REIT Dividend Determinants: Excess Dividends and Capital Markets
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2008 V36 2: pp. 349–369 REAL ESTATE ECONOMICS REIT Dividend Determinants: Excess Dividends and Capital Markets William Hardin III∗ and Matthew D. Hill∗∗ The determinants of excess dividend payments above mandatory requirements in real estate investment trusts (REITs) are evaluated. Payment of excess divi- dends is related to factors associated with reduced agency costs, strong oper- ating performance, the implementation of a stock repurchase plan and an ability to access short-term bank debt. Recognizing that access to external capital is essential for long-term growth, REITs manage dividend policy to allow for capital acquisition in the form of both equity and debt. The acquisition and use of short-term bank debt provides REIT management flexibility in determining dividend policy. A number of studies have focused on the determinants of real estate investment trust (REIT) dividend policy (Wang, Erickson and Gau 1993, Bradley, Capozza and Seguin 1998, Ghosh and Sirmans 2006) as regulatory constraints imposed on REITs allowing them preferable tax status require the payment of dividends. The existing published studies on REIT dividends, however, do not differenti- ate between the mandatory and nonmandatory components of REIT common dividends. Dividend payment and policy analysis should explicitly recognize that dividend payments to REIT common shareholders can be decomposed into two components. The first component of the dividend payment is the manda- tory payment required to retain the tax-preferenced REIT regulatory status. The second component of the dividend payment is an additional or excess payment over and above the minimal statutorily driven payment. It is this excess pay- ment that is of most interest as it is not driven by mandatory requirements, but is instead the component of the dividend payment that is directly attributable to management decisions and a firm’s operating performance. Contemporaneous REIT research focused on capital formation shows the considerable limitations REITs have in generating sufficient internal cash flow to substantially increase assets under management. REITs employing a growth strategy are dependent on the capital markets for short-term bank debt, ∗ Department of Finance and Real Estate, Florida International University, Miami, FL 33199 or hardinw@fiu.edu. ∗∗ Department of Finance, University of Mississippi, Oxford, MS 38677 or mhill@bus.olemiss.edu. C 2008 American Real Estate and Urban Economics Association
350 Hardin and Hill long-term debt and additional equity. Ott, Riddiough and Yi (2005) point out that retained earnings account for only 7% of the capital used by REITs to expand their balance sheets. REITs’ dependency on capital markets, along with their inability to substantially use self-generated capital for growth, provides other dimensions to the REIT dividend policy debate. Reliance on external capital requires REITs to be more transparent and to reduce agency costs as- sociated with debt and equity capital. In essence, while Bradley, Capozza and Seguin (1998) show that the required dividend payments made by REITs are not constraining with REITs having discretion in the amount of dividends actually paid, REITs are very much constrained in using the firm’s residual cash flow to make meaningful acquisitions of additional real property to grow assets and subsequent funds from operations. In fact, REITs pursuing a growth strategy are constrained because of their relative inability to generate residual cash flow from operations. This implies capital market constraints that can be mitigated by reducing agency costs and evidencing an ability to effectively and profitably acquire and manage real estate. The analysis that follows evaluates the excess dividends paid by REIT managers over and above what is required to meet regulatory requirements. The results show that the payment of excess dividends is impacted by factors implying re- duced agency costs, such as the acquisition and use of short-term bank debt that subjects the firm to additional monitoring, advisement type, the management of equity markets through stock repurchase programs and strong operating per- formance as measured by excess funds from operations and return on assets (ROA). The next section of the article discusses the applied model and theory. The third and fourth sections present the data and empirical results, while the final section provides general conclusions. Existing Literature and Base Model Prior REIT Dividend Studies The evaluation of REIT dividend policies requires the synthesis of two related streams of financial theory and empirical work. Capital formation in REITs and all firms is impacted by internally generated funds, dividend policies and an ability to tap debt and equity markets. While there are a number of REIT dividend policy studies focused on firm performance and management structure, the need of REITs to tap capital markets has not been investigated, although it might also be of importance in determining dividend policy. As Ott, Riddiough and Yi (2005) show, internally generated REIT cash flow provides only a small portion of the capital required for REIT asset growth. The management of this cash flow, however, is then important as it provides information to the capital market on how management is performing in the acquisition and management of
REIT Dividend Determinants 351 its real property assets. After REITs pay required dividends, there is insufficient cash generated to fund substantial growth, but the use of this relatively scarce resource has implications on how a firm accesses capital markets. A number of studies on REIT dividend policies exist within the literature, al- though none of the existing published works differentiates between mandatory and excess dividend payments.1 Wang, Erickson and Gau (1993) provide an initial evaluation of REIT dividend policies in the premodern REIT period and find a robust negative relationship between ROA and the payment of dividends. No relationship with Tobin’s Q is found. Bradley, Capozza and Seguin (1998) show that REIT managers are aware of the need to strategically manage div- idend policy to take into account the potential negative impact a reduction in dividends might signal. The authors show that REITs with greater leverage and smaller size have lower payout ratios. These results are consistent with the information-based explanations for dividends developed by Bhattacharya (1979), John and Williams (1985) and Miller and Rock (1985). REITs evaluate current and prospective funds from operations to ensure that funds are available to make dividend payments expected by equity investors. Ghosh and Sirmans (2006) investigate dividend policies and dividend yield us- ing data from the 2-year period 1999 to 2000 and specifically look at the influ- ence of the chief executive officer (CEO) and corporate board on firm dividend policy. The payment of dividends is related to a CEO’s tenure and ownership and is associated with board independence. The primary focus of the Ghosh and Sirmans study is equity claimants, although debt claimants are recognized as an additional source of potential monitoring. As is the case with the initial REIT dividend policy studies, Ghosh and Sirmans make no differentiation between mandatory and nonmandatory dividend payments. This study builds on these existing studies by differentiating between mandatory dividends and excess dividends paid over the statutory minimum. The relevant measure of dividend policy is postulated to be discretionary dividend payments. The Model and Expected Outcomes The following model is used to evaluate the potential determinants of excess dividends. The accompanying endnotes provide the SNL keyfields from which the data used in this study are derived.2 1 Lu and Shen (2003) and Lee and Slawson (2004) address excess REIT dividends in articles presented at conferences in Taipei, Taiwan and Bangkok, Thailand. 2 Market value of equity is taken from SNL Keyfield 6,111. Common dividends paid are taken from SNL Keyfield 14,126. Common stock repurchases is SNL Keyfield 7,561.
