(Italian) REIT managers' compensation structure. The effects on investment performance

Abstract

(Italian) REIT managersí compensation structure typically provides a payment based alternatively on (i) ìgross asset valueî [GAV] or (ii) ìnet asset valueî [NAV]. In addition, managers also gain a performance fee when REIT total return exceeds some minimum level. In this respect, the paper analyses how the two alternative compensation schemes influence REITsí investment decisions and capital structure and, consequently, REITsí share performance at the investor level. The final issue addressed is whether one compensation scheme is superior to the other, i.e. if REITs having a fee-structure based on net asset values outperform REITs with a compensation indexed on gross asset value. Due to the severe market price discount on net asset values and the inability to issue new shares, both fee structures incentive managers to leverage even in a tax-free environment in order to maximize the calculation basis of management fees. However, it will be shown that leverage motivation is stronger for GAV-based REITs than for NAV-based REITs, which are also expected to be more selective in investment decisions because only positive net present value investment projects increase their compensation basis. Overall, considering initial fee percentage, GAV-based REITs are expected to pay higher management fees than NAV-based REITs due to the leverage effect. Moreover, debt recourse produces different effects on share value if measured upon market price or net asset value due to the different implicit valuation methodologies. The empirical analysis supports the theoretical expectations. GAV-based REITs have higher debt trends and levels than NAV-based REITs. At the same time, GAV-REITs generally experience lower real estate asset returns net of management fees for both current and growth yields. Differences in net real estate returns seem to lead to permanent higher performance over total return indexes of NAV-based REITs compared to GAV-based REITs. While the focus of the paper is largely on Italian REITs compensation, the issue addressed seems to be of broader interest due to the fact that similar compensation structures are also typical of other European REITs.