Real Estate Investment Trusts and Joint Ventures [1st ed.] 9783658319762, 9783658319779

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Essays in Real Estate Research Band 19 Nico B. Rottke · Jan Mutl Hrsg.

Julian Eibel

Real Estate Investment Trusts and Joint Ventures

Essays in Real Estate Research Volume 19 Series Editors Nico B. Rottke, Frankfurt, Germany Jan Mutl, Wiesbaden, Germany

Die Reihe „Essays in Real Estate Research”, herausgegeben von Professor Dr. Nico B. Rottke FRICS und Professor Jan Mutl, Ph.D. umfasst aktuelle Forschungsarbeiten der Promovenden der Lehrstühle und Professuren des Real Estate Management Institutes der EBS Business School. Forschungs- und Lehrschwerpunkte des Institutes bilden die interdisziplinären Aspekte der Immobilientransaktion sowie die nachhaltige Wertschöpfungskette im Immobilienlebenszyklus. Die Kapitalmärkte werden als essenzieller Bestandteil der Entwicklung der Immobilienmärkte aufgefasst. Die in der Regel empirischen Studien betrachten transaktions- und kapitalmarktnahe Themenbereiche aus dem Blickwinkel der institutionellen Immobiliengewerbe- und -wohnungswirtschaft, wie bspw. Finanzierung, Kapitalmarktstruktur, Investition, Risikomanagement, Bewertung, Ökonomie oder Portfoliomanagement, aber auch angewandte Themen wie Corporate Real Estate Management, Projektentwicklung oder Unternehmensführung. Die ersten 11 Bände der Reihe erschienen bis 2014 auch im Immobilien Manager Verlag, Köln. The series “Essays in Real Estate Research”, published by Professor Dr. Nico B. Rottke FRICS and Professor Jan Mutl, Ph.D., includes current research work of doctoral students at the chairs and professorships of the Real Estate Management Institute of EBS Business School. The research and teaching focus of the Institute constitutes the interdisciplinary aspects of real estate transactions as well as the sustainable value creation chain within the real estate life cycle. The capital markets are regarded as essential components of the development of the real estate markets. The mostly empirical studies consider transactional as well as capital market topicsfrom the point of view of the institutional commercial and residential real estate industry, such as finance, capital market structure, investment, risk management, valuation, economics or portfolio management, but also applied topics such as corporate real estate management, real estate development, or leadership issues in the property industry. The first 11 volumes of the series appeared up until 2014 in Immobilien Manager Publishing, Cologne, as well.

More information about this series at http://www.springer.com/series/13911

Julian Eibel

Real Estate Investment Trusts and Joint Ventures With a Foreword by Prof. Dr. Jan Mutl

Julian Eibel Real Estate Management Institute (REMI) EBS Universität für Wirtschaft und Recht Wiesbaden, Germany Doctoral Thesis, EBS Universität für Wirtschaft und Recht, Wiesbaden, 2019

ISSN 2570-2246 ISSN 2570-2254  (electronic) Essays in Real Estate Research ISBN 978-3-658-31976-2 ISBN 978-3-658-31977-9  (eBook) https://doi.org/10.1007/978-3-658-31977-9 © Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer Gabler imprint is published by the registered company Springer Fachmedien Wiesbaden GmbH part of Springer Nature. The registered company address is: Abraham-Lincoln-Str. 46, 65189 Wiesbaden, Germany

To my son Philip To my family, friends, and life companions, foremost Dr. Holger Markmann, for the unrestricted support and belief.

Foreword The thesis of Mr. Eibel focuses on the topic of the motives and role of Joint Ventures (JV) in the context of Real Estate Investment Trusts (REITs). It has thus a quite well focused topic that is relevant for both the industry as well as academic research. The dissertation is based on four connected academic research papers that each make a separate and well defined contribution to the topic. After an introduction, the thesis starts with a survey of the relevant strands of the literature in Chapters 2 and 3. The literature review serves as an introduction and basis for the rest of the thesis. It should be noted that the survey is quite impressive and comprehensive and goes in much more depth than a typical introduction. The core contribution of the thesis is, however, the empirical investigation in Chapter 4. The chapter investigates the timing of the JV announcements in order to determine whether and how the different motives for erecting a JV structure react to market conditions. The author uses time-series approach applied from the market perspective (i.e. the dependent variable is the aggregate number of JV announcements). The results demonstrate the importance of distinguishing between acquisitory and dispositional JVs (in line with the arguments in the literature reviewed in Chapter 3). The author finds that the former are driven by market conditions whereas the announcements of the second type of JVs do not seem to react to market conditions. To investigate this issue in more detail, the paper performs the same analysis from the individual firm perspective. Here a Probit estimation using a much larger dataset is utilized. The results support the conclusions from the time-series regressions. Furthermore, the individual firm perspective allows to determine whether the individual characteristics play a role. The conclusion seems to be that ‘size matters’, i.e. larger REITs are more likely to use JV structures. Furthermore, after accounting for fixed effects (i.e. partly also for size insofar this does not change dramatically over time), the leverage ratios as well as valuation (market-to-book) are shown to play a role. This again confirms what the ‘theory’ suggests. Many dissertations I have seen in the past would split the previous chapter into two parts (time-series and Probit approach) and stop here. Mr. Eibel has shown persistence and ambition and supplemented the previous analysis with one more empirical paper. Chapter 5 takes the time-series perspective again but now applied the firm level. The focus here is not to explain what makes a REIT more likely to announce a JV structure but rather at the causality (in the sense of Granger) – i.e. what are the consequences of announcing JV for the firm characteristics (such as performance, etc.) in the future as well as what are the

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Foreword

consequences of changes in firm characteristics for the usage of JVs in the future. To achieve this, a dynamic panel vector-autoregressive (PVAR) model is estimated and interpreted. Overall, the thesis of Mr. Eibel, besides being directly relevant for the practice, satisfies the highest academic standards. The analysis of Chapter 4 is well suited for publication in a top finance journal as the contribution and quantitative results are there at the level required to get in: the paper makes a clear, interesting and novel contribution to the literature using state-of-the-art methodology combined with laboriously prepared dataset. Furthermore, the PVAR methodology used in Chapter 5 is not widespread in the applied literature and hence I think that this paper also has a fair chance of getting into a top field journal. To conclude, the thesis presented by Mr. Eibel shows a great potential for academic publications and has made a clear and substantial contribution to academic research and I am happy I had the privilege to supervise it. Enjoy reading it!

With best regards,

Jan Mutl, PhD

Preface of the Author Starting in the early 1990s and fueled by several regulatory changes of the legal framework combined with several economic and financial developments, the liquidity constrained and capital-intensive real estate investment trust industry changed in nature from a passive investment vehicle structure to active real estate portfolio managers. At the same time, the heavy restrictions on REIT financing remained rather unchanged from a structural perspective and therefore stricter than for other portfolio managers, which operate [which remains to differ from corporations] in non-exogenously constrained financing environments. In parallel, the marketplace established regular use of joint venture vehicles comprising acquisitive and dispositional types. As such, I am proud to provide a valuable academic contribution to provide reasoning for this development and tendency to structure different joint venture type as well as showing the strong correlation between REIT strategy and REIT financing. Consequently, I have high hopes to reveal a better understanding of the market-timed rationale of joint venture use and the financial flexibility rationale showing the effect of REIT managers’ need for flexible financing instruments that allow for timely funding outside the regulated environment and the conventional financing instruments. Yet I hope to have stimulated scholars’ interest to include JV in the analysis of long-term strategy and financing behavior within and outside the REIT laboratory. I herewith express my deepest sense of gratitude to my first supervisor Professor Jan Mutl for his continuous academic support, motiviation, and advise as well as his inspiring leadership despite all challenges we had to take. It was an honor to work with him throughout these years. At the same time, I thank my second supervisor Professor Max Urchs, as well as Professor Nico B. Rottke and Professor Dirk Schiereck for their relentless help. However, I like to sincerely thank my former colleague and fellow PhD student Dr. Holger Markmann for his indefatigable academic and intellectual support that turned a working relationship into a lifelong friendship. I had the priviledge of collaboration with the great and admiring team of EBS REMI within EBS Universität für Wirtschaft und Recht with its outstanding academic positioning, spirit, and sense of belonging. It will stay a place to feel home. My biggest acknowledgements are dedicated to my family and friends for their commitment and all the personal sacrifices throughout this journey that made me complete my doctoral study right before the next chapter of life started and my son Philip was born to whom I dedicate this work with all my heart and love. Dr. Julian Eibel

Table of Contents

List of Figures .................................................................................................. XIII List of Tables .................................................................................................... XV List of Abbreviations ...................................................................................... XVII 1

Introduction ............................................................................................. 1

2

Joint Ventures Motives in Classical Corporations and REITs: Same or Different? ................................................................................... 7 2.1 Introduction ....................................................................................... 7 2.2 Joint Ventures Characteristics ........................................................... 9 2.3 Corporate Joint Venture Motives and Effects ................................. 11 2.4 Real Estate and REIT Joint Ventures .............................................. 24 2.5 Subsidiary Conclusion .................................................................... 37

3

Why REIT Act, REIT Capital Structure, and Diversification Needs call for Joint Venture............................................................................. 41 3.1 Introduction ..................................................................................... 41 3.2 Observations on the Use of (REIT) Equity JVs .............................. 43 3.3 Why the REIT Act calls for JV Use ................................................ 55 3.4 Subsidiary Conclusion .................................................................... 94

4

REIT Joint Venture Formations as Means for Financial Flexibility to Capture Market Timing Opportunities .......................................... 99 4.1 Introduction ..................................................................................... 99 4.2 Joint Venture Activity ................................................................... 104 4.3 Data and Methodology .................................................................. 108 4.4 Results ........................................................................................... 113 4.5 Robustness .................................................................................... 117 4.6 Subsidiary Conclusion .................................................................. 119

XII

5

Table of Contents

The Role of REIT Joint Ventures to Market Timing and Capital Structure Considerations .................................................................... 121 5.1 Introduction ................................................................................... 121 5.2 Literature ....................................................................................... 124 5.3 Data and Methodology .................................................................. 128 5.4 Results ........................................................................................... 135 5.5 Subsidiary Conclusion .................................................................. 145

6

Conclusion and Implications............................................................... 149 6.1 Summary and Conclusion ............................................................. 149 6.2 Implications for Future Research and Policy ................................ 151

References ........................................................................................................ 153 Appendices....................................................................................................... 171

List of Figures Figure 1: Figure 2: Figure 3: Figure 4: Figure 5: Figure 6: Figure 7: Figure 8: Figure 9: Figure 10: Figure 11:

Restriction on internal financing ................................................ 2 Accounting treatment of Joint Ventures .................................... 3 Joint Venture Rationale Framework for REIT ........................... 9 Categorization of JV Motivation .............................................. 13 Formation of Acquisitive REIT JV Structures ......................... 51 Formation of Dispositional REIT JV Structures ...................... 53 The development of REIT JV announcements 01/2003-09/2014 .................................................................... 105 Roots of Companion Matrix for Panel A ............................... 137 Roots of Companion Matrix for Panel B ............................... 137 Impulse Response Function for Panel A ................................ 143 Impulse Response Function for Panel A ................................ 145

List of Tables Table 1: Table 2: Table 3: Table 4: Table 5: Table 6: Table 7: Table 8: Table 9: Table 10: Table 11: Table 12: Table 13: Table 14: Table 15: Table 16: Table 17: Table 18: Table 19: Table 20: Table 21: Table 22: Table 23:

Exemplary Financial Acquisition Capacities ........................... 52 JV Deal Types and Distribution ............................................. 106 JV Property Type by JV Type................................................ 107 JV Transaction Value per JV type ......................................... 108 Descriptive statistics .............................................................. 111 Correlation matrix .................................................................. 112 OLS ........................................................................................ 114 OLS with lagged economic data ............................................ 115 Panel Random Effects Probit ................................................. 116 Panel Random Effects Probit with lagged economic variables ..................................................... 117 Pooled Probit.......................................................................... 118 Pooled Probit with unconditional Fixed Effects ..................... 119 JV Deal Types and Distribution ............................................. 129 JV Transaction Value per JV type ......................................... 130 JV Relative Distribution of Transaction Value by JV type .... 131 JV Relative Distribution of Transaction Value by JV type .... 132 Summary Statistics of Panel Data .......................................... 133 Granger Causality Tests for Panel A and Panel B.................. 136 PVAR Model Results for Panel A and Panel B ..................... 138 Simplified PVAR Model Results for Panel A and Panel B ... 140 PVAR Model Results excluding market data (Panel A) ........ 171 PVAR Model Results including market data (Panel B) ......... 172 Estimated Impulse Coefficients for Panel A and Panel B ...... 173

List of Abbreviations AD AJV ATM CAR CEO DIV DJV EO EPS FFO GAAP GDP HPI IO IPO IR IRF IRS JV LTV M&A MBR NPV OLS OPRA R&D REIT REOC RMA ROA ROE S&P SD SEO SPV TRA TRS

Announcement Date Acquisitive Joint Venture At-The-Market Cumulative Abnormal Return Chief Executive Officer Dividend Pay-out Ratio Dispositional Joint Venture Equity Offering Earnings per Share Funds from Operations Generally Accepted Accounting Principles Gross Domestic Product House Price Index Institutional Ownership Initial Public Offering 6-month t-bill Interest Rate Impulse Response Functions Internal Revenue Service Equity Joint Venture Loan-To-Value Mergers and Acquisitions Market-to-Book-Ratio Net Present Value Ordinary Least Squares Omnibus Budget and Reconciliation Research and Development Real Estate Investment Trust Real Estate Operating Company REIT Modernization Act Return on Assets Return on Equity Standard and Poor’s Standard Deviation Seasoned Equity Offering Special Purpose Vehicle Tax Reform Act Taxable REIT Subsidiary

XVIII

UPREIT US USD VAR

List of Abbreviations

Umbrella Partnership Real Estate Investment Trust United States of America United States/American Dollar Vector Autoregression

1 Introduction We1 study the contribution of equity joint venture (JV) use to listed and traded US-Equity Real Estate Investment Trusts (REITs).2 Specifically, we attempt to reveal the meaning of JVs as platform to provide financing flexibility in a liquidity constrained and capital-intensive environment opposing several financial restrictions on the market participants in the REIT industry. To introduce the topic and lay out the basic understanding, we therefore present the challenges opposed by the REIT Act to the REIT managers followed by the background of financing flexibility concept. We then illustrate why we choose JV as research object as means of REIT financing flexibility. We then present the composition of the work. Existing research reveals that REITs face a number of limitations in the efficient use of funds while complying with the legal duties required by the REIT Act.3 These are financial constraints in capital retention (Campbell, WhiteHuckins, & Sirmans, 2006; Riddiough & Wu, 2009), limited ability to internally finance new investments (Campbell, Petrova, & Sirmans, 2006; Ott, Riddiough, & Yi, 2005), a negligible cash balance of only 1.4% of total assets compared to 18.5% in classical corporations (Damodaran, 2005; Hardin III, Highfield, Hill, & Kelly, 2009), and a large dependency on capital markets (Aguilar, Boudry, & Connolly, 2018; Brounen & de Koning, 2013; Devos, Devos, Ong, & Spieler, 2019; Dogan, Ghosh, & Petrova, 2019; Hardin III & Hill, 2008). REITs have therefore limited financial latitude and rely on the availability of (short-term) bank lines (An, Hardin III, & Wu, 2012; Dogan et al., 2019; P. Eichholtz & Yönder, 2015; Howton, Howton, & Scheick, 2018; Riddiough & Wu, 2009). In consequence, REIT managers need to manage permanent funding access to be able to react to market movements and to avoid underinvestment (Hartzell, Howton, Howton, & Scheick, 2019; Howton et al., 2018). Due to the restrictive REIT legislation, existing studies conclude that REIT managers seek operational and financial flexibility (Campbell, 2002; Campbell, Petrova, et al., 2006; Campbell, White-Huckins, et al., 2006; Hartzell et al., 2019; Howton et al., 2018). Managers are particularly encouraged to seek financial flexibility by alternative means, when they experience weaker capital market access and higher degree of financial 1 2 3

For consistency, ease of readability and comprehension, we use the first person plural entirely throughout the document. Co-authorship is explicitly mentioned. We follow the common approach in the literature to concentrate on (listed and traded) equity REITs, more information is provided in Section 3.3. Section 3.3 gives an overview on the REIT Act development since inception in the 1960s.

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 J. Eibel, Real Estate Investment Trusts and Joint Ventures, Essays in Real Estate Research 19, https://doi.org/10.1007/978-3-658-31977-9_1

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1 Introduction

distress and need to timely obtain funding for a specific (investment) purpose (Hartzell et al., 2019; Howton et al., 2018). Further literature reveals that REITs apply a market timing theorem so that equity offerings (EO) issues are executed in a favorable market environment and manager are reluctant in indolent market conditions due to undervaluation (Feng, Ghosh, & Sirmans, 2007). To attract new funds (for growth), REITs have to regularly issue new shares which contradicts classical financing theories and pecking order (Goodwin, 2013). As consequence, REIT managers are heavily limited in their strategic financing options and need to closely monitor their liquidity as well as their financing structure to balance external financing for investment and operating objectives (An et al., 2012). REIT financing structure will prove itself to largely differ from corporations in non-exogenously constrained financing environments throughout this work. Figure 1 illustrates the underlying constraints on REITs internal financing rationales. It shows the substantial dependence of REITs on public capital markets to acquire new funds. REIT

+

Capital increase (SEO)

Revenue

Investor Sentiment

EBITDA

Capital intensity

EBIT EBT EQUITY

Potential losses through economic impacts

Required dividend payment (~90%) Retained earnings (~10%)

-

Loss of rent Investment requirements

Figure 1: Restriction on internal financing Source: own illustration Note: The figure depicts the determinants that influence the equity position of REITs in a simplified way.

JVs4 had not been structured prior to 1994 in the REIT marketplace (Campbell, White-Huckins, et al., 2006; Ro & Ziobrowski, 2012), Hess and Liang (2004) argue that this might be caused by REIT Modernization Act (RMA) of 1999 that affected REIT portfolio strategy and concluded that REIT JVs were on the rise by 2002. A few studies identify a financing function of REIT JVs to allow for sufficient funding in property acquisitions in line with an identified capital attraction 4

The concept of JV is presented in more detail in Section 2.

1 Introduction

3

motive for real estate companies (Behrens, 1990; Campbell, 2002; Campbell, White-Huckins, et al., 2006; Elayan, 1993; Hess & Liang, 2004; Siegel, 1999). In line with US Generally Accepted Accounting Principles (GAAP)5 as i.a. depicted by Ernst & Young LLP (2019), the dividend distribution requirement can be partially mitigated and liquidity can be accumulated outside the REIT balance by using accounting treatments in the JV that allow for decreasing transparency. Hence, occurring costs and cash flows are shielded from the REIT in the JV (Campbell, White-Huckins, et al., 2006), the JV structure has own debt capacities so that additional debt can be obtained off-balance in JVs in line with Siegel (1999), Kibel, Emrick, Bisono, and Kriz (2006), and An et al. (2012). Campbell et al. (2006) conclude that REIT JV offer the ability to structure corporate option and flexibility, whereas Freybote, Gyamfi-Yeboah, and Ziobrowski (2014) presents a refinancing function. Figure 2 illustrates the different accounting treatments in line with US GAAP. Capital market: Shareholder / Investors

REIT Management

Joint Ventures

100% REIT Investments and Shareholdings >50% Threshold

At equity (in general) Fair Value (optional)

Full consolidation

Transparency problem

Figure 2: Accounting treatment of Joint Ventures Source: own illustration Note: The figure depicts the accounting treatment of joint ventures compared to full and majority investment in line with Ernst & Young LLP (2019).

In the attempt to determine the contribution of JVs to REITs and in particular as means of financing flexibility against the background of various financial restrictions opposed by the institutional and regulated environment of the REIT Act, this work contributes to the identified financial flexibility constraints and the corresponding evolving financial flexibility body of literature that suggests and implies that REIT managers are in need of flexible financing instruments that allow

5

Similar accounting and consolidation procedures are found in Europe.

4

1 Introduction

timely funding outside the regulated environment and its conventional financial instruments. The structure of this work is as follows: The basic body of this dissertation is mainly comprised by four individual research papers 6 on REITs and JV use, thereof Section two (paper one) starts an analytical review of the motivation and rationales of JV that are already identified in the corporate, real estate, and REIT literature. Section three (paper two) applies an holistic view to deduct and apply different rationales and perspectives on specific REIT behavior and peculiarities that existing research has shown to result from the exogenous-restricted environment. Section four (paper three) determines if there is a market timed financial flexibility-rationale for REIT JVs as means of financial flexibility to correspond to market opportunities. Section five (paper four) analyzes if a specific financing role of REIT JV exists with regard to market timing and capital structure considerations. Section six concludes and gives recommendations for future research related hereto. The research structure and composition of each Section (paper) is presented in more detail in the subsequent paragraphs. In particular, Section two is structured as classical literature review and introduces the background of this thesis and thereby also lays out the basic terminologies for all following Sections herein. We compare the underlying rationales, motivation, the use, and the associated benefits between classical corporate and REIT JV use to determine if the JV use differ across these marketplaces. In Section three (paper two), we extend the research findings of the previous Section (paper one) and postulate a holistic concept why REITs erect JV structures. Considering the insights of existing research from various literature streams, we identify various managerial rationales for REIT JVs. In detail, we review literature streams on REIT Act, REIT capital structure including the literature on secondary equity offerings (SEO), and diversification, which have several specialties in common within the REIT area and contradict classical corporation, to determine if these factors foster REIT JV use. In the subsequent Section (paper three), we analyze if REIT JV, differentiating between both acquisitive and dispositional structures, are motived and used by REIT managers’ demand for operational and financial flexibility. We determine if REIT JVs are a function of changes in the space and capital markets as proxies for market opportunities and base our analysis on a manually coded dataset 7 with 1,146 REIT JV announcements from 2003 to 2014. We first control for market data as time-series followed by a panel that comprises market data and specific REIT characteristic to analyze whether JV announcements can be explained by specific financial REIT data to determine market timing aspects. We assume that 6 7

Due to the content-related overlaps, repetitions may arise throughout this work. Raw data was provided by SNL Financial. The authors reviewed all transactions and manually coded for missing data.

1 Introduction

5

REIT JVs occur when financial frictions exist that do now allow to access classical financing instruments Section five (paper four) focuses on the financial contribution of REIT JVs with regard to market timing and capital structure considerations further elaborating the financial flexibility rationale. The focus of this Section is to assess if JV use is limited to short-term financing when financial frictions exist that do now allow to access classical financing instruments or if JV contribute to long-term financing. In order to draw conclusion on the underlying (financial) motive as means of financial flexibility we apply a dynamic Panel (VAR) model. Chapter six concludes the dissertation thesis by applying a holistic conclusion on our main findings. In addition, we elaborate identified research needs in the REIT JV area to further explore the underlying motivation and resulting benefits

2 Joint Ventures Motives in Classical Corporations and REITs: Same or Different?8 2.1

Introduction

While JV had not been structured prior to 1994 in the REIT industry (Campbell, White-Huckins, et al., 2006; Ro & Ziobrowski, 2012), more than 1,100 joint venture announcements by REITs were set up between 2003 and 20149 motivating us to review and compare existing findings on JV motives and effects of regular corporations to REITs to explain joint venture use in the REIT marketplace. We thereby tie in with the argumentation and research proposition of Campbell (2002) and Campbell, White-Huckins, et al. (2006) that motivation and strategic application should be different in the case of REITs compared to classical corporations. Contradictory, we assume that general motivation and application areas do not differ. As such, we shed light on the dominant rationale of REIT JV use as existing research has shown that 24% of all property acquisitions and about 14% of all properties held by REITs are jointly executed and owned respectively with the relatively use of JV growing three times faster than the overall acquisition pace of REITs in the timeframe from 1998 to 2002 (Hess & Liang, 2004).10 JVs and the underlying dominant rationales are well researched for the corporate world and attracted academic interest in the fields of strategic management, finance, and other literature with foci on the theoretical and empirical analysis of characteristics, motivation, and effects of joint organizational entities. As depicted by Beamish and Lupton (2009), the existing streams of literature can be classified in (1) performance-related, (2) knowledge management, (3) internationalization / globalization, (4) cultural differences, (5) governance and control, and (6) joint venture valuation issues. However, in real estate and especially the REIT literature the field of JV has not yet fully addressed the question of the underlying 8 9 10

This Section is co-authored by Dr. Holger Markmann and is intended for separate publication. We apply a dataset based on SNL Financial data with these announcements, see Section 4 and Section 5. While it needs to be acknowledged that this growth pattern is asymptotic, i.e. it can not be continued to perpetuity.

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 J. Eibel, Real Estate Investment Trusts and Joint Ventures, Essays in Real Estate Research 19, https://doi.org/10.1007/978-3-658-31977-9_2

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2 Joint Ventures Motives in Classical Corporations and REITs

motivations of REITs for joint venture erections. While existing studies analyze the underlying strategic rationale with regard to achievable synergies11 and the capital markets effects around announcement date (AD), yet an attempt to explain the huge difference between corporate and REIT JV use is missing. In their attempt to explain REIT JV motives, Hess and Liang (2004) find that REIT joint venture use is accelerating by showing that REITs have increased joint venture structures from 11.7% in 1998 to 13.7% by year-end 2002. Since then announcements of joint venture erections and changes of threshold in JV have been regularly issued by REITs. This research contributes to existing research by reviewing and comparing the classical joint venture with REIT joint venture literature to draw conclusions on deviations in the rationale, the motivation, the use, and the benefits between classical corporate and REIT JV use. We conclude that the dominant motivation and strategic applications for REITs are identical to classical corporations, while the only differentiator in the REIT world is the application on the asset class real estate and the exclusion of pure R&D activities which can still be referred to as real estate development activities and are comparable to all uncertainty-mitigating aspects in the classical JV literature. It remains open to debate if the REIT Act and its practical effects implicate further motivations to co-invest in JVs that can, however, be based on the herein identified motives. So far, several studies have identified that the REIT sector is cash-restrained (An et al., 2012; Hardin III et al., 2009; Hardin III & Hill, 2008; Riddiough & Wu, 2009) but not yet established that there has to be a connection to joint venture activities in the REIT sector, which becomes the apparent differentiator between corporate and REIT JV. We apply the following framework, as depicted in Figure 3, for our research, we first examine the findings of joint venture literature and combine them with the findings on real estate rationales to apply these two in the REIT marketplace. The remainder of this paper is organized as follows. Sub-Section two reviews the described characteristics of JV the general motives of companies to enter joint venture structures, while Sub-Section three concentrates on motives and empirical findings in the real estate and REIT area. The final Sub-Section presents the conclusion and gives recommendations for further research.

11

Further, the synergy aspect looks different in the real estate industry and most importantly presents itself to be rather unstudied in the special case of REITs.

2.2 Joint Ventures Characteristics

9

Joint Venture Rationale Framework for REITs Joint Ventures

vs

Mergers & Acquisitions Permanent Acquisition of all resources & assets

Non-permanent Acquisition of single, needed resources

No market, i.e. not relevent Corporate JV Rationale

well-researched for non-RE corporates

Largely Applicable

Largely Non-Applicable

Business Extension

Network Effects

International JV

Signals

Capital Structure

Risk Sharing

well-researched

REIT- Regulation Rationale Largely Applicable

Largely Non-Applicable

Investment Finance

Network Effects

International JV

Signals

Capital Structure

Risk Sharing

research gap

RE Rationale Largely Applicable

Largely Non-Applicable

RE Development (=Min. Risk)

Network Effects

Investment Enhancement

Signals

JV Signals

Risk Sharing

well-researched

Figure 3: Joint Venture Rationale Framework for REIT Source: own illustration

2.2

Joint Ventures Characteristics

Kogut (1988a) defines (equity) JVs as separate legal organizations set up as platforms to share resources and as complementary option to acquisitions, supply contracts, license provisions, or purchases at spot market. Further, JV entities get own identities and are liable with own share capital (Schut & Van Frederikslust, 2004). In more detail, Harrigan (1988a) defines JVs as contractual agreements of two or more sponsors to erect a separate entity, while Borys and Jemison (1989) refer to them as hybrid organizational arrangements. Beamish (2008) concludes JVs are formed on the basis of contractual agreements between two or more companies to invent new product and service lines, penetrate new or international markets. JVs can be differently related to its parents in terms of vertical and horizontal integration: Vertical JVs are structured by the parents to establish a buyer-seller relationship with the new entity, while horizontally integrated JVs are set up in the same strategic area as the parents (Harrigan, 1988a). Most JVs are focused on the purpose of shared R&D, marketing, and technological licensing as i.a. lined out by Mariti and Smiley (1983), Harrigan (1985b), Contractor and Lorange (1988), and Kogut (1991). Thereby, companies engaging in JVs gain access to distinctive

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2 Joint Ventures Motives in Classical Corporations and REITs

expertise and know-how (Kanter, 1989; Koh & Venkatraman, 1991; Powell, 1990), enabling a competitive advantage over the environmental and industrial competition (Harrigan, 1988a). Depending on the JV objective, JV partners need to choose the organizational and juridical JV form and choose either the form of a partnership, a closely held corporation, or a corporation with right to issue securities in its own name (Harrigan, 1988a). Equity contributions facilitate the collaboration as commitment signal and thus symbolize a success-prerequisite in the long-run (Beamish & Lupton, 2009). In particular, equity JVs are legally separate entities with two or more shareholders holding at least 5% of all share capital, whereas significant shareholder influence is attributed to a minimum of 20% ownership in several jurisdictions resulting in different accounting treatment and effects in most jurisdictions (Beamish & Lupton, 2009). While resources of the different partners are polled in the new legal entities, the parental firms’ management remains with their original company and structural changes are not required on the parental level (McConnell & Nantell, 1985). To distinguish, Harrigan (1988a) also introduces the term “cooperative agreements” where JVs are erected without contributing equity that offer the benefit of termination ease compared to equity JVs but not involve as much resources and efforts in line with Harrigan (1985b, 1986) and Mantecon and Chatfield (2007) elaborating equity JVs to be the most cost effective solution in line with Williamson (1979, 1985). Further, one needs to differentiate minority investments where sponsor companies invest in existing entity’s equity and do not create a new entity and therefore do not offer the same strategic benefits as JV agreements (Harrigan, 1988a). Consequently, they are excluded in our research. Additionally, (equity) JVs offer superior performance compared to other cooperative agreements as pointed out by Koh and Venkatraman (1991) and thus we will concentrate on those JVs where the partners contribute equity stakes if not explicitly otherwise presented.12 Commonly interchangeably used is the term strategic alliances,13 Koza and Lewin (1998) conclude that alliance goals need to be differentiated between exploitation and exploration intention: Explorative JVs follow the goal to monetize existing market places through innovation and invention, risk taking and new capability creation, whereas exploitative entities are set up to minimize costs and increase productivity of existing resources through standardization (Koza & Lewin, 1998). With regard to thresholds, scholars, foremost Harrigan (1988a), have postulated the importance of equal ownership distribution among partners. Empirically, however, most shareholder value seems achievable in JVs 12 13

This is in line with previous studies in the context of REIT joint ventures, i.a. Campbell, White-Huckins, et al. (2006). Y. Wang and Rajagopalan (2015) provide an in-depth literature on alliance building differentiating three stages of analysis resulting in a framework how to best capture value.

2.3 Corporate Joint Venture Motives and Effects

11

that do not have equal ownership, as equal ownership leads to abnormal negative returns while both majority and minority holders gain positive abnormal returns (Schut & Van Frederikslust, 2004). Recognizing a concentration on international expansion aspects in the JV literature, Harrigan (1988a) presents a framework combining industry characteristics and strategic alternatives that shape JVs characteristics in the dimensions of (1) the organizational form with regard to shareholding structure, (2) strategic focus, (3) operating autonomy, and (4) duration. Beamish and Lupton (2009) depict a four-stage JV erection four-stage process initiated by the assessment of strategic rationales, followed by a partner selection process, and the negotiation of the agreement finished by the final erection of the new venture and its subsequent management. Simultaneously, the performance goals and definition of a JV needs to be established a priori and is a strategic subject throughout the erection process, whereas, besides financial JV KPIs, JV success can also be subject to subjective terms, such as expertise transfer and capability development, JV lifetime, ownership stability, number of patents, and market value changes of the sponsoring firms (Beamish & Lupton, 2009). JVs do not only mitigate informational asymmetries and are more efficient than other arms-length collaborations (Mantecon & Chatfield, 2007), McConnell and Nantell (1985) find in their investigation14 that JV use contributes and generates value for the parent firms in line with synergy hypothesis, even though they do not further analyze the impact of different strategies, characteristics, and industry effects. This analysis would be beneficial in order to generate a better understanding how to maximize value from JV activities (Koh & Venkatraman, 1991). However, Harrigan (1988b) concludes from her attempt of JV characteristics’ isolation that industry-traits rather than specific strategies or characteristics of the vehicle itself matter. Madhavan and Prescott (1995) subsequently control for industry-effects and find return differences across industries depending on the information-load the capital markets possess about a certain industry. Additionally, JV erections seem to follow some market trend that can not be explained by any market determinants, while it could be inferred that JVs are erected because competitors do so (DiMaggio & Powell, 1983; Kogut, 1988a).

2.3

Corporate Joint Venture Motives and Effects

The dominant logic of JV erection as a corporate combination is to share resources (Beamish, 2008; Beamish & Banks, 1987; Beamish & Lupton, 2009; Corgel & 14

McConnell and Nantell (1985) apply an event-study methodology on a sample of 136 joint ventures from various industries.

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2 Joint Ventures Motives in Classical Corporations and REITs

Rogers, 1987; Darrough & Stoughton, 1989; Harrigan, 1985a, 1985b, 1985c, 1986, 1987, 1988a, 1988b; Hennart, 1988, 1991; Hennart & Reddy, 1997; Inkpen & Beamish, 1997; Johnson & Houston, 2000; Kogut, 1988a, 1988b, 1991; Powell, 1990). As Powell (1990) depicts, companies seek JVs to gain technological expertise and assets, market access, economies of scale in research and production, expertise capitalization, and risk sharing platforms which supports the transaction rationale in the literature stream. However, the resource sharing platform, the JV, can then consequently be utilized for various alternative operational reasons (Johnson & Houston, 2000). Motivation-wise, Kogut (1988a) argues the erection decision follows transaction costs, strategic behavior, and organizational knowledge and learning motives, while Koh and Venkatraman (1991) summarize the existing literature stream on JVs and classify four different streams: (1) strategic motives that relate to the improvement and increase of market power and operating efficiency, (2) effectiveness matters focusing on the issue which parameters need to be in place to make the joint matters most effective and the impact itself, (3) efficient market mechanisms explaining that JVs are the best instrument to minimize the costs of production and transaction, and (4) effectiveness of governance mechanisms arguing that firms engaging in JVs show better performance than those that do not. Following the approach of more operational clustering by Johnson and Houston (2000) who divide the motives in (1) Synergy Sharing, (2) Governance of Hazardous Transactions, (3) Supplier Finance Constraints, and (4) Efficient Risk Sharing, we cluster the rationale into the eight sub-rationales as depicted in Figure 4. In line with the aforementioned, we identified eight main application streams, consisting of (C1) investment financing (C2) international expansion, (C3) business extension, (C4) risk-sharing and uncertainty, (C5) international expansion, (C6) partner signals, (C7) information hub and network learning, and (C8) M&A alternative rationales, in the general literature, while six application areas of very similar nature, comprising (RE1) investment financing vehicle (RE2) international expansion, (RE3) business extension, (RE4) real estate development or high risksharing (RE5) investment enhancement and signaling, and (RE6) M&A alternative rationales, can be identified in the REIT area. Figure 4 depicts how our categorization fits into existing research categorizations. The motives in the REIT area relate to needs for specific properties as well as to meet operational business needs.

REI T Framework

Figure 4: Categorization of JV Motivation Source: own illustration

Harrigan (1988a)

Johnson & Houston (2000)

Beamish & Lupton (2009)

Corporate Framework

Concept

Success factors (market)

- Risk-Sharing & Uncertainty Rationale

- Spider Web of Joint Ventures and Network Learning

I mprovement of market power & op. efficiency

- Business Enhancement Rational and Restructuring of Current Market Power - Spider Web of Joint Ventures and Network Learning

Real Estate Business Rationales

Real Estate Specifics (property-specific)

Category 3

Corporate Rationales

- Spider Web of Joint Ventures and Network Learning - Business Enhancement and Restructuring of Current Market Power

Change of Characteristics

- Investment Financing Rationale and Transaction Cost

Supplier Finance Constraints

- Investment Financing Rationale and Transaction Cost - Business Extension Rationale

Success factors (corporate)

- M&A Alternative Rationale - Joint Venture Signals

Governance Rationales

(RE1) Investment financing vehicle & (C1) Investment Financing

(RE6) M&A alternative / (C8) M&A alternative (C6) Information Hub and Network Learning (RE5) Investment Enhancement and Signaling (C7) Partner Signals (C2) Business Enhancement (RE4) Real estate development or high risk-sharing (C4) Risk-sharing and Uncertainty (RE3) Business extension / (C3) Business Extension (RE2) international expansion / (C5) International Expansion

Profit Level stabilization

- M&A Alternative Rational - Investment Financing and Transaction Cost - Risk-Sharing and Uncertainty Rationale

Competitive Advantage

- M&A Alternative Rational

- International Joint Ventures - Business Extension Rationale - Spider Web of Joint Ventures and Network Learning

- Business Extension Rationale - International Joint Ventures - Joint Venture Signals

- Joint Venture Signals

Governance of Hazardous Transactions

- Business Enhancement Rational and Restructuring of Current Market Power

Synergy Sharing

- Business Extension Rationale - Investment Financing Rationale and Transaction Cost - International Joint Ventures - Business Enhancement Rational and Restructuring of Current Market Power - Risk-Sharing and Uncertainty Rationale

Descriptive

- International Joint Ventures

Category 2 Business Rationales

Category 1

- Risk-Sharing and Uncertainty Rationale

Efficient Risk Sharing

- Joint Venture Signals

- M&A Alternative Rationale

Governance

Category 4

2.3 Corporate Joint Venture Motives and Effects 13

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2 Joint Ventures Motives in Classical Corporations and REITs

Investment Financing and Transaction Costs Argued by Johnson and Houston (2000), vertical JVs can serve as financing platform between a buyer and seller / supplier in order to circumvent financing constraints of the seller given asymmetric information with regard to new working capital requirements to fulfill the contract in line with Myers and Majluf (1984). As such, JVs are formed where the original buyer injects the needed capital in exchange for equity ownership and control serving as security, whereas the supplier provides the needed expertise resources as production inputs (Johnson & Houston, 2000). Consequently, vertical JVs can also be initiated by suppliers in order to reduce capital requirements and risk for a new buyer’s order. In particular, JVs with buyers enable to realize more orders and an increased dependence of the buyer on the supplier while value increases in dependence of insolvency costs, which is to be recommended to suppliers with a high risk exposure and a small degree of customer diversification (Johnson & Houston, 2000). In parallel, vertical JVs allow to circumvent hold-up hazards that can arise from asset specificity, transaction uncertainty, and transaction complexity (Alchian & Woodward, 1987; Johnson & Houston, 2000; Klein, Crawford, & Alchian, 1978; Williamson, 1979). Setting up JVs restricts the mutual interdependeny as such that suppliers avoid to be left with sunk asset-specific capital for buyer who then change to different suppliers or demand contract renegotiation or vice versa the supplier could monetize the switching costs of the buyer (Johnson & Houston, 2000). This is in line with Berg and Friedman (1977) concluding that the attraction and acquisition of capital are the main drivers for JVs, while Beamish and Lupton (2009) argue that the pooling of complementary capabilities and resources in a JV make product development faster, more reliably, and more cheaply compared to each partner working alone or corporate acquisitions through achievable economies of scale and / or scope. This confirms the research findings of Hennart (1988) who concludes that the main motive for JV activity is to reduce transaction costs to a minimum. From a transaction cost perspective, JVs lower production and transaction costs in line with different cost structures arising from operative scale and scope, the current learning status, and the underlying knowledge, and the underlying expenses for legal contracts and claims (Kogut, 1988a). This results in higher dependence levels but also stabilizing relationships, and transaction enforcement (Kogut, 1988a; Williamson, 1975, 1985). The decision depends on the underlying bargaining of the involved parties so that one company may decide to produce a certain good on one’s own even though suppliers would be cheaper but the dependence on this party is more costly from a transaction perspective. Combined with a production perspective, Kogut (1988a) determines JVs to be corporate combinations that overcome acquisition diseconomies, the issue of managing non-core business activities, and the higher costs of own research,

2.3 Corporate Joint Venture Motives and Effects

15

development and production. JVs are therefore erected when at least one partner experiences costs benefits. Additionally, JVs are favored over long-term contracts when high performance uncertainty and asset specificity are given thus enforcing a competitive production advantage. This theory goes hand in hand with a strategic rationale for JV erections for profit maximization through reshaping the positioning towards competition as depicted by Harrigan (1988a). This also results in welfare effects as duplications of activities in research and development are avoided and finally assets can be produced at lower prices and higher quality. In line with Vickers (1985), Kogut (1988a) argues that JVs can be means for safeguarding competitive positioning so that competitors can not enter or experience disadvantages and postulates that JVs serve a safeguard-function for strategic uncertainty in line with Vernon (1983). Though, the two frameworks of strategic behavior and transaction costs share certain traits but result in the search for the partner that best hedges the current competitive positioning with the potential to drive competitors out of the market while the latter yields a search for a partner with the best skillset to drive down costs (Kogut, 1988a). Applying a holistic perspective, JVs enable investments in more projects for a given capital basis as project investments are shared and thus needed resources and risk are reduced (Johnson & Houston, 2000). Business Enhancement and Restructuring of Market Power Darrough and Stoughton (1989) conclude that the main drivers for JVs are joint resource control and synergies given the opportunity of joint strategic exploitation to achieve a comparative advantage to enhance the current business and to reorganize the current market power. In addition, Harrigan (1985b) suggests JVs are set up in those cases where an investor can bring in its specific knowledge and ability, where one is leading, and can concentrate on this in the JV. Further, JVs allow to foster corporate learning as well as the retention of knowledge and capabilities so that the partners inject their knowledge with the intention to sustain and enlarge competitive advantages as they are mostly protected within organizational borders (Kogut, 1988a; McKelvey & Aldrich, 1983). Thereby, other forms of partnering are obsolete, as knowledge can not be transferred at zero costs and the JVs represents the platform for duplicating expertise to exploit future potential (Kogut, 1988a). Therefore, JVs are formed if a positive value comparing benefits over cost is recognized. Consequently, Koh and Venkatraman (1991) postulate that the positive synergies achievable through the combination of resources between the JV partners should lead to positive abnormal returns of the single stock prices once a JV is announced if the JV is related to the core business of the parent company finding two-day abnormal returns of 1.32% for identical parents and 0.37% for unrelated parents. Further, Johnson and

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2 Joint Ventures Motives in Classical Corporations and REITs

Houston (2000) find positive abnormal returns of 0.65% in 59 horizontal JVs and confirm the horizontal synergy assumption which enhances the current business positioning and the current market power. Business Extension In order to achieve business extension, JVs are erected to generate the needed assets to achieve the corporate growth goals (Harrigan, 1985b). These assets can be defined as lacking knowledge (Kogut, 1988a; Teece, 1986) which depends on the willingness and ability of a company to generate new knowledge in addition to the existing know-how base and its absorptive capacity (Cohen & Levinthal, 1990; Hamel, 1991; Shenkar & Li, 1999). Through the rationale to maintain and extend knowledge, companies are willing to accept failure and high instability rates caused by the underlying complexity (Contractor & Lorange, 1988; Gomes-Casseres, 1987; Kogut, 1989; Osborn & Hagedoorn, 1997; Shenkar & Li, 1999). The success and the subsequent value creation depends on the set strategic direction, the decision-making processes embedded in the environmental context, and control level (Schut & Van Frederikslust, 2004). Following Bresnahan and Salop (1986), Reynolds and Snapp (1986), and Kwoka Jr (1992), JVs follow the rationale to increase market power and the busines scope. Thus, there should be no full overlap of the sponsors’ core businesses but the more overlapping the core businesses of the partners are, the greater gains in market power in their product-market space should be, which implies an inverted-U-correlation as neither assets and skills should be duplicated nor should the complementary skills be too diverging (Mohanram & Nanda, 1998). These benefits come, however, at potential costs for coordination between the partners, costs for the loss of a competitive edge as the partner-competitor gains access to know-how. However, market entry barriers can be lowered (Koh & Venkatraman, 1991). Finally, an adverse bargaining position can be created from sunk and specific investments that enables one partner to capitalize an excessive value of the JV (Balakrishnan & Koza, 1993; Koh & Venkatraman, 1991). Harrigan (1988a) conclude that JVs are strategic vehicles to initiate strategic change or to enforce and extend the current strategic positioning of one firm with resources that the sponsor can not afford and establish on a stand-alone basis by postulating that JVs become more important the shorter product life cycles become, cost leadership are necessary, the more international competitors are. Thereby, the formation of JVs can be described as a strategic option in mature economies and can even be characterized as generic alternative within mature domestic economies (Harrigan, 1988a). Further, JVs can be abused by management to achieve larger companies in line with Jensen (1986) or to diversify risk upon acceptance of lowering profitability ratios (Mohanram & Nanda, 1998). JV

2.3 Corporate Joint Venture Motives and Effects

17

erections represent a fundamental change in the competitive behavior that can affect industry structures and strengthen the competitive positioning of a firm through three factors: (1) gain of competitive advantage, (2) profit level stabilization, and (3) changes in the structure of vertical integration, technology, and industry characteristics (Harrigan, 1988a). Harrigan (1987) summarizes the role of JVs in restructuring industries and to solve overcapacity issues, as they can be used to reshape a company’s skillset by accelerating the process of technological development through risk sharing between partners. Further, she elaborates that JVs can be well used for the introduction of new products through licensing, shared development, and other forms of cooperation but also for restructuring by combining complementary assets to achieve economies of scale and scope. Hence, exit barriers can be circumvented and capabilities can be transformed into new industries and product areas and a business extension can be achieved. She argues that especially companies from mature economies use JVs to sustain competitive advantages facilitated by deregulation of economies, shorter product life cycles and faster product replacements, higher capital needs, higher associated risks, market entries of new firms from domestic and international markets as well as globalization, and communicative coalescence (Harrigan, 1987). Further, vertical integration through JVs offers the potential to achieve all advantages from downstream integration while lowering exit barriers if the business potential is not in line with the overall company strategy (Harrigan, 1985c). Corgel and Rogers (1987) link JVs to the classical financing theorem of Modigliani and Miller (1958) and its subsequent investigations and summarize that JVs erections represent a financial restructuring of the parental firms as the given set of financial agreements may be affected and thus a share price reaction should be observable as synergies may be achieved in line with Bradley, Desai, and Kim (1983). Empirically, Balakrishnan and Koza (1993) conclude from their analysis of 64 domestic JVs and 165 acquisitions between 1974 and 1977 that JV announcements follow strong performance, while the erection could also be means of further performance improvement. In contrast, Nanda and Williamson (1995) report several occasions in their sample where JVs are a result of division-wide underperformance. In contradiction, Mohanram and Nanda (1998) find in their analysis of 253 JV announcements between US corporations from 1986 to 1993 that JVs are erected when the parent firms perform weakly regarding stock market undervaluation and a subsequent weak accounting-wise performance leading to positive abnormal returns of 0.49% in a two day window upon AD representing an average excess return of USD 17.8 million. The reactions to synergy effects can be attributed to resource combination (positive reaction), managerial misalignment in terms of abuse of free cash flow (negative reaction), and signaling effects for small firms when entering JVs with larger companies supporting their value

18

2 Joint Ventures Motives in Classical Corporations and REITs

(Mohanram & Nanda, 1998). Further, JVs create value measured by abnormal returns if the key business areas are neither overlapping nor too diverse from each other in order to lever the complementary skillset best possibly (Mohanram & Nanda, 1998). In line with Gomes-Casseres (1987) and Nanda and Williamson (1995), Mohanram and Nanda (1998) argue that maturity is no value driver for JVs as successful JVs may be shut down (buy-out of one partner, acquisition through a third party, or termination) as project goals are achieved, while unsuccessful JVs are kept alive, which can be attributed to sunk costs or the managerial incentive to finally achieve the company’s goal in line with Kogut (1991). In general, JVs therefore exist for a shorter timeframe than normal corporations (Mantecon & Chatfield, 2007). Risk-Sharing and Uncertainty Pfeffer and Nowak (1976) conclude that JVs are used in order to have an instrumental platform to align resources for future uncertainty and to manage given dependencies in line with the findings that firm managements are alone heavily limited in the ability to influence the survivorship prospects of their companies, i.a. proposed by Hannan and Freeman (1977) and McKelvey and Aldrich (1983). Koh and Venkatraman (1991) summarize that four benefits are given for value-creation through JV erections. Given the combination of explicit knowledge and activities, economies of scale (and scope) can be achieved; further through pooling of the parents’ know-how in different corporate functions (such as production skills of one partner and marketing skills of the other) a JV parent gets access to complementary skills; while foremost risks and costs for uncertain projects with regard to future demand can be jointly burdened, and the competitive environment can be reshaped (Koh & Venkatraman, 1991). As project-specific risk is shared, projects become feasible and acceptable for company boards, the equity and debt capital markets, and other financial providers even if the risk would be too high for one partner alone (Burton, Lonie, & Power, 1999; Jones & Danbolt, 2004). Thus, JVs can be best characterized as decision-facilitator to invest and expand into new markets where demand is uncertain (Kogut, 1991). Further, demand uncertainty becomes more complex when the activity to invest is not part of the core business. Kogut (1991) describes those investments as real options with significant value as the new investment enables a window on future market opportunities which can have significant value on project level but also on firm level. Thereby, Kogut (1991) argues that creating a competitive advantage is subject to “lumpy and nontrivial investments” (p. 19) to enable an option value for accessing future market opportunities exceeding the available capital needs and resources of a single entity. Thus, (a) suitable partner(s) equipped with the right set of resources is looked for to split the financial burden between the partners to

2.3 Corporate Joint Venture Motives and Effects

19

share underlying risk representing some insurance characteristic (Kogut, 1991; Tong, Reuer, & Peng, 2008). Additionally, bundling different expertise and capital leads to a reduction in total investment and thereby JVs are suitable instruments to expand into risky markets. Whenever one involved party evaluates the option value for the future opportunities greater than its partner in the negotiation process for further investment, it is probable that the partner decides to pursue a buy out, if sufficient funds are available. In the following empirical investigation on the question whether the timing of the acquisition depends on a signal for favorable growth opportunities, Kogut (1991) finds, given the common contractual agreement between the JV partners to acquire full ownership, that the key market signal is unexpected growth in the product market affecting the likelihood to buyout the partner. The decision is facilitated through the given JV characteristics of sunk investment costs and moderate operating costs (Kogut, 1991). Further, Mantecon and Chatfield (2007) find empirical evidence that a buyout of one partner creates the highest wealth effect to both sponsors while other exit paths do not allow significant value transition. The authors attribute this to a mutual understanding of the real asset value in the JV that mitigates informational asymmetries. In line with Kogut (1991), JVs serve as exploitative countermeasure with a buffering effect for uncertainty and volatility in the environment a firm engages in and JVs represent a real option to react to uncertain developments. Thereby, JV sponsors can participate in and benefit from the JV’s positioning in favorable market upswings while cushion losses from the given downside exposure which is in line with the cash flow theory proposed by Myers (1977) that value of any investment is driven by its current cash flows and those that arise from redeployment and future utilization affecting the discretionary value of any future investment. International Expansion While R. D. Robinson (1962) attributes the origin of JVs and strategic alliances to the beginning of the globalization process, he considers common popularity of partnerships in foreign countries with local partners that could either be companies or governments in order to secure market entry in other than the domestic markets. However, he finds that foreign market entry through JVs can not be preferred right away over direct entry while the decision which entry strategy to pursue depends on various market parameters, such as the identity of the partner and the targets of the host government. However, in some countries local authorities restrict foreign ownership so that Franko (1989) finds evidence that U.S. companies accept minority ownership in these countries although the willingness to accept minority ownership is low. Even though only a few jurisdictions restrict (direct) foreign

20

2 Joint Ventures Motives in Classical Corporations and REITs

ownership, the erection and holding of JVs for international market entry and investment still accounts for a large proportion (Beamish & Lupton, 2009). JVs with foreign companies do not only enable market access but also local expertise for unknown business practices and policies as well as more credibility (Beamish & Lupton, 2009). Further, we deduct that more credibility can be attributed to both an existing track record of the (local) partner but also as the JV is likely to be organized in a local company structure. In particular, also creditworthiness increases as local debt providers are more likely to be familiar with local accounting policies than foreign standards. Thus, the partner’s market positioning and local knowledge is exploited to gain market access, product and market asymmetries across countries (I. Lee & Wyatt, 1990). Against these benefits, Chung, Koford, and Lee (1993) identify the disadvantage of risk exposure of the foreign partner regarding managerial conflicts and victimization. However, I. Lee and Wyatt (1990) do not obtain positive abnormal returns in their sample of 109 American – foreign JVs between 1974 and 1986 which they attribute to informational asymmetries, as the negative effect is more negative in the case of JV announcements in less developed countries, which is further validated by Chung et al. (1993).15 However, Chen, Hu, and Shieh (1991) find positive abnormal returns of 0.71% for 88 JVs between American and Chinese companies in a two day-window in line with Crutchley, Guo, and Hansen (1991) reporting 0.99% abnormal returns in the two-day window16 for US companies venturing with Japanese firms. Comparing 244 acquisitions and 184 JVs between Japanese and US companies on US territory, Hennart and Reddy (1997) find evidence that JVs, with companies that produce comparable products, are preferred to enter foreign markets if scale effects and dominating market positions of domestic companies are given. Empirically, Schut and Van Frederikslust (2004) find in their sample consisting of 233 international JVs with Dutch companies that the main motives are market development, technology search, and efficiency goals. Applying the transaction cost theorem of Williamson (1975), Beamish and Banks (1987) illustrate that opportunism, high bargaining power of few local players, and vagueness of future development combined with a high degree of complexity drive companies to prefer international JVs over wholly-owned subsidiaries even though they would better allow to maximize profits. However, partner opposition needs to be actively managed through monitoring and budgeting tools as well as active decision-making involvement (Das, 2005; Das & Rahman, 2001, 15 16

The abnormal returns are not negative but around zero in those joint ventures erected in developed countries (Chung et al., 1993). Cheng, Fung, and Lam (1998) even report three day cumulative positive abnormal returns of 1.02% in their sample of 103 US-Chinese joint ventures and argue joint ventures are the best market entry into China.

2.3 Corporate Joint Venture Motives and Effects

21

2010). But in order to benefit from the advantages of partnering with local partners, companies accept failure and high instability rates through the underlying complexity in developing countries (Contractor & Lorange, 1988; Gomes-Casseres, 1987; Kogut, 1989; Osborn & Hagedoorn, 1997; Shenkar & Li, 1999). Side Effect: Information Hub and Network Learning In accordance with Harrigan (1988a), there may also exist a “spider’s web of joint ventures” (p. 16) meaning that firms set up various JVs in dependence of their own bargaining power where the higher the bargaining power is the more centralized the firm becomes in the spider web. Subsequently, Powell (1990) concludes that JVs can be set up at the inter-organizational or network level. Initiators of networks gain access to exploitation opportunities such as disproportional profits and competitive advantage (Dyer & Singh, 1998; Dyer, Singh, & Kale, 2008; Gulati, 1995), as well as enhanced exploration gains in line with the differentiation between exploitation and exploration JVs (Koza & Lewin, 1998). The integration of firms in alliance networks affects the resource flow and thereby is an explaining factor for organizational characteristics and decisions (Gnyawali & Madhavan, 2001). In line with the centrality concept of Freeman (1979) measuring the average closeness to all other network members through direct and indirect connectors, centrality enables superior information access as well as flow and thus market and technological trends are better identifiable decreasing search costs considerably (Haunschild & Beckman, 1998).17 Gnyawali and Madhavan (2001) conclude that central firms are supplied with information earlier and can access resources more easily and quicker than peripheral firms besides gaining more visibility, higher status, and power as depicted by Brass and Burkhardt (1990, 1993). Empirically, more central firms show more alliance than acquisition activity and prefer partnering with companies that have low distances in their network or that have already been a partner before (Gulati, 1995; Powell, Koput, & Smith-Doerr, 1996). In detail, companies tend to venture with partners that are characterized by an equally good resource base, sound growth prospects, and a similar Tobin’s Q (M. S. Kumar, 2010; S. Kumar & Park, 2012; Rhodes-Kropf & Robinson, 2008). This underlines the hypothesis of DiMaggio and Powell (1983) that companies become more alike the more change is initiated as close companies become more similar through collaboration and acquisitions. Hence, as JVs and its network effects enable the recognition of trends more efficiently and a shared risk for future uncertainty, they are both a fundament and substitute for acquisition (Dyer, Kale, & Singh, 2004). Thereby, a central

17

The same implications are found for company size (Haunschild & Beckman, 1998).

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2 Joint Ventures Motives in Classical Corporations and REITs

positioning in the network of JVs supplies the company with power while consequently decreasing dependence (Brass & Burkhardt, 1993). Side Effect: Partner Signals While JVs are a good instrument for corporate learning and competitive advantage, finding the best partner will remain the most challenging task in joint venturing processes and leads to different managerial styles (Harrigan, 1987). In particular, besides the pure synergistic gains, positive signaling can be attributed to the parents of a JV, as the quality or pure size of the partner conveys additional information about a firm as it is able to raise interest about its know-how and assets (Mohanram & Nanda, 1998). Further evidence is provided by S. Kumar and Park (2012) who find positive two-day time window abnormal returns of 0.61% for 532 firms in 279 JVs through growth prospects and the resource quality of a JV partner for firms that the capital market associates with information asymmetry. However, negative value can be also incorporated in the stock price through a company’s inability to attract attractive partners for JV partners as it is assumable that other companies evaluate the company as not providing minimal hazards and a suitable fit for collaboration (Hennart, 1988; S. Kumar & Park, 2012; Teece, 1986). In detail, companies are assumed to choose partners that are characterized by an equally good resource base and sound growth prospects (M. S. Kumar, 2010; S. Kumar & Park, 2012). Based on the study results of Rhodes-Kropf and Robinson (2008) on acquisitions that companies are most likely to acquire companies with a similar Tobin’s Q (S. Kumar & Park, 2012). The rationale to achieve complementary assets as depicted by Teece (1986) and Hennart (1988) is the heart of the transaction rationale as depicted by Kogut (1988a) and the resource-based view as applied on strategic alliances by Tsang (1998) who argues that the search for rent generation, expanding the utilization of assets, resource diversification, imitation, and disposals motivates companies to erect JVs from a resource-based view approach to achieve a competitive advantage. M&A Alternative The rationale behind JVs and mergers and acquisitions (M&A) have the same intention to gain resources and incorporate learning for the parent company, while both can also be motivated by seeking synergistic and competitive advantage (Hamel, 1991; Hennart & Reddy, 1997; Villalonga & McGahan, 2005). The two activities thus substitute each other but should be holistically assessed (Dyer et al., 2004). Hennart and Reddy (1997) compare JVs to merger rationales and argue that both corporate combination mechanisms serve to pool comparable and

2.3 Corporate Joint Venture Motives and Effects

23

complementary resources, while JVs are erected when an acquisition would lead to higher managerial costs of the merged entity due to existing undesired assets outside the scope of the target resource in line with Hennart (1988). This finding supports the rationale that JVs are a merger alternative in case the parent company seeks access to specific assets and resources of other organizations, that can not be extracted from organizational boarders (Kogut, 1988a; McKelvey & Aldrich, 1983), and contradicts the rationale of Balakrishnan and Koza (1989, 1993) arguing JVs are aimed at reducing the transaction costs incurred in M&A. Further, JVs are the preferable corporate expansion instrument in the case of high information asymmetries (Balakrishnan & Koza, 1993; Reuer & Koza, 1998). Thereby, comparing JV erections to corporate M&A implies that JVs offer the advantage to acquire the optimal and needed set of resources for a temporary time instead of a fixed acquisitions with infinite maturity executable without shareholder approval, as JVs should be part of the normal course of the business and its financial budgeting (Corgel & Rogers, 1987). JVs are preferred over mergers when reorganization costs should be minimized and when the potential merger target dislikes and refuses a merger offer decreasing the risk exposure as the corporate combination on JV level can be reversed (Nanda & Williamson, 1995). Comparing 244 acquisitions and 184 JVs between Japanese and US companies on US territory, Hennart and Reddy (1997) find evidence that JVs, with companies that produce comparable products, are a preferred method to enter foreign markets if scale effects and dominating market positions of domestic companies are given. Further, it is revealed that acquisitions are chosen over JVs when the parent company seeking market access has existing experience with the target market as this facilitates the integration process of the acquired company (Hennart & Reddy, 1997). The option view, as introduced by Kogut (1991), is further applied on the rationale of M&A concluding that JVs serve as information platform for following acquisition decisions by (Chi, 2000; Folta & Miller, 2002; M. V. S. Kumar, 2005; Tong et al., 2008). However, it remains open how companies incorporate their JV experience and learnings into acquisition rationales (Dyer et al., 2004; Villalonga & McGahan, 2005). The main difference between JVs and M&A is the rationale that acquisitions are of irreversible nature and requires more financial resources and management expertise, while JVs enable a continuous partnering process where input factors can be more easily adjusted and thus a final exit option is always present (Balakrishnan & Koza, 1993). Looking for very narrow and specific resources, other forms of partnering or acquisitions are obsolete, as knowledge can not be transferred at zero costs while JVs represent the best possible platform for duplicating expertise to exploit future potential through the contractual commitment and injected resources and capital (Beamish & Lupton, 2009; Kogut, 1988a). Further, a JV is a platform for enabling first close contact with the partner and provides the

24

2 Joint Ventures Motives in Classical Corporations and REITs

ability to enforce the collaboration (S. Kumar & Park, 2012). Therefore, we deduct that joint venturing could also be part of organizational learning in the sense of getting a better understanding of what resources a company should have that might be acquired. Further, Nanda and Williamson (1995) as well as Mantecon and Chatfield (2007) elaborate that JVs are often used as transition vehicle where a mutual understanding is generated in preparation of a future merger or acquisition.

2.4

Real Estate and REIT Joint Ventures

In line with traditional JV theory, real estate JV structures are based upon contracts creating new legally separate entities by the combination of the partners’ resources, mostly financial, and commonly also management know-how for shared projects (Campbell, White-Huckins, et al., 2006). In their study, Hess and Liang (2004) find that the use of JV structures of REITs has tremendously increased in the period between 1998 and 2002. By the end of 2002 JV activity has grown two to three times faster than the underlying total assets of REITs. In detail, 13.7% of all properties are held in joint structures and represent 12.5% of the REITs’ market value. Corgel and Rogers (1987) as well as Ravichandran and Sa‐Aadu (1988) argue that real estate JVs represent the combination of resources of the partners’ firms in order to achieve a shared target while the managements of all involved partner companies are responsible for the management of the JV which contradicts the common procedure in M&A where the management of the acquired company is replaced or made redundant.18 Campbell, White-Huckins, et al. (2006) analyze JVs as an instrument for structuring corporate options and differentiate between dispositional and acquisitive structures. While acquisitive joint ventures (AJVs hereafter) are erected to acquire properties together with partners, dispositional structures (dispositional joint ventures, DJVs hereafter) are given when assets are partially disposed to JVs with a subsequent cash flow from the partner to the REIT in the form of cash or other liquid assets. Campbell, White-Huckins, et al. (2006) assume that the rationale and the experience for REITs and their JVs heavily differ from classical corporations and classical real estate companies given their regulatory environment and the constraining cash flow effects in line with Damodaran, John, and Liu (1997). By reviewing the real estate JV literature, we will analyze this hypothesis and draw conclusions between corporate and REIT JVs where possible.

18

At the same time, this implies that a new management is installed in the joint venture while the management of the parental firms does not change.

2.4 Real Estate and REIT Joint Ventures

25

Use of Real Estate Joint Ventures for Business Extension In line with classical JV literature, He, Neil Myer, and Webb (1997) argue that JVs are chosen as instruments to enable corporate expansion. The rationale to set up JVs in the scope of real estate business can be allocated to capital access, combination of know-how, and access to anchor tenants (Behrens, 1990). As lined out by Elayan (1993), one key motivation for JV erection is the goal to achieve synergies in both operations and financials by the resource combination which enables operative synergies from economies of scale and scope, the more efficient allocation of human and asset capital, risk reduction, efficiency effects in administration and management, alignment of research interest, and a monopolistic competitive advantage while making use of diversification and further leverage potential respectively. Further, Ravichandran and Sa‐Aadu (1988) argue that real estate JV use can be motivated through the existence of asymmetric information, the lack of standardization in real estate markets due to diverging local characteristics, the importance of pronounced property management expertise, and the presence of anchor tenants for commercial real estate that can mostly only be attracted through network and knowledge (He et al., 1997; Ravichandran & Sa‐Aadu, 1988). This is in line with classical international JV theory that despite opportunism, high bargaining power of few local market participants, and vagueness of future development accompanied with a high degree of complexity (Beamish & Banks, 1987) making companies accept venture failure and instability rates (Contractor & Lorange, 1988; Gomes-Casseres, 1987; Kogut, 1989; Osborn & Hagedoorn, 1997; Shenkar & Li, 1999). Empirically, Ravichandran and Sa‐Aadu (1988) analyze the announcement effect for 59 real estate-related JVs in the time frame from 1972 to 1983 and find abnormal returns of 0.76% in a two-day window which they attribute to the creation of competitive advantage through location and property-specific expertise and the acquisition of anchor tenants. In his study of 125 real estate JVs from 1972 to 1989, Elayan (1993) shows the announcement effects on returns to stockholders and finds that real estate companies benefit the most if they partner with non-real estate companies with positive abnormal returns of 2.96% compared to 1.78% between pure real estate companies. As result, he postulates that the synergy effect fully explains his empirical findings. With regard to the subject of this work, some limitations are apparent: The work does not differentiate between Real Estate Operating Companies (REOCs hereafter) and REITs but also is outdated with regard to REITs that changed in kind as the used data is from a different REIT era. Through regulatory changes the framework for REITs has changed. Additionally, the analysis has not been controlled for the threshold. Hess and Liang (2004) find that REITs have invested a stable ratio of their capital in JV structures. However, their investigation yields that the value of net assets in unconsolidated firms, as a ratio of total book value of assets, is not only

26

2 Joint Ventures Motives in Classical Corporations and REITs

low but has also decreased in the time frame from 1998 to 2002 (from its peak of 5.5% in 2000) to 4.5% by the end of 2002. They find that unconsolidated firms mostly comprise firms with a minority voting interest.19 In their analysis, the authors apply a balance-sheet analysis to find the appropriate value for the minorityheld ventures through the underlying disclosed information on the properties held in those structures. In their panel study, they find that the value of minority-share properties would equal 5.1%.20 In addition, they find that a higher share on average was invested in JVs totaling 12.5% by year-end 2002 given a 2.4% rise from 10.1% in 1998 equaling a 47% relative change. At the same time, this equals a 250% relative growth to the jointly-held and wholly owned property interests whose value increased by 19%. They explain this growth by a heavy expansion of majority JVs, which comprised a share of 4.8% compared to total REIT assets in 2002. As well, equally-owned (50% JVs) firms gained importance from 4.4% in 1998 to 5.1% in 2002, whereas the share of minority vehicles increased from 1.9% to 2.6%. They argue that the increase of JVs is even more important because the number of properties acquired through joint structures have consequently changed even more relatively: While 11.7% of all properties were jointly held in 1998, 13.7% of all properties were jointly owned in 2002. This equals a 30.1% increase, however, the total number of REIT properties increased by only 11.6% in the same timeframe. However, the analysis is somehow biased as most of the change and growth with regard to REIT JVs can be attributed to the REIT Modernization Act in 1999 which favored those structures. Therefore, we expect this trend to have continued until now and to be understated by the time of 2002 and the increase of JV acquisitions and participations could be caused by the REIT Modernization Act that accelerated the use of taxable JV structures. As consequence, the authors find the increase of minority vehicles obvious and find evidence in the number of acquisitions through those structures that increased by more than 100% to 17.8% in 2002 compared to a 6.9% year-over-year average for the two previous periods. With regard to the slow-down in REIT acquisitions of the late 1990s and early 2000s, the absolute number of properties acquired including JV use increased at slow pace.21 However, the JV acquisition is about 50% higher in 2002 than the average annual rate for the late 1990s. Further, Hess and Liang (2004) find evidence that the more pronounced JV use correlates with the property size spectrum. 19

20 21

The ownership level determines if a firm has to consolidate the venture’s balance-sheet and income-statement into its annual group report. If unconsolidated, only the net contributions to assets and the partial income of its shares need to be disclosed. Under certain circumstances this can be circumvented. The authors apply two panels and weight for the standard shareholding in the JV of 50%. Hess and Liang argue that the acquisition rate of REITs dropped at the millennium change to some 60% of the previous rate.

2.4 Real Estate and REIT Joint Ventures

27

As consequence, the relative use of JVs becomes higher the larger the properties become: While 31.3% of all properties between USD 100 million and USD 500 million are jointly held, only 12.1% of all properties below USD 10 million are partially owned. However, they also find that the probability of equal and majority ownership increases as well the larger the property is. Additionally, the authors argue that the decision to form a JV structure is subject to the balancing between control, single-asset risk, and possible revenues arising from property management fees. Further, they explain that a joint ownership in large properties could decrease single-asset risk in the portfolio through diversification and / or increase the probability to collect the needed equity for large acquisitions. At the same time, we can argue that the dependence on the capital market decreases as the REIT could be able to finance the acquisition through the small portion of retained earnings. On the other hand, firms in general have a higher preference for control of large properties as they affect the balance sheet and profit and loss statements more strongly. Thereby, the trend can be explained that the proportion of equal and majority ownership correlate with the size of the property held (Hess & Liang, 2004). Thus, a minimum of 50% ownership in the JV is mostly set up for properties exceeding the minimum value of about USD 100 million (Hess & Liang, 2004). Another characteristic of JV acquisition strategy is the age of properties according to Hess and Liang (2004) who find that more newly constructed properties are jointly held compared to older buildings overall. By 2002, more than 18% of all REIT properties constructed after January 2000 have been jointly acquired. Buildings from the 1980s have a joint ownership from 7% to 9%, while buildings from the 1990s range between 12 to 13%. However, old buildings with construction completion before 1980 have a higher share, but REITs seem to prefer majority ownerships in those buildings. This might be attributable to the predictability of cash flows from those buildings and the existing know-how and the decision to enter minority JVs may consequently be subject to the fact that REITs take a developer role, bundling their competencies with the partners’ ability in real estate development. Hess and Liang (2004) argue that this might be caused by REIT Modernization Act of 1999 (RMA) as well, that affected the REIT portfolio strategy. Taking the acquisition dates into account, the authors find supporting evidence that there is a preference of REITs to acquire older properties in (majority-held) JV structures. JV acquisitions had a market share of 6% in the 1980s and increased to 11% in the 1990s. At the same time, they identify that buildings completed in these years have a higher share in JVs while, however, no interference can be made. They attempt to explain the connection through the fact that jointly held properties may be held longer than wholly owned properties. With regard to the asset class of JV properties, Hess and Liang (2004) find that hotel properties have the smallest proportion in JVs equaling some 5%. At the same time, if REITs decide to jointly acquire hotels, there seems to be the

28

2 Joint Ventures Motives in Classical Corporations and REITs

preference to hold a majority stake. On the other hand, malls make up the highest proportion of properties held in JVs totaling 32.2% with a higher likelihood of shared ownership (50/50). Apartment properties seem to be held mostly in minority structures (6.8%) avoiding equal (1.1%) or majority ownership (4.8%) with an average total propensity of 12.7%. With regard to office buildings, JVs are rarely used (8.6% in total) with a preference for minority holdings (3.9%). Warehouse and other retail properties have a propensity of 16.0% and 16.6% respectively and seem to be minority-held in general (8.6% and 9.0% respectively). Joint Ventures in Real Estate Development or High Risk-Sharing JVs are key elements in real estate development projects, as Corgel and Rogers (1987) conclude that the key motive for real estate-related JVs is the attraction of development-specific know-how even though capital may be sufficiently in place and developer often lack enough capital to undertake large-scale development projects. Thus, JVs are structured by REITs and real estate operating companies in order to acquire the local knowledge, the development-specific, and property-specific expertise (Campbell, 2002), which play a key role in the local and non-standard real estate industry (Gau, 1987).22 Further elaborated by Ravichandran and Sa‐ Aadu (1988), the uniqueness of the real estate market is characterized through the fragmentation into local submarkets requiring special knowledge, asset segmentation, low liquidity, and relationships to anchor tenants. Accordingly, in line with McConnell and Nantell (1985) and Ravichandran and Pinegar (1990), Ravichandran and Sa‐Aadu (1988) conclude JVs to be value-creating transactions for the parent companies, or partially because the real estate market is affected by unique market characteristics. The uniqueness is discussed in various literature streams and is not without controversy: Even though real estate valuations should be easily done as human capital and growth options are limited, Han (2006) infers that the illiquidity and heterogeneity of real estate assets complicate fair real estate market valuations. Though, the information asymmetry paradigm with regard to real estate and REITs remains unclear (Feng et al., 2007). As result, JVs are frequently erected to share resources by real estate companies to do real estate development projects and evidence is found through the concentration on developments in the samples of McConnell and Nantell (1985), Corgel and Rogers (1987), and Ravichandran and Sa‐Aadu (1988). In addition, Campbell, White-Huckins, et al. (2006), find in their sample a development concentration of 75% with 60% of all AJVs structured for developments with a financial partner and additional 15% of all AJVs structured for joint developments with development companies. 22

The real estate market characteristics lead to higher costs for firms in market entry situations in comparison to local companies (Gau, 1987).

2.4 Real Estate and REIT Joint Ventures

29

From a financing perspective, real estate development JVs can be motivated through a facilitated debt raising processes in the case of partnering between real estate companies and the attraction of financial (equity) injection from third parties while real estate (operating) companies contribute development concepts, land, and know-how (Corgel & Rogers, 1987). In line with the beforementioned, Elayan (1993) stresses the importance of market locality and segmentation as main attributes of the real estate sector so that informational advantage can be achieved and maintained in the ventures. Further, Mantecon and Chatfield (2007) acknowledge that JVs often serve a financing function for REIT projects with a finite project lifecycle. At the same time, risk is reduced and value enhanced through acquisition of property type-specific expertise of the partner in the JV (A. J. Jaffe & Sirmans, 1984). Further risk can be minimized through JVs between the developer and the future tenant (Behrens, 1990), while positive share price reaction can be observed if tenants are (partial) shareholders of the development venture (Ravichandran & Sa‐Aadu, 1988). Therefore, complementary partnering can only be acquired at substantial costs in line with Miles and McCue (1984), and decision-makers for anchor tenant contracts23 is the key rationale for real estate JVs; as such information asymmetries can be overcome and materialized (Ravichandran & Sa‐Aadu, 1988). Further, special managerial know-how can be materialized as uncertainty reduction in the management of certain properties (A. J. Jaffe & Sirmans, 1984; Ravichandran & Sa‐Aadu, 1988). In particular, joint vehicles have a safeguarding function for negative income effects and allow cost-effective exits when developments default (Campbell, White-Huckins, et al., 2006). These structures allow a cost-effective exit in case of default and enable full consolidation in the case of a buy-out (Campbell, White-Huckins, et al., 2006), while REITs as well secure access to future properties and avoid competitive biddings in sale processes (Hess & Liang, 2004). Finally, Ravichandran and Sa‐Aadu (1988) find evidence that JV announcements positively affect shareholder value and that the capital market incorporates both differential information of real estate markets, as firms with an informational advantage benefit most, and the transferability of technical asset type-specific knowledge. In addition, if an announcement conveys information on the presence of anchor tenants the stock price reaction yields positive returns in certain market segments which implies that the capital market is able to process the unique market and product characteristics to some degree (Ravichandran & Sa‐Aadu, 1988). Contradictory, Corgel and Rogers (1987) do not find any statistical significance in their event-study of real estate (development) JV announcements.

23

The existence of anchor tenants, for example in large retail developments, lowers information asymmetries and can increase the success of the projects as further tenants and finally customers can be better attracted (Ravichandran & Sa‐Aadu, 1988).

30

2 Joint Ventures Motives in Classical Corporations and REITs

Use of Real Estate Joint Ventures for Investment Financing Berg and Friedman (1977) conclude that the attraction and acquisition of capital is the main driver for JVs, this driver seems to be of outmost importance for real estate and especially for REITs given the main characteristic of real estate to be very capital-intensive. For REITs, this seems to be even more important as REITs are not only highly regulated but also have a severe dependence on the capital market, as several studies have identified that the REIT sector is cash-restrained (An et al., 2012; Hardin III et al., 2009; Hardin III & Hill, 2008; Riddiough & Wu, 2009). In their work on domestic and international Equity-REIT JVs, Campbell, White-Huckins, et al. (2006) differentiate between dispositional and acquisitive structures with the conclusion that JVs are a valid option to circumvent the tough institutional environment. In line with Damodaran et al. (1997), Campbell, WhiteHuckins, et al. (2006) argue that REIT JVs are erected due to the corporate lack to accumulate cash through retained earnings and thus offer higher strategic benefits than to normal corporations given the dependence on capital markets in the case of growth goals. Further, JVs can be financed through stocks and debt of REIT and thus are alternative financing measures outside the capital markets (Campbell, White-Huckins, et al., 2006). These are most often AJV structures, while dispositional structures where assets are partially disposed to JVs with a subsequent cash flow from the partner to the REIT in the form of cash or other liquid assets, are chosen to bridge liquidity gaps that can arise from the cash constraints in the REIT Act (Campbell, White-Huckins, et al., 2006). Based upon findings of Campbell, White-Huckins, et al. (2006), an acquisitive structure is chosen in 60 out of 100 cases to undertake developments with a financial partner, in 25 out of 100 cases to acquire existing assets with cash flows in place, and in 15 out of 100 cases to partner with a development company. Developments in JV schemes offer the benefits that risk is shared and the lasting negative cash flows are assumed by both partners while if several properties are developed potential income streams of completed and leased up properties can be counterbalanced by losses of to be completed projects (Campbell, White-Huckins, et al., 2006). Further advantage is to secure the prospects of the projects in the case of success while structuring a vehicle that shields the REIT itself from negative income effects with regard to balance sheet, income and cash flow statements, and debt-related covenants (Campbell, White-Huckins, et al., 2006). In the case of failure, they conclude this structure allows for a cost-effective termination path and a solid base for full consolidation upon termination of the project and subsequent buyout of the partner. Further, Campbell, White-Huckins, et al. (2006) find that JV announcements lead, in general, to positive market reactions while especially acquisitive structures lead to positive and dispositional structures to negative alpha returns respectively. They do not control for different threshold effects given their summary that dispositional

2.4 Real Estate and REIT Joint Ventures

31

structures are mostly minority-held and acquisitive structure are majority-held. However, Ro and Ziobrowski (2012) obtain negative alpha returns when AJVs increase the diversification grade of REITs24 while positive returns can be measured upon announcements of DJVs leading to an increase of property-type focus.25 In a non-academic contribution, Siegel (1999) argues that REITs use JVs to attract capital for acquisitions and developments offering additional income streams with a very profitable ratio to contributed capital. As illustrated by Campbell, White-Huckins, et al. (2006) and Hess and Liang (2004), shareholdings are not always majority positions, thus JV debt is off-balance and often higher leverage is taken, resulting in various risks, such as lease-up risk in development scenarios with a mandatory buyout upon project completion and further credit risk even in the case of non-recourse structures (Siegel, 1999). In addition, Plumb and Azrack (2001) argue in their working paper that the internal financing restrictions of REITs triggered JV use as alternative financing measure at the end of the 1990s, while external investors favor the high-quality assets of REITs over other direct investment opportunities lowering the dependence of equity capital markets, as capital can be obtained without seeking capital markets. Dispositional structures are chosen in cases where a property or portfolio is underperforming and a second party joins to materialize these parties’ knowledge and expertise to do a work-out (Campbell, 2002; Campbell, White-Huckins, et al., 2006). In general, the REIT maintains the property management in exchange for a management fee from the owner,26 the JV, which enables the REIT to secure some income and allow partial priority claim in line with the threshold, mostly a minority position; one of three other advantages to the REIT identified by Campbell, White-Huckins, et al. (2006): ◼

Bankruptcy risk is minimized, as interest obligations are reduced or even obsolete if the JV is purely equity-financed;

◼

Balance sheet is streamlined as potential debt is off-balance due to the fact that a consolidation obligation is not given due to the minority threshold, and

◼

Greater operational and strategic flexibility is achieved.

24

25 26

Overall all alpha returns are positive for AJVs with a Cumulative Abnormal Return (CAR) of 0.450% in a two-day window, while those events that reduce property-type focus are statistically insignificant. The alpha return of dispositional joint venture that increase focus are statistically significant with a CAR of 1.260% in a two-day window. In the sample of Campbell, White-Huckins, et al. (2006), 16 out of 185 joint ventures are managed by the partner which might be due to local or asset-specific knowledge of the partner, information asymmetries should be overcome as equity ownership is given by both parties.

32

◼

2 Joint Ventures Motives in Classical Corporations and REITs

Aufzählung.

With regard to the financial partner, Campbell, White-Huckins, et al. (2006) conclude that the following three drivers motivate the joint shareholdings with REITs: ◼

Given majority thresholds, information asymmetries are obsolete;

◼

Time-varying, complex cash flow sharing agreements do not only give a legal claim on cash flows but also allow an arrangement of equity participation mortgage; and

◼

A low-cost exit scheme for the case of project failure.

Further, Plumb and Azrack (2001) elaborate that investors prefer co-investments in REIT properties due to the high-quality of the underlying assets and that diversification is achieved with a consequent reduction of specific asset risk and the acquisition of property-specific knowledge provided by the REIT. Based on the findings of Campbell, White-Huckins, et al. (2006), Freybote et al. (2014) further investigate the motivation of REITs to erect DJVs with regard to financing constraints. As previously lined out, REITs can either sell parts of their portfolio completely or they sell partially through a JV structure while maintaining a minority interest, i.e. less than 50% of the equity, and secure a buy back – option given the benefit of maintenance of (partial) proprietorship while receiving liquidity. At the same time, they do not only keep proprietorship but also management contracts for the underlying asset due to the fact that the buyer is nearly always a pure finance provider.27 The authors postulate that DJV structures are means of disposal and financing strategy. Within the scope of the investigation, Freybote et al. (2014) find that REITs participating in those structures suffer from low Market-to-Bookratios, high leverage, etc. and dispose high-quality assets.28 Thus, they conclude that DJVs serve as financing instrument for distressed REITs insofar that they have no other financing choice left which also explains the high quality of disposed assets given the urgent need to gain liquidity. As such, the underlying rationale can be aligned with classical theory for vertical JVs where financing informational asymmetries are given (Johnson & Houston, 2000). Hess and Liang (2004) summarize their work by concluding that JV use corrupts the true and fair picture in the balance sheets of REITs: Even though the unconsolidated statements may imply that JV activities have decreased in their sample in the timeframe from 1998 to 2002, they find that absolute use in terms of acquisitions and value has highly increased in fact. This is attributable to the 27 28

Most often a pension fund or an institutional investor (Campbell, White-Huckins, et al., 2006) Freybote et al. (2014) infer the high quality from higher rent levels and tenant base, as well as larger transaction sizes.

2.4 Real Estate and REIT Joint Ventures

33

REIT preference to participate in minority JVs for smaller properties which directly affects the obvious figures. In the year 2002, 24% of all property acquisitions were completed via JVs. Further, about 14% of all properties held by REITs are jointly owned. International Expansion In line with classical JV literature, He et al. (1997) argue that JVs enable foreign market access. This is of tremendous importance especially in those countries where legislation does not allow direct real estate investments through foreign parties and thus JVs are widely used methods to circumvent those restrictions (He et al., 1997). They show a research gap in the real estate literature concentrate on international real estate JVs defined as entities where at least one involved shareholder is from a foreign jurisdiction. Due to the characteristic of real estate immovability international real estate JVs are thus more exposed to political and economic risks traded against diversification benefits in line with diversification theory. With regard to international expansion, JVs have a special effect for the Asian market where JVs between Asian and American REITs can drive the enforcement of currently weak corporate control and transparency mechanisms as well as the facilitation of cash flow streams from the US capital markets to local Asian markets with the benefits of investor protection and American accounting standards (Campbell, Ghosh, & Sirmans, 2005; Campbell, White-Huckins, et al., 2006). However, the announcements of Asian JVs lead to some undervaluation which might be associated with information asymmetries and potential taxation in the foreign legislation (Campbell, White-Huckins, et al., 2006). Further, Ravichandran and Sa‐Aadu (1988) argue that real estate JV use can be motived through the existence of asymmetric information, the lack of standardization in real estate markets due to diverging country-specific characteristics, the importance of property management expertise, and the presence of anchor tenants for commercial real estate that can mostly only be attracted through network and knowledge, especially in foreign markets (He et al., 1997; Ravichandran & Sa‐ Aadu, 1988). This is in line with classical international JV theory that market development and efficiency goals are dominant (Schut & Van Frederikslust, 2004). In a subsequent study, He et al. (1997) examine the wealth effects of international real estate JV announcements in a sample of 53 US compared to 28 international ventures in line with prior general industry insights in order to test for the synergy theory as lined out by Elayan (1993). With regard to JVs, He et al (1997) conclude, due to positive two-day abnormal returns of 1.11%, that the synergy intention holds true. Arguing the main drivers are the motive for economies of scale (and scope), management efficiency, the combination of complementary capabilities, and market power exploitation. The findings do not hold true for international JVs

34

2 Joint Ventures Motives in Classical Corporations and REITs

with insignificant abnormal returns of 0.26% and for hotel JVs with insignificant two-day returns of 0.70% attributable to the immovability of realty assets across countries, higher political and economic risk for international JVs and an oversupply of hotels in the US (He et al., 1997).29 Use of Real Estate Joint Ventures for Investment Enhancement and Signaling Aspects With regard to REIT motives, Hess and Liang (2004) find the rationale that REIT managers can allocate a suitable risk level to each partner and argue that REITs can structure a JV with a developer to inject long-term capital for a new property and can thus circumvent the competitive bidding environment upon construction. This is especially important as this can be connected to the fact that new REIT investments are primarily financed through funds obtained from bank credit lines, private debt and equity, while unsecured debt is raised for refinancing of maturing debt and a capital structure adjustment (Brown & Riddiough, 2003). The findings of Ott et al. (2005), that investments are funded through debt and equity issuances as result of the REIT tax rules, support this. The developer, however, injects his real estate development know-how. As result, Hess and Liang (2004) conclude that a conservative strategy REIT can partner with an opportunistic venture and subsequently, the JV can invest in more risky assets than the REIT itself or increase leverage. Especially for diversified REITs, JVs should be beneficial as information asymmetries can be circumvented while getting access to specialized managerial or development expertise for one property type (Campbell, WhiteHuckins, et al., 2006). In line with Hess and Liang (2004), REITs can therefore lever their acquisitive potential in the long-run while keeping an acceptable risk as the partner is knowledgeable in managing the underlying risk-return profile of the jointly acquired property and benefit from diversification. In particular, available capital funds can be used to invest in more projects as corporate JV theory suggests (Johnson & Houston, 2000). As result, Hess and Liang (2004) argue that if ownership is spread among different partners large properties can be acquired that neither partner could acquire on its own. As such, properties can be acquired that would be not suitable for one firm alone as too much capital would be tied into one property which is unacceptable with regard to diversification or investment volume. By bundling capacities through a JV, the environment in the bidding process also becomes less competitive and consequently REITs can improve their market 29

Another possible explanation is that investors regard hotels more like conventional than real estate-related businesses (He et al., 1997).

2.4 Real Estate and REIT Joint Ventures

35

presence by partnering with the right operator for some specialized property types (Hess & Liang, 2004). These property types could for instance include trophy properties.30 By announcing that a REIT has joint ownership in such a property, more market participants become knowledgeable about the REIT and its managerial capabilities leading to more visibility, higher status, and power as illustrated in general JV theory (Gnyawali & Madhavan, 2001). As a result, the REIT can position itself more centrally in the real estate network as depicted by Freeman (1979) and gain access to superior information flows and leading to considerably decreasing search costs (Haunschild & Beckman, 1998). Hence, one can draw the conclusion that real estate JVs and its network effects enable a more efficient recognition of acquisition and managerial trends and a shared risk for future uncertainty supplying the REIT with power while decreasing dependence at the same time (Brass & Burkhardt, 1993; Dyer et al., 2004). With regard to motivation, Hess and Liang (2004) argue that strategy and tactics do matter as well. These factors could include structures that have an optimizing effect on accretive capital deployment, operating cost reductions, ownership control management, and the enhancement of fee-based revenue streams. Through exploiting the legally admissible taxable REIT subsidiary structures (TRS) REITs can structure the entities to achieve market advantages, e.g. by an additional service offering to tenants. Further, they can utilize their property management skills even if the property itself would have not matched their risk profile if acquired alone. Finally, REITs can thus expand their investment universe and align their risk exposure, while the true and fair picture in the balance sheets of REITs can be corrupted given the unconsolidated statements may imply that JV activities have decreased in their study period while absolute use in terms of acquisitions and value has highly increased in fact (Hess & Liang, 2004). Use of Real Estate Joint Ventures as M&A Alternative The literature on real estate- and REIT-related mergers is not only rare but also not without controversy (Anderson, Medla, Rottke, & Schiereck, 2012; D. Ling & Petrova, 2011; Medla, 2011), and especially the synergistic motivation is not fully clear despite obvious size-related benefits of REITs (Anderson et al., 2012; Lewis, 30

Trophy property is a commonly used expression in the real estate industry, sporadically used in research (Gheno & Lee, 2006; Hara & Eyster, 1990; N. G. Miller, Markosyan, Florance, Stevenson, & Veld, 2003; Mundy, 2003; Newell & Fife, 1995; J. Robinson, 2005; Ziering & McIntosh, 1999), and best defined by B. Mundi (2002) as follows: "a trophy property is an investment grade property represented by value or price at top 2,5 percentile of properties in its particular land use category and is distinguished by the special high quality attributes that will attract the financial resources, in cash, to purchase it."

36

2 Joint Ventures Motives in Classical Corporations and REITs

Anderson, & Springer, 2000). This is attributed to the unique institutional environment and the characteristics of real estate assets that does not allow monopolistic effects in the real estate and foremost in the REIT area, whereas tax effects from targets with tax losses could drive REIT mergers (P. R. Allen & Sirmans, 1987). Contradictory, more recent findings suggest that the underlying acquisition rationale differs in the private and public area (Campbell, 2002; D. Ling & Petrova, 2011), however, listed REITs seem to follow the rationale to increase market power motivation as they typically acquire high dividend paying REITs with higher leverage (D. Ling & Petrova, 2011). Within the controversy discussion, one literature stream argues that the special homogenous operational characteristics of real estate companies lower synergy effects and the uniform asset composition throughout REITs restricts vertical integration (Campbell, Ghosh, & Sirmans, 2001; P. M. Eichholtz & Kok, 2008), whereas the most recent stream argues REITs better achieve synergy effects through cost side effects enabled by economies of scale (Anderson, Medla, Rottke, & Schiereck, 2011; Anderson et al., 2012; Medla, 2011). This supports previous findings that corporate combinations enable a more efficient asset management but also operational and financial gains (P. R. Allen & Sirmans, 1987; Elayan & Young, 1994). Due to tough institutional and regulatory environment, REITs have internal hurdles to establish growth and thus corporate acquisitions are a common growth method, also in the REIT industry but are of friendly manner as aforementioned (Campbell et al., 2001; Campbell et al., 2005). However, the real estate and especially the REIT industry is not characterized by hostile takeovers which seems to support that synergies are not achievable (Anderson et al., 2012; Campbell, 2002; P. M. Eichholtz & Kok, 2008; Lu, Mao, & Shen, 2015; Ratcliffe & Dimovski, 2012; Womack, 2012). Mergers and acquisitions in the REIT area are instead motivated by managerial hubris and tend to be executed by large and profitable REITs facing weak growth prospects (Lu et al., 2015). In his review on three REIT restructuring measures (1) sell-offs, (2) mergers, and (3) JVs, Campbell (2002) concludes JVs enable the initiating parental firms to only pool project-specific resources that are obviously needed which is in line with classical theory as suggested by in line with Hennart (1988) as those specific resources are protected by organizational boarders (Kogut, 1988a; McKelvey & Aldrich, 1983). In line with transaction cost theory (Williamson, 1979), Campbell (2002) argues JVs allow decreasing combination costs to a minimum level, especially when the takeover is hostile, and a suitable termination path within the contractual agreement as such that the venture is of reversionary nature as in general theory (Balakrishnan & Koza, 1993; Corgel & Rogers, 1987; Nanda & Williamson, 1995). Finally, we can argue that the motivations for REITs to decide between JV and merger and acquisitions are the same as for classical corporations while the identified information asymmetries in the real estate industry explain the absence

2.5 Subsidiary Conclusion

37

of an active takeover market that makes REITs to structure corporate combinations in JVs. We base this argumentation on the findings that UPREITs are the most common form within the Equity REIT market due to the given acquisition flexibility through the mechanism of the UPREIT structure (Sinai & Gyourko, 2004). Further, this acquisition structure enables the REIT to retain cash at acquisition if it holds stocks in the same amount measured in market value as the purchase price due at conversion date (Campbell et al., 2005). While IRS rules restrict ownership structure that the five main shareholders may not control more than 50% of underlying shares (Campbell et al., 2005), the UPREIT structure allows managing the 5-50 ownership rule31 as the REIT can exercise its call option on the OP units by cashing out some of the OP units in order to adjust the ownership structure (Campbell et al., 2005). Campbell et al. (2005) describe that managers that enter a REIT through the acquisition of their entity while accepting acquirer’s stock as deferred payment instrument is a signal to mitigate information asymmetries. In detail, they discover that value is created when managers of acquired companies obtain equity units in REIT subsidiaries with lock-up periods for the conversion of shares into cash, as hence positive signals regarding the combined entity’s outlook are given to the market. However, this mechanism has two practical implications as the REIT needs to make sure that sufficient shares are authorized for being issued at time of conversion and to have enough liquidity at hand in order to prevent a breach of the 5-50 ownership restriction (Campbell et al., 2005). This explains the rationale for the regular one-year lock-up period for conversion as this is a reasonable duration to execute internal restructuring, calculate liquidity requirements, and to seek fund sources at the capital market for debt and equity offerings (Campbell et al., 2005). As corporate takeovers have characteristics with JVs in common, we therefore deduct that JVs are a common instrument for corporate expansion and combination and are preferred over straight takeovers to mitigate information asymmetries allowing a first close contact with the partner and provides the ability to enforce the collaboration (S. Kumar & Park, 2012) that could serve as transition vehicle for future corporate acquisitions as in classical industry (Mantecon & Chatfield, 2007; Nanda & Williamson, 1995).