352 Hardin and Hill
EXDIV = f (EXFFOt−1 , EXFFO, Q, SIZE, LEV, ROA, PROP,
ADV, COMMREPOt−1 , COMMREP and LOC) (1)
where:
EXDIV = common dividends paid minus mandatory dividend pay-
ments, 90% or 95% of before tax net income, divided by
total assets,3
EXFFOt−1 = the prior year’s funds from operations, defined as net in-
come excluding gains or losses from sales of property, plus
depreciation and amortization and after adjustments for
unconsolidated partnerships and joint ventures, minus the
mandatory dividend payment and divided by last period’s
total assets,
EXFFO = excess funds from operations in the current period minus
excess funds from operations in the prior period and scaled
by current period total assets,
Q = sum of market capitalization, total debt and preferred equity,
divided by total assets,
SIZE = natural logarithm of market value of equity in 2005 dollars,
LEV = total debt, long-term debt plus short-term debt, divided by
total assets,
ROA = net income available to common shareholders divided by
total assets,
PROP = dummies for property focus categories (HOTEL, INDUS-
TRIAL, MULTIFAMILY, OFFICE, OTHER, RETAIL and
STORAGE),
ADV = dummy variable based on internal or external advisement,
COMMREPOt−1 = common stock repurchased in last period divided by total
assets in last period,
COMMREPO = common stock repurchased in current period minus com-
mon stock repurchased in last period and divided by current
period total assets and
LOC = amounts drawn against credit lines divided by credit lines
available.
Net income is SNL Keyfield 833. Taxes come from SNL Keyfield 4,427. Before tax
income is SNL Keyfield 833 plus SNL Keyfield 4,427. Total assets come from SNL
Keyfield 220. Preferred equity is from SNL Keyfield 3,798. Funds from operations
come from SNL Keyfield 6116. Amounts drawn to credit lines available are from SNL
Keyfield 6,181. Total debt is from SNL Keyfield 845. SNL Keyfield 6,270 provides the
property sector type. Advisor type is taken from SNL Keyfield 63.
3
Prior to 2001 the dividend restriction equaled 95% of before tax net income. The
calculations of excess dividends and excess funds from operations reflect this prior
restriction.REIT Dividend Determinants 353 The dependent variable in each of the model specifications is excess dividends scaled by total assets (EXDIV). The dependent variable is scaled to establish a relationship proportional to size and to mitigate the potential for the largest firms to skew the results. Increased free cash flow allows managers to avoid capital market scrutiny by funding projects and acquisitions internally, potentially for the purposes of em- pire building and unnecessary diversification. Jensen (1986) shows that free cash flow can lead managers to consume perquisites, thereby wasting corporate resources and eroding shareholder wealth. Free cash flow imposes substan- tial agency costs on shareholders, especially under conditions that lack trans- parency. Dividend policy can be effective in limiting the resources under man- agement’s control by reducing discretionary cash flow. Therefore, it is expected that excess dividends will be positively associated with cash flow. Because a certain proportion of REIT cash flow is preallocated due to mandatory dividend requirements, the standard funds from operations measure might not have a meaningful effect on excess dividends. Thus, the impact of cash flow on excess dividends is modeled using excess cash flow, calculated as funds from opera- tions minus the mandatory dividend. A direct relation between excess dividends above the mandatory dividend requirement and excess funds from operations (EXFFO) is expected. As Bradley, Capozza and Seguin (1998) demonstrate that REIT management addresses the potential volatility in funds from operations by implementing dividend polices that mitigate the likelihood of a reduction in dividends, this study similar models excess funds from operations using prior period excess funds from operations (EXFFOt−1 ) and the change in excess funds from operations (EXFFO). Bradley, Capozza and Seguin’s findings imply a positive relationship between prior period excess funds from opera- tions (EXFFOt−1 ) and excess dividends (EXDIV) with the coefficient on the EXFFOt−1 variable of less than one. A similar relationship between the change in excess funds from operations (EXFFO) and excess dividends (EXDIV) is also implied, especially in situations where REITs have only limited access to short-term debt markets. In the modern REIT era, the use of Tobin’s Q to measure asymmetric informa- tion for REITs should generate a positive relationship because REITs that limit asymmetric information and are more transparent should have greater access to capital markets and be at an advantage when raising both equity and debt. For non-REIT firms, Myers and Majluf (1984) show that asymmetric information increases the cost of external financing. This postulate implies that greater trans- parency reduces capital costs. In essence, the proper management of the firm’s assets and excess dividends should generate a positive market response and a virtuous capital acquisition cycle. Although neither Wang, Erickson and Gau (1993) nor Ghosh and Sirmans (2006) can empirically support this contention
354 Hardin and Hill in their dividend policy studies, it can be argued that the development of the post-1993 REIT era has been driven by greater transparency. Given the overall dependence REITs have on the capital market for growth, relative transparency should be a prerequisite for capital acquisition. Improved capital market access makes funding projects easier, which reduces the likelihood of underinvest- ment. The liquidity provided by debt and equity markets should also enhance a firm’s ability to pay dividends in excess of the mandatory distribution. This leads to an expectation that excess dividends are directly correlated with capital market access captured by Tobin’s Q. In this study, the market value of REIT equity is used to proxy size (SIZE). Because the majority of the assets held by equity REITs is in the form of real estate, and the ownership of real estate generates the revenues and operating cash flows (FFO in REITs) managed by a REIT, this is an appropriate measure. The equity market values are inflated to 2005 dollars using the consumer price index. Because size may have a nonlinear impact on excess dividends, the natural logarithm of market value is used. Similarly, Bradley, Capozza and Seguin (1998) use the natural logarithm of the market value of assets to proxy size, with the expectation of a direct relation between size and dividends. An increase in size generally increases the diversification of the REIT’s property holdings, which reduces the volatility of the underlying cash flows. Due to the stock price penalty occurring when dividends are cut, REITs with more volatile cash flows should pay out less in dividends. Thus, it might be expected that size will be positively correlated with excess dividends. However, for a growth REIT interacting with the capital markets, a larger size would mean a greater need for cash to expand the firm’s asset base. In such a situation, the actual relationship between firm size and excess dividends may be ambiguous. While larger REITs need capital market access as the nominal amount of capital needed by these REITs requires additional relative infusions of capital, the greater transparency of the bigger REITs and their more diversified cash flow may reduce the need to pay excess dividends. Debt service payments reduce discretionary cash flow under the control of management and increase the frequency of trips to capital markets, meaning increased monitoring. That is, leverage (LEV) may act as a means of reducing agency costs. One can also assume that the capital markets have an optimal capital structure for REITs.4 Therefore, it is expected that excess dividends and leverage will be inversely related. This expected inverse association is also supported by the tautological relationship between increased debt, indicating increased interest expense and a reduction in cash flow available to shareholders. The third rationale for the expectation of an inverse relation 4 There is substantial literature on the optimal capital structure for REITs (see Feng, Ghosh and Sirmans 2007; Brown and Riddiough 2005). The capital market monitors each REIT’s debt structure intensely.
