reit dividend determinants: excess dividends and capital markets

2008 V36 2: pp. 349–369

REAL ESTATE

ECONOMICS

REIT Dividend Determinants: ExcessDividends and Capital MarketsWilliam Hardin III∗ and Matthew D. Hill∗∗

The determinants of excess dividend payments above mandatory requirementsin real estate investment trusts (REITs) are evaluated. Payment of excess divi-dends is related to factors associated with reduced agency costs, strong oper-ating performance, the implementation of a stock repurchase plan and an abilityto access short-term bank debt. Recognizing that access to external capitalis essential for long-term growth, REITs manage dividend policy to allow forcapital acquisition in the form of both equity and debt. The acquisition and useof short-term bank debt provides REIT management flexibility in determiningdividend policy.

A number of studies have focused on the determinants of real estate investmenttrust (REIT) dividend policy (Wang, Erickson and Gau 1993, Bradley, Capozzaand Seguin 1998, Ghosh and Sirmans 2006) as regulatory constraints imposedon REITs allowing them preferable tax status require the payment of dividends.The existing published studies on REIT dividends, however, do not differenti-ate between the mandatory and nonmandatory components of REIT commondividends. Dividend payment and policy analysis should explicitly recognizethat dividend payments to REIT common shareholders can be decomposed intotwo components. The first component of the dividend payment is the manda-tory payment required to retain the tax-preferenced REIT regulatory status. Thesecond component of the dividend payment is an additional or excess paymentover and above the minimal statutorily driven payment. It is this excess pay-ment that is of most interest as it is not driven by mandatory requirements, butis instead the component of the dividend payment that is directly attributableto management decisions and a firm’s operating performance.

Contemporaneous REIT research focused on capital formation shows theconsiderable limitations REITs have in generating sufficient internal cashflow to substantially increase assets under management. REITs employing agrowth strategy are dependent on the capital markets for short-term bank debt,

∗Department of Finance and Real Estate, Florida International University, Miami, FL33199 or [email protected].

∗∗Department of Finance, University of Mississippi, Oxford, MS 38677 [email protected].

C© 2008 American Real Estate and Urban Economics Association

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long-term debt and additional equity. Ott, Riddiough and Yi (2005) point outthat retained earnings account for only 7% of the capital used by REITs toexpand their balance sheets. REITs’ dependency on capital markets, along withtheir inability to substantially use self-generated capital for growth, providesother dimensions to the REIT dividend policy debate. Reliance on externalcapital requires REITs to be more transparent and to reduce agency costs as-sociated with debt and equity capital. In essence, while Bradley, Capozza andSeguin (1998) show that the required dividend payments made by REITs are notconstraining with REITs having discretion in the amount of dividends actuallypaid, REITs are very much constrained in using the firm’s residual cash flowto make meaningful acquisitions of additional real property to grow assets andsubsequent funds from operations. In fact, REITs pursuing a growth strategyare constrained because of their relative inability to generate residual cash flowfrom operations. This implies capital market constraints that can be mitigatedby reducing agency costs and evidencing an ability to effectively and profitablyacquire and manage real estate.

The analysis that follows evaluates the excess dividends paid by REIT managersover and above what is required to meet regulatory requirements. The resultsshow that the payment of excess dividends is impacted by factors implying re-duced agency costs, such as the acquisition and use of short-term bank debt thatsubjects the firm to additional monitoring, advisement type, the managementof equity markets through stock repurchase programs and strong operating per-formance as measured by excess funds from operations and return on assets(ROA). The next section of the article discusses the applied model and theory.The third and fourth sections present the data and empirical results, while thefinal section provides general conclusions.

Existing Literature and Base Model

Prior REIT Dividend Studies

The evaluation of REIT dividend policies requires the synthesis of two relatedstreams of financial theory and empirical work. Capital formation in REITsand all firms is impacted by internally generated funds, dividend policies andan ability to tap debt and equity markets. While there are a number of REITdividend policy studies focused on firm performance and management structure,the need of REITs to tap capital markets has not been investigated, although itmight also be of importance in determining dividend policy. As Ott, Riddioughand Yi (2005) show, internally generated REIT cash flow provides only a smallportion of the capital required for REIT asset growth. The management of thiscash flow, however, is then important as it provides information to the capitalmarket on how management is performing in the acquisition and management of

REIT Dividend Determinants 351

its real property assets. After REITs pay required dividends, there is insufficientcash generated to fund substantial growth, but the use of this relatively scarceresource has implications on how a firm accesses capital markets.

A number of studies on REIT dividend policies exist within the literature, al-though none of the existing published works differentiates between mandatoryand excess dividend payments.1 Wang, Erickson and Gau (1993) provide aninitial evaluation of REIT dividend policies in the premodern REIT period andfind a robust negative relationship between ROA and the payment of dividends.No relationship with Tobin’s Q is found. Bradley, Capozza and Seguin (1998)show that REIT managers are aware of the need to strategically manage div-idend policy to take into account the potential negative impact a reduction individends might signal. The authors show that REITs with greater leverageand smaller size have lower payout ratios. These results are consistent withthe information-based explanations for dividends developed by Bhattacharya(1979), John and Williams (1985) and Miller and Rock (1985). REITs evaluatecurrent and prospective funds from operations to ensure that funds are availableto make dividend payments expected by equity investors.

Ghosh and Sirmans (2006) investigate dividend policies and dividend yield us-ing data from the 2-year period 1999 to 2000 and specifically look at the influ-ence of the chief executive officer (CEO) and corporate board on firm dividendpolicy. The payment of dividends is related to a CEO’s tenure and ownershipand is associated with board independence. The primary focus of the Ghosh andSirmans study is equity claimants, although debt claimants are recognized as anadditional source of potential monitoring. As is the case with the initial REITdividend policy studies, Ghosh and Sirmans make no differentiation betweenmandatory and nonmandatory dividend payments.

