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

1. The size of the initial public offering - larger REITs might be assumed to have a broader asset mix and lower management fee percentages. They might also be more attractive to institutional investors (generally considered as a proxy for "informed" investors). Ling and Ryngaert (1997) found returns dropped as the size of the offering increased.

2. Whether or not the REIT was one of the three transformed to a closed-end fund (i.e., had a longer history than the new offerings) - the level of uncertainty about performance could be less for these funds since they were already available to the public as investments prior to their re-issuance as REITs. Lower returns for these funds would lend support for the winner's curse theory.

3. Whether the REIT's portfolio was diversified or not -- it could be argued that portfolios of diversified types of properties would be expected to be lower risk than, for example, a REIT which held only hotels.

4. Whether an installment payment option was available to purchase the REIT units - several funds sold units for an initial price of $6.00 with a further $4.00 due within the next several months after the IPO date. This allowed investors more time to assess the REIT before committing all their funds.

5. Maximum allowable debt as specified in the prospectus - higher debt levels imply higher risk and less opportunity to grow through property acquisition without returning to the equity market, given the restrictions on retaining earnings in REITs.

There were insufficient data for satisfactory regression analysis. However, Table 4 reports the correlation coefficients for the variables cited above relative to the market adjusted day 1 (MAI) returns and cumulative returns for days 1-10.

Row 4 indicates that MAI is significantly negatively correlated with "transformed." This implies that if the REIT had been operating as an open-ended fund and thus had a track record prior to the IPO, the underpricing was likely to be smaller. The cumulative returns were also likely to be smaller although the correlation is not significant. This is consistent with lower uncertainty about future results for the fund leading to a smaller requirement for underpricing.

If investors were allowed to buy their units with installment payments, MAI was likely to be higher; the correlation is significant and positive. The correlation for the cumulative returns is also positive but not significant. This result implies that allowing the investor time before he has to commit the full unit price increases the amount of underpricing required. This result seems counterintuitive. It may be that these IPOs were targeted at individual investors-Rock's "uninformed" investors-and that this accounts for the increased underpricing. However, Ling and Ryngaert (1997) found underpricing increased with the amount of institutional ownership.

These are the only significant correlations. The higher the maximum debt specified in the prospectus, the lower the returns; this is the opposite of expectations but the results are not significant. There was not a substantial difference in the maximum debt specified in the prospectuses for the different funds, which may explain this result. Offering size and level of diversification had mixed and non-significant correlations with the two return measures.