REIT Dividend Determinants 355 between debt and excess dividends is that, as shown by Bradley, Capozza and Seguin (1998), leverage can be a proxy for cash flow volatility. Ghosh and Sirmans (2006) find no correlation between dividends and debt, while Bradley, Capozza and Seguin (1998) show a significant inverse relation between the variables. However, Wang, Erickson and Gau (1993) provide marginal evidence of a direct relation between the debt and dividends. The total debt-to-total assets ratio is used for the leverage variable. REITs and other firms with superior operating performance have a legitimate case for retaining funds and for obtaining additional capital, assuming that past successful projects and efficient asset utilization can be expected in the future. Hence, an inverse relationship between excess dividends and financial perfor- mance is expected as is found in Wang, Erickson and Gau (1993) and Ghosh and Sirmans (2006). Operating performance is measured using ROA, defined as net income available to shareholders scaled by total assets. For relatively transparent REITs, positive ROA allows greater retention of cash flows and provides for the provision of additional capital as the firm evidences property acquisition and management skills. In short, the capital markets should reward performance by allowing better performing REITs to retain some of their earn- ings for investment purposes. Because different types of real property may have dissimilarities in their cash flow cycles, a REIT’s property focus may impact the payment of excess divi- dends. Although the SNL database lists a number of property focus categories, the number of property focus categories is reduced by combining relatively ho- mogeneous types, thereby reducing the number of dummy variables used in the regression model. Specifically, REITs classified as retail have property focus types of mall, retail or shopping. REITs with property focus types of diversified, manufactured homes or other are lumped into one category named other. In all, seven property focus categories are used: MULTIFAMILY, RETAIL, OFFICE, INDUSTRIAL, SELF-STORAGE, HOTEL and OTHER. The expected relation- ships between excess dividends and the various property focus dummies are left unsigned as they are essentially control variables. Ambrose and Linneman (2001) examine differences in the financial characteris- tics of externally and internally advised REITs (ADV). The internal advisement structure is shown to dominate the REIT industry, as most externally advised REITs have responded to capital market pressure and now employ an internal advisement structure. This capital market pressure stems from agency problems inherent with external advisors. Therefore, it is likely that externally advised REITs are more financially constrained than REITs with internal advisors. This implies an inverse relation between excess dividends and internal advisement. Concurrently, the use of internal advisement helps mitigate the principal-agent conflict, reducing the necessity of excess dividends.
356 Hardin and Hill The inclusion of the stock repurchase variables in the models reflects two related decisions required of REIT managers concerned with access to capital markets. REIT managers can choose to either increase excess dividends or to implement a stock repurchase program or some combination of these two policies. In an environment where REITs must access equity markets, policies that support equity investor returns and the firm’s stock price can be expected.5 In the present model, one would expect a negative relationship between the payment of excess dividends and stock repurchases. Stock repurchases can signal management’s perception that a firm’s share price is undervalued, reduce agency costs due to the use of firm cash to acquire outstanding shares and are a direct measure of the importance of the equity market for REIT expansion. Finally, corporate liquidity encompasses not only cash flow, but also the ability to obtain ready access to funds via bank lines of credit. Consequently, access to credit lines should impact the decision to pay excess dividends. Draws from lines of credit provide an influx of cash and explicitly indicate that REIT managers have increased discretionary funds. One such use of these funds would be to support dividend payments by smoothing a REIT’s operating cash flow, financing and investment cycle. The use of credit lines can also be considered an additional proxy for capital market access as firms with access to lines of credit, especially unsecured lines of credit, undergo substantial monitoring, as these lines of credit are periodically evaluated for renewal, and a REIT’s bank lending group has substantial current information on a REIT’s financial activities via the monitoring of its operating accounts and its actual line usage. Accordingly, a direct relation between excess dividends and the use of credit lines is expected. Credit line use is measured as the amount drawn divided by the maximum credit line. The expansion of credit lines to REITs in the modern REIT era is reflective of a maturing capital market in which short-term bank lenders have become additional monitors of REIT performance, which provides an overall reduction in agency costs associated with REITs. By subjecting themselves to additional monitoring from short-term lenders and making the use of short- term bank lines, a major component of their permanent capital structure, REITs have more flexibility to address dividend policy as well as property acquisitions and equity market activities related to stock repurchases and seasoned equity offerings as postulated by Hartzell, Sun and Titman (2005). 5 A number of recent studies investigating the impact of stock repurchases imply that their use has a positive effect on stock performance. These include articles by Giambona, Giaccotto and Sirmans (2005), Adams, Brau and Holmes (2007), Giambona, Giaccotto and Sirmans (2005), Brau and Holmes (2006) and Giambona, Golec and Giaccotto (2005). Other articles, including Hartzell, Sun and Titman (2005), show that repurchase activity is related to investment options and share performance. The present results are complementary to these findings.