This study builds on these existing studies by differentiating between mandatorydividends and excess dividends paid over the statutory minimum. The relevantmeasure of dividend policy is postulated to be discretionary dividend payments.

The Model and Expected Outcomes

The following model is used to evaluate the potential determinants of excessdividends. The accompanying endnotes provide the SNL keyfields from whichthe data used in this study are derived.2

1 Lu and Shen (2003) and Lee and Slawson (2004) address excess REIT dividends inarticles presented at conferences in Taipei, Taiwan and Bangkok, Thailand.2 Market value of equity is taken from SNL Keyfield 6,111. Common dividends paid aretaken from SNL Keyfield 14,126. Common stock repurchases is SNL Keyfield 7,561.

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EXDIV = f (EXFFOt−1, �EXFFO, Q, SIZE, LEV, ROA, PROP,

ADV, COMMREPOt−1, �COMMREP and LOC) (1)

where:

EXDIV = common dividends paid minus mandatory dividend pay-ments, 90% or 95% of before tax net income, divided bytotal assets,3

EXFFOt−1 = the prior year’s funds from operations, defined as net in-come excluding gains or losses from sales of property, plusdepreciation and amortization and after adjustments forunconsolidated partnerships and joint ventures, minus themandatory dividend payment and divided by last period’stotal assets,

�EXFFO = excess funds from operations in the current period minusexcess funds from operations in the prior period and scaledby current period total assets,

Q= sum of market capitalization, total debt and preferred equity,divided by total assets,

SIZE = natural logarithm of market value of equity in 2005 dollars,LEV = total debt, long-term debt plus short-term debt, divided by

total assets,ROA = net income available to common shareholders divided by

total assets,PROP = dummies for property focus categories (HOTEL, INDUS-

TRIAL, MULTIFAMILY , OFFICE, OTHER, RETAIL andSTORAGE),

ADV = dummy variable based on internal or external advisement,COMMREPOt−1 = common stock repurchased in last period divided by total

assets in last period,�COMMREPO = common stock repurchased in current period minus com-

mon stock repurchased in last period and divided by currentperiod total assets and

LOC = amounts drawn against credit lines divided by credit linesavailable.

Net income is SNL Keyfield 833. Taxes come from SNL Keyfield 4,427. Before taxincome is SNL Keyfield 833 plus SNL Keyfield 4,427. Total assets come from SNLKeyfield 220. Preferred equity is from SNL Keyfield 3,798. Funds from operationscome from SNL Keyfield 6116. Amounts drawn to credit lines available are from SNLKeyfield 6,181. Total debt is from SNL Keyfield 845. SNL Keyfield 6,270 provides theproperty sector type. Advisor type is taken from SNL Keyfield 63.

3 Prior to 2001 the dividend restriction equaled 95% of before tax net income. Thecalculations of excess dividends and excess funds from operations reflect this priorrestriction.


The dependent variable in each of the model specifications is excess dividendsscaled by total assets (EXDIV). The dependent variable is scaled to establisha relationship proportional to size and to mitigate the potential for the largestfirms to skew the results.

Increased free cash flow allows managers to avoid capital market scrutiny byfunding projects and acquisitions internally, potentially for the purposes of em-pire building and unnecessary diversification. Jensen (1986) shows that freecash flow can lead managers to consume perquisites, thereby wasting corporateresources and eroding shareholder wealth. Free cash flow imposes substan-tial agency costs on shareholders, especially under conditions that lack trans-parency. Dividend policy can be effective in limiting the resources under man-agement’s control by reducing discretionary cash flow. Therefore, it is expectedthat excess dividends will be positively associated with cash flow. Because acertain proportion of REIT cash flow is preallocated due to mandatory dividendrequirements, the standard funds from operations measure might not have ameaningful effect on excess dividends. Thus, the impact of cash flow on excessdividends is modeled using excess cash flow, calculated as funds from opera-tions minus the mandatory dividend. A direct relation between excess dividendsabove the mandatory dividend requirement and excess funds from operations(EXFFO) is expected. As Bradley, Capozza and Seguin (1998) demonstrate thatREIT management addresses the potential volatility in funds from operationsby implementing dividend polices that mitigate the likelihood of a reduction individends, this study similar models excess funds from operations using priorperiod excess funds from operations (EXFFOt−1) and the change in excessfunds from operations (�EXFFO). Bradley, Capozza and Seguin’s findingsimply a positive relationship between prior period excess funds from opera-tions (EXFFOt−1) and excess dividends (EXDIV) with the coefficient on theEXFFOt−1 variable of less than one. A similar relationship between the changein excess funds from operations (�EXFFO) and excess dividends (EXDIV) isalso implied, especially in situations where REITs have only limited access toshort-term debt markets.

In the modern REIT era, the use of Tobin’s Q to measure asymmetric informa-tion for REITs should generate a positive relationship because REITs that limitasymmetric information and are more transparent should have greater access tocapital markets and be at an advantage when raising both equity and debt. Fornon-REIT firms, Myers and Majluf (1984) show that asymmetric informationincreases the cost of external financing. This postulate implies that greater trans-parency reduces capital costs. In essence, the proper management of the firm’sassets and excess dividends should generate a positive market response and avirtuous capital acquisition cycle. Although neither Wang, Erickson and Gau(1993) nor Ghosh and Sirmans (2006) can empirically support this contention

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in their dividend policy studies, it can be argued that the development of thepost-1993 REIT era has been driven by greater transparency. Given the overalldependence REITs have on the capital market for growth, relative transparencyshould be a prerequisite for capital acquisition. Improved capital market accessmakes funding projects easier, which reduces the likelihood of underinvest-ment. The liquidity provided by debt and equity markets should also enhancea firm’s ability to pay dividends in excess of the mandatory distribution. Thisleads to an expectation that excess dividends are directly correlated with capitalmarket access captured by Tobin’s Q.

