Income growth and pricing of REITs

Abstract

Office REITs have been doing well recently in terms of exhibiting high dividends and total returns. Since the payout dividend depends on a REIT's income, positive income growth can increase shareholder wealth and therefore keep investors interested in its stock. So far, the primary channel for REITs to grow fast is by arbitraging the spread between their cost of capital and their capitalization rate for acquisitions. Because a REIT's cost of capital reflects investors' pricing of it, positive stock performance enhances investors confidence and enables the REIT to have continuous access to public capital. This study examined the components of REIT growth income and the determinants of a REIT's cost of capital. Evidence of office REIT achievements in the current market is first introduced, along with the financial details for each office REIT used in the analysis. Considering the financial data, the primary question was whether the income growth of a REIT is attributable to its size, its acquisition activities, and/or the rental growth of its properties. Additionally, several variables were listed and investigated for influences on the public capitalization rate of a REIT. The results revealed that the operating income of a REIT is unreliable as an indicator for evaluating a REIT, and the pricing of a REIT is driven by its debt ratio, its acquisition activities, the rental growth of its real estate portfolio, and current market conditions. Finally, it can be concluded that investors and capital providers do not look backward on a REIT's historical operating income. On the contrary, they are forward-looking and reward REITs with a lower cost of capital as long as the REIT owns good real estate, which means that investors expect REITs to display their good acquisition abilities in the markets where they are likely to experience rental growth in the future.