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

Given the relative small number and newness of REITs in Canada, a full analysis of REIT underpricing was not possible. However, a preliminary study to examine pricing of Canadian REIT IPOs is described in the balance of the paper.

Canadian REIT IPO Pilot Study

IPOs of recently introduced Canadian REITs were examined to determine whether excess returns were available on these investments or whether they experienced the overpricing observed for U.S. REIT IPOs in the 1970s and '80s. IPO data for all 13 REITs trading in Canada as of May 1998 were used in the study.5 Summary data describing these are presented in Table 1. The REITs are now all closed-end funds. However, three of them-RioCan, RealFund, and Canadian REIT-operated for several years as open-ended funds, and were restructured to closed-end funds when the tax legislation governing REITs changed.6 It could be argued that the uncertainty regarding future prospects for these three funds was less than that for the remaining REITs. All IPOs were issued over a relatively short time frame: three in 1993-94 and the remaining 10 between January 1996 and February 1998.

These Canadian REITs concentrate on equity investment; eight of the 13 are diversified, owning a combination of retail, office and industrial properties. The other five, which are all newer REITs, are characterized by specialized investment in a particular type of real estate (hotels, long-term care facilities, or residential buildings.)

MR, is the market return calculated from the TSE 3009 index between day n and day n-1.

The cumulative raw and market adjusted returns were calculated over the first 20 trading days for three different intervals: days 1-10, 11-20, and 1-20. Mean returns and standard deviations of returns for the individual days and for the cumulative returns were also calculated.

The results of the data analyses appear in Tables 2 and 3. The raw and market adjusted mean daily and cumulative returns are reported in Table 2, as well as the number of REITs with positive returns each day and t-- test results for whether the returns are significantly different from zero. Table 3 reports daily and multi-day returns for individual REITs, separated into diversified and single property type panels.

The results in Table 2 indicate that neither raw nor market-adjusted returns were significantly different from zero on any of the 20 individual days, with the exception of day 17. However, the bottom rows in this table indicate that cumulative market-adjusted returns for days 1-- 10 and 1-20 were significantly positive. Investors, on average, would have done well to buy these REIT units through the IPO, hold them for 10 days and then sell. Table 3 does not indicate that diversification made a significant difference in the returns for the first 20 days. Winners and losers are spread throughout both panels of the table.

The presence of significantly positive cumulative returns led to the question of what might explain this evidence of underpricing. Information was collected on the following features of the REITs in the sample10: