Information asymmetry and the excess dividends of REITs: a comparison between the American and European markets

Brick-and-mortar is one of the most common forms of investment in Italy, Europe and the US. But direct investments in real estate involve countless complications in terms of property management and risk diversification. To offset for these drawbacks, more and more investors are turning to indirect investments in Real Estate Investment Trusts (REIT). These listed firms, which manage and invest in properties, represent a valid alternative to direct investments in property.

REITs are subject to regulations that differ from country to country, but the underlying rationale is inspired by similar principles, placing restrictions on potential investment options (primarily leased buildings) and governance (a broad shareholder base). REITs are also required to distribute a generous share of their profits in the form of dividends to shareholders; in exchange they get major tax breaks.

Over the years, REITs have been distributing dividends above and beyond the level required to maintain their privileged fiscal status, because investors prefer companies that generate high cash flows.

In a recent study, we analyzed the determinants that enable REITs to payout higher dividends than the minimum requirements.

Specifically, we focused on the effect that information asymmetry has on dividend distributions, in particular with regard to the discretionary portion of these payments, i.e. over and above the minimum amount required by law. The research was conducted both on the European and the US markets, allowing for a comparison between the two, and highlighting similarities and differences.

Our research sample counted 341 REITs, of which 238 were in the US and 103 in Europe (specifically 33 in France, 27 in the UK, 16 in Spain, 15 in Belgium, 6 in Germany, 3 in the Netherlands, and 3 in Italy). Observations numbered 3,411 over the time horizon from 2000 to 2016, which also covers the two years of the financial crisis (2007-2008).

As regards payments of mandatory dividends, each country has its own relevant regulatory framework, with different requirements on the percentage distribution and how this percentage is calculated.

Utilizing multiple linear regression models and Tobin’s Q ratio (as a proxy for quantifying information asymmetry), our findings show that the greater the information asymmetry, the greater the portion of discretionary dividends that REITs distribute. What’s more, this effect is more pronounced in Europe as compared to the US. In addition, the impact of cash flows on excess dividend distribution is weaker in the US compared to Europe. The market on this continent is not as mature as in the US, and lower competition may well put less pressure on managers when making decisions about dividend distribution. This means they can base their choices primarily on the availability of cash flows. Moreover, lower competition among European REITs also allows them to curb the competition on excess dividend distribution.

These results were what we expected, in light of the fact that market capitalization of American REITs at the end of March 2021 was around 1,351 billion dollars, more than double the European market. Because the US market is more mature, it also sees higher values in terms of leverage. As regards other determinants of dividend distribution, what emerges from the study is that the return on assets (ROA) and repurchase of common shares are inversely related to excess dividends. Repurchasing can be used as a tool for reducing information asymmetry and agency costs, because such a move reflects management’s confidence in the future of the REIT, and signals an undervaluation of the REIT stock by the capital markets. Both buybacks and excess dividends create the same effect, but in two different ways, because in both cases internal resources are given to shareholders, so they can be considered substitutable.

This research shines a light on the negative relationship between excess dividends and performance for REITs. The reason for this is that the best-performing REITs prefer to withhold the funds they generate and seek out new investment opportunities, confident that they can replicate their track record. Consequently, REITs that perform more poorly have to payout more dividends to remain attractive on the market.

The negative relationship between buybacks on REIT stock and excess expected dividends might reveal which REITs are less astute at identifying profitable investment opportunities, given that the REITs that withhold more cash earn higher returns, as a rule. Since these results also confirm that share buybacks are a substitute for dividend distribution, investors should see a similar signal in the distribution of excess cash flow.

As far as information asymmetry, this has a bigger impact on excess dividends in Europe than in the US. The REIT market in Europe is less developed compared to its American counterpart, and this may be the cause of a higher level of investor diffidence and skepticism, with REITs obliged to distribute higher dividends.