In this study, the market value of REIT equity is used to proxy size (SIZE).Because the majority of the assets held by equity REITs is in the form of realestate, and the ownership of real estate generates the revenues and operatingcash flows (FFO in REITs) managed by a REIT, this is an appropriate measure.The equity market values are inflated to 2005 dollars using the consumer priceindex. Because size may have a nonlinear impact on excess dividends, thenatural logarithm of market value is used. Similarly, Bradley, Capozza andSeguin (1998) use the natural logarithm of the market value of assets to proxysize, with the expectation of a direct relation between size and dividends. Anincrease in size generally increases the diversification of the REIT’s propertyholdings, which reduces the volatility of the underlying cash flows. Due to thestock price penalty occurring when dividends are cut, REITs with more volatilecash flows should pay out less in dividends. Thus, it might be expected that sizewill be positively correlated with excess dividends. However, for a growth REITinteracting with the capital markets, a larger size would mean a greater need forcash to expand the firm’s asset base. In such a situation, the actual relationshipbetween firm size and excess dividends may be ambiguous. While larger REITsneed capital market access as the nominal amount of capital needed by theseREITs requires additional relative infusions of capital, the greater transparencyof the bigger REITs and their more diversified cash flow may reduce the needto pay excess dividends.

Debt service payments reduce discretionary cash flow under the control ofmanagement and increase the frequency of trips to capital markets, meaningincreased monitoring. That is, leverage (LEV) may act as a means of reducingagency costs. One can also assume that the capital markets have an optimalcapital structure for REITs.4 Therefore, it is expected that excess dividendsand leverage will be inversely related. This expected inverse associationis also supported by the tautological relationship between increased debt,indicating increased interest expense and a reduction in cash flow availableto shareholders. The third rationale for the expectation of an inverse relation

4 There is substantial literature on the optimal capital structure for REITs (see Feng,Ghosh and Sirmans 2007; Brown and Riddiough 2005). The capital market monitorseach REIT’s debt structure intensely.


between debt and excess dividends is that, as shown by Bradley, Capozzaand Seguin (1998), leverage can be a proxy for cash flow volatility. Ghoshand Sirmans (2006) find no correlation between dividends and debt, whileBradley, Capozza and Seguin (1998) show a significant inverse relationbetween the variables. However, Wang, Erickson and Gau (1993) providemarginal evidence of a direct relation between the debt and dividends. Thetotal debt-to-total assets ratio is used for the leverage variable.

REITs and other firms with superior operating performance have a legitimatecase for retaining funds and for obtaining additional capital, assuming that pastsuccessful projects and efficient asset utilization can be expected in the future.Hence, an inverse relationship between excess dividends and financial perfor-mance is expected as is found in Wang, Erickson and Gau (1993) and Ghoshand Sirmans (2006). Operating performance is measured using ROA, definedas net income available to shareholders scaled by total assets. For relativelytransparent REITs, positive ROA allows greater retention of cash flows andprovides for the provision of additional capital as the firm evidences propertyacquisition and management skills. In short, the capital markets should rewardperformance by allowing better performing REITs to retain some of their earn-ings for investment purposes.

Because different types of real property may have dissimilarities in their cashflow cycles, a REIT’s property focus may impact the payment of excess divi-dends. Although the SNL database lists a number of property focus categories,the number of property focus categories is reduced by combining relatively ho-mogeneous types, thereby reducing the number of dummy variables used in theregression model. Specifically, REITs classified as retail have property focustypes of mall, retail or shopping. REITs with property focus types of diversified,manufactured homes or other are lumped into one category named other. In all,seven property focus categories are used: MULTIFAMILY , RETAIL, OFFICE,INDUSTRIAL, SELF-STORAGE, HOTEL and OTHER. The expected relation-ships between excess dividends and the various property focus dummies areleft unsigned as they are essentially control variables.

Ambrose and Linneman (2001) examine differences in the financial characteris-tics of externally and internally advised REITs (ADV). The internal advisementstructure is shown to dominate the REIT industry, as most externally advisedREITs have responded to capital market pressure and now employ an internaladvisement structure. This capital market pressure stems from agency problemsinherent with external advisors. Therefore, it is likely that externally advisedREITs are more financially constrained than REITs with internal advisors. Thisimplies an inverse relation between excess dividends and internal advisement.Concurrently, the use of internal advisement helps mitigate the principal-agentconflict, reducing the necessity of excess dividends.

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The inclusion of the stock repurchase variables in the models reflects two relateddecisions required of REIT managers concerned with access to capital markets.REIT managers can choose to either increase excess dividends or to implementa stock repurchase program or some combination of these two policies. Inan environment where REITs must access equity markets, policies that supportequity investor returns and the firm’s stock price can be expected.5 In the presentmodel, one would expect a negative relationship between the payment of excessdividends and stock repurchases. Stock repurchases can signal management’sperception that a firm’s share price is undervalued, reduce agency costs due tothe use of firm cash to acquire outstanding shares and are a direct measure ofthe importance of the equity market for REIT expansion.

Finally, corporate liquidity encompasses not only cash flow, but also the abilityto obtain ready access to funds via bank lines of credit. Consequently, access tocredit lines should impact the decision to pay excess dividends. Draws from linesof credit provide an influx of cash and explicitly indicate that REIT managershave increased discretionary funds. One such use of these funds would beto support dividend payments by smoothing a REIT’s operating cash flow,financing and investment cycle. The use of credit lines can also be consideredan additional proxy for capital market access as firms with access to lines ofcredit, especially unsecured lines of credit, undergo substantial monitoring,as these lines of credit are periodically evaluated for renewal, and a REIT’sbank lending group has substantial current information on a REIT’s financialactivities via the monitoring of its operating accounts and its actual line usage.Accordingly, a direct relation between excess dividends and the use of creditlines is expected.