2.5

Subsidiary Conclusion

By reviewing and comparing the literature on corporate, real estate- related, and REIT JVs motivation, we find that the identified dominant theories, motives, 31

The IRS rules restrict the ownership structure in this way that the five largest shareholders may not control more than 50% of underlying shares (Campbell et al., 2005).

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2 Joint Ventures Motives in Classical Corporations and REITs

methodologies, and results do not heavily differ across the corporate and real estate / REIT marketplaces but two facets are accelerated in the case of REITs: the need for specific knowhow, which is attributable to the characteristics in the real estate industry, and the search for capital, which is accelerated in the REIT marketplace given exogenous capital restrictions. Yet, we are not able to confirm the hypothesis of Campbell (2002) and Campbell, White-Huckins, et al. (2006) that REIT JV motivation should heavily differ from the rationale of classical corporations, we find that the strategic applications are ailke. While we identified eight application streams, consisting of (C1) investment financing (C2) international expansion, (C3) business extension, (C4) risk-sharing and uncertainty, (C5) international expansion, (C6) partner signals, (C7) information hub and network learning, and (C8) M&A alternative rationales, in the general literature, while six application areas of very similar nature, comprising (RE1) investment financing vehicle (RE2) international expansion, (RE3) business extension, (RE4) real estate development or high risk-sharing (RE5) investment enhancement and signaling, and (RE6) M&A alternative rationales, in the REIT area. Following our research, we can deduct that the local and non-standard characteristics of the real estate industry (Gau, 1987) and the resulting fragmentation into local sub-markets (Ravichandran & Sa‐Aadu, 1988) explain the presence of JV use in the REIT industry to obtain the required local knowledge, the development-specific, and property-specific expertise for property acquisitions and the following management (Campbell, 2002), which can also be applied to existing properties resulting in DJVs. Further, the rationale for JVs in development activities becomes apparent, as real estate development projects require more local knowhow and tenant access, as i.a. lined out by Corgel and Rogers (1987), Behrens (1990), Campbell (2002). This is line with corporate JV use experiencing a focus on shared R&D, as i.a. lined out by Mariti and Smiley (1983), Harrigan (1985b), Contractor and Lorange (1988), and Kogut (1991). However, the implications from the overall real estate industry become more explanatory for REIT JV use given that REITs are exogenously cash-constrained firms with limited growth prospects, low security cushion and buffer, and limited cooperation with anchor shareholders compared to classical corporations, REITs‘ internal growth limitation to the remaining 10% of profits, REITs need to issue both equity and debt to grow internally (Plumb & Azrack, 2001) and hence, a maximum of 10% of earnings can be used for new investments while evidence by Ott et al. (2005) illustrates that only 7% of REIT investments are done through capitalization of retained earnings, we postulate that the internal constraints drive REIT JV use. In line with Plumb and Azrack (2001), Feng et al. (2007) argue that the main concern for REIT management is the maintenance of capital access and the adequate liquidity level, as well as the refinancing of maturing loans, there are difficulties for a REIT in weak times, either in a weak market environment or in

2.5 Subsidiary Conclusion

39

weak operational phases, to access both equity and debt sources and as such, JV offer financing flexibility for REITs, in line with the work of Freybote et al. (2014) that already applies a refinancing perspective on JVs from a DJV-perspective. This in line with the argumentation of Plumb and Azrack (2001) that the internal financing restrictions of REITs triggered JV use as alternative financing measure at the end of the 1990s, which becomes more apparent if connected to the identified REIT cash constraint (An et al., 2012; Hardin III et al., 2009; Hardin III & Hill, 2008; Riddiough & Wu, 2009). Consequently, it remains open to research and debate if JV use should correlate with capital constraints, high capital requirements, and difficulties to raise capital from capital markets. It is hoped that this contribution stimulates scholars’ interest to include JV in their analysis of REITs and its financing behavior. We suggest to analyze the pattern of when REITs chose JV structures and to what extent JV are an overall financing instrument within REIT capital structure.

3 Why REIT Act, REIT Capital Structure, and Diversification Needs call for Joint Venture32 3.1

Introduction

Outside the academic literature, we find newspapers looking at REIT JV, such as Wall Street Journal titling: “REITs Are Jumping at Joint Ventures” (Dunham, 2006) and Pensions & Investments headlining “Joint ventures emerging as new vehicle for REITs” (Jacobius, 2008), REIT ratings handbooks accounting for joint venture use (Kibel et al., 2006), and an emerging offering of JV structuring services in the legal industry, i.a. Skadden (2019) explicitly present their REIT JV services and depict numerous deals they advised. At the same time, the SEC filings of REITs contain whole sections on JVs and Boston Properties Limited Partnership (2003) present their JV strategy to jointly explore high quality assets with real estate and financial partners. But why are REIT managements motivated to pursue JVs? What drives REIT management boards into JV vehicles where they face risk to lose control? While Campbell (2002) claims that JVs should be in-depth investigated from a REIT perspective and Campbell et al. (2006) argues that management motivation should be different in REITs than in classical corporation, the previous Section reveals that the catalogue of principal motivations and applications do not differ largely across classical corporations and REITs while concluding that the REIT Act and capital structure constraints may drive REIT managements into JV use. This Section attempts to holistically investigate REIT JV use in the context of the highly regulated REIT environment, particularly capital structure restrictions enforced through the legal regulation of the REIT Act, and capital market expectations to draw conclusion on the overall motivation of REIT managements for JV use by also reviewing the existing literature on REIT capital structure and by combining with classical JV literature. We hypothesize that the need for financial flexibility in the REIT industry as proposed by Howton et al. (2018) and Hartzell et al. (2019) drives the active REIT JV market. Existing research has already yielded the insight that 24% of all property acquisitions and about 14% of all properties held by REITs are jointly executed and 32

This Section is co-authored by Dr. Holger Markmann and is intended for separate publication.

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 J. Eibel, Real Estate Investment Trusts and Joint Ventures, Essays in Real Estate Research 19, https://doi.org/10.1007/978-3-658-31977-9_3

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3 Why REITs Call for Joint Venture

owned respectively with the relatively use of JVs growing three times faster than the overall acquisition pace of REITs in the timeframe 19998 to 2002 (Hess & Liang, 2004). More importantly, several studies make clear that the REIT sector is exogenously liquidity-constrained (An et al., 2012; Hardin III et al., 2009; Hardin III & Hill, 2008; Riddiough & Wu, 2009) and others attribute a financing role to JVs (Campbell, White-Huckins, et al., 2006; Freybote et al., 2014). But yet a holistic connection to JV activities in the REIT sector has not been established that could provide reasoning for the postulation of Hess and Liang (2004) REIT JV use is on the rise by showing that REITs have increased JV structures from 11.7% in 1998 to 13.7% by year-end 2002 with regard to total assets. Since then, more than 1,100 announcements of JV erections and changes of threshold in JVs have been collected by SNL.33 To shed light on the financing motivation in the special case of REITs, we herein apply a holistic view on REIT JVs with regard to REIT Act evolution and review several specialties in the REIT marketplace such as dividend policies, stock repurchase programs, restructuring measures, capital structure, liquidity management, capital raising, and diversification rationales to draw conclusions on underlying rationales and strategies of REIT managers to use JVs. The reviews reveal that REIT managers can apply JVs for financial flexibility and use JVs (1) as facilitator to become more integrated real estate operating corporations; (2) to access income sources to gain financial and operational flexibility (Campbell, WhiteHuckins, et al., 2006; Freybote et al., 2014; Hess & Liang, 2004; Plumb & Azrack, 2001; Siegel, 1999); (3) as alternative funding sources in acquisitions and refinancing, (4) as liquidity management vehicle, (5) as part of capital market strategy to enable classical funding access as stock price stimulator, and (6) to establish diversification through external knowledge of partners while risk and capital exposure is minimized. The remainder of this Section is organized as follows. Sub-Section two defines equity JVs and subsequently reviews the general motives and market observations of classical and real estate companies to enter JV structures, while SubSection three depicts the technical overview of acquisitive and dispositional JVs in the real estate and foremost REIT area. In the following Sub-Sections, we present the REIT Act and the REIT capital structure literature respectively and introduce how JVs can be embedded in these fields, while the subsequent Sub-Section reviews the diversification discussion with regard to REITs and the role of JV use. Finally, we present critical remarks and our conclusion including recommendations for further research.

33

These announcements will be covered in more detail in the next two Sections.

3.2 Observations on the Use of (REIT) Equity JVs

3.2

43

Observations on the Use of (REIT) Equity JVs

As hybrid organizational arrangements (Borys & Jemison, 1989) based upon contractual agreements of two or more sponsors to erect a separate entity (Harrigan, 1988a), equity JVs are set up as separate legal organizations to share resources (Beamish, 2008; Beamish & Banks, 1987; Beamish & Lupton, 2009; Corgel & Rogers, 1987; Darrough & Stoughton, 1989; Harrigan, 1985a, 1985b, 1985c, 1986, 1987, 1988a, 1988b; Hennart, 1988, 1991; Hennart & Reddy, 1997; Inkpen & Beamish, 1997; Johnson & Houston, 2000; Kogut, 1988a, 1988b, 1991; Powell, 1990). The venture gets an own identity and is liable with its own share capital (Schut & Van Frederikslust, 2004), and is self-governed (He et al., 1997; McConnell & Nantell, 1985).34 In line with traditional JV theory, real estate equity JV structures are based upon contracts creating legally separate entities by the combination of the partners’ resources, mostly financial, and commonly also management know-how for shared projects (Campbell, White-Huckins, et al., 2006). Following the general rationale depicted by Powell (1990) and Koh and Venkatraman (1991), Hess and Liang (2004) argue that real estate and REIT JVs are set up by the sponsoring entities if they value positive benefits from the exploitation of the complementary resources allocated to the specific projects. The gain through complementary strengths should be higher and thus offset underlying weaknesses. Therefore, economies of scale are created and market power is bundled. Allowing the gain of technological expertise and assets, market access, economies of scale in research and production, expertise capitalization, and risk sharing platforms (Powell, 1990), JVs are one complementary option next to acquisitions, supply contracts, license provisions, or purchases at spot market (Kogut, 1988a). A four-stage JV erection process35 is crucial for long-term success with performance goals defined a priori comprising both financial measures and subjective terms, i.a. expertise transfer and capability development, JV lifetime, ownership stability, number of patents, and market value changes of the sponsoring firms (Beamish & Lupton, 2009). The success and the subsequent value creation depends on the set strategic direction, the decision-making processes embedded in the environmental context, and control level (Schut & Van Frederikslust, 2004). McConnell and Nantell (1985) find in their investigation36 that use of JV contributes and generates value for their parent firms confirming synergy hypothesis. 34 35

36

Structural changes are not required on parental level and consequently parental firms’ managements remain with their original companies (McConnell & Nantell, 1985). Initiated by the assessment of the strategic rationale for the foundation, followed by a partner selection process, the agreement negotiation, and the final erection of the new venture and its subsequent management (Beamish & Lupton, 2009). They apply an event-study methodology on a sample of 136 JVs from various industries.

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3 Why REITs Call for Joint Venture

However, JV erections follow no certain market trend whereas the formation behavior can not be explained by any market determinants (DiMaggio & Powell, 1983; Kogut, 1988a). Harrigan (1988b) concludes that industry-traits rather than specific strategies or characteristics of the vehicle itself matter. Madhavan and Prescott (1995) control for industry-effects and find return differences across industries depending on the information-load the capital markets possess about a certain industry. Koza and Lewin (1998) differentiate between joint entities targeting either exploitation or exploration, while also a differentiation between vertical and horizontal JV integration is possible (Harrigan, 1988a).37 Equity contributions38 of the partners represent the final commitment of the shareholders, facilitate the collaboration, and are a prerequisite for long-term success (Beamish & Lupton, 2009), while one literature stream, i.a. Harrigan (1988a), postulates the importance of equal ownership distribution among partners. Empirically, most shareholder value seems attributable to JVs with unequal ownership, as equal ownership leads to abnormal negative returns while both majority and minority holders gain positive abnormal returns (Schut & Van Frederikslust, 2004). As such, equity JVs offer superior performance compared to other cooperative agreements in line with the empirical findings of Koh and Venkatraman (1991)39 and achieve greater strategic benefits compared to minority investments40 (Harrigan, 1988a). Consequently, we limit our research on JVs where the partners contribute equity stakes in line with previous studies in the context of REIT JVs, i.a. Campbell, White-Huckins, et al. (2006).

37

38

39

40

Meaning that a buyer-seller relationship will follow the erection between parents and the new entity in the case of vertical integration, while horizontal JV will act in the same strategic area than (one of) the parents (Harrigan, 1988a) Equity JVs are legally separate entities with two or more shareholders holding at least 5% of all share capital, whereas significant shareholder influence is attributed to a minimum of 20% ownership in several jurisdictions resulting in different accounting treatment and effects (Beamish & Lupton, 2009) This contrasts cooperative agreements, where no equity capital is contributed but ease of termination is given as less resources and efforts are shared in line with Harrigan (1985b, 1986, 1988a). Minority investments are those corporate investments where parent companies invest in existing businesses with no subsequent erection of a new entity (Harrigan, 1988a), i.e. it represents a special case of corporate acquisition not targeting a majority shareholding. From an accounting perspective it may be that minority joint ventures can be disclosed as minority investments.

3.2 Observations on the Use of (REIT) Equity JVs

45

Brief Overview on JV Motives Attraction and acquisition of capital is one of the main drivers for JVs (Berg & Friedman, 1977), while Hennart (1988) concludes that the main motive for JV activity is to minimize costs of the transaction. Kogut (1988a) extends the transaction cost rationale by strategic behavior, organizational knowledge, and learning motives, while Darrough and Stoughton (1989) conclude the main drivers for JVs to be joint resource control and synergies from joint strategic exploitation to achieve a comparative advantage. Mostly focused on shared R&D, marketing, and technological licensing as i.a. outlined by Mariti and Smiley (1983), Harrigan (1985b), Contractor and Lorange (1988), and Kogut (1991), JVs allow its sponsors to gain access to distinctive expertise and know-how (Kanter, 1989; Koh & Venkatraman, 1991; Powell, 1990), which enables the sponsors to gain a competitive advantage over the environmental and industrial competition (Harrigan, 1988a). While JV agreements are arranged to invent new product and service lines, penetrate new or international markets (Beamish, 2008), pooling complementary capabilities and resources make product development faster, more reliably, and cheaper compared to each partner working independently or corporate acquisitions through achievable economies of scale and scope (Beamish & Lupton, 2009). The beforementioned is in line with the four value-creating benefits depicted by Koh and Venkatraman (1991): economies of scale (and scope) through combination of explicit knowledge and activities can be achieved; further through pooling of the parents’ know-how in different corporate functions (such as production skills of one partner and marketing skills of the other), a JV parent gets access to complementary skills; risks and costs for uncertain projects with regard to future demand are jointly burdened, and the competitive environment is reshaped. Each investor contributes and concentrates on the specific knowledge and ability, where he is leading, while needed assets to achieve the corporate goals are generated (Harrigan, 1985b). These assets are mostly knowledge (Kogut, 1988a; Teece, 1986) and knowledge generation depends on existing know-how and absorptive capacity (Cohen & Levinthal, 1990; Hamel, 1991; Shenkar & Li, 1999). To maintain and extend knowledge, companies are willing to accept failure and high instability rates caused by underlying complexities (Contractor & Lorange, 1988; GomesCasseres, 1987; Kogut, 1989; Osborn & Hagedoorn, 1997; Shenkar & Li, 1999). As result, JVs are a generic alternative within mature domestic economies and a strategic vehicle to drive strategic change or to enforce the current strategic positioning with resources that JV sponsors can not afford and establish on a standalone basis but needed with regard to shorter product life cycles, necessity of cost leadership, and more international competitors (Harrigan, 1988a). JVs thus fundamentally change competitive behavior and competitive positioning affecting industry structures through (1) gain of competitive advantage, (2) profit level

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3 Why REITs Call for Joint Venture

stabilization, and (3) changes in the structure of vertical integration, technology, and industry characteristics (Harrigan, 1988a). Pfeffer and Nowak (1976) conclude JVs are used to have an instrumental platform to align resources for future uncertainty and to manage given dependencies. This is in line with the findings that firm managements are heavily limited in the ability to influence going-concern prospects of their companies, i.a. proposed by Hannan and Freeman (1977) and McKelvey and Aldrich (1983). As such, JVs are decision-facilitators to invest and expand into new markets outside the core business, where demand is uncertain and complex (Kogut, 1991). Due to risk sharing, projects become feasible and acceptable for company boards, the capital equity and debt markets, and other financial providers even if risks exceed the capability of each partner (Burton et al., 1999; Jones & Danbolt, 2004). Following Bresnahan and Salop (1986), Reynolds and Snapp (1986), and Kwoka Jr (1992), JVs are motivated by the rationale to increase market power. Thereby, the better the balance between complementary and overlap of the core businesses of the partners, the greater gains in market power in their product-market space should be, as neither assets and skills are then duplicated nor should the complementary skills be too diverging (Mohanram & Nanda, 1998). In empirical studies JV announcements mostly yield positive abnormal returns of single stock prices from potential synergy effects in resource combinations of JV partners, i.a. presented by Koh and Venkatraman (1991),41 Chen et al. (1991),42 Crutchley et al. (1991),43 Balakrishnan and Koza (1993)44, Cheng, Fung, and Lam (1998),45 Mohanram and Nanda (1998),46 Johnson and Houston (2000).47 Further, positive abnormal returns are triggered by signaling effects for small firms when entering JVs with larger companies supporting their value to lever the complementary skillset as presented by Mohanram and Nanda (1998) and Koh and 41

42 43 44 45 46

47

Koh and Venkatraman (1991) postulate that achievable positive synergies are achievable if the JV relates to the core business of its sponsors: They find two-day abnormal cumulative returns of 1.32% for identical parents and 0.37% for unrelated parents. Chen et al. (1991) find positive CARs of 0.71% for 88 JVs between American and Chinese companies in a two day-window. Crutchley et al. (1991) report 0.99% CARs in the two-day window. Balakrishnan and Koza (1993) analyze 64 domestic JVs and 165 acquisitions in the timeframe from 1974 and 1977. Cheng et al. (1998) report three day cumulative positive abnormal returns of 1.02% in their sample of 103 US-Chinese JVs. Mohanram and Nanda (1998) analyze 253 JV announcements between US corporations from 1986 to 1993 and find positive CARs of 0.49% in a two day window upon announcement. Johnson and Houston (2000) find positive CARs of 0.65% in 59 horizontal JVs and confirm the horizontal synergy assumption.

3.2 Observations on the Use of (REIT) Equity JVs

47

Venkatraman (1991). Corgel and Rogers (1987) link JVs to the classical financing theorem of Modigliani and Miller (1958) and summarize that JVs erections represent a financial restructuring of parental firms as the predefined set of financial agreements are affected and thus share price reactions should be observable as (financial) synergies may be achieved in line with Bradley et al. (1983). Contradictory, negative abnormal returns are obtained when attributed to informational asymmetries in an international context, as the negative effect becomes stronger in the case of JV announcements in less developed countries, i.a. presented by I. Lee and Wyatt (1990)48, Chung, Koford, and Lee (1993)49. Further, negative effects are observable when capital markets expect managerial misalignment in terms of abuse of free cash flow to achieve larger companies in line with Jensen (1986) or when risk diversification requires acceptance of lowering profitability ratios (Mohanram & Nanda, 1998). Market Observations on Real Estate and REIT JVs The leading set of rationale for JV erections in the scope of real estate business can be allocated to capital access, combination of know-how, and access to anchor tenants (Behrens, 1990; Berg & Friedman, 1977). Subsequently, Corgel and Rogers (1987) and Ravichandran and Sa‐Aadu (1988) argue that JVs represent the combination of resources of the partners’ firms in order to achieve a shared target while all involved partner companies are responsible for the management of the JV which contradicts the common procedure in M&A where the management of the acquired company is replaced or made redundant.50 From a financing perspective, real estate JVs can be motivated through a facilitated debt raising processes in the case of partnering between real estate companies and the attraction of financial (equity) injection from third parties while real estate companies contribute the development concept, land, and know-how (Corgel & Rogers, 1987). However, Corgel and Rogers (1987) do not find any statistical significance in their eventstudy of real estate (development) JV announcements. Contradictory, Ravichandran and Sa‐Aadu (1988) analyze the announcement effect for 59 real estate-related JVs in the time frame from 1972 to 1983 and find abnormal returns of 0.76% in a two-day window which they attribute to the creation of competitive advantage through location- and property-specific expertise and the acquisition of anchor tenants. 48 49 50

I. Lee and Wyatt (1990) analyze 109 American – foreign JVs between 1974 and 1986. The abnormal returns are not negative but around zero in those JVs erected in developed countries (Chung et al., 1993). However, this also implies that a new management is installed in the JV while the management of the parental firms does not change.

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3 Why REITs Call for Joint Venture

Elayan (1993) elaborates that one key motivation for JV erection in real estate is the goal to achieve synergies in both operations and financials by the resource combination which enables operational synergies from economies of scale and scope, the more efficient allocation of human and asset capital, risk reduction, efficiency effects in administration and management, alignment of research interest, and a monopolistic competitive advantage while making use of diversification and further leverage potential respectively. Studying 125 real estate JV announcements from 1972 to 1989, Elayan (1993) finds that real estate companies benefit most if they partner with non-real estate companies with positive abnormal returns of 2.96% compared to 1.78% between pure real estate companies. Despite contradicting classical JV theory, synergy theory fully explains the findings (Elayan, 1993). In line with classical JV literature, He et al. (1997) explain that real estate JVs are a common instrument for corporate expansion and offer the ability to expand overseas, especially if policy constraints for direct real estate investment by foreign investors or other direct investment regulations are in place. As such, JVs with at least one shareholder from the host jurisdiction are widely used to circumvent restrictions in exchange for accepting more political and economic risk exposure in the JV compared to other foreign direct investments due to the immovability of real estate. These risks need to be balanced against achievable diversification benefits attributed with international expansion while JVs extent the competitive ability and enable strategic benefits (He et al., 1997). He et al. (1997) examine the wealth effects of international real estate JV announcements in a sample of 53 US compared to 28 international ventures to test for synergy theory in line with by Elayan (1993) and obtain positive two-day abnormal returns of 1.11% so that synergy intention holds true for domestic JVs. The findings do not hold true for the 28 international JVs with insignificant abnormal returns of 0.26% and for hotel JVs with insignificant two-day returns of 0.70% attributable to immovability of realty assets across countries, higher political and economic risk for international JVs and an US oversupply and a more conventional (and less real estate specific) business nature of hotels (He et al., 1997). JVs can be used for Asian market entry where JVs with a foreign partner can drive the enforcement of corporate control and transparency mechanisms as well as the facilitation of cash flow streams from the (US) capital markets to local Asian markets with the benefits of investor protection and American accounting standards (Campbell et al., 2005; Campbell, White-Huckins, et al., 2006). In an empirical sample, announcements of Asian JVs do not generate excess returns which might be associated with information asymmetries and potential taxation in the foreign legislation (Campbell, WhiteHuckins, et al., 2006). In a non-academic contribution, Siegel (1999) argues that REITs use JVs to attract capital for acquisitions and developments, as JVs offer additional income

3.2 Observations on the Use of (REIT) Equity JVs

49

streams with a very profitable ratio to contributed capital. However, as shareholdings are not always majority positions, JV debt can be off-balance and often higher leverage is taken, resulting in various risks, such as lease-up risk in development scenarios with a mandatory buyout upon project completion and further credit risk even in the case of non-recourse structures (Siegel, 1999). In addition, Plumb and Azrack (2001) elaborate in their working paper that the internal financing restrictions of REITs triggered JV use as alternative financing measure at the end of the 1990s, while external investors favor the high-quality assets of REITs over other direct investment opportunities lowering the dependence of equity capital markets. Titling “joint venture use is on the rise”, Hess and Liang (2004) find that a higher share on average was invested in JVs totaling 12.5% by year-end 2002 given a 2.4% rise from 10.1% in 1998 (47% relative change). At the same time, this equals a 250% relative growth to the jointly-held and wholly owned property interests whose value increased by 19%. They explain the growth by a heavy expansion of majority JVs. Majority-owned firms had a share of 4.8% in 2002 with regard to total REIT assets. As well equally-owned (50% JVs) firms gained importance from 4.4% in 1998 to 5.1% in 2002, whereas the share of minority vehicles increased from 1.9% to 2.6%. They argue that the increase of JV is even more important as the number of properties acquired through joint structures have thus relatively changed disproportionately. While 11.7% of all properties were jointly held in 1998, 13.7% of all properties were jointly owned in 2002. This equals a 30.1% growth, however, the total number of REIT properties increased by only 11.6% in the same timeframe. This growth pattern is asymptotic though and can not last. With regard to the sector of JV properties, Hess and Liang (2004) conduct various analyses of proportions of JV per asset class and present distribution of majority, equal, and minority shareholdings no general statements can be inferred. Campbell, White-Huckins, et al. (2006) analyze JVs as an instrument for structuring corporate options differentiating between dispositional and acquisitive structures. They conclude that JVs are a valid option to circumvent the tough institutional environment and find that JV announcements lead, in general, to positive market reactions, while acquisitive structures lead to positive and dispositional structures to negative alpha returns respectively.51 Freybote et al. (2014) elaborate on DJV structures and postulate that JV are means of disposal and financing strategy for REITs in financial distress and find evidence in the characteristics of DJV-structuring REITs.

51

While mentioning the limitation that dispositional structures are mostly minority-held and acquisitive structure are majority-held, they do not control for the threshold.

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3 Why REITs Call for Joint Venture

Technical Overview on Real Estate and REIT JVs As aforementioned, REIT JVs can be used to attract external capital and offer additional income streams with very attractive profitability ratios to contributed capital. Further, JV debt can be structured off-balance and higher leveraged on the one hand, which leads to risks from lease-up in development scenarios, a mandatory buyout agreement upon project completion and refinancing even in the case of non-recourse structures (Siegel, 1999). On the other hand, JV schemes offer risk-sharing in addition to a shared assumption of negative cash flows by the JV partners while potential negative income streams can be counterbalanced by positive income streams of other parts of the JV property portfolio. As consequence the vehicle shields its sponsors from negative income effects with regard to their balance sheet, income and cash flow statements, and debt-related covenants (Campbell, White-Huckins, et al., 2006).52 In case of failure, this structure can be easily liquidated, while the entity can be fully consolidated upon termination of the project in case of buying out the JV partner (Campbell, White-Huckins, et al., 2006). We deduct that the same advantages hold true for JV owning existing / disposed properties. We will elaborate the two different structures that have been evolved in the REIT JV literature in the next two Sub-Sections. Acquisitive Joint Ventures In line with Campbell, White-Huckins, et al. (2006) and Ro and Ziobrowski (2012) the erection of acquisitive joint ventures (AJV) structures aims at acquiring properties at minimized transaction costs, as depicted in JV transaction theory (Hennart, 1988; Kogut, 1988a). The erections are based on agreements between the partners, then the JVs are erected and capital contributions by the partners are injected with additional capital to be provided through (bank) debt and finally targeted properties can be acquired in JVs or developments can be executed as depicted in Figure 5 (Campbell, White-Huckins, et al., 2006). Existing research does not fully differentiate between different AJV functions: The acquisition of assets can either simultaneously occur once the JV has its own identity (as outlined) so that the partnership is erected on means of acquiring specific asset(s) or the partnership is based on means to raise capital first and then initiate the market screening process for acquisitions with no particular asset or time of purchase.

52

Ceteris paribus we argue that positive cash flows can be shielded from its sponsors. We will discuss this fact throughout the next main Sub-Sections.

3.2 Observations on the Use of (REIT) Equity JVs

51

Acquisitive Structure 1

REIT Capital

2

Joint Venture

4

REIT Partner 1

REIT Partner 2

Capital

Capital

3

Bank

Property

1. Agreement to partner 2. Foundation of Joint Venture 3. Collection of capital 4. Acquisition of property

Figure 5: Formation of Acquisitive REIT JV Structures Source: own illustration Note: The figure depicts the erection process of AJV structures in a simplified approach.

Further, REITs can as well obtain JV equity in exchange for own shares. Based upon findings of Campbell, White-Huckins, et al. (2006), the acquisitive structure is chosen in 60 out of 100 cases to undertake developments with a financial partner, in 25 out of 100 cases to acquire existing assets with cash flows in place, and in 15 out of 100 cases to partner with a development company. This confirms previous observations of real estate development concentrations in real estate JV samples of McConnell and Nantell (1985), Corgel and Rogers (1987), and Ravichandran and Sa‐Aadu (1988). Table 1 illustrates the effects for financial acquisition capacities for JV use by changing the two basic input determinants of loan-to-value (LTV hereafter) as leverage parameter and threshold of the sponsor. By investing through a 50% JV structure into the same property with the same LTV of 50% (assumed as the REIT’s target leverage), the REIT sponsor can double its financial acquisition power by using the diversification effect as theoretically two properties of the same kind could be acquired. Further, through additionally increase of leverage to 80% which is line with the beforementioned, the REIT increases its financial firepower by additional 300% to a total of 500% of the original potential. The same applies if the REIT and its partner maintain the conservative financing of 50% LTV but the REIT only holds 25% shareholding. If the REIT only holds 25% but the jointly acquired property is financed with 80% LTV, the firepower can be increased to 1000% implying that the REIT can invest into ten properties of a kind

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3 Why REITs Call for Joint Venture

instead of one while benefiting from the diversification effect. However, the extended financial capacity gained through JV structures require more managerial capacities to be allocated to partner and JV monitoring and the alignment of interests, especially in the case when then REIT takes a minority participation. Table 1:

Exemplary Financial Acquisition Capacities

Acquisition characteristics

Purchase Price REIT ownership Leverage Mandatory REIT equity contribution Firepower

Scenario 1: Scenario 2: REIT JV strucalone ture (50% REIT shareholding) 100 100%

Scenario 3: Scenario 4: JV struc- JV structure (50% ture (25% REIT REIT sharehold- shareholding, higher ing) leverage) 100 100 100 50% 50% 25%

Scenario 5: JV structure (25% REIT shareholding, higher leverage) 100 25%

50% 50

50% 25

80% 10

50% 10

80% 5

100%

200%

500%

500%

1000%

Source: own illustration Note: Tables serves as illustration to compare acquisition capacities through JV use.

