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REIT Operational Efficiency: Performance, Risk, and Return

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Abstract

Relations between Real Estate Investment Trust (REIT) efficiency and operational performance, risk, and stock return are examined. REIT-level operational efficiency is measured as the ratio of operational expenses to revenue, where a higher operational efficiency ratio (OER) indicates a less efficient REIT. For a sample of U.S. equity REITs from the modern REIT era, operational performance, measured by return on assets (ROA) as well as return on equity (ROE), is negatively associated with previous-year operational efficiency ratios, which suggests that more efficient REITs generate better operating results. Results further show that more efficient REITs have lower levels of credit risk and total risk. Perhaps most important, empirical evidence shows that the cross-sectional stock return of REITs is partially explained by operational efficiency and that a portfolio consisting of highly efficient REITs earns, on average, a higher cumulative stock return than a portfolio consisting of low efficiency REITs.

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Notes

  1. See Brounen and de Koning (2013) and Baker and Chinloy (2014) for more details.

  2. https://www.fdic.gov/bank/analytical/qbp/glossary.html

  3. https://www.reit.com/investing/reit-basics/what-reit

  4. The measure is adjusted to reflect those costs that are directly associated with asset operations and management. The adjustment is made for expenses that are passed through to tenants. Not all property expenses are reimbursed so we also control for property type, which is the primary determinant of reimbursements.

  5. We recognize there still exists a potential endogeneity issue between operational efficiency and firm performance and there may be possible unobserved heterogeneity that determines the observed relation between operational efficiency and firm performance. As this is one of the first papers on the topic, it is likely that more research needs to be done to refine all potential conclusions.

  6. Theoretically, a reverse causality issue for REIT risk, especially stock return volatility, stock return and REIT operational efficiency should not exist. The empirical results that REIT operational efficiency has a negative (positive) relation with one period ahead firm risk (stock return) can provide reliable casual inference. It is not likely that the lower risk and/or higher return causes higher operational efficiency.

  7. The sample period starts in 1995 because the property level data are used to calculate geographic diversification and property type diversification are only available from 1995. For robustness, we extend the sample to a longer period and find quantitatively similar empirical results, while not controlling for diversification. We also only address publicly traded REITs as Seguin (2016), Soyeh and Wiley (2018) and others argue that these firms are sufficiently different to warrant segmentation.

  8. All revenue including nonrecurring. Revenue is net of interest expenses for banks, thrifts, lenders, FHLBs, investment companies, asset managers and broker-dealers, as defined by SNL.

  9. Expenses reimbursed from tenants for common area maintenance and improvements, including operating expenses such as real estate taxes, insurance, and utilities, as defined by SNL.

  10. When REIT accounting information is not available in one period, but is available for the pervious and subsequent periods, it is replaced by the estimation calculated from the characteristics in previous and subsequent periods using the formula: \( {Value}_{i,t}^x=\left({Value}_{i,t+1}^x+{Value}_{i,t-1}^x\right)/2 \). Where \( {Value}_{i,t}^x \) is the value of x (TA, TE, etc.) of REIT i in year t.

  11. Kenneth R. French’s Data Library: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.

  12. These are common performance metrics for REITs.

  13. When the IPO date is not available, we use the year a REIT status is established instead.

  14. Similar models can be found in Baker and Wurgler (2006) and Giacomini et al. (2017), among others.

  15. We recognize that REIT operational efficiency may also be an endogenous outcome of managerial decisions and other factors. For instance, ownership structure, corporate governance, investments in a growing market just by chance.

  16. For robustness, we also obtain residual stock return via the Fama and French (1993) three-factor model and the Carhart (1997) four-factor model. We find quantitatively similar results. For brevity, these results are not reported, but are available upon request.

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Acknowledgements

We thank an anonymous referee and C. F. Sirmans (Editor). Their insightful comments contributed to a much-improved paper. We are also grateful for helpful comments from seminar participants at the 2017 ARES annual meeting in San Diego and 2017 ERES annual conference in Delft. All errors remain those of the authors.

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Authors and Affiliations

  1. Hollo School of Real Estate, College of Business Administration, Florida International University, 1101 Brickell Ave., Suite 1100-S, Miami, FL, 33131, USA

    Eli Beracha & William G. Hardin III

  2. Department of Finance, College of Business Administration, Florida International University, Miami, FL, 33199, USA

    Zifeng Feng

Authors
  1. Eli Beracha
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  2. Zifeng Feng
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  3. William G. Hardin III
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Corresponding author

Correspondence to William G. Hardin III.

Appendix

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Table 9 Definition of variables
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This table presents the definition of variables used in the paper.

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Beracha, E., Feng, Z. & Hardin, W.G. REIT Operational Efficiency: Performance, Risk, and Return. J Real Estate Finan Econ 58, 408–437 (2019). https://doi.org/10.1007/s11146-018-9655-2

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  • DOI: https://doi.org/10.1007/s11146-018-9655-2

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