Credit line use is measured as the amount drawn divided by the maximumcredit line. The expansion of credit lines to REITs in the modern REIT era isreflective of a maturing capital market in which short-term bank lenders havebecome additional monitors of REIT performance, which provides an overallreduction in agency costs associated with REITs. By subjecting themselves toadditional monitoring from short-term lenders and making the use of short-term bank lines, a major component of their permanent capital structure, REITshave more flexibility to address dividend policy as well as property acquisitionsand equity market activities related to stock repurchases and seasoned equityofferings as postulated by Hartzell, Sun and Titman (2005).

5 A number of recent studies investigating the impact of stock repurchases imply thattheir use has a positive effect on stock performance. These include articles by Giambona,Giaccotto and Sirmans (2005), Adams, Brau and Holmes (2007), Giambona, Giaccottoand Sirmans (2005), Brau and Holmes (2006) and Giambona, Golec and Giaccotto(2005). Other articles, including Hartzell, Sun and Titman (2005), show that repurchaseactivity is related to investment options and share performance. The present results arecomplementary to these findings.


Data

The preliminary sample includes all REITs covered by the SNL REIT Data-source database over the period 1998 to 2005.6 The SNL database covers finan-cial and property data for equity, mortgage and hybrid U.S. REITs. NonequityREITs are deleted from this sample as are observations missing accountingdata. The initial filtered sample consists of 619 firm-year observations for 121equity REITs. The data set is an unbalanced panel. As the empirical model in-cludes lagged and differenced values, the first observation for each REIT is lost.Thus, the final sample consists of 498 firm-year observations for 121 uniqueequity REITs over the 1999 to 2005 period. Acquired, merged or delisted REITsremain in the sample until the time of their status change, which reduces theincidence of survivorship bias.

Because the present research focuses on the determinants of excess dividends,the observations with negative reported earnings must be addressed. Dividendpaying REITs with negative earnings are problematic within the context ofthe definition of excess dividends because these REITs have no mandatorydividends during the year in which earnings are negative. However, depreciationexpense (a noncash charge) typically affords REITs with negative earningsthe ability to pay dividends as these firms can still generate positive fundsfrom operations (FFO). Using the present definition of excess dividends, REITswith negative earnings would have inflated levels of excess dividends. Simplydeleting these observations is not appropriate, as this would bias the sample,and the inferences would only be applicable to REITs with positive earnings.The issue is resolved by setting earnings equal to zero for the year in whichearnings are negative. All dividends paid by a REIT with negative earnings areconsidered to be excess dividends.

Discussion of Results

Descriptive statistics for the sample of equity REITs are found in Table 1. Thedistribution of excess dividends relative to total assets is distributed symmetri-cally across the sample of REITs with the sample mean and median equal to0.60% and 0.62%, respectively. The distribution of excess cash flow as a per-centage of total assets is slightly left-skewed with a mean of 2.44% and a medianof 2.62%. The average Tobin’s Q is 1.19. The means of the market capitalization,total debt-to-total assets and return on total assets variables ($1,280,960,000,52.95% and 2.74%, respectively) are very similar to the sample averages of the

6 The SNL database has become more expansive over time as the REIT industry hasmatured and demand for extensive data has increased. While SNL continues to updateits database with historical records, data prior to year-end 1999 is limited at present.

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Table 1 � Descriptive statistics for excess dividends and its determinants.

Variables N Mean Minimum Median Maximum

EXDIV 498 0.60 −8.60 0.62 11.63EXFFO 498 2.44 −25.37 2.62 11.05EXFFOt−1 498 2.59 −25.37 2.68 11.05�EXFFO 498 0.06 −16.09 0.22 23.78Q 498 1.19 0.40 1.14 2.97MKTCAP 498 1280.96 2.15 503.21 11782.10LEVERAGE 498 52.95 0.00 53.19 100.00ROA 498 2.74 −20.70 2.83 38.92COMMREPO 485 0.35 0.00 0.00 8.45COMMREPOt−1 485 0.44 0.00 0.00 15.42�COMMREPO 485 −0.08 −13.82 0.00 8.45LOC 456 39.61 0.00 40.85 100.00

Table 1 shows the sample characteristics of the 498 REIT-years for 121 unique publiclytraded equity REITs over the period 1999 to 2005. EXDIV , EXFFO, lagged EXFFO(EXFFOt−1), change in EXFFO (�EXFFO), LEVERAGE, ROA, COMMREPO, laggedCOMMREPO (COMMREPOt−1), change in COMMREP (�COMMREP) and LOCare reported in percent form. EXDIV is the ratio of excess dividends, calculated asdividends paid minus the mandatory dividend payment, divided by total assets. EXFFOis funds from operations, defined as net income excluding gains or losses from the saleof properties, plus depreciation and after adjustments for unconsolidated partnershipsand joint ventures, minus the mandatory dividend payment and scaled by total assets.Lagged EXFFO is the ratio of last year’s funds from operations, net the mandatorydividend payment, to last period’s total assets. Change in EXFFO is current periodEXFFO minus last period’s EXFFO and divided by current period total assets. Q is theratio of the sum of market capitalization, total debt and preferred equity to total assets.MKTCAP is market value of equity in 2005 dollars. LEVERAGE is the ratio of totaldebt to total assets. ROA is net income available to common shareholders divided bytotal assets. COMMREPO is common stock repurchased divided by total assets. LaggedCOMMREPO is last year’s common stock repurchased divided by last period’s totalassets. Change in COMMREPO is current period common stock repurchased minuslast period’s common stock repurchased and divided by current period total assets.LOC is funds drawn from credit lines scaled by total credit lines available.

same variables reported by Ghosh and Sirmans (2006).7 The slight differencesin the sample means are attributable to the temporal changes in the data seriesas the Ghosh and Sirmans data are for the 1999 to 2000 period and the data inthis study are for the longer 1999 to 2005 period.