REIT Dividend Determinants 357 Data The preliminary sample includes all REITs covered by the SNL REIT Data- source database over the period 1998 to 2005.6 The SNL database covers finan- cial and property data for equity, mortgage and hybrid U.S. REITs. Nonequity REITs are deleted from this sample as are observations missing accounting data. The initial filtered sample consists of 619 firm-year observations for 121 equity REITs. The data set is an unbalanced panel. As the empirical model in- cludes lagged and differenced values, the first observation for each REIT is lost. Thus, the final sample consists of 498 firm-year observations for 121 unique equity REITs over the 1999 to 2005 period. Acquired, merged or delisted REITs remain in the sample until the time of their status change, which reduces the incidence of survivorship bias. Because the present research focuses on the determinants of excess dividends, the observations with negative reported earnings must be addressed. Dividend paying REITs with negative earnings are problematic within the context of the definition of excess dividends because these REITs have no mandatory dividends during the year in which earnings are negative. However, depreciation expense (a noncash charge) typically affords REITs with negative earnings the ability to pay dividends as these firms can still generate positive funds from operations (FFO). Using the present definition of excess dividends, REITs with negative earnings would have inflated levels of excess dividends. Simply deleting these observations is not appropriate, as this would bias the sample, and the inferences would only be applicable to REITs with positive earnings. The issue is resolved by setting earnings equal to zero for the year in which earnings are negative. All dividends paid by a REIT with negative earnings are considered to be excess dividends. Discussion of Results Descriptive statistics for the sample of equity REITs are found in Table 1. The distribution of excess dividends relative to total assets is distributed symmetri- cally across the sample of REITs with the sample mean and median equal to 0.60% and 0.62%, respectively. The distribution of excess cash flow as a per- centage of total assets is slightly left-skewed with a mean of 2.44% and a median of 2.62%. The average Tobin’s Q is 1.19. The means of the market capitalization, total debt-to-total assets and return on total assets variables ($1,280,960,000, 52.95% and 2.74%, respectively) are very similar to the sample averages of the 6 The SNL database has become more expansive over time as the REIT industry has matured and demand for extensive data has increased. While SNL continues to update its database with historical records, data prior to year-end 1999 is limited at present.
358 Hardin and Hill
Table 1 Descriptive statistics for excess dividends and its determinants.
Variables N Mean Minimum Median Maximum
EXDIV 498 0.60 −8.60 0.62 11.63
EXFFO 498 2.44 −25.37 2.62 11.05
EXFFOt −1 498 2.59 −25.37 2.68 11.05
EXFFO 498 0.06 −16.09 0.22 23.78
Q 498 1.19 0.40 1.14 2.97
MKTCAP 498 1280.96 2.15 503.21 11782.10
LEVERAGE 498 52.95 0.00 53.19 100.00
ROA 498 2.74 −20.70 2.83 38.92
COMMREPO 485 0.35 0.00 0.00 8.45
COMMREPOt −1 485 0.44 0.00 0.00 15.42
COMMREPO 485 −0.08 −13.82 0.00 8.45
LOC 456 39.61 0.00 40.85 100.00
Table 1 shows the sample characteristics of the 498 REIT-years for 121 unique publicly
traded equity REITs over the period 1999 to 2005. EXDIV, EXFFO, lagged EXFFO
(EXFFOt −1 ), change in EXFFO (EXFFO), LEVERAGE, ROA, COMMREPO, lagged
COMMREPO (COMMREPOt −1 ), change in COMMREP (COMMREP) and LOC
are reported in percent form. EXDIV is the ratio of excess dividends, calculated as
dividends paid minus the mandatory dividend payment, divided by total assets. EXFFO
is funds from operations, defined as net income excluding gains or losses from the sale
of properties, plus depreciation and after adjustments for unconsolidated partnerships
and joint ventures, minus the mandatory dividend payment and scaled by total assets.
Lagged EXFFO is the ratio of last year’s funds from operations, net the mandatory
dividend payment, to last period’s total assets. Change in EXFFO is current period
EXFFO minus last period’s EXFFO and divided by current period total assets. Q is the
ratio of the sum of market capitalization, total debt and preferred equity to total assets.
MKTCAP is market value of equity in 2005 dollars. LEVERAGE is the ratio of total
debt to total assets. ROA is net income available to common shareholders divided by
total assets. COMMREPO is common stock repurchased divided by total assets. Lagged
COMMREPO is last year’s common stock repurchased divided by last period’s total
assets. Change in COMMREPO is current period common stock repurchased minus
last period’s common stock repurchased and divided by current period total assets.
LOC is funds drawn from credit lines scaled by total credit lines available.
same variables reported by Ghosh and Sirmans (2006).7 The slight differences
in the sample means are attributable to the temporal changes in the data series
as the Ghosh and Sirmans data are for the 1999 to 2000 period and the data in
this study are for the longer 1999 to 2005 period.
Table 2 shows the distribution of the sample across time, property focus and
advisement type. The observations are distributed across property type in a
pattern that is reflective of the values of the underlying properties as components
7
Summary statistics in terms of dollars are available, but are not presented.REIT Dividend Determinants 359
Table 2 Time and property focus distribution of sample of REITs.