Dispositional Joint Ventures Erections of dispositional joint venture (DJV) structures are based on agreements between the partners, then the JVs are erected with the REIT contributing a property and the partner(s) capital, equity and potentially also debt, which directly flows to the REIT, and additional capital can be provided by bank debt (Campbell, White-Huckins, et al., 2006). The erection process is illustrated in following Figure 6. DJVs can be erected to simultaneously acquire existing properties from the REIT. Thereby dispositional structures allow the partial disposition to JVs with a subsequent cash flow from the partner to the REIT in the form of cash or other liquid assets which can allow to bridge liquidity gaps due to the cash constraints in the REIT Act (Campbell, White-Huckins, et al., 2006; Freybote et al., 2014). In case of property or portfolio underperformance, dispositional structures can be chosen to get access to a specific partner’s knowledge and expertise to do a work-out and turnaround of the income situation (Campbell, 2002; Campbell,

3.2 Observations on the Use of (REIT) Equity JVs

53

White-Huckins, et al., 2006). In the case of urgent liquidity needs, Freybote et al. (2014) argue that REITs mostly dispose their high quality assets (characterized by higher space prices for office properties, a larger tenant base in retail

Dispositional Structure 1

REIT Disposition

Capital

Property 2

4

Joint Venture

3

Capital

Capital

REIT Partner 1

REIT Partner 2

Bank

1. Agreement to partner 2. Foundation of Joint Venture 3. Disposition of property into Vehicle and Buy-In of Partners 4. Flow of dispositonal cash proceeds to REIT

Figure 6: Formation of Dispositional REIT JV Structures Source: own illustration Note: The figure presents the erection process of DJV structures in a simplified manner.

buildings, and their larger transaction size) to guarantee for sufficient funding. Beneficially, the REIT maintains the property management in exchange for a management fee from the new owner entity.53 Mostly a REIT minority position in this structure, the DJV offers four advantages to the REIT management as identified by Campbell, White-Huckins, et al. (2006): (1) Securitization of some income through asset management contracts allows partial priority claim in line with threshold; (2) bankruptcy risk is minimized, as interest obligations are reduced or even obsolete if the JV is purely equity-financed; (3) REIT balance sheet is streamlined as potential debt is off-balance due to the fact that a consolidation obligation is not given due to the minority threshold, and (4) greater operational and strategic flexibility is achieved. For the DJV (financial) partner, Campbell, White-Huckins, 53

In the sample of Campbell, White-Huckins, et al. (2006) in 16 out of 185 JVs are managed by the partner which might be due to local or asset-specific knowledge of the partner, information asymmetries should be overcome as equity ownership is given by both parties.

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3 Why REITs Call for Joint Venture

et al. (2006) conclude that the following three drivers motivate the shareholding in JVs with REITs: (1) Given majority thresholds, information asymmetries are obsolete; (2) time-varying, complex cash flow sharing agreements give a legal claim on cash flows and allow an arrangement of equity participation mortgage; and (3) a low-cost exit scheme for the case of project failure. Further, Plumb and Azrack (2001) elaborate that investors prefer co-investments in REIT properties due to high-quality of the underlying assets (attributable to a dedicated search and acquisition process) so that investors gain diversification while reducing specific asset risk and obtaining property-specific knowledge through the REIT partner. Interim Conclusion In line with Damodaran et al. (1997) and Campbell, White-Huckins, et al. (2006) we postulate that REIT JVs erection are motived by the corporate lack to accumulate cash through retained earnings and thereby offer higher strategic benefits than to normal corporations because the dependence on classical capital markets can be bypassed for strategic goals. JVs can be financed through stocks and debt of REIT and thus offer a broad alternative financing measure outside the capital markets (Campbell, White-Huckins, et al., 2006). Whilst offering financial flexibility on the one hand, the JV erection announcement also generally yield positive market reactions while AJVs lead to positive and dispositional structures to negative alpha returns respectively, as i.a. depicted by Campbell, White-Huckins, et al. (2006).54 The results of Ro and Ziobrowski (2012), however, indicate that DJV can as well trigger positive alpha returns. Recapitulating, JV scenarios seem to be very attractive to REIT management as transparency and corporate governance goals can be evaded to gain financial flexibility outside the REIT structure and even gain positive market reactions which is in line with the conclusion of Glascock, Zhang, and Zhou (2018) doubting the efficiency of the REIT structure. Existing research, i.a. Gamba and Triantis (2008), Almeida, Campello, and Weisbach (2011), Denis (2011), Howton et al. (2018), Hartzell et al. (2019), concludes that financial flexibility is needed if companies face underinvestment and have hurdles to access financing for investments, as being perfectly fulfilled in the REIT area.

54

They do not control for different threshold effects except for their summary that DJV are mostly minority-held and AJV are preferably majority-held.

3.3 Why the REIT Act calls for JV Use

3.3

55

Why the REIT Act calls for JV Use

In the year 1960, the 86th U.S. congress passed the Real Estate Investment Trust Act. Defined in §§ 856 – 860 Internal Revenue Code, the corporate structure reliefs REITs from taxation at corporate level in exchange for a set of regulations and restrictions with regard to income distribution in form of dividends, organizational regulations, and operational restrictions (Feng, Price, & Sirmans, 2011). In detail, REITs have four principle restrictions to comply with, being (1) that 75% of its assets must be invested in real estate, mortgages, cash and other cash items, or government bonds and at least 75% of gross income must be generated in these assets, (2) income should predominantly be generated from passive sources, rents, or mortgages, (3) the ownership structure needs to comprise at least 100 shareholders and 50% of a REIT’s stock must not be owned by less than 5 shareholders, the 5-50 rule or five-or-fewer rule, and (4) most importantly shareholders are eligible to receive no less than 90% (95% before 1999) of annual taxable income need as dividends (Campbell, 2002; Feng et al., 2011; Ro & Ziobrowski, 2012; Striewe, Rottke, & Zietz, 2013). While the REIT Act differentiate three different kinds of REIT organizational forms: (1) Equity REITs, (2) Mortgage REITs, and (3) Hybrid REITs, we follow the common approach in the literature to concentrate on (listed and traded) equity REITs, as all other forms are constituted by a different asset base composition and varying implications of the findings. 55 Since its inception, ongoing change of the REIT Act has been introduced, such as the Tax Reform Act of 1986 (TRA hereafter), the Omnibus Budget and Reconciliation Act of 1993 (OBRA hereafter), and the RMA of 1999. These reforms enabled REITs to tremendously grow in size and nature and changed the industry characteristics per se (Feng et al., 2011). In more detail, the REIT industry comprised around 35 REITs in 1980 and grew to more than 200 Equity REITs by the 2000s (Campbell, 2002). In particular, REITs before 1990 were not allowed to actively manage their portfolios requiring outside managers and can thus be described as liquid, double-taxation exempted passive investment vehicles owning property-type diversified, regionally-focused real estate portfolios with no specialized managerial knowhow (Campbell, 2002; D. C. Ling & Ryngaert, 1997). The TRA of 1986 changed the organization and business purpose by introducing the eligibility to actively manage their properties so that REIT evolved to become active and fully integrated operating corporations rather than passive real estate portfolios (D. C. Ling & Ryngaert, 1997). REITs have become internally-advised and internally-managed with asset management services, including investment and sell-off decisions, as well as property management provided in-house or by a 55

This is in line with existent literature in the REIT area, i.a. Anderson, Benefield, and Hurst (2015)

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3 Why REITs Call for Joint Venture

group(-affiliated) company, whereas most externally-advised also have external property management providers (Striewe, Rottke, & Zietz, 2013). Another milestone in organizational REIT development is the introduction of the umbrella partnership structure (UPREIT) through the initial public offering (IPO) of Taubman in 1992 (Feng et al., 2011), that made individuals or partnerships with real estate ownerships eligible to contribute their real estate assets as property partnerships to a newly-found umbrella partnership and receive operating partnership (OP) units (or REIT shares) with a REIT as managing partner and majority shareholder of the umbrella partnership (D. C. Ling & Ryngaert, 1997). The contribution of real estate in exchange for operating units or REIT shares does not trigger a tax event for the individuals and defers the potential capital gain tax (An et al., 2012; D. C. Ling & Ryngaert, 1997).56 In particular, ownership of properties remains with subsidiary partnerships whose OP units are owned by the umbrella partnership and individuals that sold the property to the REIT in exchange for share conversion rights (or cash) (Campbell et al., 2005; Feng et al., 2011). The contributing individuals thereby remain limited partners and obtain partial cash flows from the provided properties until conversion of OP units (Campbell, 2002; Feng et al., 2011). The main advantage is that capital gain taxes can be paid in several tranches over years, capital gains can be offset by losses and conversion of OP ownerships into REIT shares can be timed, while OP units do not violate the 5-50 ownership rule at the same time (Capozza & Seguin, 2003; Feng et al., 2011). Against this background, one literature stream argues the umbrella structure has certain weaknesses because the organizational complexity increases potential information asymmetries across the dual ownership structure so that OP shareholders can affect the course of business through conversion rights and associated payment obligations of the REIT (Campbell, 2002; Feng et al., 2011; D. C. Ling & Ryngaert, 1997). Contrastingly, other research finds the dual ownership structure to positively affect agency conflicts, as an additional monitoring is given through the OP shareholders whose interest may be aligned with other REIT shareholders (Feng et al., 2011; Han, 2006). Nonetheless, the underlying lock-up periods of the OP shareholders for conversion decreases the maneuverability in market movements (Campbell, 2002). Consequently, the UPREIT structure has evolved to be the most common corporate structure of US REITs as 80% of US Equity REITs are UPREITs (Campbell et al., 2005). The umbrella structure itself implies tremendous implications for JV use because (1) the umbrella structure itself has certain JV characteristics and (2) the market value of a UPREIT is positively 56

The background for this facilitation of the REIT Act is that in cases where REITs acquire properties for purchase prices higher than the underlying book value from a private entity with own stocks, the tax code implies realized capital gains and consequently tax gains would become due which is suspended until conversion execution (Campbell et al., 2005).

3.3 Why the REIT Act calls for JV Use

57

affected by the number of OP units whereas the effect decreases in case of insider and management ownership (Han, 2006). The following Sub-Sections combine the existing findings in the literature on JV use and REIT characteristics and expands the works of Campbell, WhiteHuckins, et al. (2006) and Freybote et al. (2014). As result, the RMA has made REITs become high-yield stocks with a strong dividend policy. While corporate growth is limited, stock repurchases are one result to mitigate information asymmetries. Both effects, dividend policies and stock repurchases, are subsequently analyzed with the acknowledgement of potential contribution of JVs. REIT Dividend Policy and JV Contribution REIT Act changes have transformed the REIT marketplace into a high-dividend industry and have contributed to establish investor expectation that dividend levels have to be maintained or even increased so that dividend cuts lead to significant capital market penalties (Bradley, Capozza, & Seguin, 1998). As depicted by Aharony and Swary (1980), dividends are distributed to signalize managerial going-concern information to the market in addition to financial reporting and thus mitigate information asymmetries in line with the original statement by M. H. Miller and Modigliani (1961): "Investors are likely to (and have good reason to) interpret a change in the dividend rate as a change in management's views of future profit prospects for the firm" (p. 430).

However, we deduct that REIT managements acknowledge that JV structures contribute to a steady dividend policy due to the aforementioned characteristics of i.a. offering high returns over contributed equity (Siegel, 1999), co-insuring cash flows, and shielding effects (Campbell, 2006). The dividend policy of REITs has certain special characteristics that we will present and discuss the role of JV subsequently. K. Wang, Erickson, and Gau (1993) find that REITs tend to distribute dividends in excess of the legal REIT Act requirement, as higher cash flows than earnings are generated in a period caused by three parameters being (1) accrued income and expenses, (2) depreciation on properties, and (3) debt repayment and refinancing. Empirically, An et al. (2012) find that REITs distribute some 85% of funds from operations (FFO hereafter) as cash dividends to their shareholders, while Bradley et al. (1998) find that payouts amount two-times net income and Ghosh and Sirmans (2006) calculate a 150% net income distribution, leaving REITs with substantial hurdles for asset base growth (Hardin III & Hill, 2008). In fact, Ott et al. (2005) derive that internally generated cash flow only contributes 7% to

58

3 Why REITs Call for Joint Venture

required funding for asset growth in the REIT industry.57 Given the identified lack of internal fund-generating ability, the first benefit of JVs as depicted in the acquisition power analysis (Table 1 in previous Sub-Section) becomes apparent. Hence, REITs circumvent their internal restrictions by attracting capital resources off-balance from third parties to allow sufficient funding to realize property acquisitions in line with the identified capital attraction motive for real estate companies and REITs (Behrens, 1990; Campbell, 2002; Campbell, White-Huckins, et al., 2006; Elayan, 1993; Hess & Liang, 2004; Siegel, 1999).58 While underlying transaction expenses are split among the partners (Kogut, 1988a), JVs serve as decision-facilitator for unknown investment markets and property-specific uncertainty, i.a. A. J. Jaffe and Sirmans (1984) and Ravichandran and Sa‐Aadu (1988),59 and circumvent hold-up hazards from asset specificity, transaction uncertainty, and transaction complexity (Alchian & Woodward, 1987; Klein et al., 1978; Williamson, 1979). As side-effect in partnering with other real estate companies REITs gain complementary knowhow and regional market access, such as property-specific management expertise and access to potential anchor tenants, to establish successful property management, i.a. Powell (1990) and Koh and Venkatraman (1991) for classical JVs and He et al. (1997), Hess and Liang (2004), Campbell, White-Huckins, et al. (2006) for REIT JVs, and to overcome general information asymmetries (Balakrishnan & Koza, 1993; He et al., 1997; Ravichandran & Sa‐Aadu, 1988; Reuer & Koza, 1998). Additionally, Siegel (1999) argues that additional profitable income streams can be secured in asset management while keeping contributed capital low in line with Campbell, WhiteHuckins, et al. (2006) and Freybote et al. (2014). From a capital market perspective, positive abnormal returns on the stock price can as well be expected in accordance with event-study results in real estate JV context (Campbell, WhiteHuckins, et al., 2006; Elayan, 1993; He et al., 1997; Ro & Ziobrowski, 2012), especially if non-real estate companies, such as financial investors, co-invest (Elayan, 1993).60 The underlying rational is that the announcement embodies information of (dividend) growth to capital markets.

57 58 59 60

This compares to 70% for non-regulated listed companies (Fama & French, 1999; Ott et al., 2005; Riddiough & Wu, 2009). See i.a. Berg and Friedman (1977) and Johnson and Houston (2000) for JVs and capital attraction in general. See i.a. Pfeffer and Nowak (1976), Vernon (1983),Vickers (1985), and Kogut (1988a) for classical JVs and uncertainty-facilitation. See, i.a. Koh and Venkatraman (1991), Chen et al. (1991), Crutchley et al. (1991), Balakrishnan and Koza (1993), Cheng, Fung, and Lam (1998), Mohanram and Nanda (1998), Johnson and Houston (2000) for event-studies in a classical JV context.

3.3 Why the REIT Act calls for JV Use

59

Simultaneously potential to reduce underwriting fees is found if connected to K. Wang et al. (1993) discovering REITs to execute significant equity and debt offerings to finance the beforementioned excess dividend distribution which requires banks as arrangers. We infer large cash amounts for issuances could be saved if REITs reduce payout-ratios, while this reduction alone could be used as internal financing source for growth or as means of dividends. 61 In an analysis of the effect on cash flow volatility from leverage grade, asset base size, and diversification degree on dividend payout ratio, Bradley et al. (1998) conclude that REITs strategically set their dividend payout ratios62 the greater expected volatility is and as such the asset and financing base of REIT has constraining effect on dividend payouts being consistent with explanations for dividend signaling depicted by Bhattacharya (1979), John and Williams (1985), and M. H. Miller and Rock (1985). In line with Glascock et al. (2018) we deduct that the REIT structure is not efficient as common practices is to use mechanisms that are associated with positive dividend signaling but are meant to stimulate the stock to keep momentum for capital access. Regarding cash flow volatility, REIT management can materialize JV structures. As JVs expand the portfolio as well as the investment universe of REITs, diversification effects can be achieved resulting from the creation of a greater, more efficient internal capital pool and more efficient resource allocations, the existence of coinsuring cash flows through broader sets of income sources resulting in higher achievable leverage and a given tax advantage through offsetting potential losses of one income source by profits of another income stream respectively, as i.a. depicted by Weston (1969), Lewellen (1971), and Majd and Myers (1987). Lower volatility can thus be achieved in line with Miles and McCue (1984) and Bradley et al. (1998). Additionally, asset management contracts in joint properties allow a steady cash flow (Campbell, White-Huckins, et al., 2006; Freybote et al., 2014; Siegel, 1999). Both aspects contribute to stabilize financial position and to reduce offering costs for equity and debt instruments, because bankruptcy risk and interest obligations are decreased compared to full acquisition or obsolete if equity financed (Campbell, White-Huckins, et al., 2006), as well as potential streamlining of REIT balance sheets by having potential debt off-balance in minority vehicles (Campbell, White-Huckins, et al., 2006; Siegel, 1999), leading to greater operational and strategic flexibility (Campbell, White-Huckins, et al., 2006). Finally, dividend discretion is made possible for REIT managements, i.e. more cash funds should be available in line with Bradley et al. (1998). Even though agency-cost theory implies high cash flow uncertainty would require higher dividend payouts to mitigate underlying agency conflicts and 61 62

K. Wang et al. (1993) find that the average dividend ratio amounted to 1.65 instead of the legal 0.95 in 1998 throughout their sample. Bradley et al. (1998) refer to this as discretion.

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3 Why REITs Call for Joint Venture

subsequent penalties, Bradley et al. (1998) find for REITs that the signaling hypothesis is superior in the explanation and argue that financing and investment decisions have to be considered at once and not separately, despite contradictions with classical corporate finance literature. Hence, we deduct JV investments are the result of parallel and shared considerations of financing and investment aspects. Wansley, Sirmans, Shilling, and Lee (1991) conclude from their analysis that future REIT earnings potential can not be predicted by dividend policy adjustments. Subsequently, Hardin III and Hill (2008) conclude REITs adjust their dividend policies in a way to maintain equity and debt capital access to have sufficient funding for growth while short-term debt represents a cornerstone in dividend determinations. As a consequence, REITs follow a dividend payout strategy that reduces both agency costs and probability of dividend cuts, as mitigation of agency conflicts is needed to ensure funding for future property acquisitions (Hardin III & Hill, 2008). In particular, K. Wang et al. (1993) find that investors invest less in monitoring when REITs perform well, measured by return on assets (ROA),63 and hence when performance is weak shareholders demand high pay-out ratios to enable ongoing monitoring through capital markets. Subsequently, Ghosh and Sirmans (2006) conclude that excess dividends originate from poor managerial performance and as effect investors demand high pay-out ratios to mitigate the risks of overinvestment and decreasing shareholder value in line with Jensen (1986). Dividend payments aim at shareholder sanction prevention. In a nutshell, good managerial performance aligned with shareholder interest 64 does not necessitate excess dividends because inside chief executive officers (CEO) seek profitable acquisition opportunities only. The findings of Hardin III and Hill (2008) confirm the beforementioned and the results of Wang et al. (1993), as their ROA effect is negative and significant at the 10% level implicating that the capital markets does not penalize high-performance REITs when they waive excess dividends to retain earnings to finance future property acquisitions. From the finding that well-performing REITs are less penalized by capital markets and thus obtain greater operational and financial flexibility, REIT managements should be motived to achieve a minimum ROA of 10%. As JVs allow access to complementary and specialized knowhow, information, and skills, we argue that joint investments with partners enable higher profitability, because there are no interest conflicts between the partners due to equity contributions (Beamish & Lupton, 2009), e.g. compared to single investments with an external asset manager. This in line with the conclusion of Balakrishnan and Koza (1993) that JV 63 64

Wang et al. (1993) derive a robust negative causality between ROA and dividend payments. Ghosh and Sirmans (2006) conclude dividend distribution relates to CEO tenure and ownership as well as to board independence.

3.3 Why the REIT Act calls for JV Use

61

erections enable further performance improvement and with Nanda and Williamson (1995) arguing that JV are a result of divisional-wide underperformance. Mohanram and Nanda (1998) find in their analysis of 253 JV announcements between US corporations from 1986 to 1993 that JVs are erected when the parent firms perform weakly, i.e. profitability improvement is needed. For existing investments where internal REIT knowledge base is not sufficient to extract full profitability potential of underlying properties, REITs can use DJVs structures with knowledgeable partners to manage these properties to full profitability (Campbell, 2002; Campbell, Petrova, et al., 2006; Campbell, WhiteHuckins, et al., 2006; Freybote et al., 2014). Subsequently, dividend payments can be increased to reduce agency costs of free cash flows (Jensen, 1986). Again positive market signaling is conveyed with regard to future profitability (Ghosh & Sirmans, 2006; K. Wang et al., 1993). Further, through partial disposition of valuedestroying projects, in terms of relative underperformance, firm value can be increased and some of the achieved purchase prices can be distributed to investors, either as dividend or as stock repurchase, where another positive signaling is given due to the momentum of hindsight by management regarding their failure in underlying properties in line with Giambona, Giaccotto, and Sirmans (2005)65 and Campbell, Petrova, et al. (2006). As consequence, additional available funds are not invested but being distributed to shareholders as means of mitigating informational asymmetries. To realize cash distributions and acquisitions at the same time, AJVs allow efficient investments as capital requirements decrease for acquisitions (Campbell, 2002; Campbell, White-Huckins, et al., 2006; Elayan, 1993; Johnson & Houston, 2000). In parallel, AJVs and DJVs allow to access private capital markets and thus contribute liquidity for dividend pay-outs. Hardin III and Hill (2008) argue that REIT dividend changes only reflect absolute profitability increases and incorporate no more than the positive change of excess FFO from previous period thereby excluding short-term bank loans as dividend funding source in this cases. In addition, they conclude that stock repurchases are financed from additional FFO, if FFO is not allocated to excess dividends, in order to minimize cost of capital. From an information-content perspective, capital markets anticipate the information and share prices increase facilitating future capital offerings for growth at capital markets (Hardin III & Hill, 2008). In addition to ongoing monitoring through equity capital markets, REITs accept additional monitoring and review processes by debt providers for shortterm bank lines for two reasons: (1) liquidity from short-term debt is not used to fund excess dividends that are not sustainable with regard to cash flow predictions 65

Giambona et al. (2005) base their argumentation on full dispositions. We apply this to partial disposition as well. Even though dispositional JVs yield negative abnormal returns in the sample of Campbell, White-Huckins, et al. (2006), we argue positive effects should be achievable with the right communication strategy.

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but allows financial flexibility and (2) overall agency costs are further minimized through the ongoing review and covenants of debt providers so that subsequently all capital providers appreciate any transparency-increasing mechanism which is then again incorporated in the next funding process (Hardin III & Hill, 2008). In line with Freybote et al. (2014), we argue REIT managements use JVs to decrease dependencies on public capital markets because private capital markets can be easier accessed through JV structures. Given own legal identities and liabilities (Schut & Van Frederikslust, 2004) as well as self-governance (He et al., 1997; McConnell & Nantell, 1985), JV have the ability to access private and in cases public capital markets on their own and become financially independent from the REIT parent(s) while allowing full transparency to its capital providers due to its property- and project-specific structure which results in adequate financing structures. Property- and project-specific capital needs are isolated and shielded from the REIT sponsors (Campbell, White-Huckins, et al., 2006; Siegel, 1999) which allows for a more flexible REIT financing strategy. The income situation can be improved through fixed-income management contracts with absolute profitability gains so that higher dividends are to be distributed. Following Fama and French (2002), Riddiough and Wu (2009) link REIT dividend policy with investments and observe that dividend payouts decrease for capital investment allocation purposes if REITs are more financially constrained, whereas increases are correlated with secondary equity issuances, increases in available credit line capacities, and increases in credit line utilization. 66 Their financially constrained sub-sample uses retained cash flows to pay down short-term borrowings in credit lines indicating that managements pay close attention to not breach covenants that would result in additional borrowing costs (Riddiough & Wu, 2009). In liquidity crisis situations as in 2008 and 2009 with dysfunctional capital markets, REITs adjust their dividend polices to the weak environment in accordance with their attributes of being highly dependent on external capital funds, capital-intensive, and highly levered (Case, Hardin, & Wu, 2012). The findings of Case et al. (2012) illustrate that dividend cuts can be explained by lower market-to-book ratio (MBR hereafter)67 and higher leverage prior to and during the liquidity crisis. In order to react to liquidity shortfalls as a result of capital structure and market value impact, REITs attempt to maintain cash reserves and to reduce going-concern risks by either paying stock dividends (usually larger REITs) or cutting dividends, the more volatile FFO are (Case et al., 2012). The findings support the results of Bradley et al. (1998) and the dividend catering theory postulated by Baker and Wurgler (2002), that dividend policies result from investors’ demands and objectives. Case et al. (2012) conclude that even though 66 67

The findings do not apply to less financially constrained REITs (Riddiough & Wu, 2009). MBR denotes the ratio of market value over book value.

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dividends are cut private information on future survivability is disclosed and hence uncertainty of investors decreases given that abnormal returns after dividend cut announcements are obtained in the sample. From the aforementioned, we deduct that REIT managements may utilize JVs as means for internal financing given that JVs allow safeguarding financial positions and improvement of financial performance and contribute to more stable income situations preventing dividend cuts. Further, the core benefit of JVs to mitigate and manage dependencies in uncertain environments, as depicted by Pfeffer and Nowak (1976), can be used to minimize managerial limitations to positively affect going-concern prospects as i.a. proposed by Hannan and Freeman (1977) and McKelvey and Aldrich (1983). Accounting for the presence of excess dividends (Bradley et al., 1998; Ghosh & Sirmans, 2006; Hardin III & Hill, 2008; K. Wang et al., 1993), REIT managers experience stronger limitations to impact going-concern prospects and have to maintain their dividend policy, in line with Miller and Modigliani (1961) and Baker and Wurgler (2002), as any cut is negatively perceived which further restricts REITs in the expansion of their investment universe (Hardin III & Hill, 2008) if not related to overall market downturn (Case et al., 2012). As result, we find JVs to be a potential cornerstone in dividend policies as they allow for diversification and decrease volatility of cash flows through coinsuring cash flows and subsequently the dependence on short-term debt. Further, income bases are diversified through management contracts securing stable income and mitigating uncertainty in additional properties, whilst negative cash flows and investment risk are shielded from REIT figures and would be assumed by all JV partners while different income streams can counterbalance each other (Campbell, White-Huckins, et al., 2006). Enabling a cost-efficient exit route (Campbell, White-Huckins, et al., 2006), partnering should generally enable to circumvent competitive bidding environments for target properties in line with Hess and Liang (2004). Thereby JVs are very beneficial for turnaround properties and development scenarios as own balance sheets are less or not affected by developments which would otherwise oppose dividend policies. Additionally, higher returns on contributed capital are achievable as REITs can monetize some of uncertainty-reduced developer returns, i.a. Williams (1991), Keuschnigg and Nielsen (1996), Capozza and Li (2002), Rocha, Salles, Garcia, Sardinha, and Teixeira (2007), and Bulan, Mayer, and Somerville (2009). We deduct that the same advantages hold true for JVs owning completed properties, so that REIT managers can allocate a suitable risk level to each partner (Hess & Liang, 2004). The importance becomes apparent if connected to the fact that new REIT investments are primarily financed through funds obtained from (high interest rate-bearing) bank credit lines, while unsecured debt is raised for refinancing of maturing debt and capital structure adjustments (Brown & Riddiough, 2003). This is supported by

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the findings of Ott et al. (2005), that investments are funded through new debt and equity issuances as result of the REIT tax rules. Thus, we find that DJV vehicles have the same refinancing and adjustment function as unsecured debt when looking at the more recent findings in the REIT JV research area (Freybote et al., 2014). In addition, JVs enable conservative-strategy REITs to partner with opportunistic investors as platform for growing income potential allowing investments in more risky assets and higher leverage compared to REIT-alone acquisitions (Hess & Liang, 2004). Especially for diversified REITs, JVs are beneficial as information asymmetries can be mitigated due to additional monitoring in the JV and conveying positive information while getting access to specialized managerial or development expertise for certain property types (Campbell, White-Huckins, et al., 2006). REITs can utilize their property management skills even if the property itself would have not matched their risk profile if acquired alone and thus efficiently allocate existing managerial (over-)capacities. Thus JV use should result in REITs expanding their investment universe and aligning risk exposure (Hess & Liang, 2004), while their profitability is enhanced which enables strategic adjustments in dividend policies through obtained financial flexibility in line with Bradley et al. (1998). We conclude that JVs allow REITs to achieve market advantages in line with findings from general JV use, i.a. Darrough and Stoughton (1989), Harrigan (1985b), and Kogut (1988a) as capital market penalties for dividend policy become obsolete. REIT Stock Repurchases and JV Contribution While Freybote et al. (2014) find that proceeds from partial disposals to JVs are used for stock repurchases besides debt repayment and reinvestment, they do not present the role of repurchase programs for REIT financing and thus the contribution of JVs for corporate strategy remains open. Existing studies show that REITs regularly engage in open-market stock repurchases (Ghosh, Giambona, Harding, Sezer, & Sirmans, 2010; Giambona et al., 2005; Giambona, Golec, & Giaccotto, 2006; C.-H. Lee, Hsieh, & Peng, 2005). Contradictory to findings from firms in non-regulated environments where repurchases are motivated by cash distribution, capital structure, and equity undervaluation (Aharony & Swary, 1980; Bagwell, 1991; Barth & Kasznik, 1999; Bartov, 1991; Brav, Graham, Harvey, & Michaely, 2005; Dittmar, 2000; Fenn & Liang, 2001; Hovakimian, Opler, & Titman, 2001; Jagannathan, Stephens, & Weisbach, 2000; Jensen, 1986; Jolls, 1998; C.-H. Lee et al., 2005; Stephens & Weisbach, 1998) as well as profitability (EPS) manipulation68 (Bens, Nagar, Skinner, & 68

After a stock repurchase, number of outstanding shares decrease and divide the same absolute profit, i.e. higher earnings per share (EPS) figure can be presented.

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Wong, 2003; Brav et al., 2005; Fenn & Liang, 2001), the dominant motivation of REIT stock repurchases is not without controversy. One the one hand, there is argumentation REIT repurchases are driven by employee stock option plans, institutional ownership ratio, and/ or inside ownership (C.-H. Lee et al., 2005), on the other hand Giambona et al. (2005)69 derive that signaling theory holds true implying that REIT managements announce repurchases when they expect free cash flow to increase. In general, firms that have weak prospects for growth investments and some available cash reserves tend to repurchase stock to use this as a more flexible cash distribution alternative compared to dividends with no investor expectation of reoccurrence (Barth & Kasznik, 1999; Brav et al., 2005; Dittmar, 2000; Fenn & Liang, 2001; Jagannathan et al., 2000; Jensen, 1986; Stephens & Weisbach, 1998). Managements may use stock repurchases as undervaluation signal (Barth & Kasznik, 1999; Dittmar, 2000; C.-H. Lee et al., 2005), as mitigation of information asymmetries in earnings potential70 (Bartov, 1991; C.-H. Lee et al., 2005), and as leverage-increasing mechanism to either adjust to target leverage (Dittmar, 2000; Hovakimian et al., 2001; C.-H. Lee et al., 2005) or to protect against hostile takeovers (Bagwell, 1991; Dittmar, 2000; C.-H. Lee et al., 2005). Repurchase programs can also be motivated by tax-effects due to different tax treatment of dividends and capital gains. Positive abnormal returns can be expected and are empirically found upon repurchase announcements, i.a. by Dann (1981), Vermaelen (1981, 1984), Asquith and Mullins Jr (1986), Comment and Jarrell (1991), D. Ikenberry, Lakonishok, and Vermaelen (1995, 2000), and Stephens and Weisbach (1998), that can be attributed to the aforementioned motives (G. L. Adams, Brau, & Holmes, 2007). These announcement results also hold true in the REIT industry, while only the information-content hypothesis has explanatory power for REITs experiencing abnormal positive returns upon announcement among the classical repurchase hypotheses (Brau & Holmes, 2006; Giambona et al., 2005).71 Further, exchange options are embedded in stock buyback announcements that enable managements to monetize information asymmetries with investors, as the repurchase programs convey information about future profitability and as result the exchange option hypothesis yields firm value increases if even 69 70 71

Giambona et al. (2005) find no evidence that executive stock option plans affect repurchases. Also commonly referred to as information-content hypothesis or signaling hypothesis. Brau and Holmes (2006) explain their results by the special REIT environment making both the agency cost and tax hypotheses redundant in announcement effects: (1) The 90%/95% income distribution requirement evades managerial interests to overinvest and thus agency theory can not be applied and (2) dividend requirements make REIT investors unresponsive to different tax treatments of capital gains and thus the tax hypothesis can not be applied.