Table 2 shows the distribution of the sample across time, property focus andadvisement type. The observations are distributed across property type in apattern that is reflective of the values of the underlying properties as components

7 Summary statistics in terms of dollars are available, but are not presented.


Table 2 � Time and property focus distribution of sample of REITs.

Panel A: Time Distribution of Sample

ExcessDividends to

Number of Total AssetsYear Observations (Mean)

1999 6 2.132000 87 0.212001 83 0.832002 80 0.892003 76 0.362004 82 0.722005 84 0.48

Total 498 REIT-years (121 unique REITs)

Panel B: Property Focus Distribution of Sample

Excess Dividends DividendNumber of to Total Assets Payout

Property Focus Observations (Mean) (Mean)

Hotel 33 1.66 22.56Industrial 30 −0.26 59.25Multifamily 91 0.79 71.85Office 69 0.42 59.33Other 130 0.69 43.82Retail 130 0.46 39.73Storage 15 0.09 66.65

Total 498 REIT-years (121unique REITs)

Panel C: Advisement-Type Distribution of Sample

Excess Dividends DividendNumber of to Total Assets Payout

Advisement Type Observations (Mean) (Mean)

Self-advised 448 0.61 45.11Externally advised 50 0.53 96.11

Total 498 REIT-years (121 unique REITs)

Panels A, B and C present the distribution of the sample across time, property focus andadvisement type, respectively, for the sample of REITs used for the excess dividendsanalysis. The sample consists of 498 REIT-years for 121 unique publicly traded equityREITs over the 1999 to 2005 period. REITs are categorized on the basis of property focus(taken from SNL), and seven categories are used: Hotel, Industrial, Multifamily, Office,Other (Diversified, Health Care, Manufactured Homes and Other), Retail (Retail,Regional Mall, Shopping Center) and Storage. Excess Dividends to Total Assets andDividend Payout are reported in percent form. Payout is based on funds from operations.

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of the asset class. Panel C of Table 2 shows the distribution of the sampleby advisement type. Approximately 90% of the advisement type observationsare from internally advised firms. The externally advised firms pay out more oftheir FFO than the internally advised REITs as would be expected for firms withgreater potential agency costs. The excess dividend payments as a percentage oftotal assets for the internally advised REITs is greater than those of the externallyadvised REITs, which indicates, when evaluated along with the dividend to FFOratio (Dividend Payout in Table 2), that internally advised REITs have betterperformance and retain more of their FFO than externally advised REITs evenwhile paying excess dividend payments.

Tables 3 and 4 present pooled ordinary least squares (OLS) and cross-sectionalOLS regression results, respectively, for the determinants of excess REIT

Table 3 � Pooled OLS regression estimates of the determinants of excess dividends.

Independent PredictedVariables Sign Model 1 Model 2 Model 3 Model 4

Constant (+/−) 0.006 0.005 0.005 0.005(0.014) (0.15) (0.015) (0.016)

Lagged EXFFO (+) 0.168 0.158 0.075 0.072(0.107) (0.105) (0.103) (0.101)

Change in EXFFO (+) 0.227∗∗ 0.214∗∗ 0.133 0.128(0.105) (0.104) (0.103) (0.102)

Q (+) 0.003 0.001 0.008 0.006(0.006) (0.006) (0.006) (0.007)

SIZE (+/−) −0.000 −0.000 −0.000 −0.000(0.001) (0.001) (0.001) (0.001)

LEVERAGE (−) 0.003 0.003 0.007 0.008(0.009) (0.009) (0.011) (0.010)

ROA (−) −0.137 −0.121 −0.192∗ −0.174(0.088) (0.087) (0.113) (0.112)

RETAIL (+/−) −0.004 −0.005∗ −0.000 −0.001(0.003) (0.003) (0.002) (0.002)

OFFICE (+/−) −0.003 −0.004 −0.002 −0.003(0.003) (0.003) (0.003) (0.003)

INDUSTRIAL (+/−) −0.009∗∗ −0.010∗∗ −0.007∗ −0.008∗∗

(0.004) (0.004) (0.004) (0.004)STORAGE (+/−) −0.006 −0.006 −0.003 −0.002

(0.006) (0.006) (0.005) (0.005)HOTEL (+/−) 0.005 0.003 0.006 0.005

(0.006) (0.006) (0.006) (0.006)OTHER (+/−) 0.002 0.000 0.002 0.001

(0.003) (0.003) (0.003) (0.003)ADVTYPE (−) −0.002 −0.001 −0.009∗∗ −0.008∗

(0.004) (0.004) (0.004) (0.004)


