Long-run renewal of REIT property portfolio through strategic divestment

Abstract

Real Estate Investment Trusts (REITs) are on-going concerns that invest, divest and recycle capital into properties that provide stable long term distributions for shareholders. REIT property portfolios require renewals through divestment of inefficient assets to be replaced by more efficient assets. While most of the previous literature focuses on the effect of acquisition/divestment event on REIT-level performance, little research has been carried out on property-level renewal process of REIT portfolios. In particular, this paper focuses on (i) the choice of properties for divestment, (ii) the choice of the timing to divest such properties, and (iii) the management strategy leading up to divestment. To address these questions, we use the unique property-level datasets for Japanese REITs that contain information on property characteristics and their performance with half-year frequency while the properties are in the portfolio, that is, from the initial acquisition to the final divestment.First, we investigate the determinants of the property designated for divestment using the probit model. We provide a strong evidence that properties requiring relatively large operation cost and/or are less yield accretive with respect to the REIT portfolio, and/or properties that do not match the geographical focus of the REIT, are likely to be divested. These assets are usually replaced with more efficient assets. Second, we investigate the timing of such divestments using the probit model. We show that properties may be divested after undergoing relatively large drop in capital value. Third, we investigate whether REITs engage in short-term earnings management post the divestment decision. Our fixed-effect panel estimations show that REITs reduce the size of capital expenditure, which is a long-term investment, just before the divestment so that their final net cash flow, which indicates the short-term property performance, look attractive for potential buyers.Further subsample analysis on market dynamics reveals that, unlike the entire sample, REITs seek for capital gain and even divest properties which are efficient for their portfolio during the REIT restructuring periods around 2010, suggesting the need for REITs to liquidate those properties during this time period.