Do taxable REIT subsidiary spell risk for REITs? An empirical examination

Abstract

Purpose – The purpose of this paper is to employ a unique data sample to study the relationship between risk and the use of taxable real estate investment trusts (REITs) subsidiary (TRS). Design/methodology/approach – Total volatility is decomposed into systematic risk and idiosyncratic risk in order to examine whether cross-sectional variations in REITs’ risk are related to use of TRS. The relation between REITs risk and REITs liquidity is also explored in this paper by using three liquidity measures: percentage spread, dollar volume and price impact. GMM regressions are used to explore diversification and risk-adjusted returns. Findings – The evidence, using GMM regressions, suggests that: REITs increased in firm risk during the years 2002-2011; REITs with TRS are more liquid than REITs with non-TRS; TRS-REITs’ prices becomes more volatile than the broader market after year 2007 – S & P500 index is used as benchmark; and TRS-REITs’ portfolios requires a larger number of securities to obtain similar levels of diversification as non-TRS portfolio. Practical implications – TRS-REITs’ portfolio is riskier (systematic risk) than non-TRS-REITs, its assets are the more demanded (liquid) among investor, meaning that when necessary those assets can be easier converted to cash without affecting to much its prices. When S & P500 is used as benchmark the TRS-REITs’ portfolio requires a larger number of securities to obtain similar levels of diversification as non-TRS portfolio. Originality/value – This paper employs a unique data sample to study the relationship between risk and the use of TRS in the USA. Although the relationship between risk and returns has been largely studied in the finance field, still there is a gap in REIT literature about the relation between REIT return volatility and the use of TRS’s.