Table 3 � continued


Lagged (−) −0.299∗∗ −0.205∗

COMMREPO (0.119) (0.114)Change in (−) −0.227∗∗∗ −0.224∗∗∗

COMMREPO (0.086) (0.083)LOC (+) 0.010∗∗∗ 0.010∗∗∗

(0.003) (0.003)N 498 485 456 443Adj. R-Square 0.197 0.201 0.246 0.246

Table 3 presents pooled OLS regressions predicting REIT excess dividends. Thesample consists of 498 REIT-years for 121 unique publicly traded equity REITs overthe period 1999 to 2005. Lagged COMMREPO and Change in COMMREPO aremissing for 13 observations in the original sample, so Model 2 is estimated with 485observations. LOC is missing for 42 observations in the original sample, so Model 3 isestimated using 456 observations, while Model 4 is estimated using 443 observations.The dependent variable is EXDIV , calculated as common dividends paid minus themandatory dividend payment, divided by total assets. Lagged EXFFO is the ratio oflast year’s funds from operations, defined as net income excluding gains or lossesfrom sales of property, plus depreciation and amortization, and after adjustments forunconsolidated partnerships and joint ventures, minus the mandatory dividend paymentand divided by last period’s total assets. Change in EXFFO is the ratio of current periodEXFFO minus last period’s EXFFO to total assets in the current period. Q is the ratioof the sum of market capitalization, total debt and preferred equity to total assets. SIZEis the natural logarithm of market value of equity in 2005 dollars. LEVERAGE is theratio of total debt to total assets. ROA is net income available to shareholders scaledby total assets. RETAIL, HOTEL, OFFICE, INDUSTRIAL, STORAGE and OTHERrepresent the property focus of the REIT and are accounted for using dummy variables.MULTIFAMILY is the base case. ADVTYPE is a dummy variable equaling 1 if internallyadvised, 0 otherwise. Lagged COMMREPO is last year’s common stock repurchaseddivided by last period’s total assets. Change in COMMREPO is current period commonstock repurchased minus last period’s common stock repurchased and divided bycurrent period total assets. LOC is funds drawn from credit lines scaled by total creditlines available. The models are estimated with annual dummy variables. The standarderrors (in parentheses) are corrected for autocorrelation and heteroskedasticity usingNewey-West (1987) consistent standard errors. ∗∗∗, ∗∗ and ∗ indicate significance at the1%, 5% and 10% levels, respectively.

dividends. Each model estimates a variation of Equation (1) to evaluate thefactors influencing REIT dividend policy for the equity REIT sample duringthe 1999 through 2005 period. For the pooled OLS model results in Table 3, thet statistics are calculated using Newey-West (1987) robust standard errors tocorrect for serial correlation and heteroskedasticity. Similar to Ghosh and Sir-mans (2006), the models presented in Table 4 are cross-sectional regressions(between-estimator) estimated by using the time-series averages of the financial

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variables for each REIT. The between-estimator methodology mitigates prob-lems arising from short-term fluctuations in firm characteristics, outliers andserial correlation of the error terms. White’s (1980) robust standard errors areused to calculate the t statistics for the cross-sectional models. The sample con-sists of 498 REIT-years for the base pooled models, while 121 unique REITsare used to estimate the cross-sectional models. Dummy variables for sampleyears are used to control for time-effects in the pooled models.

Four models are applied using the two methods noted. Model 1 is the basemodel, which includes the advisor type variable. Model 2 includes the stock

Table 4 � Cross-sectional (between-estimator) OLS regression estimates of thedeterminants of excess dividends.


Constant (+/−) 0.041∗∗ 0.045∗∗ 0.028 0.029(0.020) (0.021) (0.021) (0.022)

Lagged EXFFO (+) 0.238∗∗∗ 0.235∗∗∗ 0.176∗ 0.170∗

(0.089) (0.089) (0.096) (0.094)Change in EXFFO (+) 0.651∗∗∗ 0.653∗∗∗ 0.480∗∗ 0.494∗∗

(0.143) (0.148) (0.199) (0.202)Q (+) 0.004 0.001 0.014∗ 0.012

(0.006) (0.006) (0.008) (0.008)SIZE (+/−) −0.002∗ −0.002∗ −0.002∗ −0.002∗

(0.001) (0.001) (0.001) (0.001)LEVERAGE (−) −0.006 −0.003 −0.009 −0.005

(0.14) (0.014) (0.016) (0.016)ROA (−) −0.098 −0.072 −0.202∗ −0.170

(0.068) (0.069) (0.116) (0.116)RETAIL (+/−) −0.004 −0.004 −0.000 −0.000

(0.003) (0.004) (0.003) (0.003)OFFICE (+/−) −0.004 −0.004 −0.002 −0.001

(0.004) (0.004) (0.004) (0.004)INDUSTRIAL (+/−) −0.010 −0.008 −0.009 −0.007∗

(0.006) (0.005) (0.006) (0.004)STORAGE (+/−) −0.006 −0.005 −0.003 −0.001

(0.008) (0.008) (0.008) (0.007)HOTEL (+/−) −0.001 −0.002 0.001 0.000

(0.005) (0.005) (0.006) (0.006)OTHER (+/−) −0.002 −0.003 −0.000 −0.001

(0.004) (0.004) (0.004) (0.004)ADVTYPE (−) −0.002 −0.002 −0.005 −0.005

(0.005) (0.005) (0.005) (0.005)Lagged (−) −0.263 −0.209

COMMREPO (0.237) (0.217)Change in (−) 0.160 0.283

COMMREPO (0.498) (0.459)