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companies are correctly valued (G. L. Adams et al., 2007; D. L. Ikenberry & Vermaelen, 1996; Margrabe, 1978). G. L. Adams et al. (2007) extend the exchange option in line with the dividend catering hypothesis of Baker and Wurgler (2002) by including a long call and a long put option, representing future repurchase and the ability to sell additional shares respectively to differentiate between pure undervaluation motivations and the realization of options on future mispricing in REIT stock repurchases and conclude only their theory, referred to as straddle hypothesis, explain positive announcement effects and the following stock buyback realization rate. They find that REITs announcing share repurchases execute SEOs twice the volume of their repurchase announcement volume within two years upon (repurchase) announcement which more specifically means announcing REITs become net share-issuers rather than share-purchasers and in fact the number of shares outstanding increases.72 From the previous observations on REIT stock repurchases, we deduct that REIT managements not only strategically determine dividend policies, as introduced by Bradley et al. (1998), but also include stock repurchases as common measure in their capital market strategy. In particular, stock repurchases should mitigate information asymmetries by conveying managerial perceptions of current undervaluation (Brau & Holmes, 2006; Giambona et al., 2005) and to give momentum to stocks (G. L. Adams et al., 2007). The beforementioned gives supporting argumentation that the REIT structure is per se not efficient in line with of Glascock et al. (2018). We argue REIT managers are motived to use JVs as part of this strategy or to replace the (unfulfilled) stock repurchase announcement. The results of G. L. Adams et al. (2007) suggest that REIT managements announce repurchase programs to drive up stock prices to benefit from higher cash inflows when new stocks are issued. This is attributable to the fact that REITs face high constraints in reinvesting residual cash flows for growth investment that are evaded by agency cost reductions to access funds from short-term bank lines of credit, long-term borrowing, and equity issuances for future property acquisitions (Hardin III & Hill, 2008). While results of dividend policies propose REITs adjust their dividend payments to cope with future dividend expectations of their shareholders (Bradley et al., 1998; Hardin III & Hill, 2008), G. L. Adams et al. (2007) show that REIT managements, either intentionally or unintentionally, strategically manage their stock prices to facilitate capital raising activities. However, these proceedings corrupt the perception of REITs and negatively affect funding cycles, as agency costs increase. Rather than strategically adjusting stock prices, we infer that REIT 72

G. L. Adams et al. (2007) find that only 32% of announcing REITs complete their repurchase program by 100% or more of the intended buyback-volume, while 34% become net-issuing companies. However, they do not further attempt to argue why REITs behave like this.

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managers use JVs to mitigate the funding issue through attracting capital of equity co-sponsors to bridge own equity gaps, while the stock price is also positively affected in accordance with synergy theory (Campbell, 2002; Campbell, WhiteHuckins, et al., 2006; Elayan, 1993; He et al., 1997; Ravichandran & Sa‐Aadu, 1988) so that the subsequently gained stock momentum through JV announcement can be used for future SEOs the same way momentum of repurchase announcements are. Empirically, C.-H. Lee et al. (2005) find that REITs engaging in repurchasing activities sell more assets and long-term investments as well as issue more debt compared to non-repurchasing REITs as subject to finance their repurchasing activities. REITs generate cash to buy back stocks and do not use idle cash as classical corporations do, as suggested by Jensen (1986). Under the assumption that information-content hypothesis holds true, we argue that core assets are fully sold or debt and higher leverage are obtained to fund repurchases. As result, REITs resign from future potential of sold assets or use debt capacity for repurchases that could be used for acquisitions in order to convey growth prospects to capital markets that could however be as well achieved through DJVs. Subsequently, future prospects of single assets are not fully quit in DJVs but partially maintained while positive signaling can be achieved if the contents of the disposition announcement are correctly phrased (Ro & Ziobrowski, 2012), as Freybote et al. (2014) argue that debt repayment content indicates an agency cost issue which results in negative share price reaction. This is in line with the results of Campbell, Petrova, et al. (2006) who argue that the negative share price reaction is attributable to underlying leverage theory. However, they find in their sample significant positive abnormal return for REITs announcing property sell-offs in the timeframe between 1992 and 2002 and argue that this is due to more efficient asset allocations after dispositions, while low-performing REITs, measured by ROA, Net Income / Total Assets, and FFO return performance prior to sell-off announcements, have the greatest returns as the achievable efficiency gains are relatively higher compared to well-performing REITs. This should hold true for DJV announcements with the right content formulation and should stimulate the stock performance. Evidence is found in the study on REIT announcement effects of acquisitive and dispositional events of Ro and Ziobrowski (2012) obtaining significantly positive cumulative returns of 1.26% in a two-day window for DJVs. In particular, they find that JV events are not only bigger in size than REIT-alone property acquisitions (USD 40 million on corporate level and USD 251 million in JVs) but also reconfirm that AJVs yield significantly positive returns (CARs of 0.45% in the two-day window) with the restriction that events that reduce property-type focus have low or negative yields (0.07% compared to 0.53% for JV acquiring the same property-type) in the announcement window, while DJVs are on general not significantly negative (-0.06%) with significantly positive returns of 1.26% for property-type focus

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enhancing events (-0.21% for DJV where properties are disposed within propertytype focus) (Ro & Ziobrowski, 2012). Especially in public capital market environments with no given momentum for capital issuances, i.e. the public capital market does not attribute growth prospects and reinvestment opportunities to the REIT, which results in low MBR and high leverage, REITs can dispose properties to DJVs, use part of the inflow for acquisitions (and debt repayment) while the remainder can be used for repurchases in line with C.-H. Lee et al. (2005) and Freybote et al. (2014). Further, investor demand for the equity participation in the DJV should be given as investors have appetite for REIT assets (Plumb & Azrack, 2001). As such there is a set of signaling effects for future growth and information asymmetry mitigation of going-concern risks. Additionally, through disposition of low-performing projects and properties, firm value can be increased and achieved purchase prices can be distributed to investors whereas repurchasing stocks could also give momentum of hindsight by management regarding their failure in new projects (Giambona et al., 2005). The effect should be greater if properties are partially disposed to a DJV where the partner contributes needed knowhow to improve asset performance so that the one dominant rationale of JVs becomes apparent: to achieve synergies in line with Elayan (1993). The inability to increase free cash flow can thereby be evaded and JVs enable REITs to allocate free cash flow to additional projects increasing longrun cash flows which mitigates the lack of reinvestment opportunities and as well allow for launching stock repurchase programs to further stimulate the stock in line with Giambona et al. (2005). In contradiction to full disposals of assets, DJVs allow to circumvent the disadvantages of full disposals where the partial proceeds enable strategic and financial flexibility. Additionally, asset management contracts allow steady (cash flow) incomes, while dividend pay-out ratios are increased given that the same or higher profit is distributed to less outstanding shares when idle cash from DJV are reinvested into stock repurchases (Bens et al., 2003; Brav et al., 2005; Fenn & Liang, 2001). Following a repurchase program funded through DJV inflow, REITs obtain a currency for future M&A and JV activity as own shares can be used as means of payment. In line with results of Campbell et al. (2001), the share price reaction is positively stimulated when takeovers are paid with own shares as information asymmetries are mitigated. Following a merger or takeover, DJV can be used as exit strategy in properties that does not fit the investment focus. REIT Restructuring and JV Contribution Given the limited financial flexibility as well as the underlying capital market perception, REITs have difficulties to implement restructuring measures, both operative and financial measures, as own profitability figures could be negatively

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impacted so that negative signals could be sent to investors from underlying restructuring efforts, as such restructurings are even more subject to strategy for REITs than for other companies (Campbell, 2002). However, DJV structures allow operative and financial restructuring measures where agency-costs can be mitigated on property- as well as entity-level. This is in line with Corgel and Rogers (1987) who link JVs to the classical financing theorem of Modigliani and Miller (1958) and summarize that JVs erections represent a financial restructuring of the parental firms as the given set of financial agreements is affected.73 Consequently, JVs serve as restructuring and refinancing platform in financing strategy based on and extending the findings of Campbell (2002), Campbell, White-Huckins, et al. (2006), and Freybote et al. (2014). Facing capital constraints, REITs can sell properties and receive cash or cash-equivalents and circumvent the legal restriction to not maintain cash flows (Campbell, 2002), while positive announcements effect can be expected at the same time due to a more efficient asset allocation (Campbell, Petrova, et al., 2006; Ro & Ziobrowski, 2012). As aforementioned, instead of selling off parts of their portfolios, REITs can sell partially through a DJV, maintain a minority interest, and secure buy back–options given the benefit of maintenance of (partial) proprietorship and liquidity inflow. Besides, REIT management can offer management contracts for the underlying asset if the buyer is a finance provider74 or not capable of the management. Freybote et al. (2014) argue that DJV structures are means of disposal and financing strategy because DJV-announcing REITs suffer from low MBRs and high leverage so that they conclude DJVs serve as financing instrument for distressed REITs when no other financing choice is left and illustrate that proceeds from the partial disposals are used for debt repayment, stock repurchases, and for reinvestment. In general, corporate divestures represent the reallocation of the productive asset portfolio while giving up specific productive assets as well as underlying cash flows. Boudreaux (1975) analyzes a sample of 169 divestures comprising 138 voluntary and 31 involuntary sell-offs enforced by antitrust authorities and finds positive returns following voluntary sales attributed to the acknowledgement of financial theory75 while involuntary sell-offs cause negative share price reactions due to the perception that future cash flows are more valuable than obtained purchase prices in line with valuation theory. Alexander, Benson, and Kampmeyer (1984) investigate wealth effects in voluntary corporate divestures, sell-offs and 73 74

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As result, financial synergies should trigger a positive share price reaction in line with Bradley et al. (1983). Most often a pension fund or other institutional investor (Bergsman, 2001; Campbell, White-Huckins, et al., 2006; Plumb & Azrack, 2001; "REITs Benefit from Pension Ventures," 2001) Even though Boudreaux (1975) recognizes that voluntary sell-offs amd spinoffs could be motivated to cirumvent following antitrust authorities’ enforcements a priori.

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spinoffs, where assets are sold to another company in exchange for cash and securities (sell-offs) and reallocation of stock ownership of subsidiaries to shareholders of a company (spinoffs) in line with Galai and Masulis (1976) and Schipper and Smith (1983). Both cases are motivated by wealth transfers from bond- to stockholders and the elimination of negative synergies resulting in positive abnormal returns. The assumption that increasing debt ratios should imply managerial confidence about future prospects in line with Myers and Majluf (1984) is also confirmed by aforementioned REIT event study on property sell-offs by Campbell, Petrova, et al. (2006) for asset allocation efficiency-motivated but do not hold true for those sell-offs announced to repay debt. Following P. R. Allen and Sirmans (1987), Glascock, Davidson, and Sirmans (1989), and Elayan and Young (1994), disposals may be beneficial to capitalize carried-forwards tax-losses. Vice versa disposals of fully depreciated assets and a subsequent purchase of similar properties can be motivated by depreciation effects that lead to net gains. Campbell (2002) argues, regardless of tax effects, that disposals are one source to gain liquidity which can not be obtained otherwise or other sources are too expensive, in line with the empirical findings of Lang, Poulsen, and Stulz (1995), and argues JVs contribute to solve the issue of low liquidity caused by the institutional REIT environment. If the announcement conveys information on debt repayment motivation, share price penalties can be caused, as debt use is positively perceived by capital markets and debt repayment motivations lead to share price penalties (Campbell, 2002; Campbell, Petrova, et al., 2006; Campbell, White-Huckins, et al., 2006; Freybote et al., 2014) incentivizing REIT managements to sell properties only if no other financing source can be accessed even though asset allocation efficiency motivation might be given (Campbell, 2002; Freybote et al., 2014). However, the results of Ro and Ziobrowski (2012) show that also DJVs can yield positive returns. In case of financial distress, any sell-off, especially if potential buyers have knowledge about the timely need to sell,76 leads to discounts and further implies total loss of underlying prospects of the property. However, selling properties does not fully allow to use all cash flows from disposals because REITs can only keep the inflow amounting to the pre-sale book value, while the capital gain in the disposal is again subject to distribution requirement (Campbell, 2002). This can be circumvented if the proceedings from dispositions are reinvested in new acquisitions with subsequent depreciation again lowering net income which has a direct positive effect on retainable cash flows (Campbell, 2002). However, we deduce this procedure requires to not only reinvest but also to use the majority of the gained proceeds if otherwise the depreciation does not largely affect income as such the procedure has limited use to free up tied capital. 76

We argue this can be easily inferred as traded REITs have to regularly disclose financial statements.

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In line with Campbell, White-Huckins, et al. (2006) and Freybote et al. (2014) DJVs allow to maintain partial ownership, secure management income streams, obtain liquidity, and redefine corporate options, while targeted institutional investors as potential partners positively acknowledge the expertise of the REIT as asset manager (Plumb & Azrack, 2001) and thus purchase prices are less discounted compared to other real estate investors that would acquire full property ownership, which explains the high-quality characteristics found by Freybote et al. (2014) as those assets can be well and timely sold. At the same time, value-adding control services with decreasing agency cost effect can be expected from the new anchor shareholder in the JV in line with Shleifer and Vishny (1986, 1997), Chang (1998), Campbell et al. (2001), and Campbell (2002). As aforementioned, dividend distribution requirements are evaded if new properties are acquired from sale proceedings, where again REIT management may find JVs to be beneficial in decreasing capital needs for single properties (to be disposed) and to acquire more properties exchange, which allow for conveying positive information to equity and debt capital markets. From an operational perspective, DJVs allow to partially sell low-performing assets that lower overall REIT profitability but have sufficient future prospects so that REITs do not have to fully withdraw. Through the resource contribution of the other JV sponsors, the financial performance can be increased in the long-run, while the REIT uses the shielding effect during the work-out. The financial performance improvement of disposed properties can be subject to the partners’ expertise in local characteristics, specialized property management expertise, and access to anchor tenants (He et al., 1997; Ravichandran & Sa‐Aadu, 1988). Furthermore, one financial performance aspect is that JVs allow to increase leverage outside the REIT balance which can again positively affect the property performance resulting in a higher net income base for dividends. However, while Campbell (2002) questions why REITs experience negative abnormal returns upon DJV announcements,77 we suggest that REITs have to include synergy aspects in their announcements, as needed expertise is accessed that improves the property performance that can lead to higher cash flow increasing the dividend payment ability in line with Ro and Ziobrowski (2012). Why REIT Capital Structure Calls for JV Use Due to the legal obligation to pay out more than 90%78 of taxable income as dividends to their shareholders, i.a. Matheson (2008), Hardin III and Hill (2008), the 77 78

Based on a previous working paper that was later published as Campbell, WhiteHuckins, et al. (2006). Before the introduction of the REIT Modernization Act effective as of January 1st, 2001 the required dividend pay-out equaled 95% (Feng et al., 2011; C.-H. Lee et al., 2005). Before 1980 it used to be 90% as well (K. Wang et al., 1993).

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resulting inability of REITs to grow internally (Campbell, 2002; Campbell, WhiteHuckins, et al., 2006; Damodaran et al., 1997), and the restriction in cash usage (C.-H. Lee et al., 2005), RETs finance new investments only by 7% through retained earnings (Ott et al., 2005), while the corporate tax-exemption makes the usage of debt financing a core question in REIT financing. Accounting for the tax status, the leverage effect theory changes in the application of REITs as interest payments can not be used for tax deductions and could be seen as a disadvantage in bidding processes (Howe & Shilling, 1988). Therefore, debt financing should be less attractive to REIT managements, whereas J. F. Jaffe (1991) argues that leverage does not matter to value of REITs in line with Modigliani and Miller (1958). However, Feng et al. (2007) find that REITs with high growth opportunities and high market valuations in terms of MBR regularly use public debt placements to obtain funds even though this contradicts financing decisions made by firms in non-regulated environments. The key rationale of debt use is that capital requirements from targeted properties exceed current liquidity supplies of acquirers where outside finance is used to close the financing gap (Riddiough, 2004), while value-destroying management activity can be mitigated for shareholders through additional monitoring by capital providers as i.a. depicted by Shleifer and Vishny (1986, 1997), Chang (1998), Campbell et al. (2001), Campbell (2002), Riddiough (2004), Hardin III and Hill (2008), Yun (2009), and An et al. (2012).79 The additional monitoring aligns the interest between shareholders and managers as such that only proper acquisitions are undertaken, acquired properties are well-managed and operated, and that adequate capital expenditures for property maintenance are realized (Riddiough, 2004). In line with the KZ index method developed by Kaplan and Zingales (1995), Riddiough and Wu (2009) find that higher financial constraints in the REIT marketplace cause less investments, lower cash flows generation, lower dividend payments, higher leverage ratios, weaker bond credit ratings, and a smaller network to bank lenders and security underwriters. These results show that REITs face challenges in liquidity management and SEOs where REIT managements may use potential benefits from JVs. REIT Liquidity Management and JV Contribution The topic of liquidity management involves the indemnification of adequate liquidity levels to realize operational investment needs while external financing sources are expensive (An et al., 2012; Myers & Majluf, 1984). The cash holding 79

An et al. (2012) use REITs as laboratory for cash-constrained and capital-intensive firms that use bank funds for acquisitions and investments to investigate the effects of agency costs on liquidity management.

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policy needs to be adjusted to volatility in operating cash flow, information asymmetries, opportunities to invest, and the internal firm’s ability to generate cash (Almeida, Campello, & Weisbach, 2004; Kim, Mauer, & Sherman, 1998). The unique characteristics of the REIT industry restrict liquidity management to investments in long-term assets (and its maintenance) and make classical working capital discussions redundant, while analyst coverage reduces information asymmetries (An et al., 2012). An et al. (2012) find that increasing degrees of information asymmetries, quantified by analyst forecast accuracy, lead to weaker REIT access to bank credit lines in terms of total and unused lines. Liquidity management is yet a very sensitive issue for dividend-paying REITs as they are highly dependent on volatile capital markets and thus need to pay close attention on the usage of external financing for investment and operating objectives (An et al., 2012). The dependence on capital markets can be lowered through JV use, as additional capital sources can be accessed, most importantly the private capital markets (Freybote et al., 2014). Given self-governance and own identities of JVs, the underlying properties can be operated from existing funds and credit lines in the JV entity where REIT liquidity issues can be circumvented. Applying the information asymmetry theorem, An et al. (2012) postulate that information asymmetry affects short-term credit line lending from banks and find evidence that more transparent REITs tend to use bank lines as substitute for cash as liquidity management. More transparent REITs have better access to equity and debt capital markets and use those sources to repay bank lines while banks assess capital market access of its REIT customer within their creditworthiness evaluation (An et al., 2012). Riddiough and Wu (2009) observe that REITs decrease dividend payouts for capital investment if REITs are more financially constrained and show for the financially constrained sub-sample that retained cash flows are directly used to pay down short-term borrowings in credit lines. Further, Riddiough and Wu (2009) argue that only available bank lines of credit enable REITs to quickly engage in acquisition opportunities and would not be able without available lines as they distribute almost all available cash as dividends80 in accordance with their minimum cash restraint. In particular, a typical REIT acquisition funding cycle starts with an identified investment opportunity, the payment of the full acquisition price is due at closing of the transaction and thus the acquiring REIT sets up or utilizes a sufficiently large short-term bank line of credit to pay the purchase price throughout the negotiation process in order to take out the money from the bank credit line, while subsequently seeking long-term financing agreements with other banks 80

An et al. (2012) find that REITs distribute some 85% of FFO as cash dividends to their shareholders and Ghosh and Sirmans (2006) derive that 70% of FFO is distributed which translates to over 150% of earnings.

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which are then, combined with proceeds from SEOs, used to clear the credit line balance which can then be utilized again for the next acquisition process (Riddiough & Wu, 2009). While credit lines should be arranged based on repayment sources and maturity matching of sources and uses of cash flows they should generally not enable to finance long-term projects with short-term loans (An et al., 2012). Given the aforementioned findings, acquisition probabilities for REITs are restricted by access to short-term credit lines and subsequent refinancing through other sources. This is in line with the argumentation of Howton et al. (2018) arguing it is a constant REIT management task to have appropriate funding on hand to meet market opportunities. In detail, there is a two-folded critical path that limits corporate growth options for REITs. Identified opportunities are only gathered if sufficient credit lines are available which presupposes capital market momentum to secure long-term financing. If long-term financing sources can not be obtained, even if the probability at point of acquisition for long-term financing is positively evaluated, REITs can face financial distress as short-term credit lines are then fully utilized which reduces the possibility to maintain the portfolio. As result, REIT managements need to adjust dividend payouts to mitigate going-concern risks (Case et al., 2012), sell long-term assets (C.-H. Lee et al., 2005) which results in less investments, lower cash flows generation, less dividends, and higher leverage ratios (Riddiough & Wu, 2009). Consequently, REIT capital markets are expected to penalize share prices, while it is open to debate if credit line utilization is used as capital market strategy to facilitate refinancing, as investors can perceive going-concern risk and participate in equity-bracing offerings. We infer that this procedure limits REIT managements in the evaluation of corporate growth options on entity-level, while JVs offer the benefit to acquire properties and mitigate given uncertainties while monetizing synergy effects, which results in both positive share price reactions and a recovery of liquidity management issues. While other JV sponsors contribute further equity as well as needed knowhow to efficiently operate the acquired property, secured long-term debt can be attracted in the JV which should result in lower financing costs compared to long-term unsecured corporate debt that REITs attempt to issue in general to readjust capital structures (Ott et al., 2005). We deduct that the preference of unsecured debt is due to operational flexibility needs that can not be obtained with the use of mortgage-secured debt on property-level within the REIT entity, while the JV shielding effect should change this REIT preference in the case of JV use. Agency costs are decreased through the possibility for the debt providers to monitor the property-related operations (Riddiough, 2004), while other JV sponsors also provide governance in line with i.a. Shleifer and Vishny (1986, 1997), Chang (1998), Campbell et al. (2001), and Campbell (2002).

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Due to the theory that cash flow retention constraints influence (equity) investment decisions, i.a. proposed by Myers and Majluf (1984), Riddiough and Wu (2009) hypothesize that REITs invest at lower rates than less cash-restricted firms but obtain, however, contradictory results. They argue that the payout duty is not as restricting because payout obligations are based on taxable income and not on available FFO and thus depreciation and write-offs offer some leverage that shields cash. In their investigation, they find bank line capacity and utilization triggering investment activities and responsiveness to cash flow availability. Cash flows directly substitute line of credit utilization and cash retention decisions do not correlate with investments while dividend payout decisions seem to correlate between periods. Thereby, credit lines enable some operative flexibility in terms of facilitating cash constraints, whereas shareholder objectives to distribute available cash flows seem to affect cash retention decisions of REIT managements (Riddiough & Wu, 2009). From these findings, we deduct that investment opportunities can not be fairly evaluated at all time, as acquisition can not be undertaken if not sufficient shortterm bank funding is available. As result, there could be bias in the evaluation processes when funding from bank lines is available. In order to convey growth prospects to capital markets, managements only consider acquisitions when funding is available and as result acquisitions might occur that are not in line with value-maximization compared to continuous opportunity evaluations. This is in line with the most recent developments in equity offering through at-the-market (ATM hereafter) issuances, where REIT managements make use of market timing when favorable MBRs and market opportunities are given but classical SEO processes are too long and too costly and insecure in proceeds while ATM equity offerings trade at prevailing stock prices (Billett, Floros, & Garfinkel, 2019; Hartzell et al., 2019; Howton et al., 2018). Howton et al. (2018) find that REITs engaging in ATM transactions seek financial flexibility for investments, while REITs with greater financial constraints (measured by leverage) use proceeds to also repay debt. Hartzell et al. (2019) find that REITs that participate in ATM offerings are characterized by higher MBRs and can not obtain funds from classical financing sources but are willing to pursue property acquisitions so that they conclude REIT managers are in need of financial flexibility. Given these limited growth considerations, JVs offer the strategic rationale that less own equity (and liquidity) is needed in order to pursue a growth strategy and that available funds can be contributed to JVs when internally generated without accessing credit lines. Consequently, cash accumulates in the JV entity that can then evaluate more acquisition opportunities than the REIT itself, as it is (1) financially less dependent on liquidity issues and (2) has a larger information network given the additional knowhow and network from JV partners. As such, the fundamentals of JVs become apparent to be decision-facilitators to invest and

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expand into new markets when demand is uncertain and complex in markets outside the core business (Kogut, 1991). In line with the beforementioned, long-term secured debt can be more easily obtained in JVs as partnering conveys credibility signal to debt providers. From a capital market perspective, JV erections should be positively evaluated due to synergy effects (Campbell, White-Huckins, et al., 2006; Corgel & Rogers, 1987; Elayan, 1993; He et al., 1997; Ravichandran & Sa‐Aadu, 1988), where existing findings show that financial institutions seem to be motivated to co-sponsor JVs with REITs, even in case of financial stress (Campbell, White-Huckins, et al., 2006; Freybote et al., 2014; Plumb & Azrack, 2001). From existing findings, i.a. as presented by Mohanram and Nanda (1998) and Koh and Venkatraman (1991), one can assume to cause positive share price reactions by partner characteristics. In particular, the quality or pure size of partner companies convey insights about firms with regard to one’s own ability to raise interest about own know-how and assets (Mohanram & Nanda, 1998). Further evidence is provided by S. Kumar and Park (2012) who link the positive cumulative abnormal return (CAR) to growth prospects and resource quality of the JV partners.81 If, as aforementioned, banks consider capital market access in their credit opinion, REIT managements should be motived to use JVs to gain liquidity and to make use of the positive announcement effects which at first stimulate capital markets and subsequently could again foster the availability of credit line funds. An et al. (2012) acknowledge that developments and undisclosed liabilities from JVs exacerbate valuations of the corporations and its assets, they conclude that information asymmetries have an impact on corporate liquidity management of REITs as less transparent REITs have less lines available and accordingly need more cash holdings to realize quick acquisition processes incorporating that available bank lines do represent the only strategic growth instrument on REIT-level. The problem at hand becomes more obvious when accounting for the fact that REITs only have 1.57% cash and cash equivalents on their balances, whereas classical public firms hold cash amounting to 18.48% of total assets (Damodaran, 2005; Hardin III et al., 2009). The motivation for holding cash is either to afford operating expenses, to execute investments, or to have a cushion for weaker times (Damodaran, 2005). Yet the legal dividend payout requirement does not fully capture the low cash holdings, as translating the income distribution requirements into cash flow from operation payout ratio the dividends amount to 50 to 65% by Bradley et al. (1998) and 85% as identified by An et al. (2012) and still a free cash flow 81

Contradictory, negative value can also be incorporated in the stock price through a company’s inability to attract attractive JV partners as it is assumable that other companies evaluate the company as not providing minimal hazards and a suitable fit for collaboration (Hennart, 1988; S. Kumar & Park, 2012; Teece, 1986).

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problem, in line with principal-agent problem described by Jensen (1986), can be identified (Hardin III et al., 2009).82 Hardin III et al. (2009) find a negative impact on cash holdings from FFO, leverage, as well as bank line of credits availability and utilization on cash holdings while external financing costs and opportunities for growth positively affect the REIT liquidity levels so that they draw the conclusion that REIT managements decide to maximize pay out to increase transparency to minimize debt costs. In line with trade-off theory, Yun (2009) concludes that both cash and credit lines are functions of costs and benefits so that credit lines are only arranged if marginal costs are less than cash, whereby more transparent firms should realize less costs on credit lines as banks have less monitoring and due diligence expenses. The underlying rationale is that the two cost sources are incorporated in credit risk margins and fees resulting in less transparent firms to not only need more cash, as they borrow more costly, but also to refinance maturing debt due to weaker (equity) capital market access (An et al., 2012). As result, only 7% of new REIT investments are funded through retained earnings compared to 70% for non-regulated listed companies (Ott et al., 2005; Riddiough & Wu, 2009). As result, JVs contribute to more flexible liquidity management and financing which facilitates debt raising processes, because agency costs can be mitigated through high transparency efforts by the additional equity providers and their monitoring services. Further, JVs enable more stable and previsible cash flows given diversification effects as well as possibilities to obtain flat management fees and thus evade financial constraints in REIT liquidity management. As such, REITs utilize the original JV intention to manage uncertainty (Dyer et al., 2004; A. J. Jaffe & Sirmans, 1984; Kogut, 1988a, 1991; Pfeffer & Nowak, 1976; Ravichandran & Sa‐Aadu, 1988; Vernon, 1983; Vickers, 1985). Additionally, JVs are legally separate entities (He et al., 1997; McConnell & Nantell, 1985) which can have own available cash funds, cash management, and available credit lines that allow further strategic value. We derive several contributions to REIT liquidity management: At first, typical REIT acquisition cycles can be bypassed, as JVs can be erected without a specific property (portfolio) to be acquired. Thus, JVs can be erected as shelf company to identify suitable opportunities where capital accumulation allows future acquisition following Behrens (1990) and Elayan (1993). From a liquidity management perspective, we identify the advantage that REITs inject capital upfront and upon availability, which might also result in off-balance / minority vehicles. Secondly, JVs themselves can contribute liquidity to meet operating needs of REITs as existing funds in JVs can be lent as intra-company loans to REITs to facilitate liquidity management and decrease capital market dependencies. As result, REITs gain cushions for potential losses, that could otherwise only be implemented through retained earnings (Damodaran, 2005), and evade the 82

Hardin III et al. (2009) find a correlation on cash holdings and advisement type with externally-advised REITs holding more cash.

