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 1.Motivation & Purpose of the Study 2.Sample 3.Dependent & Independent Variables 4.Data & Methodology 5.Empirical Results 6.Summary & Conclusion 2

3. Motivation 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 Performance Cyclicality Asset 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) Segmentation 3

4. Purpose 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 Questions 4

5. 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 5

6. Dependent Variables Dependent & Independent Variables Sharpe RatioSortino Ratio 6

7. Independent Variables Dependent & Independent Variables VariableProxyLiterature 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 variableOoi/Liow (2004), Glascock/Lu/So (2006),... 7

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

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

10. Empirical Results (2) 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? 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

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

12. Empirical Results (4) Yes, it does ! Size effect only consistent driver of the risk-adjusted performance of equity REITs Question 2: Does the impact and/or significance vary over time, esp. over boom and bust phases? 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

13. Empirical Results (5) FFO Payout Only significant in 2001:2007 Increased risk of overinvesting ? Question 2: Does the impact and/or significance vary over time, esp. over boom and bust phases? Sector Specialisation Focused REITs never outperformed their counterparts Interest Rate Changes Now insignificant when only downside risk is penalised 13

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

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

16. Empirical Results (8) Yes, it does ! Size effect only consistent driver of the risk-adjusted performance of equity REITs Question 3: Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors? 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

17. Empirical Results (9) FFO Payout Insignificant for residential, niche & diversified REITs Less prone to overinvesting ? Question 3: Does the impact and/or significance vary over property type, esp. between focused / diversified REITs and the distinct sub-sectors? 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 17

18. 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 Summary 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 18

19. 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 Thank you for your attention 19

20. 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 BACKUP (1) Sharpe RatioSortino Ratio 20