Panel A: Time Distribution of Sample
Excess
Dividends to
Number of Total Assets
Year Observations (Mean)
1999 6 2.13
2000 87 0.21
2001 83 0.83
2002 80 0.89
2003 76 0.36
2004 82 0.72
2005 84 0.48
Total 498 REIT-years (121 unique REITs)
Panel B: Property Focus Distribution of Sample
Excess Dividends Dividend
Number of to Total Assets Payout
Property Focus Observations (Mean) (Mean)
Hotel 33 1.66 22.56
Industrial 30 −0.26 59.25
Multifamily 91 0.79 71.85
Office 69 0.42 59.33
Other 130 0.69 43.82
Retail 130 0.46 39.73
Storage 15 0.09 66.65
Total 498 REIT-years (121unique REITs)
Panel C: Advisement-Type Distribution of Sample
Excess Dividends Dividend
Number of to Total Assets Payout
Advisement Type Observations (Mean) (Mean)
Self-advised 448 0.61 45.11
Externally advised 50 0.53 96.11
Total 498 REIT-years (121 unique REITs)
Panels A, B and C present the distribution of the sample across time, property focus and
advisement type, respectively, for the sample of REITs used for the excess dividends
analysis. The sample consists of 498 REIT-years for 121 unique publicly traded equity
REITs over the 1999 to 2005 period. REITs are categorized on the basis of property focus
(taken from SNL), and seven categories are used: Hotel, Industrial, Multifamily, Office,
Other (Diversified, Health Care, Manufactured Homes and Other), Retail (Retail,
Regional Mall, Shopping Center) and Storage. Excess Dividends to Total Assets and
Dividend Payout are reported in percent form. Payout is based on funds from operations.360 Hardin and Hill
of the asset class. Panel C of Table 2 shows the distribution of the sample
by advisement type. Approximately 90% of the advisement type observations
are from internally advised firms. The externally advised firms pay out more of
their FFO than the internally advised REITs as would be expected for firms with
greater potential agency costs. The excess dividend payments as a percentage of
total assets for the internally advised REITs is greater than those of the externally
advised REITs, which indicates, when evaluated along with the dividend to FFO
ratio (Dividend Payout in Table 2), that internally advised REITs have better
performance and retain more of their FFO than externally advised REITs even
while paying excess dividend payments.
Tables 3 and 4 present pooled ordinary least squares (OLS) and cross-sectional
OLS regression results, respectively, for the determinants of excess REIT
Table 3 Pooled OLS regression estimates of the determinants of excess dividends.
Independent Predicted
Variables Sign Model 1 Model 2 Model 3 Model 4
Constant (+/−) 0.006 0.005 0.005 0.005
(0.014) (0.15) (0.015) (0.016)
Lagged EXFFO (+) 0.168 0.158 0.075 0.072
(0.107) (0.105) (0.103) (0.101)
Change in EXFFO (+) 0.227∗∗ 0.214∗∗ 0.133 0.128
(0.105) (0.104) (0.103) (0.102)
Q (+) 0.003 0.001 0.008 0.006
(0.006) (0.006) (0.006) (0.007)
SIZE (+/−) −0.000 −0.000 −0.000 −0.000
(0.001) (0.001) (0.001) (0.001)
LEVERAGE (−) 0.003 0.003 0.007 0.008
(0.009) (0.009) (0.011) (0.010)
ROA (−) −0.137 −0.121 −0.192∗ −0.174
(0.088) (0.087) (0.113) (0.112)
RETAIL (+/−) −0.004 −0.005∗ −0.000 −0.001
(0.003) (0.003) (0.002) (0.002)
OFFICE (+/−) −0.003 −0.004 −0.002 −0.003
(0.003) (0.003) (0.003) (0.003)
INDUSTRIAL (+/−) −0.009∗∗ −0.010∗∗ −0.007∗ −0.008∗∗
(0.004) (0.004) (0.004) (0.004)
STORAGE (+/−) −0.006 −0.006 −0.003 −0.002
(0.006) (0.006) (0.005) (0.005)
HOTEL (+/−) 0.005 0.003 0.006 0.005
(0.006) (0.006) (0.006) (0.006)
OTHER (+/−) 0.002 0.000 0.002 0.001
(0.003) (0.003) (0.003) (0.003)
ADVTYPE (−) −0.002 −0.001 −0.009∗∗ −0.008∗
(0.004) (0.004) (0.004) (0.004)REIT Dividend Determinants 361
Table 3 continued
Independent Predicted
Variables Sign Model 1 Model 2 Model 3 Model 4
Lagged (−) −0.299∗∗ −0.205∗
COMMREPO (0.119) (0.114)
Change in (−) −0.227∗∗∗ −0.224∗∗∗
COMMREPO (0.086) (0.083)
LOC (+) 0.010∗∗∗ 0.010∗∗∗
(0.003) (0.003)
N 498 485 456 443
Adj. R-Square 0.197 0.201 0.246 0.246
Table 3 presents pooled OLS regressions predicting REIT excess dividends. The
sample consists of 498 REIT-years for 121 unique publicly traded equity REITs over
the period 1999 to 2005. Lagged COMMREPO and Change in COMMREPO are
missing for 13 observations in the original sample, so Model 2 is estimated with 485
observations. LOC is missing for 42 observations in the original sample, so Model 3 is
estimated using 456 observations, while Model 4 is estimated using 443 observations.
The dependent variable is EXDIV, calculated as common dividends paid minus the
mandatory dividend payment, divided by total assets. Lagged EXFFO is the ratio of
last year’s funds from operations, defined as net income excluding gains or losses
from sales of property, plus depreciation and amortization, and after adjustments for
unconsolidated partnerships and joint ventures, minus the mandatory dividend payment
and divided by last period’s total assets. Change in EXFFO is the ratio of current period
EXFFO minus last period’s EXFFO to total assets in the current period. Q is the ratio
of the sum of market capitalization, total debt and preferred equity to total assets. SIZE
is the natural logarithm of market value of equity in 2005 dollars. LEVERAGE is the
ratio of total debt to total assets. ROA is net income available to shareholders scaled
by total assets. RETAIL, HOTEL, OFFICE, INDUSTRIAL, STORAGE and OTHER
represent the property focus of the REIT and are accounted for using dummy variables.