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inability to retain free cash flow problem. Following, liquidity is obtained to refinance maturing debt (An et al., 2012) and to finance stock repurchases and reinvestments (Freybote et al., 2014). As consequence REITs become more stable and decrease uncertainty in liquidity management mitigating going-concern risks. REIT Capital Raising and JV Contribution From the restrictions and the resulting lack to retain free cash flows, REITs are heavily dependent on capital markets, as dividend distribution requirements makes the two debt characteristics of tax-deductibility and mitigation of agency costs of free cash flow redundant to REITs, while debt use still is incremental to REIT capital structure (Feng et al., 2007). To acquire funds for growth, REITs have to regularly issue new shares which contradicts classical financing theories (Goodwin, 2013). Even though pecking order theory suggests to use less equity as investors discount new equity by information asymmetries expectations so that firms use the safest way of financing by (1) retained earnings, then (2) debt, and finally (3) new equity, so that a dynamically applied pecking order theorem suggests that firms with stable profitability and investment occasions maintain low dividend payout ratios to secure funding and debt capacity to mitigate SEOs (Feng et al., 2007). Baker and Wurgler (2002) find that listed corporations use certain market timing practices for equity issues and repurchases so that shares are placed when high prices can be achieved and repurchase programs are announced when stock prices are low. From a pure capital market financing perspective, REITs need to postpone asset acquisitions to favorable market environments, whereas REIT management find characteristics in JVs to address and bypass this issue. The background of market timing and pecking order is based on potential informational asymmetries between managements and shareholders on firm value, so that investors suspect only inferior corporations to sell equity and thus managements would assume overvaluation so that new equities are either fully avoided or discounted upon issuance by investors (Myers, 1977, 1984; Myers & Majluf, 1984). The overvaluation suggests that firm performance will decline in current line of business or in new operations (Ghosh, Roark, & Sirmans, 2013; Loughran & Ritter, 1997). Empirical evidence for classical corporations shows that the capital market view proofs correct and that earnings performances diminish postSEOs, as i.a. depicted by R. S. Hansen and Crutchley (1990), McLaughlin, Safieddine, and Vasudevan (1996), Loughran and Ritter (1997), and Fu (2010). As REITs have a corporate need to regularly obtain funding from capital markets, Ghosh et al. (2013) questions if investors anticipate this notion upon SEOs and what the performance effects are, motivated by (1) the results of Friday, Howton, and Howton (2000) that performance improvements can be found for REITs after

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SEOs,83 (2) Bauer, Eichholtz, and Kok (2010) finding that corporate governance differently affects REIT performance than classical corporation, (3) Masulis and Korwar (1986) concluding that the utility sector as another laboratory for cashconstrained and capital-intensive firms does not experience high SEO penalties, and (4) the argumentation of Easterbrook (1984) that the lack of free cash flow restricts value-destroying investments while ongoing issuances convey information and allow ongoing institutional governance. In line with industry company findings, they do not find a REIT-specific effect as REITs that issue new stock experience performance increases pre- and decreases post-offerings, while offerings are subject to market timing- and asymmetric information aspects. In contrast to classical capital structure assumptions, Baker and Wurgler (2002) find a lasting negative causality between MBR and leverage, so that equity issues are offered when high MBRs are given. In line with Myers and Majluf (1984), this managerial behavior protects shareholder value and interests of existing equity investors (Ghosh et al., 2013). Thus, MBR is in fact a capital structure determinant and REIT growth is financed by equity issuance (Baker & Wurgler, 2002; Feng et al., 2007), despite contradicting trade-off theory, so that a capital structure optimum is obtained when financial distress costs offset the amount of tax-deductible interest payments (Feng et al., 2007). As result, target leverage ratios for REITs can not be based on trade-off theory, rather target capital structures are used for long-run leverage and investment-grade credit ratings (Brown & Riddiough, 2003). Additionally, Ooi, Ong, and Li (2010) conclude that target leverage ratios are subordinated in REIT financing decisions applying an hybrid hypothesis that long-term target leverage exists but that financial decisions are mostly determined by short-term market timing rationales. Thereby, REITs time capital instrument issues and reductions in reaction to which financial instrument can be placed best at the needed time with target leverage achieved over the long-run (Ooi et al., 2010). Basically, ATM offerings need the same market timing in terms of MBR and yield negative stock price reactions but are faster to implement, require less set-up and handling fees and due to their flexible offering approach have more certain proceeds (Billett et al., 2019; Hartzell et al., 2019; Howton et al., 2018). As REITs intend to issue (and repurchase) new shares in accordance with current capital market sentiment, JVs can be financed through existing funds and equity injections of co-sponsors who most likely evaluate the investment opportunity at hand as well as the knowhow of the REIT partner for the joint project rather than current the REIT stock price and MBR. The partner provides equity regardless of public equity sentiment, while debt can be raised on basis of the overall financial position of all sponsors facilitated through mortgage-securement, 83

Friday et al (2000) attempt to explain this finding in various ways, but most likely the results are biased by changes in overall performance increase in the real estate sector throughout the sample period (Ghosh et al., 2013).

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which should result in a relatively flexible funding process in line with Corgel and Rogers (1987), independent from public capital markets parameters. As depicted by Feng et al. (2007), trade-off theory states under the premise of holding assets and investments constant that debt usage is a function of debt benefits and costs and that any variation from target levels are only of momentary character. Therefore, the pecking order theorem has limited explanation in the case of REITs which use depreciation as lowering-retained earnings mechanism and historically pay out some 70% of FFO on average over a five-year period (Ghosh & Sirmans, 2006). However, given the institutional environment, information asymmetries should be low for REITs compared to classical corporations, i.a. Bertin, Kofman, Michayluk, and Prather (2005), Bauer et al. (2010), and Goodwin (2013). But still, REITs are left with managerial entrenchment possibilities so that strong governance is needed (Bauer et al., 2010).84 Whereas interest payments are tax-shielded in general, they reduce free cash flow to the firm and lower agency conflicts between management and financing providers, which also holds true in the case of REITs (Feng et al., 2007). Thus, profitable firms should use high debt ratios to shield income and free cash flow, whereas firms with only risky investment opportunities and high sensitivities to market cycles use low leverage ratios (Feng et al., 2007; C.-H. Lee et al., 2005). While bankruptcy costs and costs for financial distress are major disadvantages for debt use, the existence of fixed assets that can be used as collateral mitigate some of the risk and support debt usage in the case of REITs (Feng et al., 2007). As a consequence any financing decisions serve to adjust leverage ratios to given long-run targets while leverage ratio and the character of investment opportunities do not systematically correlate (Feng et al., 2007). JV use supports this capital structure-catering rationale, even though REITs are not able to access needed funds complying with target leverages, available funds can be used with partners to acquire, while, if certain premises are fulfilled, JVs are off-balance and thus do not create a deviation from target capital structure (Siegel, 1999). Following acquisitions and subsequent improvement of public capital market access, JVs can be bought out (or sold) complying with capital structure determinants. Whereas there is no correlation between external capital raising activities and a shortfall of retained earnings (Helwege & Liang, 1996), profitability is negatively correlated with leverage in classical corporations (Fama & French, 2002). A subsequent analysis on REITs by M.Z. Frank and Goyal (2003) draws the conclusion that SEOs are more often the result of financing issues than debt placements. From market timing theorem it can be inferred that security issues are executed in a favorable market environment and are idle in indolent market 84

Bauer et al. (2010), however, do not find a correlation between performance and monitoring in the REIT area, which they describe as “REIT effect”.

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conditions (Feng et al., 2007). Upon SEO announcements, REITs experience severe discounting85 with issued shares so that an average of USD 2 million is foregone in addition to expensed underwriting fees for the placements (Goodwin, 2013). Goodwin (2013) finds that the discounts of new shares relate to (1) a new equilibrium price of supply and demand through additional supply and (2) uncertainty on information asymmetry so that he recommends REITs to adjust their issuance strategy to more but smaller SEOs instead of one-time large issues, as ongoing issuances reduce information asymmetries and balance underwriting fees and discounts (Ghosh et al., 2013). To reduce asymmetries REITs also time capital market access to disclosure events and increasing transparency (Devos et al., 2019). The presence of an active ATM equity offering market turns the aforementioned recommendation into practice (Billett et al., 2019; Hartzell et al., 2019; Howton et al., 2018). Contradictory, JVs allow raising external equity without any discounting effects, while information asymmetries can as well be decreased through the partner’s and debt providers’ governance (Feng et al., 2011; Han, 2006; Riddiough, 2004). Instead, stock premium effects can be expected. This should drive managerial preference to structure JVs and to further adequately time capital offerings. From the additional governance REITs capital market access can as well be improved, as REITs suffer from weaker access to capital markets and bank credit lines in correlation with the level of information asymmetries which affects REITs in the offering and utilization of external financing for investment and operating objectives (An et al., 2012). Additionally, Riddiough and Wu (2009) find that proceeds from SEOs are not only used for capital investment allocation purposes but are also one source to finance dividend increases.86 It is open to debate if this behavior is associated with underlying share price penalties from SEOs that managements intend to offset by announcing higher dividends. This connects to K. Wang et al. (1993) who argue REITs could decrease their dependence on equity (and debt) offerings if REITs cut excess dividends which would free large sums for investment activities rather than issuance underwriting fees and decrease dependencies on capital markets. Further, in line with implied cash flow change hypothesis, investors perceive unexpected security offerings as information for decreasing future cash flows (Ghosh, Nag, & Sirmans, 1999). We deduct REIT managements use JVs to mitigate perceived issues of SEOs and to strategically time offerings by bridging current equity gaps, based on the results of Bradley et al. (1998) that REITs apply dividend discretion correlating with expected volatility that constraints asset and financing base of REIT. This results are in line with 85 86

Discounting relates the closing price on the day of the announcement to the offer price in line with Goodwin (2013). As aforementioned, also increases in available credit line capacities are used to finance dividend increases (Riddiough & Wu, 2009).

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explanations for dividend signaling depicted by Bhattacharya (1979), John and Williams (1985), and M. H. Miller and Rock (1985). Not only is additional equity raised, but also positive abnormal returns upon JV announcements can be expected to facilitate public equity raising processes in line with aforementioned results of G. L. Adams et al. (2007) on positive effects of share repurchase announcements and following stock buyback realization rates where announcing REITs contradictory increase floating share volume. Thus, in line with Plumb and Azrack (2001), Howton et al. (2018), Hartzell et al. (2019), we deduct that REITs are in need of financial flexibility instruments that allow a timely implementation of corporate actions, such as capital expenditures in existing properties and acquisitions so that JVs can be erected to acquire through partnering with private equity while DJVs serve to close given financing gaps at the same time or as well be used to free tied capital for further acquisitions. These procedures allow to circumvent dependencies on market timing aspects as well as capital market penalties in case of SEOs or dividend cuts, as event study research finds negative alpha returns in announcement windows for SEOs by REITs, i.a. Howe and Shilling (1988) who not only obtain negative abnormal returns of 1.29% in the same time window but find positive 0.98% abnormal returns for debt placements, contradicting findings for classical corporations. The results are confirmed by M. T. Allen and Rutherford (1992) with abnormal negative returns of 1.45%, Ghosh et al. (1999) obtaining abnormal negative returns of 0.46%, and Ghosh et al. (2013) finding abnormal negative returns of 0.39%. Denich, Maul, Schiereck, and Wieber (2014) observe negative 3.05% abnormal returns in the two-day time window throughout the financial crisis. Therefore, the authors conclude in line with previous findings that REIT SEOs are still perceived as solution of last resort but results suggest that REITs have reduced information asymmetries since the financial crisis. Contradictory, JV announcements most likely trigger positive reactions due to possibly achieved synergy through partnering with third parties (Campbell, White-Huckins, et al., 2006; Elayan, 1993; Ravichandran & Sa‐Aadu, 1988) and outside real estate (Johnson & Houston, 2000; Koh & Venkatraman, 1991; McConnell & Nantell, 1985; Schut & Van Frederikslust, 2004). From observed debt decisions we infer a need of REITs for flexible financing instruments as public capital markets can not always be accessible (Freybote et al., 2014) and only those REITs can access capital sources whose growth prospects are perceived in capital markets (Feng et al., 2007) Subsequently, REIT managements are in need of alternatives to raise funds and erect JVs with suitable partners to realize projects together. REITs can make use of AJV structures in the case that REITs can not access capital market to raise funds for acquisitions, even though doable investment opportunities are identified, given aforementioned restrictions of lacking growth

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perception in the markets. As a consequence, REITs partially finance the joint acquisition from the remaining retained earnings, as some 15 to 30% of cash flows after dividends should still remain with the companies, and other available funds (An et al., 2012; Ghosh & Sirmans, 2006). However, as funds may not suffice to realize targeted investments and diversification grade, own internal capital resources are combined with partners to invest. This is even more important if REITs target more acquisitions in line with Johnson and Houston (2000) representing one of the dominant logics for JV use, as JVs are motivated to attract capital, both in real estate (Behrens, 1990; Campbell, 2002; Elayan, 1993) and in general (Berg & Friedman, 1977). Alternatively, own stock can be used to remunerate the partner if these stocks can not be issued in capital markets but give the partner additional upside (Campbell, White-Huckins, et al., 2006). Further, partners can provide, besides capital, needed knowledge and expertise87 for targeted properties if property-type or geography lays outside REIT’s current investment focus. Thus, JVs allow asset growth while capital market restrictions can be circumvented. Identifying suitable acquisition opportunities and partnering with suitable partners who close the acquisition equity gap, JV announcements convey growth information and mitigate informational asymmetries between REIT managements and the capital markets, as positive alpha returns through synergies can be obtained with additional signaling through partner characteristics, as i.a. shown by Mohanram and Nanda (1998) and Koh and Venkatraman (1991). From JV partners, capital markets can infer positive information regarding growth aspects and synergy effects which should positively adjust share prices so that other financing instruments become available. Therefore we deduct that this strategy may also hold true for those cases where REITs would be able to fully finance the acquisition but still use JVs for acquisitions in order to more efficiently allocate available funds (Johnson & Houston, 2000) and with more leverage (Elayan, 1993; Siegel, 1999).88 Parallel, existing funds are allocated to more properties while benefiting from additional income streams and diversification effects. This is supported by Hess and Liang (2004) illustrating that JV use correlates with property size spectra as well as relative use of JVs increases in line with property sizes.89 In addition, Hess and Liang (2004) argue the decision to form JV vehicles is subject to balancing control, single-asset risk, and possible revenues coming from property management fees and conclude that joint ownership in large properties decrease single-asset risk in the portfolio 87 88 89

We further elaborate on this in the “Diversification Section”. For a better understanding of the effect, please refer to Table 1 illustrating the effects of thresholds and leverage. Hess and Liang (2004) find only 12.1% of all properties below USD 10 million are partially owned, whereas 31.3% of all properties between USD 100 and USD 500 million are jointly held.

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through diversification and increase equity funding likelihood for large acquisitions. Additionally, REITs have preferences for control of large properties due to financial effects so that a trend can be found that the proportion of equal and majority ownership correlate with the size of the property held (Hess & Liang, 2004). Finally, REITs become able to finance acquisitions through small portions of retained earnings in line with pecking order theory, as JVs can be found to circumvent the adverse selection share price reaction while pecking order theory holds true in JV vehicles. Acknowledging attributes of acquisition and pre-emptions rights to REITs in JVs, we conclude that not only future capital market proceeds can be used to buyout JVs but also that earnings of JVs are retained to realize growth by add-on / additional acquisitions in the vehicles. Due to missing consolidation in (minority) JV these procedures can not be fully observed from a financial statement analysis of REIT (An et al., 2012; Hardin III & Hill, 2008; Hess & Liang, 2004; Kibel et al., 2006; Siegel, 1999). REIT managements therefore increase acquisitive capacity and investment universe in the long-run with diversification benefits while keeping acceptable risks as the JV partners are as well knowledgeable in managing the underlying risk-return profile of jointly acquired properties (Hess & Liang, 2004). Additionally, joint ownership make large property acquisitions feasible that each partner could not effort by one’s own or have to deny as too much capital would be tied into one property with regard to diversification, risk concentration, and investment volume (Elayan, 1993; Hess & Liang, 2004; Plumb & Azrack, 2001). By bundling capacities through JVs, the environment also becomes less competitive and, in line with Hess and Liang (2004), REITs can improve their market presence by partnering with the right operator (or financial partner) for some specialized property types. These property types could for instance include trophy assets so that the subsequent announcement of the joint ownership in those properties conveys information on the REIT, its managerial capabilities, and future outlook so that more market participants become knowledgeable about the competencies which could again drive JV activity. Accounting for REIT managements attempt to obtain investment-grade credit ratings (Brown & Riddiough, 2003) and non-consolidation requirement for minority JVs, minority shareholdings can be used to keep or obtain the targeted credit rating and long-run leverage ratio on REIT level while JV debt is kept off-balance in line with Siegel (1999), Kibel et al. (2006), and An et al. (2012). At the same time, this strategy allows for management contracts (Campbell, White-Huckins, et al., 2006; Freybote et al., 2014; Hess & Liang, 2004; Siegel, 1999) and reduction of existing managerial overcapacities in line with Harrigan (1987). As such, additional income streams are secured, positive signaling conveyed, and existing resources are efficiently monetized. So we derive that JVs are part and consequence of target leverage considerations, especially in the case of minority-held and off-

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balance vehicles, to bridge equity financing needs until capital markets allow issuances again. Further, REITs can reimburse partners with own shares. Acknowledging JVs’ substantial debt capacity and their ability to be used off-balance, we affirm JV (debt) to be part of target leverage consideration in case of AJV or a consequence of target leverage in case of DJV. This is line with a study on REIT mergers by Campbell et al. (2001) finding positive announcement returns to acquirers that are positively impacted by underlying leverages of acquired companies which supports the assumption that increasing debt ratios should imply managerial confidence about future prospects, consistent with Myers and Majluf (1984). Further support is found in Campbell, White-Huckins, et al. (2006) finding negative returns for DJV announcements as they are attributable to debt repayments. This contradicts pecking order theory of Myers and Majluf (1984) stating SEOs are financing choices when no other financing source is given while Freybote et al. (2014) argue financing of last resort is DJV use for REITs. DJVs can therefore be means for balance sheet restructuring, also with regard to long-term target leverages, especially due to the fact that they are mostly minority held (Campbell, White-Huckins, et al., 2006; Freybote et al., 2014). At the same time, additional debt capacity is created, as such that the dispositional inflow can be used to acquire further properties and the JV can be higher levered than originally (Elayan, 1993; Hess & Liang, 2004). This should provide reasoning for the fact that DJV are mostly minority positions. Why Diversification Needs calls for JV Use Even though existing corporate finance literature has discovered contradictory results regarding potential diversification premiums and discounts, we argue REITs have a need to diversify that is best realized through JV use given the findings of Anderson et al. (2015) that the capital market positively values diversification with regard to REITs. This is in line with Weston (1969), Lewellen (1971), and Majd and Myers (1987) who conclude that diversification benefits arise from creating greater, more efficient internal capital pools and more efficient resource allocations, as well as the existence of coinsuring cash flows and earning streams through broader income sources, enabling higher leverage and tax advantages through offsetting potential losses of one income source by profits of other income streams respectively. However, these benefits come, as depicted by Jensen (1986), at the risk that the broader liquidity source makes manager be incentivized to allow value-decreasing negative NPV projects (Anderson et al., 2015). On the other hand, there is empirical evidence that diversification may also cause discounts, i.a. Lang and Stulz (1994) and Berger and Ofek (1995), while the later also shows that discounts correlate with diversification measured by operating business segments. This connects to ongoing discussions on operating efficiencies in the REIT

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industry that is not without controversy. Given the change of REITs in size, one can deduct that economies of scale and scope are achievable (Ambrose, Highfield, & Linneman, 2005; Ambrose & Linneman, 2001; Lewis et al., 2000; Linneman, 1997), while Corgel, McIntosh, and Ott (1995), find no evidence for size effects. Contradictory, McIntosh, Liang, and Tompkins (1991) as well as McIntosh, Ott, and Liang (1995) conclude that scale economies are not achievable in REITs. However, long-run efficiency effects need to be weighted for initial expansion costs (Lewis et al., 2000). While larger REITs achieve lower average costs of capital (Ambrose & Linneman, 2001), increasing REIT property diversification grades indicate higher interest costs on debt but positively affects cash flows on property-level while causing higher general and administrative expenses (Capozza & Seguin, 1998). We argue higher interest costs are caused by the fact that REITs prefer unsecured debt rather than mortgage-secured debt in line with Riddiough and Wu (2009), while secured long-term debt would yield different results. Contradictory, Ambrose et al. (2005) conclude that REIT size positively affects prospects for growths and allow efficiency gains resulting in a lower cost structure, measured by NOI, ROE, and FFO yield. Benefield, Anderson, and Zumpano (2009) and Ro and Ziobrowski (2011) obtain support for realizable diversification benefits given that diversified REITs outperform specialized REITs. 90 Against this background, it is not without controversy that investors intend to allocate diversification decision in their portfolio on their own which leads to an investor preference for property-focused REITs (Campbell, 2002; Feng et al., 2011; Geltner & Miller, 2001; Ro & Ziobrowski, 2012). In the scope of their investigation, Anderson et al. (2015) explain diversification benefits by the two facts that diversification a) enables REITs to insulate property-type risk, and b) allow REITs a “cherry-picking” in property acquisitions. In particular, they argue diversification enables offsetting a downswing of one property by the upswing of another which leads to less volatile cash flows over all. With regard to enforced dividend distribution requirements of REITs, we argue that achieving the minimum volatile cash flow possible is the central aspect of a stable REIT dividend policy. However, volatility-decreasing mechanisms tie up capital in illiquid assets and lower managerial efficiency due to more needed human capital resources with broader know-how sets to manage larger property-type portfolios (Anderson et al., 2015). In line with previous findings (Benefield et al., 2009; Ro & Ziobrowski, 2011), Anderson et al. (2015) conclude that costs are overcompensated, because both ROA and ROE are higher for diversified REITs explainable by the facts that diversified REITs own better assets for further growth (or better manage them) in terms of ROA and that reinvestment opportunities arise from higher retained earnings based on higher ROEs. Thus, diversified REITs have better chances to identify opportunities to acquire properties with great 90

However, margin results of Ro and Ziobrowski (2011) are not statistically significant.

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performance on the basis of broader property bases, what they refer to as “cherrypicking” (Anderson et al., 2015). From an announcement effect perspective, Ro and Ziobrowski (2012) derive significantly negative abnormal returns for acquisition announcements that indicate a stronger diversification in property-type and regional focus, while they do not obtain clear results for dispositions that increase property-type and regional focus. They apply the same methodology for JVs and obtain significant positive abnormal return for DJVs that increase focus. With regard to both classical and real estate JV theory, we derive that the presented benefits of diversification hold true for JVs on a stand-alone basis as well. Consequently, we argue REIT managements evaluate diversification to be best achieved with JVs due to resource inflows of JV partners that do not require resources and corresponding costs in the REIT. Due to ongoing monitoring of capital markets, diversification can be hardly implemented by REIT entities without realizing capital market penalties throughout the build-up phase, when profitability is negatively affected (Bradley et al., 1998). We deduct diversification both by geography and property-types requires build-up of specific knowledge that has a directly negative effect on profit and loss statements and hence on cash generating ability within the cash-restrained environment. So REIT managements are motived to apply a JV strategy to realize the need of diversification, as JVs facilitate to enter new markets (Kogut, 1991). At the same time, partnering allows a better access to suitable market opportunities (Brass & Burkhardt, 1990, 1993; Dyer et al., 2004; Gnyawali & Madhavan, 2001; Hannan & Freeman, 1977). In particular, REIT diversification is constrained by the existence of asymmetric information, the lack of standardization in real estate markets with diverging local characteristics, importance of sparse property management expertise, asset segmentation, low liquidity, and the presence of anchor tenants for commercial real estate that is only attracted through network and knowledge which motivates real estate companies to partner (He et al., 1997; Ravichandran & Sa‐Aadu, 1988). Accordingly, in line with McConnell and Nantell (1985) and Ravichandran and Pinegar (1990), Ravichandran and Sa‐Aadu (1988) conclude JVs to be value-creating transactions for parent companies and because the real estate market is restricted by unique market characteristics. The uniqueness is discussed in various literature streams and is not without controversy discussed: Even though real estate valuations should be easily done as human capital and growth options are limited, Han (2006) infers that illiquidity and heterogeneity of real estate assets complicate fair real estate market valuations. Though, the information asymmetry paradigm remains unclear in REITs (Feng et al., 2007). Referring to Elayan (1993), real estate diversification through JVs allow efficiency synergies and competitive advantages through making use of diversification and underlying leverage potentials because JV resource combination enable operative synergies from economies of scale and scope, more efficient allocation of human and asset capital, risk reduction, efficiency effects in

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administration and management, alignment of research interest, and a monopolistic competitive advantage. As such, informational advantage can be best achieved in JVs. Otherwise, diversification-increasing properties are inefficiently managed with existing skill base or with the help of external asset managers that need to be remunerated and create value-destroying informational asymmetries. Access to Needed Diversification Capabilities and JV Contribution In line with classical JV literature, He et al. (1997) argue that JVs are chosen as instrument to enable corporate expansion. In order to achieve business extension and diversification in general, Harrigan (1985b) concludes that JVs are erected to generate needed assets to achieve the corporate goals, which is mostly internally constrained by a knowledge lack (Kogut, 1988a; Teece, 1986). Internal knowledge generation is subject to a company’s willingness and ability in addition to existing know-how base and its absorptive capacity (Cohen & Levinthal, 1990; Hamel, 1991; Shenkar & Li, 1999), while JVs allow to maintain and extend knowledge, despite failure and instability arising from underlying complexity (Contractor & Lorange, 1988; Gomes-Casseres, 1987; Kogut, 1989; Osborn & Hagedoorn, 1997; Shenkar & Li, 1999). Subsequently, new knowledge allows to increase market power in line with Bresnahan and Salop (1986), Reynolds and Snapp (1986), and Kwoka Jr (1992), while gains in market power depend on suitable overlaps of the partners’ core businesses (Mohanram & Nanda, 1998). In detail, JVs allow continuous corporate learning and retention of knowledge and capabilities so that partners inject their knowledge with the intention to sustain and enlarge competitive advantage as it is mostly protected within organizational borders (Kogut, 1988a; McKelvey & Aldrich, 1983). Thereby, other partnering forms become obsolete because knowledge can not be transferred at zero costs and JVs are platforms to duplicate expertise for future potential exploitation (Kogut, 1988a). Companies utilize JVs as strategic vehicle to drive organizational change with resources that companies can not afford and establish on a stand-alone basis (Harrigan, 1988a). Thereby, JV formations affect industry structures and competitive positioning by (1) gain of competitive advantage, (2) profit level stabilization, and (3) structural changes in vertical integration, technology, and industry characteristics (Harrigan, 1988a). In the REIT marketplace ongoing structural industry change can be observed so that REITs used to be passive investment vehicles and can now actively balance their portfolios comprising properties that they fully own and manage on the one hand and holdings limited to capital contributions on the other hand with all deviations in between these extrema. This dramatic change of the business model and the contribution of JVs can be based on fundamentals of JV literature. JVs reshape companies’ skillsets by accelerating knowledge development processes allowing

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the introduction of new (product) offerings through complementary asset acquisition with existing capabilities transformed into new industries and product areas and thus become important to companies from mature economies to sustain competitive advantage in a marketplace characterized by deregulation of economies, shorter life cycles and faster product replacements, higher capital requirements, higher risks, global market entries, and communicative coalescence (Harrigan, 1987). We argue that all conditions are fulfilled by the REIT Modernization Act that deregulated the REIT Act in such a way to make REITs active real estate owners and managers. Vertical integration through JVs offers potential to achieve all advantages from downstream integration while lowering exit barriers if business potentials are not in line with corporate strategy (Harrigan, 1985c). In the case of real estate, it can be inferred that REITs gain skills that they would otherwise obtain from asset management companies as suppliers, while joint strategic exploitation allows achieving a comparative advantage, joint control, and synergies (Darrough & Stoughton, 1989). Subsequently, this corporate combination structure overcomes acquisition diseconomies, issues of managing non-core business activities, and higher value chain costs in an environment of high performance uncertainty and asset specificity where JVs can lower transaction costs and cost structures from operative scale and scope, learning state, knowledge, and underlying expenses for legal contracts and claims leading to higher dependence levels, stabilizing relationships, and transaction enforcement (Kogut, 1988a; Williamson, 1975, 1985). In parallel, the strategic JV rationale for profit maximization through reshaping the positioning towards competition is fulfilled (Harrigan, 1988a), and welfare effects are achieved as duplications of activities in research and development are avoided and finally assets and services can be produced at lower prices and higher quality. Consequently, JVs contribute to efficiency aspects in REITs and should yield lower cost structures in line with Ambrose et al. (2005), Benefield et al. (2009), and Ro and Ziobrowski (2011). In general, JVs safeguard competitive and strategic uncertainty and allow to drive competitors out of the market (Kogut, 1988a; Vernon, 1983; Vickers, 1985). Applied on REITs, JVs allow efficient management of properties outside the existing investment foci as well as appropriate valuations through bundled knowledge. As such, the rationale to set up real estate JVs becomes apparent to attract both capital and knowhow to meet the needs of diverging local characteristics and property management expertise (Behrens, 1990; He et al., 1997; Ravichandran & Sa‐Aadu, 1988). Accordingly, risks are reduced and value enhanced through acquisition of property type-specific expertise of partners in JVs (A. J. Jaffe & Sirmans, 1984). Providing reasoning for the aforementioned, Corgel and Rogers (1987) concludes that the key motive for real estate JVs is the attraction of development-specific know-how even though capital may be sufficiently in place and developer often lack funding to undertake large-scale development

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projects. Thus, JVs grant access to local knowledge, the development-specific, and property-specific expertise (Campbell, 2002), as real estate market characteristics lead to higher costs for firms in market entry situations in comparison to local companies (Gau, 1987). It can be beneficial for all involved partners as a required set of know-how and capital can thus be accumulated which represents a win-winsituation. Finally, the cherry-picking argument of Anderson et al. (2015) can be based on network effects from JVs that Harrigan (1988a) calls “spider’s web of joint ventures” (p. 16). She argues firms set up various JVs in dependence of own bargaining power where firms become more centralized in accordance with bargaining power. Subsequently, Powell (1990) concludes that JVs can be set up at the inter-organizational or network level. As result, a network gives its initiators access to exploitation opportunities, such as disproportional profits and competitive advantage (Dyer & Singh, 1998; Dyer et al., 2008; Gulati, 1995), as well as exploitation and exploration gains (Koza & Lewin, 1998). In detail, JV networks stimulate resource flows and thereby explain organizational characteristics and decisions (Gnyawali & Madhavan, 2001). In line with the centrality concept of Freeman (1979),91 centrality enables superior information access and flow, thus market trends are better adopted and search costs are considerably decreased (Haunschild & Beckman, 1998).92 Thereby, Gnyawali and Madhavan (2001) conclude that central firms are supplied with information and resources earlier and more easily and thus gain visibility, status, and power in line with the argumentation of Brass and Burkhardt (1990, 1993) that JV networks supply power and consequently decrease dependence. Empirically, more central firms show more alliance than acquisition activity and prefer partnering with companies that have low distances in their network or that have already been a partner (Gulati, 1995; Powell et al., 1996), or equally good resource bases, sound growth prospects, and similar Tobin’s Q (M. S. Kumar, 2010; S. Kumar & Park, 2012; Rhodes-Kropf & Robinson, 2008).93 Hence, JVs and its network effects enable recognition of opportunities and trends more efficiently while risk for future uncertainty is shared representing both a fundament and substitute for acquisitions (Dyer et al., 2004). Besides enabling corporate learning and a competitive advantage, the search for the best partner remains most challenging in joint venturing and leads to different managerial styles (Harrigan, 1987). The motivation to achieve complementary assets, depicted by Teece (1986) and Hennart (1988), is the heart of the JV transaction rationale as 91 92 93

The centrality concept measures average closeness to all other network members through direct and indirect connectors (Freeman, 1979). The same implications are found for company size (Haunschild & Beckman, 1998). This underlines the hypothesis of DiMaggio and Powell (1983) that companies become more alike the more change is initiated as close companies become more similar through collaboration and acquisitions.

