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REIT Operational Efficiency: External Advisement and Management

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Abstract

This paper examines the operational efficiency of equity Real Estate Investment Trusts (REITs) with respect to external advisement and management. We employ data envelopment analysis (DEA), a non-parametric statistical procedure that tests whether decision-making units are operating on their efficient frontier, to measure the relative performance of REITs before, during, and after the 2008–2010 financial crisis. Annual observations of both advising and management status of each REIT allow us to parse efficiency by these groups in various combinations. Our evidence suggests the inefficiency of externally-advised REITs has diminished in recent years, and the structure is no longer strictly inferior. External management of property operations, however, remains less efficient than self-management. General and administrative expenses, external advisory fees and property management fees are the main sources of inefficiency over the study period. In a difference-in-difference specification we find industry-wide operational efficiency was higher in the post-crisis than the pre-crisis period, indicating efficiency gains following the crisis.

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Notes

  1. One such example is that advisors may perform services for multiple REITs and/or have their own business opportunities, which all might be competing for the same properties. Sagalyn (1996) provides an overview of the conflicts of interest for externally-advised REITs.

  2. This is discussed in detail in our literature section, but some citations to note are Anderson et al. (2002), Lewis et al. (2003) and Miller et al. (2006).

  3. Opler and Titman (1994) state, “[These authors] have noted that financial distress pushes firms to change operating strategies in ways that seem to clearly raise efficiency.”

  4. We use the term “liquidity crisis” as defined by Case et al. (2012).

  5. For example, see the September 2015 AEW Capital Management research report titled “Real Estate GICS Sector.”

  6. Please see this NAREIT website for a current list of REIT ETFs: https://www.reit.com/investing/investing-reits/list-reit-funds/exchange-traded-funds

  7. We recognize there are other techniques for examining cost efficiency such as the distribution-free approach (DFA) or thick frontier method, but have found no applications of them in the REIT literature.

  8. Please see Sherman and Gold (1985) as an early example of a bank efficiency DEA study.

  9. Please see Berger et al. (1993), Miller and Noulas (1996), and Seiford and Zhu (1999) to further understand the literature from this period.

  10. Most of the articles discussed in this paragraph that examine self-advised REITs refer to such firms as self-managed REITs in their respective papers. We refer to them as self-advised in our work in order to distinguish between day-to-day property operations (management) and high-level firm decisions related to capital and the property portfolio (advisement).

  11. The main goal of Anderson and Springer (2003) is to use efficiency measures for portfolio selection, and in the process, they report very large operational inefficiency levels.

  12. As Ambrose and Pennington-Cross (2000) outline efficiency studies in other industries often have a homogenous production unit that quantifies firm output such as barrels of beer produced by breweries, freight-tons hauled by railroads, or kilowatt-hours produced by utilities.

  13. Miller and Springer use total assets as an output in their 2007 operational efficiency working paper, while Seiford and Zhu (1999) use profitability as an output metric.

  14. DEA results using other outputs available from the authors upon request.

  15. S&P GMI’s Field Calculation Template outlines the standardized income statement and 24 different variables available in the Expenses section. Differences in firm reporting habits create data limitations that quickly shrink the list of usable variables.

  16. With respect to property-type vs geographic identification, Mueller and Ziering (1992) demonstrate that property-type diversification better accounts for market segmentation than geographic diversification.

  17. Precedence for using dummy variables for property types can be found, among other places, in Ambrose et al. (2005).

  18. These additional results are not included in this manuscript’s Tables but available from the authors upon request.

  19. We do not report these results for inefficient REITs in this manuscript, but the tables are available from the authors upon request.

  20. While some of the same arguments for or against external management can be made for external advisors, the main difference is compensation for these external parties.

  21. One example of such conflict is in 2013 when activist investors targeted CommonWealth REIT due to its external advisement by the firm REIT Management & Research (RMR).

  22. For example, Capozza and Seguin (2000) ask, “Do external advisors provide greater expertise thereby increasing revenue, FFO and AFFO that REITs could attain independently?”

  23. We selected these periods in order to use all available data. Since the periods are of slightly different length, we also ran the test with equal periods in which the pre-crisis period was 2002–2007. The levels of significance remained the same with this alternative period length.

  24. We also find statistically significant differences between the pre-crisis and crisis periods as well as the crisis and post-crisis periods using the same difference-in-difference technique.

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Acknowledgements

We thank anonymous referees and seminar participants at the 2018 ARES Annual Meeting. We are grateful to S&P Global Market Intelligence for data support. Jim Conklin and Tom Springer provided insightful feedback in the early stages of the manuscript. Any remaining errors are our own.

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  1. Department of Accounting and Finance, Feliciano School of Business, Montclair State University, Montclair, NJ, 07043, USA

    Joseph R. Nicholson

  2. Department of Accounting, Business, and Finance, Wofford College, Spartanburg, SC, 29303, USA

    James A. Stevens

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Nicholson, J.R., Stevens, J.A. REIT Operational Efficiency: External Advisement and Management. J Real Estate Finan Econ 65, 127–151 (2022). https://doi.org/10.1007/s11146-021-09818-4

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