Table 4 � continued


LOC (+) 0.014∗∗ 0.016∗∗

(0.006) (0.006)N 121 121 115 115Adj. R-square 0.241 0.258 0.307 0.331

Table 4 presents cross-sectional OLS regressions predicting REIT excess dividends.The sample consists of the time-series averages of the financial variables for each REITin the sample. The full sample consists of 498 REIT-years for 121 unique publiclytraded equity REITs over the period 1999 to 2005. Consequently, the sample sizeused to estimate Model 1, 121, matches the number of cross-sectional units in thefull sample. LOC is missing for six firms in the full sample, so Models 3 and 4 areestimated using 115 firms. The dependent variable is EXDIV , calculated as commondividends paid minus the mandatory dividend payment, divided by total assets. LaggedEXFFO is the ratio of last year’s funds from operations, defined as net incomeexcluding gains or losses from sales of property, plus depreciation and amortization,and after adjustments for unconsolidated partnerships and joint ventures, minus themandatory dividend payment and divided by last period’s total assets. Change inEXFFO is the ratio of current period EXFFO minus last period’s EXFFO to total assetsin the current period. Q is the ratio of the sum of market capitalization, total debtand preferred equity to total assets. SIZE is the natural logarithm of market value ofequity in 2005 dollars. LEVERAGE is the ratio of total debt to total assets. ROA is netincome available to shareholders scaled by total assets. RETAIL, HOTEL, OFFICE,INDUSTRIAL, STORAGE and OTHER represent the property focus of the REIT and areaccounted for using dummy variables. MULTIFAMILY is the base case. ADVTYPE isa dummy variable equaling 1 if internally advised, 0 otherwise. Lagged COMMREPOis last year’s common stock repurchased divided by last period’s total assets. Changein COMMREPO is current period common stock repurchased minus last period’scommon stock repurchased and divided by current period total assets. LOC is fundsdrawn from credit lines scaled by total credit lines available. The standard errors (inparentheses) are corrected for heteroskedasticity using White’s (1980) consistent androbust standard errors. ∗∗∗, ∗∗ and ∗ indicate significance at the 1%, 5% and 10% levels,respectively.

repurchase variables. Model 3 includes a line of credit (LOC) variable. Model 4includes both the stock repurchase variables and the line of credit variable. Theprogression of models reflects the movement of the REIT capital market froma more static market to the interactive capital market that is characteristic of themodern REIT period.

In Model 1 of the pooled results (Table 3), the change in excess FFO (�EXFFO)variable has a statistically significant positive relationship with excess dividends

364 Hardin and Hill

at the 5% level.8 In the cross-sectional results for Model 1 (Table 4), both thelagged excess FFO and the change in excess FFO variables are positive and sta-tistically significant at the 1% level. These results refine and extend the findingsof Bradley, Capozza and Seguin (1998) and show that REIT managers mon-itor operating cash flow to ensure that cash flow is sufficient not only to paymandatory dividends, but also to pay for any change in excess or discretionarydividends as well. REITs manage their excess dividends based on actual andexpected operating cash flows and are aware of the negative signal that a reduc-tion in dividends would send. While REITs do pay out more than the mandatorydividends, these excess dividends are managed so as to substantially mitigatethe likelihood that dividends will have to be reduced.

With the exception of the size variable in the cross-sectional Model 1 OLSregression, which is negative and statistically significant at the 10% level, noneof the other nonproperty type variables is statistically significant in the basemodels. This highlights the relationship between operating cash flow as mea-sured by EXFFO and the payment of dividends. For an industry with limitedaccess to debt and equity capital, this operational relationship would likely bea binding constraint, and was likely a binding constraint for the REIT industryprior to the modern REIT era that is characterized by greater capital flows fromboth debt and equity sources.

Model 2 includes two variables to evaluate the impact of stock repurchases onthe payment of excess dividends. Lagged COMMREPO is last year’s commonstock repurchased divided by last year’s total assets. Change in COMMREPOis current year common stock repurchased minus last year’s common stockrepurchased and divided by current period total assets. These variables allowfor a direct assessment of the choice management makes to support its stock inthe equity market. The firm can use either the payment of excess dividends orthe more direct repurchase of stock to support the firm’s stock price.

The results for Model 2 using the pooled OLS regression methodology showthat the change in excess FFO variable is again positive and statistically sig-nificant positive at the 5% level. Concurrently, in the cross-sectional results forModel 2 found in Table 4, both the lagged excess FFO and the change in excessFFO variables are positive and statistically significant at the 1% level. Theseresults are again supportive of the initial relationship between excess operatingcash flow and the payment of excess dividends. The results from the pooled

8 Although unreported, Models 1 and 2 are also estimated after replacing lagged excessFFO and change in excess FFO with lagged FFO and change in FFO, similar to Bradley,Capozza and Seguin (1998). The results are generally robust.


OLS regressions also highlight the relationship between the payment of excessdividends and stock repurchases. The Model 2 results in Table 3 show a negativerelationship between the payment of excess dividends and stock repurchases.The coefficients on both the Lagged COMMREPO and change in COMMREPOvariables are negative and statistically significant at the 5% and 1% levels, re-spectively. In periods where REITs take the more dramatic step of repurchasingshares, they reduce their allocation of operating funds to the payment of excessdividends. While the results from the cross-sectional data are not statisticallysignificant, the overall relationship is what might be expected from Hartzell,Sun and Titman (2005).9

Model 3 includes the base model with the additional line of credit variable(LOC). Line of credit usage, which requires greater firm transparency, subjects aREIT to greater monitoring, and reduces agency costs as these lines or revolversare often reviewed annually and typically have performance metrics, is shownto be complementary to the initial relationship between lagged EXFFO andchange in EXFFO. Increased private monitoring generated by the use of aline of credit can serve as a substitute for public monitoring. In the pooledresults from Table 3, neither the lagged EXFFO variable nor the change inEXFFO variable are statistically significant. In the cross-sectional results fromTable 4, both the lagged EXFFO variable and the change in EXFFO variableare statistically significant, but at lower levels (10% and 5%, respectively)than found in the preceding models. The line of credit variable is positive andstatistically significant at the 1% level in the Table 3 results and 5% level in theTable 4 results. The advisor type variable is negative and statistically significantin the pooled OLS presentation. This is a reasonable result. REITs recognizethat the maintenance of dividend payments is a requirement for greater access tocapital markets. By subjecting themselves to the further scrutiny required for theacquisition of short-term bank debt, REITs are forced to reduce informationalasymmetries and become more transparent and are rewarded with access toshort-term debt. The presence and use of a line of credit is evidence of additionalmonitoring and reduces agency costs. Lines of credit also allow REITs to bettermanage the payment of dividends and asset acquisitions and dispositions. Thismonitoring may also be a partial substitute for monitoring from the equitymarkets. The practical result is that access to this form of short-term capitalreduces the direct link between excess FFO and excess dividends, becauseREITs can use short-term debt to manage some of the uncertainty in theiroperating cash flows.

