Introducing “Focused Firms”: Implications from REIT Prime Operating Revenue

Abstract

We examine the relationship between a firm’s main business focus and its risk and performance, using the unique settings of U.S. equity real estate investment trusts (REITs). In this paper, a REIT’s prime operating revenue ratio (POR) is measured as the ratio of rental revenue to total revenue. The empirical results show that REITs that earn more revenue from their prime business—property rentals—are less apt to take on risk but also achieve higher operational performance in the cross-section and over the medium term. The magnitudes of these results in a market crisis period are even stronger than in normal times. We also find evidence that REITs with higher POR are associated with less information asymmetry, higher operational efficiency, and higher market value. We also use three alternative REIT business focus measures based on their assets, expenses, and income. The results are qualitatively and quantitatively similar. To investigate why some REITs focus to a greater extent on non-prime businesses, the paper provides evidence that REIT executives receive, on average, higher pay when their firms engage more extensively in other businesses, and larger REITs are more likely to explore non-rental-revenue businesses. Lastly, we use the coronavirus pandemic as a quasi-experimental setting and provide evidence that REITs that have earned higher POR in recent years generally achieve better operational performance and reduce risk during the first three quarters of 2020. In sum, the results suggest that a REIT’s focus on its prime business generally leads to greater profitability and lower risk.

Predicting the REIT Corporate Life Cycle Phase on a Financial Accounting Basis

“…The contribution of the selected variables on the REIT performance is strongly supported by the extant literature. A series of studies identify dividend distribution (Wang et al 1993;Bradley et al 1998;Ghosh and Sirmans 2006), leverage (Giacomini et al 2017), size (McIntosh et al 1991Hamelink and Hoesli 2004;Brounen and de Koning 2013), the net asset value (Clayton and MacKinnon 2001;Brent et al 2011) and the cash flows generated by the operations of business funds from operations (see for example, Gore and Stott 1998;Feng and Liu 2021), as important drivers of REIT performance.…”