Elective Stock Dividends and REITs: Evidence from the Financial Crisis

Desmond Tsang, McGill University

Authors

   Erik Devos, University of Texas – El Paso Andrew Spieler, Hofstra University Desmond Tsang, McGill University

The Financial Crisis

  The recent financial crisis and credit crunch which started in 2007 has created unprecedented liquidity problems for many industries REIT industry is not immune to the crisis:  Many REITs have capital shortfalls of more than $500 millions (e.g., Apartment Investment and Management Co.; Developers Diversified Realty Corp.)  Even financially stable REITs have serious concerns about future market uncertainties (e.g., Simon Property Group, Inc.)

REIT Structure in US

   US REITs are exempted from corporate level income tax However, they have to satisfy various requirements under the rules of US Congress: In particular, they have to distribute a minimum of 90% of taxable income as dividends to investors  The requirements represent significant financial commitment and pose huge liquidity constraint for REITs, especially at times of market downturn

Introduction of Elective Stock Dividends

 To provide REITs with temporary relief of the liquidity problems, the IRS introduced RP 2008-68:     The new rule allows REITs to offer investors to pay dividends using a mixture of cash and stock dividends REIT managers decide the proportion of stock dividends (no more than 90% of total dividends) Investors make election to receive dividends all in cash or in stock If too many investors electing cash dividends, every investor will get a mixture of cash and stock in the pre determined proportion

Are Elective Stock Dividends Good or Evil?

  Some REITs have deficient cash flows  Risk of being “de REIT” Preserve cash to address funding needs   Refinancing maturing debts Investing in new properties    Share dilution effect  Worse when REIT prices have fallen significantly Lower attractiveness of REITs  REIT investors typically search high dividend paying stocks Bad signal to market

Objective of the Study

 Given the costs and the benefits of Elective Stock Dividends, how does the REIT industry react to its introduction?

 i.e., are REITs really adopting this new, unique dividend strategy?

 What are the REIT characteristics that prompt REITs to adopt (or not to adopt) ESD?

 i.e., are REITs adopting ESD really cash-constrained? Or they adopt ESD for other reasons?

Summary of Results

  Adoption of ESD:  We find that ESD is surprisingly unpopular  There are only 17 REITs have chosen to adopt ESD from end of 2008 through taxable year of 2009!

Determinants of ESD:  Contrary to prediction, liquidity is NOT a determinant   Maturing debt position drives ESD decision REIT size, growth and performance matters

Related Literature

  Determinants of REIT Dividend Policy:  Wang, Erickson and Gau 1993; Bradley, Capozza and Seguin 1998; Ooi 2001; Ghosh and Sirmans 2006; Hardin and Hill 2008; Edelstein, Liu and Tsang 2008  We examine the effect of ESD on REIT dividend policy Rationale of REIT Stock Split and Dividend Decision:  Hardin, Liano and Huang 2005; Li, Sun and Ong 2006  We examine determinants of a special form of stock dividends (ESD)

Research Design

 Empirical Equation: 

ESD = α + β

1

SDEBT +β

4

LIQ_FFO + β

2

LDEBT + β

5

GROWTH + β + β (1)

11 8

PRICEΔ + β

9

PAYOUT + β

12

LIQ_CFO + β

3

SIZE + β

6

MTB + β

7

ROA + β

10

PROP_TYPE + β

13

DIV TIME

Key Variables of Interest

        ESD: Decision to declare elective stock dividends LIQ_FFO & LIQ_CFO (-): cash flows proxied by FFO and cash flows from operations respectively SDEBT (+): Debt maturing in one year LDEBT (+): Long term liabilities SIZE (+): Log Market capitalization MTB & GROWTH (+): Market-to-book ratio and change in total assets PRICE∆ (+/-): Percentage change in quarterly stock price ROA (-): Return-on-assets

Ratio and Amount of ESD



ESD_RATIO = α + β SDEBT +β 4 GROWTH + β 8 PAYOUT + β 12 1 LIQ_FFO + β 2 LDEBT + β 5 SIZE + β PRICEΔ + β 9 PROP_TYPE + β 13 6 LIQ_CFO + β MTB + β ROA + β 10 7 DIV + β 11 TIME (2) 3



ESD_AMT = α + β SDEBT +β 4 LDEBT + β 5 GROWTH + β 8 PAYOUT + β 12 1 LIQ_FFO + β SIZE + β PRICEΔ + β 9 ROA + β 10 PROP_TYPE + β 13 2 6 LIQ_CFO + β 3 MTB + β 7 DIV + β TIME (3) 11

Sample

  Sample period: 2007-2008 (8 quarters) ESD information: SNL Financials, NAREIT website   Financial data: Compustat and SNL Financials Total sample observations: 395  17 firms have chosen ESD  13.16% of observations report ESD

List of Firms Adopting ESD

Table 1: List of REITs that choose to distribute dividends in stock and cash as of December 2009

Company Apartment Invest and Management Co. UDR Inc. Sunstone Hotel Investors Inc. Avalon Bay Communities Roberts Realty Investors Inc. Acadia Realty Trust Vornado Realty Trust Simon Property Group CBL & Associates Properties Inc. Developers Diversified Realty Corp. One Liberty Properties Lexington Realty Trust Cousins Property Macerich Co. Host Hotels & Resorts DiamondRock Hospitality Co. General Growth Properties Inc. Source: SNL Financial Ticker Symbol AIV UDR SHO AVB RPI AKR VNO SPG CBL DDR OLP LXP CUZ MAC HST DRH GGWPQ

Descriptive Statistics (Total Sample)

