Three Essays on Equity REITs Cost of Capital

163 Pages·2017·4.47 MB·English

by  Iskandar Aditya Arifin

University of Connecticut
OpenCommons@UConn
Doctoral Dissertations University of Connecticut Graduate School
6-28-2013
Three Essays on Equity REITs Cost of Capital
Iskandar Aditya Arifin
University of Connecticut - Storrs, [email protected]
Follow this and additional works at:https://opencommons.uconn.edu/dissertations
Recommended Citation
Arifin, Iskandar Aditya, "Three Essays on Equity REITs Cost of Capital" (2013).Doctoral Dissertations. 146.
https://opencommons.uconn.edu/dissertations/146
Three Essays on Equity REITs Cost of Capital

Iskandar Aditya Arifin, Ph.D.
University of Connecticut, 2013

This dissertation consists of three essays examining issues related to Equity Real Estate
Investment Trusts (REITs) cost of capital. In the first essay, we examine the cost of capital
characteristics of Equity REITs using firm-level data utilizing both single-factor and multi-factor
cost of capital model. We find that while the evidences of time-varying risk loadings are
inconclusive, the choice of estimation method in distant forecast appears to play a role. In
addition, we confirm that there is a wide variation in cost of equity estimates at the firm level.

In the second essay, we model market risk loading explicit dynamic over time. We find that
explicit modeling of market risk loading obtains a lower distant forecast error for about half of
our sample. In addition, within the subset of firms that obtains an improved forecast, we find that
a random walk market risk dynamic obtains the lowest distant forecast error.

In the third essay, we incorporate cross-sectional information to improve firm-level cost of
capital estimates. Our results suggest that incorporating cross-sectional information have only a
mild effect on cost of capital uncertainty. At the same time however, incorporating cross-
sectional information appears to lower multi-factor cost of capital estimates and weakens Equity
REITs size and book-to-market exposure at the firm level.
Three Essays on Equity REITs Cost of Capital

Iskandar Aditya Arifin

B.S., University of Wisconsin, 1998
M.B.A., University of Notre Dame, 2006

A Dissertation
Submitted in Partial Fulfillment of the
Requirements for the Degree of Doctor of Philosophy
at the
University of Connecticut

2013

i
Copyright by

Iskandar Aditya Arifin

2013

ii
APPROVAL PAGE

Doctor of Philosophy Dissertation

Three Essays on Equity REITs Cost of Capital

Presented by
Iskandar Aditya Arifin, B.S., M.B.A.

Major Advisor _____________________________________________________________
Carmelo Giaccotto

Associate Advisor _____________________________________________________________
Chinmoy Ghosh

Associate Advisor _____________________________________________________________
Gim Seow

University of Connecticut
2013
iii
ACKNOWLEDGEMENTS

I owe my major advisor, Carmelo Giaccotto, an enormous intellectual debt. His guidance has had
an enormous impact on my work that will continue well into the future. In addition, his
encouragements and support are invaluable in the completion of this dissertation. I greatly
appreciate all he has taught me. Other faculty members, in particular Chinmoy Ghosh, Joseph
Golec, Shantaram Hegde, Assaf Eisdorfer, Thomas O’Brien, John Harding and James Sfridis
have supported me in various ways during my time in Connecticut. I also greatly appreciate the
help of Gim Seow in my committee.

Finally, I thank my parents, Rudolph and Astrid, and my sister, Dian. Without them, this
dissertation would not have come into existence.
.

iv
To my parents, Rudolph and Astrid, and my sister, Dian,
for their endless love and support

v
TABLE OF CONTENTS

CHAPTER 1: On the Cost of Equity Capital of Real Estate Investment Trusts (REITs):
Estimation, Stability and Predictability
1.1 Introduction ……………………………………………………………………….. 1
1.2 Data ………………………………………………………………………………... 10
1.3 Estimating Cost of Equity Capital of REITs ………………………….................... 13
1.3.1 Cost of Equity Capital based on the CAPM ………………………………. 13
1.3.2 Cost of Equity Capital based on the three-factor model ……….………….. 15
1.3.3 Cost of Equity Capital of REIT Type portfolios and the NAREIT index … 17
1.3.4 Comparison of CAPM and Three-Factor Model Estimates ………………. 18
1.4 Inter-temporal Stability of Factor Loadings ………………………………………. 20
1.4.1 Time Variation in Factor Loadings as per Fama and French (1997)
Method …………………………………………………………………….. 21
1.4.2 Inter-temporal Patterns of Factor Loadings as per CUSUM Test ………… 23
1.5 Forecasting Power of the Cost of Equity Capital …………………………………. 26
1.5.1 Forecasts based on the single factor CAPM ………………………………. 28
1.5.2 Forecasts based on the three-factor model ………………………………... 32
1.6 Conclusion and Issues for Future Research ……………………………………….. 36
1.7 Bibliography ………………………………………………………………………. 37
1.8 Figures and Tables ……………………………...…………………………………. 39

vi
CHAPTER 2: On the Cost of Equity Capital of Real Estate Investment Trusts (REITs):
Estimation and Predictability of Time-varying Market Risk Factor Loading
2.1 Introduction ……………………………………………………………………….. 65
2.2 Data ……………………………………………………………………………….. 68
2.3 Models of Time-varying Cost of Equity Capital ………………………………...... 69
2.3.1 MCMC for single-factor cost of equity capital …………………………… 70
2.3.2 MCMC for three-factor cost of equity capital …………………………..... 84
2.4 Forecasting Power of the Cost of Equity Capital …………………………………. 91
2.4.1 Forecast based on the single-factor cost of equity capital ………………… 92
2.4.2 Forecast based on the three-factor cost of equity capital ………………….. 95
2.5 Conclusion and Issues for Future Research ……..………………………………… 99
2.6 Bibliography ………………………………………………………………………. 101
2.7 Figures and Tables ……………………………...…………………………………. 103

CHAPTER 3: On the Cost of Equity Capital of Real Estate Investment Trusts (REITs):
Improving Cost of Equity Estimates
3.1 Introduction ……………………………………………………………………….. 115
3.2 Data ……………………………………………………………………………….. 117
3.3 Accuracy of Cost of Equity Estimates under Bayesian Hierarchical Framework … 119
3.4 Conclusion and Issues for Future Research ……………………………………….. 138
3.4 Bibliography ………………………………………………………………………. 139
3.5 Figures and Tables ……………………………...…………………………………. 141

vii
CHAPTER 1

On the Cost of Equity Capital of Real Estate Investment Trusts (REITs): Estimation,
Stability and Predictability

1.1 Introduction

One of the fundamental concepts in financial economics is the cost of equity capital. A useful
tool for financial managers who must discount future cash flows for capital budgeting decisions,
it is also a critical input for analysts and investors at large in estimating the required rate of return
of a risky asset. Despite the phenomenal growth of Real Estate Investment Trusts (REITs) over
the last two decades, however, only a handful of papers have conducted detailed and systematic
analyses of the cost of equity capital (CoEC) for Equity REITs. The objective of this study is to
fill this gap in the literature. Specifically, we report findings for a comprehensive sample of 60
REITs on three related issues: (1) cost of equity capital estimates for individual REITs, and
portfolios of REITs formed by property type, based on the single-factor CAPM and the three-
factor Fama-French (1993) model over the sample period 1999 to 2011; (2) inter-temporal
stability of factor loadings over the study period; and (3) predictability of required rates of return
for both CAPM and the three-factor model.

As noted above, the extant literature on these issues is sparse and limited in scope. Three papers
deserve special mention, however. These include Khoo, Hartzell, and Hoesli (KHH, 1993),
1