms compared to externally-advised/managed firms. Based on this research and past literature we understand this phenomenon because
internally-advised/managed companies seem to outperform. This research may suffer from survivorship bias. The sample also only contains equity REITs. This means that the results of the research can’t be generalized to other markets such as the mortgage REIT market.
This research faces measurement error in Tobin’s Q. For this research, the book value of total assets and the book value of debt are used. Strictly taken, the market values of assets and debt should be used. This data is, however, not available. For the measurements of the asset values this means that they are most probably lagged and smoothed compared to “real time” data. The market value of debt can tell more about how the market estimates the liquidity and solvency status over time of REITs. Unfortunately, the market values of debt are not available. One can however argue that this component is also priced in the market
capitalization value of equity since equity holders are the (more junior) residual claimants of the cash flows after repayment of debt.
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6. Conclusion
In 1986, the private letter rulings of the Internal Revenue Service allowed REITs to assume responsibility for selecting investment properties and managing their own assets, allowing them to obtain the ‘self-advised’ and ‘self-managed’ status (Ambrose & Linneman 2001). Since then, many REITs changed their advisory and/or management style to internal-advisory and or management. Past research shows that on average, internally-advised and or managed REITs outperform the external competitors. In the past literature, a general consensus exists that the agency costs that arise from having external-advisors/management whose payment scheme is not aligned with shareholder’s interest is the main cause for the underperformance of externally-advised/managed REITs. Many changes in regulation and modernization over the last two decades are believed to have changed the external-advised/managed REITs in such a way that they more closely mimic internally-advised/managed REITs. The aim of this study is to research to what extent there is still an underperformance of external versus internal. Because of the more recent literature this research hypothesizes that there is no significant difference anymore between external and internal advisory/management in REITs. To test this hypothesis Tobin’s Q is calculated, which in this research resembles whether there is over or underinvestment by REITs and implicitly the presence of superior/inferior advisors and or management in REITs. Tobin’s Q is regressed using OLS on a dummy for internal-advisory, internal-management and an interaction variable to indicate when a REIT is both internally-advised and managed. Age, Size, Leverage and Property type are used as control variables. This research uses a data sample acquired from the SNL Database on all US equity REITs between 2002 and 2015. The main results show, contrary to the thesis’ hypothesis, that there is still a significant difference in the performance of internally and
externally-advised/managed REITs, both in statistical and economical terms. The most interesting discovery of this research is that in terms of explaining Tobin’s Q, the management-style matters significantly more than the advisory-style. Another effect that is very interesting is that individually, the relationship between internal-advisory and internal-management is positive. If a REIT is both internally-advised and internally-managed there appears to be a “penalty”. This “penalty” offsets the positive effect of being internally-advised. Based on the results of this research, A REIT performs best when deciding to manage its properties
internally but have the investment/divestment decisions made by an external third party. The results of this research also imply that the agency problem has not yet been resolved by modernization and the regulatory changes. Some limitations to the results of this research apply. For instance, OLS usually suffers from omitted variable bias and the sample used in
21 this research is rather unbalanced. The sample contains significantly more internally than externally advised/managed REITs trading on the US equity markets. This is relevant because apparently internal advisory/management is preferred by REITs so there might be some survivorship bias in the remaining externally advised/managed REITs. The estimations also suffer from measurement error since the values on debt and assets used in the calculation of Tobin’s Q are book values. This means that the asset values are probably smoothed and the debt values do not represent the market values. This might be harming the quality of the estimations. The results of this research only apply to US Equity REITs. Unfortunately the results and economical interpretations are not applicable to other markets such as the Mortgage REIT market.
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