Structural Changes, Market Growth and Productivity Gains of the US Real Estate Investment Trusts in the 1990s

By Topuz, John C.; Isik, Ihsan | Journal of Economics and Finance, July 2009 | Go to article overview

Structural Changes, Market Growth and Productivity Gains of the US Real Estate Investment Trusts in the 1990s


Topuz, John C., Isik, Ihsan, Journal of Economics and Finance


Abstract

The 1990s were tumultuous times for the US Real Estate Investment Trusts (REITs) industry. Significant structural changes occurred during the decade, especially after the 1993 Revenue Reconciliation Act, which tremendously boosted the flow of funds into the system by allowing the participation of institutional investors in REITs. As a result, the industry experienced remarkable asset growth during the decade, with a large number of initial public offerings and substantial increases in market capitalization. Employing the Data Envelopment Analysis-type Malmquist index approach, this paper explores the impact of such environmental changes on productivity growth, efficiency change, and technological progress of REITs. Our results indicate that while efficiency of the REITs significantly increased, their average productivity declined and technology regressed during this decade. It appears that the typical REIT has failed to improve technically, but exerted substantial effort to catch up with the best practice ones relying mainly on aggressive growth strategies. However, our empirical results indicate that they might have overextended themselves as most began to suffer from diseconomies of scale.

Keywords REITs * Real Estate * Productivity * Efficiency * Technology * Malmquist Index * DEA

JEL Classification C67 * D24 * G23 * L11

1 Introduction

The growth of Real Estate Investment Trusts (REITs) in the 1990s has been exceptional (Ambrose et al. 2000; Block 2002; Topuz et al. 2005; Ling and Archer 2005). Upon the introduction of many important regulatory reforms and favorable market conditions after 1993, the industry has witnessed significant consolidation and historical surge in assets and market capitalization, with strong implications on REITs productive performance. Using a panel data set from the period 1989 to 1999, this paper utilizes the methodology of Malmquist index theory to explore the effects of such structural and regulatory developments on the productivity and efficiency growth of REITs.

"Everybody loves REITs" lately. In effect, these firms are real estate mutual funds that invest money (obtained through the sale of its shares to investors) in residential or commercial properties and earn primarily rent revenue (equity REITs), invest in property mortgages and earn principally interest revenue (mortgage REITs) or combine both investment strategies for shareholders (hybrid REITs). REITs have provided small investors with an opportunity to buy skyscrapers, shopping malls, hotels, restaurants and apartment buildings, without incurring the hassles of direct property ownership. With the all right essentials - consistent and remarkable profits, low volatility, impressive dividends, enhanced liquidity, low correlation with other investment classes, and most importantly professional management, REITs have become a part of every serious investor's diversified portfolio in recent years.

However, it took REITs about five decades to mature into solid citizens of the investment world. In 1960, the US Congress under President Eisenhower created these new institutions to promote real estate development by increasing public participation. The general public responded very favorably to this innovation and REITs were an enormous success in the late 1960s. However, after many mortgage REITs failed during the recession of 1973-1974, markets soon became disenchanted and lost interest in the entire REIT industry. The 1980s, characterized by the escalation of prices, overbuilding and poor performance, did not rum things around for REITs either. During the decade, the major blow came through the Tax Reform Act of 1986 that took away the tax-shelter advantage of REITs.1 By the late 1980s, real estate sector was in "big trouble" (Block 2002).

Especially after 1993, numerous regulatory reforms have been launched to restore the attractiveness of REITs and boost their operational/managerial performance. …

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