MULTIFAMILY is the base case. ADVTYPE is a dummy variable equaling 1 if internally
advised, 0 otherwise. Lagged COMMREPO is last year’s common stock repurchased
divided by last period’s total assets. Change in COMMREPO is current period common
stock repurchased minus last period’s common stock repurchased and divided by
current period total assets. LOC is funds drawn from credit lines scaled by total credit
lines available. The models are estimated with annual dummy variables. The standard
errors (in parentheses) are corrected for autocorrelation and heteroskedasticity using
Newey-West (1987) consistent standard errors. ∗∗∗ , ∗∗ and ∗ indicate significance at the
1%, 5% and 10% levels, respectively.
dividends. Each model estimates a variation of Equation (1) to evaluate the
factors influencing REIT dividend policy for the equity REIT sample during
the 1999 through 2005 period. For the pooled OLS model results in Table 3, the
t statistics are calculated using Newey-West (1987) robust standard errors to
correct for serial correlation and heteroskedasticity. Similar to Ghosh and Sir-
mans (2006), the models presented in Table 4 are cross-sectional regressions
(between-estimator) estimated by using the time-series averages of the financial362 Hardin and Hill
variables for each REIT. The between-estimator methodology mitigates prob-
lems arising from short-term fluctuations in firm characteristics, outliers and
serial correlation of the error terms. White’s (1980) robust standard errors are
used to calculate the t statistics for the cross-sectional models. The sample con-
sists of 498 REIT-years for the base pooled models, while 121 unique REITs
are used to estimate the cross-sectional models. Dummy variables for sample
years are used to control for time-effects in the pooled models.
Four models are applied using the two methods noted. Model 1 is the base
model, which includes the advisor type variable. Model 2 includes the stock
Table 4 Cross-sectional (between-estimator) OLS regression estimates of the
determinants of excess dividends.
Independent Predicted
Variables Sign Model 1 Model 2 Model 3 Model 4
∗∗ ∗∗
Constant (+/−) 0.041 0.045 0.028 0.029
(0.020) (0.021) (0.021) (0.022)
Lagged EXFFO (+) 0.238∗∗∗ 0.235∗∗∗ 0.176∗ 0.170∗
(0.089) (0.089) (0.096) (0.094)
Change in EXFFO (+) 0.651∗∗∗ 0.653∗∗∗ 0.480∗∗ 0.494∗∗
(0.143) (0.148) (0.199) (0.202)
Q (+) 0.004 0.001 0.014∗ 0.012
(0.006) (0.006) (0.008) (0.008)
SIZE (+/−) −0.002∗ −0.002∗ −0.002∗ −0.002∗
(0.001) (0.001) (0.001) (0.001)
LEVERAGE (−) −0.006 −0.003 −0.009 −0.005
(0.14) (0.014) (0.016) (0.016)
ROA (−) −0.098 −0.072 −0.202∗ −0.170
(0.068) (0.069) (0.116) (0.116)
RETAIL (+/−) −0.004 −0.004 −0.000 −0.000
(0.003) (0.004) (0.003) (0.003)
OFFICE (+/−) −0.004 −0.004 −0.002 −0.001
(0.004) (0.004) (0.004) (0.004)
INDUSTRIAL (+/−) −0.010 −0.008 −0.009 −0.007∗
(0.006) (0.005) (0.006) (0.004)
STORAGE (+/−) −0.006 −0.005 −0.003 −0.001
(0.008) (0.008) (0.008) (0.007)
HOTEL (+/−) −0.001 −0.002 0.001 0.000
(0.005) (0.005) (0.006) (0.006)
OTHER (+/−) −0.002 −0.003 −0.000 −0.001
(0.004) (0.004) (0.004) (0.004)
ADVTYPE (−) −0.002 −0.002 −0.005 −0.005
(0.005) (0.005) (0.005) (0.005)
Lagged (−) −0.263 −0.209
COMMREPO (0.237) (0.217)
Change in (−) 0.160 0.283
COMMREPO (0.498) (0.459)REIT Dividend Determinants 363
Table 4 continued
Independent Predicted
Variables Sign Model 1 Model 2 Model 3 Model 4
LOC (+) 0.014∗∗ 0.016∗∗
(0.006) (0.006)
N 121 121 115 115
Adj. R-square 0.241 0.258 0.307 0.331
Table 4 presents cross-sectional OLS regressions predicting REIT excess dividends.
The sample consists of the time-series averages of the financial variables for each REIT
in the sample. The full sample consists of 498 REIT-years for 121 unique publicly
traded equity REITs over the period 1999 to 2005. Consequently, the sample size
used to estimate Model 1, 121, matches the number of cross-sectional units in the
full sample. LOC is missing for six firms in the full sample, so Models 3 and 4 are
estimated using 115 firms. The dependent variable is EXDIV, calculated as common
dividends paid minus the mandatory dividend payment, divided by total assets. Lagged
EXFFO is the ratio of last year’s funds from operations, defined as net income
excluding gains or losses from sales of property, plus depreciation and amortization,
and after adjustments for unconsolidated partnerships and joint ventures, minus the
mandatory dividend payment and divided by last period’s total assets. Change in
EXFFO is the ratio of current period EXFFO minus last period’s EXFFO to total assets
in the current period. Q is the ratio of the sum of market capitalization, total debt
and preferred equity to total assets. SIZE is the natural logarithm of market value of
equity in 2005 dollars. LEVERAGE is the ratio of total debt to total assets. ROA is net
income available to shareholders scaled by total assets. RETAIL, HOTEL, OFFICE,
INDUSTRIAL, STORAGE and OTHER represent the property focus of the REIT and are
accounted for using dummy variables. MULTIFAMILY is the base case. ADVTYPE is
a dummy variable equaling 1 if internally advised, 0 otherwise. Lagged COMMREPO
is last year’s common stock repurchased divided by last period’s total assets. Change
in COMMREPO is current period common stock repurchased minus last period’s
common stock repurchased and divided by current period total assets. LOC is funds
drawn from credit lines scaled by total credit lines available. The standard errors (in
parentheses) are corrected for heteroskedasticity using White’s (1980) consistent and
robust standard errors. ∗∗∗ , ∗∗ and ∗ indicate significance at the 1%, 5% and 10% levels,
respectively.
repurchase variables. Model 3 includes a line of credit (LOC) variable. Model 4
includes both the stock repurchase variables and the line of credit variable. The
progression of models reflects the movement of the REIT capital market from
a more static market to the interactive capital market that is characteristic of the
modern REIT period.
