Shareholder Wealth Effects in Equity REIT Restructuring Transactions: Sell-offs, Mergers and Joint Ventures

Abstract The restrictions of the institutional environment for Equity Real Estate Investment Trusts (EREITS) causes major restructuring to be a more important aspect of strategic planning for EREITs than it is for other firms. This study examines the literature regarding four major categories of EREIT restructuring activity: (1) sell-offs of property; (2) mergers with other REITs; (3) mergers with privately-held entities; and (4) joint ventures. The wealth effects of these forms of restructuring in REITs are different from those observed in conventional corporations. The EREIT's use of the Umbrella Partnership REIT (UPREIT) form of organization is also examined, because it is closely related to the firm's restructuring strategy. Introduction It is well-known that the decision to adopt the Equity Real Estate Trust1 form of organization implies significant constraints on managerial control of cash flows from real property investments (Damodaran, John and Liu, 1997). The most significant of these are restrictions on the nature of assets, and restrictions on the disposition of earnings. At least 95% of REIT earnings must be derived from real estate or securities, and at least 90% of earnings as determined in accordance with generally-accepted accounting principles must be paid out to shareholders each year. Prior to 2001, this payout requirement was 95%. As Damodaran, John and Liu (1997) point out, these restrictions make it more difficult for REIT managers to accumulate cash reserves to finance new investments. For REIT managers seeking growth and expansion, this circumstance reduces the importance of the first level of the pecking order (retained earnings), and increases management's exposure to the discipline of capital markets. For REITs seeking higher levels of liquidity, it means that they experience a diminished capacity to solve liquidity problems by retaining earnings. One implication of the restrictive institutional environment for REITs is that contractual restructuring arrangements may be a much more important component of strategic planning for them than it is for most other firms. For REITs seeking to expand, restructuring arrangements financed with stock and/or debt assumption may reduce transaction costs and provide an alternative to public markets. For REITs seeking to increase liquidity, dispositions of property in exchange for cash or other liquid assets may solve a problem created by the firm's inability to retain earnings. This study examines the current state of the literature with regard to four important kinds of restructuring used by EREITs: (1) major dispositions of property; (2) mergers with other REITs; (3) mergers with privately-held entities; and (4) joint ventures. It also examines the literature with regard to the Umbrella Partnership REIT (UPREIT) form of organization, which is related to restructuring in important ways, especially with regard to the acquisition of private firms. The wealth effects of these forms of restructuring, both for REITs and for conventional firms, are summarized in Exhibit 1. Sell-offs of Real Property A sell-off is a major disposition of assets, following which the selling firm continues to operate. These transactions are sometimes called "partial sell-offs," to distinguish them from total liquidations and cash-financed mergers. Asset Sell-offs by Conventional Corporations A consistent pattern observed in the literature is that corporate sell-offs significantly benefit the selling firm's shareholders, while wealth effects for purchasers are less clear. Jain (1985) tests more than 1000 sell-offs from 1976-1978 and finds that abnormal returns in a two-day window around the announcement date are significantly positive both for buyers and sellers, but higher for sellers at +0.7%. Hite, Owers and Rogers (1987) find even larger seller returns of + 1.7% in a two-day window for a sample of fifty-five sell-offs from 1971-1981. …