Panel A: Descriptive Statistics for Total Sample Variables N Mean Median

ESD ESD_RATIO ESD_AMT LIQ_FFO LIQ_CFO SDEBT LDEBT SIZE MTB GROWTH PRICEΔ ROA DIV PAYOUT

395 395 395 395 395 395 395 395 395 395 395 395 395 395 0.1316 0.104 0.1527 0.0148 0.0151 0.0564 0.5801 7.2802 1.6619 0.0267 -8.3084 3.2885 0.5289 244.87 0 0 0 0.0134 0.0138 0.0451 0.6062 7.2088 1.8252 0.0109 -6.72 3.05 0.47 148.8 Standard Deviations 0.3385 0.273 0.509 0.007 0.007 0.0386 0.1648 1.0918 6.7793 0.0675 15.3421 1.2982 0.3541 393.69 25 th Percentile 0 0 0 0.0107 0.0102 0.0303 0.5082 6.6357 1.2408 -0.002 -14.7 2.48 0.33 105.5 75 th Percentile 0 0 0 0.0173 0.0192 0.0713 0.67 7.9923 2.5775 0.0336 1.16 3.84 0.64 229.8

Descriptive Statistics (Sub-Sample)

Panel B: Descriptive Statistics for Sub-Samples Partitioned by ESD Variables

LIQ_FFO LIQ_CFO SDEBT LDEBT SIZE MTB GROWTH PRICEΔ ROA DIV PAYOUT

ESD Sample N 52 52 52 52 52 52 52 52 52 52 52 Mean 0.0145 0.0133 0.0643 0.638 8.2783 2.4378 0.0245 -10.8612 2.7668 0.698 272.72 Non-ESD Sample N Mean 343 343 343 343 343 343 343 343 343 343 343 0.0149 0.0154 0.0552 0.5713 7.1289 1.5443 0.0271 -7.9214 3.3676 0.5033 240.64 t-statistics 0.3319 1.9319* 1.5963 2.7441*** 7.5622*** 0.8854 0.2565 1.2887 3.1447*** 3.7566*** 0.5469

Regression Results: ESD

Dependent Variable

Constant LIQ_FFO LIQ_CFO SDEBT LDEBT SIZE MTB GROWTH PRICEΔ ROA DIV PAYOUT

Property Type Effect Time Effect Number of Observations Pseudo R 2

ESD

-14.93*** (5.27) 36.24

(0.93) 1.14

(0.04) 12.23** (2.29) 4.97*** (2.62) 1.25*** (4.70) 0.03** (2.55) 1.11

(0.44) -0.03* (1.92) -0.63** (2.27) 0.74* (1.82) 0.0003

(1.24) No No 395 0.29

ESD

-13.40*** (4.72) 51.65

(1.37) 12.09

(0.30) 10.90** (2.19) 1.84

(0.95) 1.78*** (5.08) 0.03** (2.34) 1.48

(0.61) -0.08*** (3.11) -1.15*** (3.32) -0.12

(0.24) 0.0002

(0.44) Yes Yes 395 0.46

Empirical Findings

     Cash positions have nothing to do with ESD, but maturing debts significantly affect ESD decision Larger REITs and those with greater growth opportunities adopt ESD, as they may have greater funding needs ESD more apparent in firms under price pressure ROA significantly negative, indicating worse performing firms may issue ESD for signaling Similar findings for ESD_RATIO and ESD_AMT

Additional Analysis

  Controls for new debt or equity issue Controls for borrowing costs and for line of credit (Riddiough and Wu 2009)  Controls for extreme cash flows  Results remain robust and these factors have little influence on ESD decision  Controls for cash flow volatility (Bradley, Capozza and Seguin 1998)

Additional Analysis on Cash Flows Volatility

Dependent Variables

Constant LIQ_FFO LIQ_CFO SDEBT LDEBT SIZE MTB GROWTH PRICEΔ ROA DIV PAYOUT CF_VOLATILITY

Property Type Effect Time Effect Number of Observations Pseudo R 2

ESD

-11.02*** (3.69) 63.17 (1.52) 7.55 (0.21) 10.95** (2.15) 1.61 (0.79) 1.44*** (3.89) 0.04** (2.37) 1.06 (0.43) -0.07*** (2.70) -1.28*** (4.21) -0.13 (0.23) 0.0001 (0.28) 0.03** (2.42) Yes Yes 395 0.47

ESD_RATIO

- 55.75 (1.49) 12.06 (0.32) 7.39* (1.65) -0.22 (0.11) 1.23*** (3.69) 0.03** (2.27) 2.93 (1.14) -0.06*** (2.59) -1.14*** (3.17) -0.16 (0.29) 0.0002 (0.51) 0.009 (0.96) Yes Yes 395 0.29

ESD_AMT

- 47.81 (1.15) -14.08 (0.39) 9.58** (2.07) -0.47 (0.18) 1.44*** (4.14) 0.03** (2.22) 1.74 (0.88) -0.06*** (2.79) -0.94*** (3.42) 0.31 (0.72) 0.0005 (1.23) 0.02*** (2.66) Yes Yes 395 0.28

Analysis of ESD Announcements

 Why firms are reluctant to adopt ESD?  Calculate abnormal returns around the announcements dates for all ESDs  We find positive returns, indicating investors do not discount ESD  The positive returns can be due to higher combined dividends of these ESD firms

Concluding Remarks

  We document only a small portion of REITs adopt ESD  These firms do not have immediate cash flow problems  They have maturing short term debts  Larger firms with growth opportunities ESD does not seem to lead to negative price reactions  Further research: Why REITs have lukewarm reactions to this new dividend strategy?