In Model 1 of the pooled results (Table 3), the change in excess FFO (EXFFO)
variable has a statistically significant positive relationship with excess dividends364 Hardin and Hill at the 5% level.8 In the cross-sectional results for Model 1 (Table 4), both the lagged excess FFO and the change in excess FFO variables are positive and sta- tistically significant at the 1% level. These results refine and extend the findings of Bradley, Capozza and Seguin (1998) and show that REIT managers mon- itor operating cash flow to ensure that cash flow is sufficient not only to pay mandatory dividends, but also to pay for any change in excess or discretionary dividends as well. REITs manage their excess dividends based on actual and expected operating cash flows and are aware of the negative signal that a reduc- tion in dividends would send. While REITs do pay out more than the mandatory dividends, these excess dividends are managed so as to substantially mitigate the likelihood that dividends will have to be reduced. With the exception of the size variable in the cross-sectional Model 1 OLS regression, which is negative and statistically significant at the 10% level, none of the other nonproperty type variables is statistically significant in the base models. This highlights the relationship between operating cash flow as mea- sured by EXFFO and the payment of dividends. For an industry with limited access to debt and equity capital, this operational relationship would likely be a binding constraint, and was likely a binding constraint for the REIT industry prior to the modern REIT era that is characterized by greater capital flows from both debt and equity sources. Model 2 includes two variables to evaluate the impact of stock repurchases on the payment of excess dividends. Lagged COMMREPO is last year’s common stock repurchased divided by last year’s total assets. Change in COMMREPO is current year common stock repurchased minus last year’s common stock repurchased and divided by current period total assets. These variables allow for a direct assessment of the choice management makes to support its stock in the equity market. The firm can use either the payment of excess dividends or the more direct repurchase of stock to support the firm’s stock price. The results for Model 2 using the pooled OLS regression methodology show that the change in excess FFO variable is again positive and statistically sig- nificant positive at the 5% level. Concurrently, in the cross-sectional results for Model 2 found in Table 4, both the lagged excess FFO and the change in excess FFO variables are positive and statistically significant at the 1% level. These results are again supportive of the initial relationship between excess operating cash flow and the payment of excess dividends. The results from the pooled 8 Although unreported, Models 1 and 2 are also estimated after replacing lagged excess FFO and change in excess FFO with lagged FFO and change in FFO, similar to Bradley, Capozza and Seguin (1998). The results are generally robust.
REIT Dividend Determinants 365 OLS regressions also highlight the relationship between the payment of excess dividends and stock repurchases. The Model 2 results in Table 3 show a negative relationship between the payment of excess dividends and stock repurchases. The coefficients on both the Lagged COMMREPO and change in COMMREPO variables are negative and statistically significant at the 5% and 1% levels, re- spectively. In periods where REITs take the more dramatic step of repurchasing shares, they reduce their allocation of operating funds to the payment of excess dividends. While the results from the cross-sectional data are not statistically significant, the overall relationship is what might be expected from Hartzell, Sun and Titman (2005).9 Model 3 includes the base model with the additional line of credit variable (LOC). Line of credit usage, which requires greater firm transparency, subjects a REIT to greater monitoring, and reduces agency costs as these lines or revolvers are often reviewed annually and typically have performance metrics, is shown to be complementary to the initial relationship between lagged EXFFO and change in EXFFO. Increased private monitoring generated by the use of a line of credit can serve as a substitute for public monitoring. In the pooled results from Table 3, neither the lagged EXFFO variable nor the change in EXFFO variable are statistically significant. In the cross-sectional results from Table 4, both the lagged EXFFO variable and the change in EXFFO variable are statistically significant, but at lower levels (10% and 5%, respectively) than found in the preceding models. The line of credit variable is positive and statistically significant at the 1% level in the Table 3 results and 5% level in the Table 4 results. The advisor type variable is negative and statistically significant in the pooled OLS presentation. This is a reasonable result. REITs recognize that the maintenance of dividend payments is a requirement for greater access to capital markets. By subjecting themselves to the further scrutiny required for the acquisition of short-term bank debt, REITs are forced to reduce informational asymmetries and become more transparent and are rewarded with access to short-term debt. The presence and use of a line of credit is evidence of additional monitoring and reduces agency costs. Lines of credit also allow REITs to better manage the payment of dividends and asset acquisitions and dispositions. This monitoring may also be a partial substitute for monitoring from the equity markets. The practical result is that access to this form of short-term capital reduces the direct link between excess FFO and excess dividends, because REITs can use short-term debt to manage some of the uncertainty in their operating cash flows. 9 For the present sample of REITs, there is little variability in COMMREPOs (see descriptive statistics). As the between-estimator methodology uses the cross-sectional averages of each variable, there is even less variability in COMMREPOs for the between- estimator results.
