Greater REIT Transparency Leads to Cheaper Capital, Study Finds

April 30, 2013

The more transparent REITs are, the easier it is for them to access the capital markets, which in turn leads to higher rates of growth, according to a recent study. Moreover, the research found that greater transparency also leads to decreased cost of capital, which has an effect on San Diego investment real estate.

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A team of academics from University of Alabama and South Dakota conducted the research and wrote a report titled “Corporate Transparency and Firm Growth: Evidence from Real Estate Investment Trusts.” It studied 273 REITs and included 2,121 REIT-year observations. 

The research suggested that greater transparency facilitates growth by relaxing information-based constraints on external financing. In other words, an abundance of information helps investors in San Diego investment real estate get comfortable with a potential investment and encourages them to part with their dough, especially in the equity markets. 

For REIT executives, the message is clear: “If you need to raise money from investors so you can grow, you’re more likely to get the money, and you’ll pay less for it, if you’re transparent,” says Heng “Hunter” An, co-author of the research paper and an assistant professor of finance at the University of South Dakota. He conducted the research in conjunction with Douglas O. Cook, a professor of finance at the University of Alabama, and Leonard V. Zumpano, head of the University of Alabama’s Real Estate Center. 

“There are clear benefits for being more transparent,” An adds. He points out REITs are especially well suited for this type of research because of their dependence on external financing, An notes. Because tax laws require REITs to pay out at least 90 percent of their taxable income as dividends (95 percent before 2001), they have limited internal funds to finance their growth and, therefore, depend on capital markets to finance new investments in San Diego investment real estate. 

An and his team also found that transparent REITs are less likely to suffer a stock price crash. He points out that less transparency implies that executive teams hide bad news. If and when that bad news gets out, investors are spooked, and often sell off their stock in droves, causing the stock price to crash. 

The team’s research focused exclusively on transparency’s impact on growth and did not delve into whether companies with greater transparent actually perform better, either operationally or financially. An points out that it’s entirely possible for REITs to be able to access money at a lower cost of capital because of their transparency, but still not perform well. 

An admits that researchers have a difficult time defining and determining transparency. In the San Diego investment real estate, for example, transparency refers to information about various property types and geographic markets, in addition to company-specific information. 

“Different researchers have put forth different measures of transparency and none have been perfect, including ours,” An says, explaining that his team measured transparency based on the stock prices of individual REITs, as well as the entire REIT universe. “Transparency and the stock price is linked.” 

An acknowledges that there is a cost to being transparent—a trade-off, if you will. He points to competitive position as the most obvious cost. “If you have a major rival, you don’t want to disclose your strategic plans,” he points out. Moreover, An agrees that it requires extra time and money to be transparent.  

Source: National Real Estate Investor 

DISCLAIMER: This blog has been curated from an alternate source and is designed for informational purposes to highlight the commercial real estate market. It solely represents the opinion of the specific blogger and does not necessarily represent the opinion of Pacific Coast Commercial.