Abstract
Although real estate investment trusts have been able to choose an internal advising structure since the passage of the Tax Reform Act of 1986, a significant number of real estate investment trusts (REITs) have opted to remain externally advised. Despite the higher management costs associated with retaining a third-party advisor, these REITs have done quite well, on average, over the intervening time period. This article examines the characteristics that lend themselves to third-party advising as an optimal management structure for REITs. It examines the decision from a perspective of profit maximization, seeking to identify significant relations between various REIT characteristics and third-party participation. Results indicate that only a REIT’s status as publicly traded and, correspondingly, the size of the firm, significantly influence the choice of internal versus external advising structure. In addition, after matching by firm type and size, the authors find that externally-advised firms experience higher returns on average assets and average equity. This finding contrasts with previous results using earlier time periods in which externally-advised REITs were shown to underperform their internally-advised counterparts.
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