366 Hardin and Hill The only additional nonproperty variable that is statistically significant in the pooled OLS regression is the ROA variable, which is negative and significant at the 10% level. The present result marginally suggests that REIT investors allow REITs with superior operating performance to retain earnings to finance future projects, in lieu of paying excess dividends. This result parallels findings reported by Wang, Erickson and Gau (1993) and Ghosh and Sirmans (2006), which show strong evidence of an inverse relation between dividends and ROA. The Model 3 results from the cross-sectional OLS regressions are confirma- tory with respect to the SIZE variable and ROA variable results. Unlike in the pooled regression, the Tobin’s Q variable, however, is positive and statistically significant at the 10% level. The positive relationship between excess dividends and Tobin’s Q implies that REITs are willing to pay excess dividends to garner continued access to the capital markets required of a growth strategy. Given the lack of statistical significance for this variable in the other models, this finding is not robust. Firms may be willing to pay excess dividends because the payment of such dividends results in greater access to capital markets, which is needed from a strategic standpoint. The results, however, are most similar to those provided by Wang, Erickson and Gau (1993) which show no statistical relation between dividends and Tobin’s Q. The results from Model 4, which are for the full model, provide further support of the importance of capital markets in the determination of REIT dividend policy. The Model 4 pooled OLS regression results highlight a strong rela- tionship between the payment of excess dividends and capital markets. The only variables that are shown to be statistically significant in this model are those related to advisement type and capital market activities. Both the lagged COMMREPO and change in COMMREPO variable coefficients are negative and statistically significant at the 10% and 1% levels, respectively. The line of credit variable coefficient is positive and statistically significant at the 1% level, while the advisor type variable is negative and statistically significant at the 10% level. The implication is that REITs monitor their stock performance and attempt to support its price through the use of either excess dividends or stock repurchases. Further, REITs submit to additional monitoring via the acquisition of bank lines of credit. These lines of credit remove the pure operational cash flow constraints to dividend payments and allow REITs greater flexibility in the actual payment of dividends. The Model 4 cross-sectional results both extend the findings from the pooled OLS regression and provide greater insight into the interaction of the internal and external determinants of excess dividends. The lagged excess FFO vari- able evidences a pattern similar to that shown across the four models using the cross-sectional methodology. Both the lagged excess FFO variable and the
REIT Dividend Determinants 367 change in excess FFO variable and are now statistically significant and positive at the 10% and 5% levels. The line of credit variable is positive and statistically significant at the 5% level. While the coefficient on the SIZE variable remains statistically significant and negative, the lagged COMMREPO and change in COMMREPO variables are not. Nor is the advisory type variable. The major overall implication is that the payment of excess divided is substantially im- pacted by excess funds from operations and a firm’s ability to use bank credit to smooth operational cash flows. Firms are willing to pay out additional dividends to position themselves for additional equity offerings and subject themselves to bank monitoring to allow for greater flexibility in operational management of the firm. The implication is that REITs are very aware of the relationship between excess dividend payments and changes in operating cash flow, and do not increase dividends in excess of changes or improvements in funds from operations, even when they have access to short-term bank debt. As Bradley, Capozza and Seguin (1998) suggest, REITs implement conservative dividend policies that reflect both a core recurring level of funds from operations and volatility in funds from operations. REITs use lines of credit to address volatility in short-term cash flows, but do not systematically use this source of capital to make excess dividend payments. REITs also adjust dividend policy to periodically support stock repurchase programs as they are cognizant of the need to support their stock price and substitute excess dividends with stock repurchase programs when appropriate. Conclusions The payment of excess dividends over and above those required to maintain statutory REIT status is assessed. The results show that REITs incorporate dividend policies that reduce agency costs and substantially minimize the prob- ability that dividend reductions will be required. The reduction in agency costs is a necessity for an asset class that requires additional capital from both debt and equity markets for growth. REITs that generate excess funds from opera- tions pay out more excess dividends. REITs, however, typically do not increase dividends more than the change in the prior period’s excess funds from opera- tions, even when they have access to short-term bank debt. REITs reduce their cost of capital by using excess funds from operations to provide either excess dividends or to repurchase stock. This signals to the capital markets that the firm knows they will require additional capital and are willing to support their share price to facilitate future access to the capital markets. REITs subject themselves to additional monitoring by their use of short-term bank lines of credit, which requires review by debt providers. This monitoring
368 Hardin and Hill is complementary to the monitoring by the equity market. While short-term debt provides liquidity, REITs do not use this source of credit to systematically pay excess dividends that are not supported by existing and prospective future cash flows. The acquisition of bank lines of credit, however, does reduce overall agency costs as these lines of credit provide financial flexibility, are periodically reviewed and often have operating covenants. REITs are aware of their need to access capital markets and manage divi- dend policy and their interaction with the capital markets accordingly. Excess dividends are a function of a firm’s capacity to generate excess funds from operations and the firm’s ability to evaluate changes in excess funds from op- erations. Equity providers value excess dividends and stock repurchases. Bank debt provides liquidity and functions as an additional monitor of firm perfor- mance, which reduces agency costs. In combination, the firm, equity sources and debt providers support actions that create greater transparency and set the foundation for a virtuous capital acquisition cycle. We thank the three reviewers and the editors for their input in improving this research. References Adams, G.L., J. Brau and A. Holmes. 2007. REIT Stock Repurchases: Completion Rates, Long-Run Returns, and the Straddle Hypothesis. Journal of Real Estate Research 29: 115–136. Ambrose, B. and P. Linneman. 2001. REIT Organizational Structure and Operating Characteristics. Journal of Real Estate Research 21: 141–162. Bhattacharya, S. 1979. Imperfect Information, Dividend Policy, and “the Bird in the Hand” Fallacy. Bell Journal of Economics 10: 259–270. Bradley, M., D. Capozza and P. Seguin. 1998. Dividend Policy and Cash-Flow Uncer- tainty. Real Estate Economics 26: 556–580. Brau, J.C. and A. Holmes. 2006. Why Do REITs Repurchase Stock? Extricating the Effect of Managerial Signaling in Open Market Share Repurchase Announcements. Journal of Real Estate Research 28: 1–23. Brown, D. and T. Riddiough. 2003. Financing Choice and Liability Structure of Real Estate Investment Trusts. Real Estate Economics 31: 313–346. Feng, Z., C. Ghosh and C.F. Sirmans. 2007. On the Capital Structure of Real Estate Investment Trusts (REITs). The Journal of Real Estate Finance and Economics 34: 81–105. Giambona, E., C. Giaccotto and C.F. Sirmans. 2005. The Long-Run Performance of REIT Stock Repurchases. Real Estate Economics 33: 351–380. Giambona, E., J. Golec and C. Giaccotto. 2005. The Conditional Performance of REIT Stock Repurchases. The Journal of Real Estate Finance and Economics 32: 129– 149. Ghosh, C. and C.F. Sirmans. 2006. Do Managerial Motives Impact Dividend De- cisions in REITs? The Journal of Real Estate Finance and Economics 32: 327– 355.
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