Academic journal article Real Estate Economics

The Role of the Underlying Real Asset Market in REIT IPOs

Academic journal article Real Estate Economics

The Role of the Underlying Real Asset Market in REIT IPOs

Article excerpt

A leading explanation for IPO cycles is time-varying supply and demand for the underlying assets of the firms that are considering going public. We test this hypothesis using REIT IPOs, taking advantage of the relative transparency of the underlying real asset markets. We document links between REIT IPO activity and both the conditions of the underlying real estate market and the price of REITs. We find no significant relation between the heat of the IPO market and post-IPO operating performance, implying homogeneous firm quality across IPO cycles. Finally, we show that lagged IPO proceeds are related to future increases in investment and in capacity utilization.


Initial public offerings have provided a rich arena for theoretical and empirical analysis. The theoretical approaches are diverse and often center on the asymmetric information characteristics of IPOs: Given that managers of the firm know more about the firm's prospects than potential equity investors, how should markets react to an IPO announcement? On the one hand, we might expect managers to exploit their informational advantage and issue equity only when markets overvalue their assets. This would imply relatively poor long-term performance of IPOs, via a lemons or adverse-selection explanation. Conversely, high levels of IPO issuance might signal positive information about the industry's prospects or future investment opportunities. This demand for investment capital would lead firms to issue equity in order to undertake favorable projects. In addition, firms could also deliberately underprice in order to signal quality in anticipation of a subsequent seasoned equity offering, as in Welch (1989). These two possibilities would not predict poor future performance of IPO firms.

These conflicting theoretical predictions have spawned a very broad array of empirical research. Ibbotson and Ritter (1995) partition this literature into three parts: initial-day underpricing, long-term underperformance of IPOs and cycles of hot and cold IPO markets. While initial-day underpricing is almost universally found in the many domestic and international studies, the evidence on long-run behavior provides no clear consensus. Ritter (1991) computes an industry-adjusted, 3-year return of -15% and provides evidence that firms that issue in hot markets tend to be of poorer quality than their peers. In contrast, Helwege and Liang (2004) find little difference between firms that issue in a hot market and those that issue in a cold market.

Additional insight into these important questions can be obtained by focusing the analysis on a restricted class of equities, real estate investment trusts (REITs), rather than on all IPOs. This study empirically addresses these issues by examining the relation between IPO performance and the underlying real assets. We study 189 REIT IPOs completed between the beginning of 1980 and the end of 1998. (1) We use REITs for this study for five major reasons: (i) to take advantage of the availability of detailed information on the underlying real asset markets; (ii) to focus on a single-industry sector (several theoretical papers on IPOs attribute the clustering of IPOs to positive shocks to an industry's prospects); (iii) to address further the conflicting literature on REIT IPOs; (iv) to analyze an industry where the problems of asymmetric information and managerial self-dealing may be mitigated due to transparency of the underlying real asset market and constraints on managerial discretion and (v) since REITs are a tax conduit, the decision to raise equity rather than debt is not influenced by tax effects.

Our study complements the earlier (sometimes conflicting) evidence on REIT IPOs. Wang, Chan and Gau (1992) document a period of REIT overpricing together with poor performance over the first 120 days of trading. Ling and Ryngaert (1997), using a later time frame, document underpricing for REIT IPOs and find positive abnormal performance up to 100 days after the offering. …

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