Abstract
This paper examines how a concentrated tenant base affects the operating performance and market valuations of US REITs. We observe that REITs adopting a concentrated tenant base present higher corporate cash flows and lower expenses. However, we identify a concentration discount effect that REITs with a more concentrated tenant base experience lower market valuations. We argue that this concentration discount is a result of the trade-offs between the impacts of the tenant base on the operating performance, risk levels and growth potentials. We find that a concentrated tenant base is associated with higher liquidity risk and lower dividend growth, resulting in an inflated discount factor. Our findings are not subject to sub-samples of focused or diversified REITs and stay robust after correcting for the selection bias as well as controlling for the lease structure, tenant quality and anchor tenant effect.r
Highlights
Concentrate or diversify? This is an extensively researched question in the business literature where the benefits are weighed against the costs associated with a diversified or concentrated strategy in order to determine the net impact on a firm’s financial performance or market valuations
We find that REITs with a more concentrated tenant base experience lower valuations measured by price-to-funds from operations (FFO) ratio, market-to-book ratio and Tobin’s Q, which is in contrast to the diversification discount effect that has been widely documented in the finance and real estate literature
The six dependent variables are different measures of the operating performance including the gross rental income (REIT), net operating income (NOI), property operating expenses (OPCOST), general and administrative expenses (G&A), interest expenses (INTEREST), and funds from operations (FFO), all presented as a share of the total assets
Summary
Concentrate or diversify? This is an extensively researched question in the business literature where the benefits are weighed against the costs associated with a diversified or concentrated strategy in order to determine the net impact on a firm’s financial performance or market valuations. REITs with more concentrated tenants present higher property-level cash flows and lower expenses, including management costs and financial expenses, leading to considerably higher corporate-level cash flows This supports the argument that suppliers with concentrated customers can improve their operating efficiency by establishing a long-term stable relationship with their customers (Patatoukas 2012; Irvine et al 2016). We find that REITs with a more concentrated tenant base experience lower valuations measured by price-to-FFO ratio, market-to-book ratio and Tobin’s Q, which is in contrast to the diversification discount effect that has been widely documented in the finance and real estate literature. This concentration discount effect holds after we control for the property type and geographic concentration. The rest of the paper is structured as follows: Sect. 2 briefly reviews the relevant literature and develops the hypotheses; Sect. 3 summarizes the sample selection, variable construction and methodology; Sect. 4 discusses the empirical results, followed by a series of robustness tests in Sect. 5; the final section concludes
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