9 For the present sample of REITs, there is little variability in COMMREPOs (seedescriptive statistics). As the between-estimator methodology uses the cross-sectionalaverages of each variable, there is even less variability in COMMREPOs for the between-estimator results.

366 Hardin and Hill

The only additional nonproperty variable that is statistically significant in thepooled OLS regression is the ROA variable, which is negative and significantat the 10% level. The present result marginally suggests that REIT investorsallow REITs with superior operating performance to retain earnings to financefuture projects, in lieu of paying excess dividends. This result parallels findingsreported by Wang, Erickson and Gau (1993) and Ghosh and Sirmans (2006),which show strong evidence of an inverse relation between dividends and ROA.

The Model 3 results from the cross-sectional OLS regressions are confirma-tory with respect to the SIZE variable and ROA variable results. Unlike in thepooled regression, the Tobin’s Q variable, however, is positive and statisticallysignificant at the 10% level. The positive relationship between excess dividendsand Tobin’s Q implies that REITs are willing to pay excess dividends to garnercontinued access to the capital markets required of a growth strategy. Giventhe lack of statistical significance for this variable in the other models, thisfinding is not robust. Firms may be willing to pay excess dividends because thepayment of such dividends results in greater access to capital markets, whichis needed from a strategic standpoint. The results, however, are most similar tothose provided by Wang, Erickson and Gau (1993) which show no statisticalrelation between dividends and Tobin’s Q.

The results from Model 4, which are for the full model, provide further supportof the importance of capital markets in the determination of REIT dividendpolicy. The Model 4 pooled OLS regression results highlight a strong rela-tionship between the payment of excess dividends and capital markets. Theonly variables that are shown to be statistically significant in this model arethose related to advisement type and capital market activities. Both the laggedCOMMREPO and change in COMMREPO variable coefficients are negativeand statistically significant at the 10% and 1% levels, respectively. The line ofcredit variable coefficient is positive and statistically significant at the 1% level,while the advisor type variable is negative and statistically significant at the10% level. The implication is that REITs monitor their stock performance andattempt to support its price through the use of either excess dividends or stockrepurchases. Further, REITs submit to additional monitoring via the acquisitionof bank lines of credit. These lines of credit remove the pure operational cashflow constraints to dividend payments and allow REITs greater flexibility in theactual payment of dividends.

The Model 4 cross-sectional results both extend the findings from the pooledOLS regression and provide greater insight into the interaction of the internaland external determinants of excess dividends. The lagged excess FFO vari-able evidences a pattern similar to that shown across the four models usingthe cross-sectional methodology. Both the lagged excess FFO variable and the


change in excess FFO variable and are now statistically significant and positiveat the 10% and 5% levels. The line of credit variable is positive and statisticallysignificant at the 5% level. While the coefficient on the SIZE variable remainsstatistically significant and negative, the lagged COMMREPO and change inCOMMREPO variables are not. Nor is the advisory type variable. The majoroverall implication is that the payment of excess divided is substantially im-pacted by excess funds from operations and a firm’s ability to use bank credit tosmooth operational cash flows. Firms are willing to pay out additional dividendsto position themselves for additional equity offerings and subject themselves tobank monitoring to allow for greater flexibility in operational management of thefirm.

The implication is that REITs are very aware of the relationship between excessdividend payments and changes in operating cash flow, and do not increasedividends in excess of changes or improvements in funds from operations,even when they have access to short-term bank debt. As Bradley, Capozza andSeguin (1998) suggest, REITs implement conservative dividend policies thatreflect both a core recurring level of funds from operations and volatility in fundsfrom operations. REITs use lines of credit to address volatility in short-termcash flows, but do not systematically use this source of capital to make excessdividend payments. REITs also adjust dividend policy to periodically supportstock repurchase programs as they are cognizant of the need to support theirstock price and substitute excess dividends with stock repurchase programswhen appropriate.

Conclusions

The payment of excess dividends over and above those required to maintainstatutory REIT status is assessed. The results show that REITs incorporatedividend policies that reduce agency costs and substantially minimize the prob-ability that dividend reductions will be required. The reduction in agency costsis a necessity for an asset class that requires additional capital from both debtand equity markets for growth. REITs that generate excess funds from opera-tions pay out more excess dividends. REITs, however, typically do not increasedividends more than the change in the prior period’s excess funds from opera-tions, even when they have access to short-term bank debt. REITs reduce theircost of capital by using excess funds from operations to provide either excessdividends or to repurchase stock. This signals to the capital markets that thefirm knows they will require additional capital and are willing to support theirshare price to facilitate future access to the capital markets.

REITs subject themselves to additional monitoring by their use of short-termbank lines of credit, which requires review by debt providers. This monitoring

368 Hardin and Hill

is complementary to the monitoring by the equity market. While short-termdebt provides liquidity, REITs do not use this source of credit to systematicallypay excess dividends that are not supported by existing and prospective futurecash flows. The acquisition of bank lines of credit, however, does reduce overallagency costs as these lines of credit provide financial flexibility, are periodicallyreviewed and often have operating covenants.

REITs are aware of their need to access capital markets and manage divi-dend policy and their interaction with the capital markets accordingly. Excessdividends are a function of a firm’s capacity to generate excess funds fromoperations and the firm’s ability to evaluate changes in excess funds from op-erations. Equity providers value excess dividends and stock repurchases. Bankdebt provides liquidity and functions as an additional monitor of firm perfor-mance, which reduces agency costs. In combination, the firm, equity sourcesand debt providers support actions that create greater transparency and set thefoundation for a virtuous capital acquisition cycle.

We thank the three reviewers and the editors for their input in improving this research.

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