Dividend Policy and Firm Performance: Hotel Reits vs. Non-Reit Hotel Companies
Dividend Policy and Firm Performance: Hotel REITs vs. Non-REIT Hotel Companies
Executive Summary. This article investigates whether the greater reliance of real estate investment trusts (REITs) relative to non-REIT corporations on external equity financing suggests greater capital market discipline of REIT management, or greater access to capital, overpaying for assets, overbuilding and overinvestment. Our analysis is based on a sample of sixteen hotel REITs and fifty-one non-REIT hotel corporations from 1993 to 1999. We examine differences in performance and whether free cash flow can explain the differences. The findings suggest that hotel REITs retain a significantly smaller amount of free cash flow than non-REIT hotel companies. Market valuation reflected in the market-tobook ratio is clearly negatively related to free cash flow measured at both before and after dividend levels. In addition, relatively small hotel REITs enjoy significantly higher excess market values than their non-REIT counterparts at similar sizes, suggesting greater growth opportunities for REITs.
by Robert M. Mooradian* Shiawee X. Yang**
Introduction
In the mid-1990s, real estate investment trusts (REITs) experienced rapid growth fueled by readily available external equity and debt financing. There were a number of REIT IPOs1 and a number of large acquisitions by REITs such as the Starwood Lodging’s acquisition of ITT Sheraton in November 1997. Some companies also went through REIT status changes. In the hotel industry, Starwood Lodging dropped its REIT status while Host Marriott became a REIT in early 1999. Given these corporate organizational changes together with the REIT ‘‘bust’’ beginning in 1998, a key question is whether REIT status affects firm performance. In particular, are REITs prone to overinvestment? One school of thought suggests that economies of scale can be achieved by relatively large companies from improved efficiency in asset management and from improved access to capital.
Executive Summary. This article investigates whether the greater reliance of real estate investment trusts (REITs) relative to non-REIT corporations on external equity financing suggests greater capital market discipline of REIT management, or greater access to capital, overpaying for assets, overbuilding and overinvestment. Our analysis is based on a sample of sixteen hotel REITs and fifty-one non-REIT hotel corporations from 1993 to 1999. We examine differences in performance and whether free cash flow can explain the differences. The findings suggest that hotel REITs retain a significantly smaller amount of free cash flow than non-REIT hotel companies. Market valuation reflected in the market-tobook ratio is clearly negatively related to free cash flow measured at both before and after dividend levels. In addition, relatively small hotel REITs enjoy significantly higher excess market values than their non-REIT counterparts at similar sizes, suggesting greater growth opportunities for REITs.
by Robert M. Mooradian* Shiawee X. Yang**
Introduction
In the mid-1990s, real estate investment trusts (REITs) experienced rapid growth fueled by readily available external equity and debt financing. There were a number of REIT IPOs1 and a number of large acquisitions by REITs such as the Starwood Lodging’s acquisition of ITT Sheraton in November 1997. Some companies also went through REIT status changes. In the hotel industry, Starwood Lodging dropped its REIT status while Host Marriott became a REIT in early 1999. Given these corporate organizational changes together with the REIT ‘‘bust’’ beginning in 1998, a key question is whether REIT status affects firm performance. In particular, are REITs prone to overinvestment? One school of thought suggests that economies of scale can be achieved by relatively large companies from improved efficiency in asset management and from improved access to capital.
References: Ambrose, B. S. Ehrlich, W Hughes and S. Wachter, REIT Economies of Scale: Fact or Fiction? Journal of Real Estate Finance and Economics, 2000, 20:1, 211–24. Berger, P. and E. Ofek, Diversification’s Effect on Firm Value, Journal of Financial Economics, 1995, 37:1, 39–65. Bers, M. and T. Springer, Sources of Scale Economies for REITs, Real Estate Finance, 1998, Winter, 47–56. Conclusion Based on a sample of sixteen hotel REITs and fiftyone non-REIT corporations from 1993 to 1999, we 86 Vol. 7, No. 1, 2001 Dividend Policy and Firm Performance Downs, A., The Pressures on Public REITs to Grow Larger, Wharton Real Estate Review, 1997, 1:1, 1–15. Graham, C. and J. Knight, Cash Flows vs. Earnings in the Valuation of Equity REITs, Journal of Real Estate Portfolio Management, 2000, 6:1, 17–26. Hopkins, R. and M. Acton, Where Does the Return Come From? Using the Risk-Adjusted Performance Measure in Real Estate, Real Estate Finance, 1999, Summer, 23–9. Jensen, M., Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers, American Economic Review, 1986, 76:3, 323–29. Kirkpatrick, D., Why REITs Are Underperforming on Wall Street, The Wall Street Journal, May 6, B10, 1998. Koch, P. and C. Shenoy, The Information Content of Dividend and Capital Structure Policies, Financial Management, 1999, 28:4, 16–35. Lang, H. P., R. Stulz and R. Walkling, A Test of the Free Cash Flow Hypothesis: The Case of Bidder Returns, Journal of Financial Economics, 1991, 29:4, 315–35. Lehn, K. and A. Poulsen, Free Cash Flow and Stockholder Gains in Going Private Transactions, Journal of Finance, 1989, 44:6, 771–87. Ling, D. and M. Ryngaert, Valuation Uncertainty, Institutional Involvement, and the Underpricing of IPOs: The Case of REITs, Journal of Financial Economics, 1997, 43:4, 433–56. Linneman, P., Forces Changing the Real Estate Industry Forever, Wharton Real Estate Review, 1997, Spring, 1–12. Nobel, T. and V. Tarhan, Share Repurchases and Firm Performance: New Evidence on the Agency Costs of Free Cash Flow, Journal of Financial Economics, 1998, 49, 187–222. Ross, S. and R. Klein, Real Estate Investment Trusts for the 1990s, Real Estate Finance, 1994, Summer, 37–44. Journal of Real Estate Portfolio Management 87