Canadian real estate investment trusts: A review of the IPO literature and preliminary analysis of Canadian REIT IPO pricing

Canadian Journal of Administrative Sciences, Dec 2002 by Jane Londerville

Equity REIT structures changed in the U.S. in the 1990s as the following quote from Ling and Ryngaert (1997) indicates:

Most of the recent REIT IPOs are fully integrated operating companies that can be characterized as 11 management plays" rather than as passive conduits for investors' capital. Their managements usually have substantial equity positions in the company (Ross & Klein, 1994) and all are infinite life REITs. Property management is either done internally or by management that works solely for the benefit of the REIT shareholders (McMahan, 1994). (p. 437)

All of the Canadian REIT IPOs date from the 1990s. The structure of these funds can be said to be similar to that described in the paragraph above. Each Canadian REIT used its IPO proceeds to purchase an existing portfolio of real estate assets; these were identified in the prospectus for the IPO. The original owners) of these properties retained some interest in the REIT through ownership of units and/or a management role.

The Residential Equities REIT (RESREIT) is a typical example of this. Greenwin Properties Group and Lehndorff Tandem Properties Group each owned and managed a significant portfolio of apartment buildings in the greater Toronto area and elsewhere in Canada. Together they developed the concept for RESREIT. The initial RESREIT portfolio consisted entirely of properties bought from either Greenwin or Lehndorff. The advisor' and property management arm for the REIT are both managed by senior personnel from Greenwin and Lehndorff and are jointly owned by these two entities. Greenwin and Lehndorff together owned approximately 25% of the REIT units after the initial public offering; they paid for their units through equity in the properties transferred. This arrangement, with partial ownership of the REIT by the advisor and property management arm, mirrors the 1990s version of REIT structure in the U.S.

This paper summarizes finance literature related to IPOs. There is considerable evidence that shares issued in the process of taking industrial firms public are, on average, underpriced. This evidence, and theories that purport to explain this underpricing, are examined in the next section. A discussion of how these theories of IPO underpricing might or might not relate to REITs follows, along with a summary of the literature related to IPOs for REITs in the U.S. A small pilot study analyzing IPOs for Canadian REITs is also reported.

Literature Summary

Firms issuing shares for the first time could be assumed to have a goal of raising as much capital as possible through the process. Therefore, it has puzzled researchers over time to find evidence of significant underpricing of IPOs. Beatty and Ritter (1986), Chalk and Peavy (1987), and Ritter (1984), among others, all found evidence of significant positive returns for the first day of trading of IPO stocks. Smith (1986) summarizes the literature which documents underpricing in IPOs; for new issues, average underpricing appears to exceed 15%, a significant amount of money for firms to "leave on the table."