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Researchers find that market capitalization and institutional ownership mushroomed in past few years

October 13, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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Hematologists count the number of white blood cells to examine the immune system. Political theorists measure civil unrest by the number of times a country’s constitution is amended. And in a recent working paper, researchers observed trends in equity REITs over the past 17 years. In all professions, analyzing the past is the first step to understand the present.

Institutional ownership percentage grew from 25 percent to 64 percent. It is a blessing because the savvy investment group often influences governance by interjecting on compensation and corporate governance. Institutional investors also offer liquidity at dire times. But it comes at a cost. The Institutional emphasis on liquid issues means that the smaller market capitalization firms are less sought by capital markets.

Market capitalization swelled by tenfold. In 1993, eqiuty REITs market capitalization was $26 billion, while in 2009, it was a quarter of a trillion dollars. Regulatory changes such as the Tax Reform of 1986, the IRS ruling on the Taubman Centers and the REIT Modernization Act (RMA) were a boon to the industry in retrospect. Tax Reform eliminated limited partnership’s favorable tax treatment for real estate. The Taubman IPO introduced the umbrella structure and RMA provided benefits to REITs structure.

Umbrella partnerships became industry standard. The umbrella ruling allowed property owners to exchange real estate interest with a REIT interest, thus prolonging a taxable capital gain. Yet pundits argue that UPREITs also created a conflict of interest due to the limited partner’s ability to influence management by converting their units to shares. Because shareholders and unit holders are not affected by leverage similarly, they often regard the use of debt differently.

Unsurprisingly, perhaps, leverage level now surpasses the historical record. On average, the ratio of long-term liabilities to total assets grew from 30 percent to 47 percent during the seventeen-year record. The greatest use of debt is in residential REITs and the lowest in health care REITs. Because REITs do not pay taxes on corporate earnings, the benefit from deducting is forfeited. Pygmy interest level environment may explain REITs preference for debt instruments.  

Yet accounting performance is stagnant. Calculated as net income to total assets, ROA ratio average was 3.33 percent and Return on equity (ROE) average was 8.03 percent. Health care and residential REITS were the best performers. Retail REITs showed the highest ROE and lodging REITs showed the lowest average at negative 0.71 percent. It can be deducted that, similar to the human condition, size does not always translate to overall well-being.