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elaborated by Kogut (1988a) as well as the resource-based view as applied on strategic alliances by Tsang (1998) who argues the search for rent generation, expanding the utilization of assets, resource diversification, imitation, and disposals motivates companies to erect JVs to achieve a competitive advantage. We conclude that all these aspects hold true for REITs seeking diversification and that the cherry-picking aspect of Anderson et al. (2015) is an application of network centrality concepts. M&A Alternative JVs as well as M&A transactions have the same intention to gain diversification, additional resources, and incorporate learning for the parent company, while both combination can be motivated by the search for synergies and competitive advantage (Hamel, 1991; Hennart & Reddy, 1997; Villalonga & McGahan, 2005). While the activities substitute each other they should be holistically assessed (Dyer et al., 2004). Hennart and Reddy (1997) compare JVs to merger rationales and argue that both corporate combination mechanisms serve to pool comparable and complementary resources, while JVs are erected when an acquisition would lead to higher managerial costs of the merged entity due to existing undesired assets outside the scope of the target resource in line with Hennart (1988). This finding supports the rationale that JVs are a merger alternative in case the parent company seeks access to specific assets and resources of other organizations (Kogut, 1988a; McKelvey & Aldrich, 1983) which partially contradicts the rationale of Balakrishnan and Koza (1989, 1993) arguing JVs are aimed at reducing transaction costs incurred in M&A. Further comparing JV erections to corporate M&A implies that JVs offer the advantage to acquire the optimal and needed set of resources for a temporary (where needed, e.g. in the case of developments) duration instead of fixed acquisitions with infinite maturity. Depending on corporate bylaws, JV can be executable without separate shareholder approval, as JVs can be part of the normal course of the business and its financial budgeting (Corgel & Rogers, 1987). JVs are preferred over mergers when reorganization costs should be minimized and when potential merger targets dislike and refuse merger offers which decrease risk exposure as the corporate combination in JVs can be terminated (Campbell, White-Huckins, et al., 2006; Nanda & Williamson, 1995). Further, JVs are platforms to enable first contact with partners and provide the ability to enforce the collaboration (S. Kumar & Park, 2012). Hennart and Reddy (1997) reveal that JVs with companies in the same product market are a preferred method to enter new markets if scale effects and dominating market positions of present companies are given. Applying the option view of Kogut (1991) on the rationale of M&A, JVs serve as a information platform for future acquisition decisions (Chi, 2000; Folta & Miller, 2002; M. V. S.

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Kumar, 2005; Tong et al., 2008). It remains open how companies incorporate JV experience and learnings into acquisition rationales (Dyer et al., 2004; Villalonga & McGahan, 2005). Nanda and Williamson (1995) as well as Mantecon and Chatfield (2007) elaborate that JVs are often used as transition vehicle where a mutual understanding is generated in preparation of a future merger or acquisition. The main difference between the two kinds of corporate combination transactions is the rationale that acquisitions are of irreversible nature and require more financial resources and management expertise, while JVs enable a continuous partnering process where input factors can be flexibly adjusted and thus a final exit option is always viable (Balakrishnan & Koza, 1993). Looking for very narrow and specific resources, other forms of partnering or acquisitions are obsolete, as knowledge can not be transferred at zero costs while JVs represent the best platform for duplicating expertise through contractual commitments as well as injected resources and capital (Beamish & Lupton, 2009; Kogut, 1988a). JVs are the preferable corporate expansion instrument in case of high information asymmetries (Balakrishnan & Koza, 1993; Reuer & Koza, 1998). Following the controversial discussion of information asymmetries in real estate and REITs with the main takeaway of unclear synergy gains, we conclude that this explains the trend of JV use and the absence of an active M&A market in the REIT sector and therefore deduct that JV use is part of organizational learning and enable understanding of needed resources in acquisition targets. As JVs thereby supplement M&A a possible explanation can be obtained for the absence of an active merger market and hostile takeovers. The literature on real estate- and REIT-related mergers does not reveal clear findings (Anderson et al., 2012; D. Ling & Petrova, 2011; Medla, 2011), and especially the synergistic motivation is not yet isolated despite obvious size-related benefits of REITs (Anderson et al., 2012; Lewis et al., 2000). The controversy results are attributed to the unique institutional environment and characteristics of real estate assets to not allow monopolistic effects in the real estate and REIT area, whereas tax loss carrying targets could drive REIT mergers (P. R. Allen & Sirmans, 1987). Contradictory, more recent findings suggest that the underlying acquisition rationale differs in the private and public area (Campbell, 2002; D. Ling & Petrova, 2011), however, listed REITs seem to follow the rationale to increase market power as they typically acquire high dividend paying REITs with higher leverage (D. Ling & Petrova, 2011). On the one hand, special homogenous operational characteristics of real estate companies lower synergy effects and the uniform REIT asset compositions limits vertical integration (Campbell et al., 2001; P. M. Eichholtz & Kok, 2008). Contradictory on the other hand, REITs are found to capture achievable synergy effects through cost side effects in overhead

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expenses94 from economies of scale (Anderson et al., 2011, 2012; Medla, 2011). This is supported by previous findings that corporate combinations enable a more efficient asset management but also operational and financial gains (P. R. Allen & Sirmans, 1987; Elayan & Young, 1994). Due to the tough institutional and regulatory environment, corporate acquisitions are a growth instruments, also in the REIT industry, but typically are friendly (Campbell et al., 2001; Campbell et al., 2005). The fact of minor hostile REIT takeover activity seems to support synergy absence (Anderson et al., 2012; Campbell, 2002; P. M. Eichholtz & Kok, 2008; Lu et al., 2015; Ratcliffe & Dimovski, 2012; Womack, 2012). Mergers and acquisitions in the REIT area can be motived by managerial hubris because acquirers tend to be large and profitable but face weak growth prospects (Lu et al., 2015). In a review on three REIT restructuring measures (1) sell-offs, (2) mergers, and (3) JVs, Campbell (2002) concludes JVs enable the initiating parental firms to only pool project-specific resources that are obviously needed which is in line with classical theory. In line with transaction cost theory (Williamson, 1979), Campbell (2002) argues JVs allow minimizing combination costs, especially compared to hostile takeovers, and offer suitable termination paths as in general JV theory (Balakrishnan & Koza, 1993; Corgel & Rogers, 1987; Nanda & Williamson, 1995) . UPREITs, which have certain commonalities with JV structures, are the most common form in the Equity REIT marketplace due to acquisition flexibility through the UPREIT mechanism (Sinai & Gyourko, 2004). In detail, this acquisition structure enables REITs to retain cash at acquisition if it holds stocks in the same amount measured in market value as the purchase price due at conversion date (Campbell et al., 2005). In addition, the UPREIT structure allows managing the 5-50 ownership rule as the REIT can exercise its call option on the OP units by cashing out some of the OP units to adjust ownership structure (Campbell et al., 2005). Campbell et al. (2005) describe that managers that enter REITs through the acquisition of their entity and accept acquirer’s stock as deferred payment instrument with lock-up periods for conversion signalize to mitigate information asymmetries, as confidence on the combined entity’s outlook is sent to the market. In its application this mechanism has two practical restricting implications as the acquiring REIT needs to make sure that sufficient shares are authorized at time of conversion and to have enough liquidity in order to bypass a breach of the 5-50 ownership restriction (Campbell et al., 2005). This explains the rationale for the regular one-year lock-up period for conversions as this is a reasonable duration to execute internal restructurings, calculate liquidity requirements, and to seek funding sources in capital markets for debt and equity offerings (Campbell et al., 2005). 94

Findings in a cross-sectional OLS analysis suggest that REITs are able to decrease general and administrative expenses as well as a minor reduction in interest expenses from scale effects (Anderson et al., 2011, 2012; Medla, 2011).

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We deduct that JVs are common instruments for corporate expansions and combinations and are preferred over straight takeovers to mitigate information asymmetries and to establish intra-company interfaces that could serve as transition vehicle for following acquisitions as in classical industry (S. Kumar & Park, 2012; Mantecon & Chatfield, 2007; Nanda & Williamson, 1995). Following a merger or takeover, dispositional joint structures can further be used as exit strategy in properties that does not (yet) fit the investment focus. However, while M&A drive company size, they do not change the overall situation for REIT management that are in need of operational and financial flexibility. Contradictory, M&A activity requires to allocate even more managerial attention to manage the institutional restrictions in the post-merger phase. We conclude that the motivation for REIT managements to decide between JV and merger and acquisitions are the same as for classical corporations but given information asymmetries on property level explain the absence of an active takeover market that drives REITs to structure JVs, because they are smaller in size and offer more focus and flexibility.

3.4

Subsidiary Conclusion

By applying a holistic view on REITs with regard to REIT Act evolution and exemplary reviews on REIT dividend policies, stock repurchase programs, restructuring measures, capital structure, liquidity management, capital raising, and diversification rationales, we derive several potential JV application rationales and conclude that REIT managers are motived for JV use to allowing for managerial (financial) flexibility needs that is hardly available to REIT managers in the exogenously cash-constrained and capital-intensive REIT industry as i.a. postulated by what Howton et al. (2018) and Hartzell et al. (2019). The review studies several literature streams of REIT managers conducting several peculiarities, such as announcing share repurchase programs to subsequently be net-issuers, where the underlying rationale are often not without controversy. We deduct that these specialties originate from managerial need of financial flexibility to run and grow their businesses while complying with the REIT Act and fulfilling investor expectations. Thereby, we draw conclusions how JV use contributes to those scenarios by introducing and applying a JV perspective to those conducts. We thereby conclude that JVs are means of strategic platforms that allow short-term flexibility to establish an efficient, high-yield REIT entity in the long-term. Thus, JVs contribute to structure corporate REIT options, as originally postulated by Campbell, White-Huckins, et al. (2006). The underlying rationales as depicted in Section two hold true but are exacerbated in the case of REITs by the need for “unlimited” flexibility in the institutional environment. Our review of REIT specialties in comparison to classical corporations reveal certain

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obstacles for managers to meet regulator’s and capital markets’ expectations simultaneously and managerial conducts to handle them. We show how limitations of REIT managers in structuring corporate options drive and innovate approaches in the stimulation and maintenance of capital market sentiment. While Glascock et al. (2018) therefore question REIT structure efficiency, we argue that the structure is efficient in the long-run as all REIT specialties in the marketplace are aimed at keeping the structure intact accounting for the fact that going private and voluntary termination of REIT status are available options at any time. In fact, the Section reveals the need of more financial flexibility to allow for operational flexibility to balance investors’ expectations and REIT status compliance. We conclude that JV use supports REIT managers to establish a REIT entity with steady and predictable cashflows, whereas the JV platform assumes all volatility-causing and -increasing activities that in the long-run again fit REIT entity business nature and positively contribute to REIT dividend policy. This conclusion can be linked to the very fundamentals of JV rationales to mitigate uncertainty (Dyer et al., 2004; A. J. Jaffe & Sirmans, 1984; Kogut, 1988a, 1991; Pfeffer & Nowak, 1976; Ravichandran & Sa‐Aadu, 1988; Vernon, 1983; Vickers, 1985) and to drive change that the REIT could not afford on its own (Harrigan, 1988a). At first, it is the REIT Act itself that contributes the main underlying motivator for REIT JV use, as the modernization reforms through the 1980s and 1990s changed the business model of REITs from passive real estate investment vehicles to fully-integrated REOCs with REIT status. However, investor expectations seem to not have adjusted for the business plan change, foremost with regard to (excess) dividend distributions (Bradley et al., 1998; Ghosh & Sirmans, 2006; Hardin III & Hill, 2008; K. Wang et al., 1993). In particular, REITs were perceived as high yield dividend stocks in the old REIT era where capital and liquidity constraints did not negatively affect the passive investment business plan, while OBRA and RMA established more entrepreneurial and managerial behavior. As part of it, the REIT Act introduced joint ventures and TRS which constitutes the platform of today’s JV use observations and explain the findings of Hess and Liang (2004) of increasing REIT JV use by 2002. We conclude that JV use is the result of REIT management to satisfy both trends: (1) to become integrated real estate operating corporations and (2) to access income sources that allow steady dividend policies where JVs are used to gain financial and operational flexibility within a restricted institutional environment (Campbell, White-Huckins, et al., 2006; Freybote et al., 2014; Hess & Liang, 2004; Plumb & Azrack, 2001; Siegel, 1999). As a direct consequence of the REIT Act and presented in the second arm of our analysis, REITs use different capital structures and financing behavior compared to classical corporations partially contradicting classical corporate finance assumptions. Existing regulations and restrictions limit REITs especially in asset growth, security cushion and buffer, and the cooperation with anchor shareholders

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compared to classical corporations. Given compulsory regulations and statutory provisions to not accumulate liquidity reserves through retained earnings, no equity instrument can be implemented on parent / REIT level to absorb potential losses and to allow internal financing for asset growth, as the internal growth ability of REITs is limited to a maximum of the remaining 10% of profits and REITs thus need to issue both equity and debt to grow internally, as i.a. depicted by Hardin III and Hill (2008) and Hardin III and Wu (2010). While retained earnings only contribute 7% of REIT financing for new investments (Ott et al., 2005), REIT managers have to manage their properties with only 1.57% cash and cash equivalents over total assets (classical public firms hold 18.48%) (Damodaran, 2005; Hardin III et al., 2009). Primary concern for REIT managements is the receipt of capital access and adequate liquidity levels, as well as refinancing maturing loans given difficulties in weak economic and operational phases to access both equity and debt sources, especially with regard to SEOs (Feng et al., 2007). We identify that REIT JV offer financial flexibility in terms of (3) alternative funding sources in both acquisition finance and refinancing terms, (4) as liquidity management vehicle, and (5) as part of capital market strategy to enable classical funding access as stock price stimulator. In the third stream of our analysis we have reviewed the diversification literature of REITs and find that diversification efforts by REIT management are a consequence of REIT Act and REIT capital structure. Combining the findings that (1) REIT size positively stimulates NAV valuations and increases efficiency levels in NOI, ROE and FFO yield (Ambrose et al., 2005), (2) diversified REITs outperform specialized REITs (Anderson et al., 2015; Benefield et al., 2009; Ro & Ziobrowski, 2011), with (3) that REITs do not experience share price penalties upon dividend cuts for property acquisitions if they achieve ROAs of more than 10% (Hardin III & Hill, 2008; K. Wang et al., 1993), it becomes apparent that REIT managers have obvious reasons to target a minimum profitability of 10% ROA and may apply a diversification strategy given diversification and size effects. We therefore conclude that JVs are used to (6) establish diversification through external knowledge of partners while risk and capital exposure is minimized. Concluding, in this Section we have examined the role of JVs for exogenously cash-constrained firms and thus this Section contributes to mainstream corporate finance, REIT, and JV literature on how managements may evaluate financial flexibility benefits by applying JV strategies. It becomes clear that the REIT Act has triggered more managerial behavior but neglects to create an efficient environment to apply growth strategies. We suggest that the policy changes adopt for financial flexibility needs in the REIT environment by i.a. setting different scenarios to comply with in accordance with maturity and strategy of REITs. In line with Glascock et al. (2018), it remains open to debate if this application represents efficient use of the REIT structure and if REIT JVs are subject to

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managerial misbehavior to increase managerial power and compensation as i.a. lined out by Jensen (1986), Denis, Denis, and Sarin (1997), and Ro and Ziobrowski (2012). For further research we suggest to empirically test for the financial flexibility theorem of REIT JVs by analyzing the market and firm conditions upon JV announcements. Thus in accordance with Freybote et al. (2014) we suggest to test if JV strategy results from financial distress or whether the need for flexibility is a general phenomenon in the REIT industry.

4 REIT Joint Venture Formations as Means for Financial Flexibility to Capture Market Timing Opportunities95 4.1

Introduction

We observe 1,146 joint venture (JV) announcements96 with an average transaction volume of USD 209 million97 by listed and traded REITs in the period from the first quarter 2003 to the end of the third quarter 2014. Many motives for JV formation have been developed and tested in the financial literature (e.g. synergyseeking, knowledge-seeking, risk-sharing, M&A alternative, and international expansion). With a focus on REITs, a stream of literature has developed on dispositional JVs (DJVs), mostly arguing for a financing motive. However, we argue operational and financial flexibility, as well as market opportunities to drive JV formations, particularly those of JVs for acquisitions (AJVs), for which only a sparse body of literature exists to date. Due to the restrictive REIT legislation, managers are encouraged to seek financial flexibility by alternative means, particularly those with weaker capital market access and higher degree of financial distress (Hartzell et al., 2019; Howton et al., 2018). This Section examines if REIT managers make use of JVs as means of financial flexibility to respond to external (real estate) market conditions as well as internal firm (REIT) characteristics. In particular, we test if JVs are structured as a result of market timing and second if only REITs facing higher financial distress decide to participate in JVs. The existing literature is inconclusive what the motives for REITs are to set up JV entities and mostly limited to classical synergy motives and empirical studies concentrate on announcement effects (Campbell, White-Huckins, et al., 2006; Corgel & Rogers, 1987; Elayan, 1993; He et al., 1997; Ravichandran & Sa‐Aadu, 1988). Particularly, the market timing aspect of REIT JV formation is not yet clarified. We assume a market timed financial flexibility-rationale for REIT JVs and argue that JVs are means of financial flexibility needs to correspond to market opportunities that occur if underlying parameters in the space and capital markets 95 96 97

This Section is co-authored by Dr. Holger Markmann and is intended for separate publication. We obtain 1,146 announcements on entity-level and 1,125 stand-alone announcements; the difference is explainable by the fact that a JV can have multiple REIT sponsors. 664 announcements of the 1,125 contain deal volumes.

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 J. Eibel, Real Estate Investment Trusts and Joint Ventures, Essays in Real Estate Research 19, https://doi.org/10.1007/978-3-658-31977-9_4

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change, as proposed by Roulac (1988) and DiPasquale and Wheaton (1992). Thus, JVs contribute to mitigate the co-existence of capital markets and real estate markets, what Zhu (2018) refers to as “dual nature” (p. 26) of REITs , while the return of REIT market is closely linked to private real estate yields (Boudry, Coulson, Kallberg, & Liu, 2012; Hardin III, Huang, Liano, & Pan, 2019). Existing research reveals that REITs are limited in the identification and realization of market opportunities due to a number of restrictions. These are a lack of know-how because of the special particularities in real estate sub-markets (He et al., 1997; Ravichandran & Sa‐Aadu, 1988), information asymmetries in fair asset valuation (Feng et al., 2007; Han, 2006), financial constraints in capital retention (Campbell, White-Huckins, et al., 2006; Riddiough & Wu, 2009), limited ability to internally finance new investments (Campbell, Petrova, et al., 2006; Ott et al., 2005),98 a negligible cash balance of only 1.4% of total assets compared to 18.5% in classical corporations (Damodaran, 2005; Hardin III et al., 2009), and a large dependency on capital markets (Aguilar et al., 2018; Brounen & de Koning, 2013; Devos et al., 2019; Dogan et al., 2019; Hardin III & Hill, 2008). REITs are therefore subject to limited funds available for acquisition opportunities and rely on the availability of (short-term) bank lines (An et al., 2012; Dogan et al., 2019; P. Eichholtz & Yönder, 2015; Howton et al., 2018; Riddiough & Wu, 2009). On the other hand, existing studies show that REITs need to regularly convey growth information to its shareholders (Campbell, Petrova, et al., 2006; Ghosh & Sirmans, 2006; K. Wang et al., 1993) in line with signaling theory as i.a. depicted by Bhattacharya (1979), John and Williams (1985) and the agency costs theorem of free cash flow depicted by Jensen (1986), but are very limited in their options (Bradley et al., 1998; Ghosh et al., 2010; Giambona et al., 2005; Giambona et al., 2006; C.-H. Lee et al., 2005). In fact, research results yield that REITs do pay out more dividends than they are legally obliged to, referred to as excess dividends, to convey adequate signals which even more decreases the ability to realize market opportunities (Ott et al., 2005). Given ongoing monitoring of capital markets, realizing REIT growth is a challenge for REIT managers as they have to pay attention to capital market penalties if overall profitability could negatively be affected (Anderson et al., 2015). In parallel, REIT managers need to manage permanent funding access to be able to realize investment market opportunities in the various space markets to decrease and avoid underinvestment (Hartzell et al., 2019; Howton et al., 2018). As a result, existing studies conclude that REIT managers seek operational and financial flexibility (Campbell, 2002; Campbell, Petrova, et al., 2006; Campbell, White-Huckins, et al., 2006; Hartzell et al., 2019; Howton et al., 2018). Extending 98

At the same time, there is no cushion, no buffer as shield for future losses that can be implemented through retained earnings that can be later used as basis for internal growth and subsequent means of capturing market opportunities.

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the argumentation of Campbell, White-Huckins, et al. (2006), we argue REIT managers find both operational and financial flexibility in JVs. First, from an operational perspective JVs contribute to discover and capture suitable market opportunities. Roulac (1988) argues the ongoing real estate market screening process for profitable acquisition opportunities is constrained by local knowledge requirements and the right timing. This is in line with existing (fundamental) JV research that knowledge can be attained via JV sponsor companies and thereby the uncertainty in new markets can be reduced to access needed information (Kogut, 1991). This way, REITs attain better access to suitable market opportunities (Brass & Burkhardt, 1990, 1993; Dyer et al., 2004; Gnyawali & Madhavan, 2001; Hannan & Freeman, 1977). In line with research beyond the real estate sphere, such as McConnell and Nantell (1985) and Ravichandran and Pinegar (1990), real estate JV transactions are found to create value for sponsor companies due to operative synergies from economies of scale and scope, the more efficient allocation of human and asset capital, risk reduction, efficiency effects in administration and management, alignment of research interest, and a monopolistic competitive advantage (Elayan, 1993; Ravichandran & Sa‐Aadu, 1988). JVs serve as decision-facilitator for an unknown investment market and property-specific uncertainty, i.a. A. J. Jaffe and Sirmans (1984) and Ravichandran and Sa‐Aadu (1988),99 and circumvent hold-up hazards from asset specificity, transaction uncertainty, and transaction complexity (Alchian & Woodward, 1987; Klein et al., 1978; Williamson, 1979). Another positive side-effect is that if another real estate company is attracted, REITs get access to complementary knowhow and regional market access, such as property-specific management expertise and access to potential anchor tenants, to establish successful property management, i.a. Powell (1990) and Koh and Venkatraman (1991) for classical JVs and He et al. (1997), Hess & Liang (2004), Campbell, White-Huckins, et al. (2006) for real estate JVs. Also general information asymmetries are overcome this way (Balakrishnan & Koza, 1993; He et al., 1997; Ravichandran & Sa‐Aadu, 1988; Reuer & Koza, 1998). Thus JVs are platforms to access additional market relevant information and to overcome information asymmetries given equity contributions of the partners as incentive which enable profitable acquisition opportunities in line with fundamental JV theory and Roulac (1988). By the use of JVs, REITs do not need to internally build up resources to enable the realization of future opportunities, to meet the local real estate markets’ particularities and circumvent capital market penalties due to increasing cash flow needs (Anderson et al., 2015; Jensen, 1986). Besides the knowledge seeking rationale as an important role in the local and non-standard real estate industry that lead to higher costs for firms in market entry 99

See i.a. Pfeffer and Nowak (1976), Vernon (1983), Vickers (1985), and Kogut (1988a) for classical JVs and uncertainty-facilitation.

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4 REIT Joint Venture formations as means for financial flexibility

situations in comparison to local companies (Gau, 1987), existing studies reveal that JVs enable access to additional financial sources and capital markets to realize the opportunities by mitigating the aforementioned financing restrictions. Through structuring JVs, REITs attract capital resources from third parties, its JV partner(s), to fund property acquisitions which is in line with the identified JV capital attraction motive for real estate companies and REITs (Behrens, 1990; Campbell, 2002; Campbell, White-Huckins, et al., 2006; Elayan, 1993; Hess & Liang, 2004; Siegel, 1999).100 Occurring costs and cash flows are thereby shielded from the REIT in the JV (Campbell, White-Huckins, et al., 2006). By sharing project-specific risk, JVs make projects feasible and acceptable for company boards, the capital equity and debt markets, and other financial providers even if the risk exceeds the capability of each partner alone (Burton et al., 1999; Jones & Danbolt, 2004). Additionally, JVs are separate, self-governed entities (He et al., 1997; McConnell & Nantell, 1985; Schut & Van Frederikslust, 2004). In addition to AJVs, existing research shows that REITs also structure JVs for dispositions as introduced by Campbell, White-Huckins, et al. (2006), REITs can either sell parts of their portfolio completely or they sell partially into DJV entities where most often the REIT keeps a minority interest, i.e. less than 50% of the equity, and secures a buy back-option. Freybote et al. (2014) argue that the benefit of this structure is the maintenance of (partial) proprietorship while receiving liquidity101 that is needed to bridge financing gaps. REITs keep proprietorship but also management contracts for the underlying assets in the case of a financial JV partner102 and thereby secure additional income streams. In case that internal REIT knowledge base is not sufficient to extract the full profitability potential of the underlying properties, REITs can use dispositional JVs structures with knowledgeable partners to manage those properties to full profitability (Campbell, 2002; Campbell, Petrova, et al., 2006; Campbell, White-Huckins, et al., 2006; Freybote et al., 2014). Contradictory to Freybote et al. (2014) concluding dispositional JV structures to serve as disposal and financing strategy of last resort for distressed REITs,103 it can be argued that DJVs serve as financial flexibility mechanism to free tied capital for new acquisitions by making use of the right timing in order to realize cash distribution and cash requirements for acquisitions at the same time and allowing efficient investments as capital requirements for acquisitions

100 101 102 103

See i.a. Berg and Friedman (1977) and Johnson and Houston (2000) for classical JVs and the capital attraction motive. The liquidity amounts to the partial threshold of the buyer in the newly formed JV. Most often this is a pension fund or another institutional investor in line with Campbell, White-Huckins, et al. (2006); Freybote et al. (2014) They find in their sample that REITs structuring DJVs structures suffer i.a. from low MBR and high leverage.

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103

decrease (Campbell, 2002; Campbell, White-Huckins, et al., 2006; Elayan, 1993; Johnson & Houston, 2000). Thus we postulate that REIT JVs, independently from an acquisitive or dispositional purpose, fulfill REIT managers’ demand for operational and financial flexibility (Campbell, 2002; Campbell, Petrova, et al., 2006; Campbell, WhiteHuckins, et al., 2006; Howton et al., 2018) that allow better access and funding for suitable market opportunities in line with the classical JV literature stream (Brass & Burkhardt, 1990, 1993; Dyer et al., 2004; Gnyawali & Madhavan, 2001; Hannan & Freeman, 1977). The present study postulates the following research question: Are REIT JVs structured (announced) when space and capital market conditions change enabling attractive investment opportunities and is JV activity limited to financial distressed REITs? For the first part of the research question we hypothesize that REIT managers respond to changes in space and capital market, as proxy for market opportunities as elaborated by Roulac (1988), by structuring JVs to gain informational advantage and financial flexibility. In particular, we assume this holds true for AJV, as REIT managers face investment opportunities that require financing which can not be obtained by traditional capital sources. Contradictory, we hypothesize DJVs do not occur when (space) market changes because DJVs are structured as refinancing instrument by REITs in financial distress which should hence use this strategy in line with Campbell, White-Huckins, et al. (2006) and Freybote et al. (2014) given that refinancing needs should not be correlated to (space) market. Additionally, the motivation to sell at a high price should timewise be different to the intention to buy at a low price. As AJVs are dominant to DJVs in terms of pure quantity, we assume the results of AJVs hold for the entire sample. For the second part of our research question we investigate the JV formation motives on an individual REIT level by including market capitalization, marketto-book-ratio, dividend-pay-out-ratio, and leverage, which we match with the aforementioned JV announcements. For this panel, we hypothesize that only REITs with weak financial access seek financial flexibility in AJV and DJV formations in line with the JV rationales proposed by Campbell (2002), Campbell, White-Huckins, et al. (2006) and Freybote et al. (2014) due to restrictions in REIT capital structure in line with the research in REIT capital structure (Dogan et al., 2019; Feng et al., 2007; Murray Z. Frank & Goyal, 2009; Harrison, Panasian, & Seiler, 2011; Howe & Shilling, 1988) that result in financial flexibility needs in case of underinvestment as existing research suggests i.a. Gamba and Triantis (2008), Almeida et al. (2011), Denis (2011), Howton et al. (2018), and Hartzell et al. (2019). We thereby extend the DJV findings of Freybote et al. (2014) who conclude that DJVs serve as financing solution of last resort, to overall REIT JV use application.

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4 REIT Joint Venture formations as means for financial flexibility

In line with our expectation, we find that AJV is clearly driven by market factors. We find a strong negative impact of house prices on the likelihood to form an AJV, as well as a positive impact for short-term financing conditions and the REIT market momentum. In contrast, neither market changes nor specific REIT characteristics explain DJV activity. The remainder of this Section is structured as follows: Sub-Section 2 describes the JV activity, followed by data description, Sub-Section 4 describes the methodology and empirical results, while Sub-Section 5 presents robustness checks. Sub-Section 6 concludes.

4.2

Joint Venture Activity

Figure 7 presents the quarterly JV announcements in the sector over the study period first quarter 2003 to third quarter 2014. In total we find 1,146 relevant JV announcements filed. Whereas between the first quarter of 2003 and the third quarter of 2008 an average of 31 occurred per quarter, this number decreased dramatically to an average of 7 between the fourth quarter 2008 to the second quarter of 2010 during peak times of the financial crisis. The average between the third quarter 2010 and the third quarter 2014 recovered to 22. Additionally, Figure 7 depicts the development of AllJV, AJV, and DJV across the entire timeframe, despite the difference in absolute number of announcements, no behavioural difference can be observed, i.e. low and high peaks show the same pattern. While Freybote et al. (2014) conclude that DJVs serve as financing solution of last resort, we should observe an increase in joint venture activity (AllJV) and especially in DJV activity during the peak of the financial crisis (2008 to 2010) due to the reason that capital markets were hard to access and investors show herding behavior (Zhou & Anderson, 2013). We observe that the JV activity has found its negative peak with only two announcements in the

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105

Figure 7: The development of REIT JV announcements 01/2003-09/2014 Source: own illustration based on data from SNL Financial Note: Data only accounts for all REIT JV (AllJV), AJV, and DJV announcements counting for every single REIT announcements and thus depicts 21 announcements simultaneously released by multiple REITs. Full lines represent all announcements of the corresponding quarters. Dashed lines depict average number of announcements per JV type. Numbers are rounded to integer numbers, thus rounding differences may occur.

first quarter of 2009 – in the peak of the financial crisis. Nonetheless a relatively quick recovery of announcements can be monitored afterwards. This is in line with previous REIT financing-related studies that the behavior of REITs has changed dramatically since the subprime crisis (Denich et al., 2014). Table 2 shows the underlying deal type of the 1,146 JV announcements as depicted in the released statements surrounding the events, thereof 86 percent are

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4 REIT Joint Venture formations as means for financial flexibility

classified as AJV and only 14 per cent are structured as DJV. Contradictory, the sample of Campbell, White-Huckins, et al. (2006) comprises only 185 events with 75 per cent AJV and 25 per cent DJV from 1994 to 2001. Table 2:

JV Deal Types and Distribution

JV Deal Type

No. of observations

Distribution

Purchase

570

49.7%

34

3.0%

Contribution

123

10.7%

Development

237

20.7%

17

1.5%

Sub-Total AJV

981

85.6%

Disposition

165

14.4%

Sub-Total DJV

165

14.4%

1146

100.0%

Capital-Raising

Re-Development

Total announcements

Source: own illustration Note: The original raw data was obtained by SNL Financial. The authors reviewed all transactions and manually coded for property type. Where necessary, the authors classified different property types.

Further, we find only 26% of the AJV to be development-focused, which corresponds to 22% of all JVs in the sample, whereas 58% of the AJV are structured to purchase specific assets, that is 50% of the entire sample. Only 3% of AJVs and the entire sample are found for capital-raising activities and do not specifically address already identified properties. In contrast, Campbell, WhiteHuckins, et al. (2006) find a more pronounced development concentration in AJVs with 75%,104 while only 25 out of 100 AJVs address the purchase of existing assets with cash flows in place. The differences in the sample relate to the sample size as well as the corresponding time frame which partially represents an older REIT era and thus represents the very beginning of JV activity (Hess & Liang, 2004). Table 3 illustrates the underlying property types of the JV transactions of our sample. In general, the distribution pattern in property types does not significantly differ across AJV and DJV. We obtain a clear focus on retail properties with 35.9% which is in line with the findings of Hess and Liang (2004) in general and Freybote 104

60 out of 100 cases to undertake developments with a financial partner and in 15 out of 100 cases to partner with a development company.

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107

et al. (2014) for DJVs in particular between 1996 to 2011 who find 39% retail, 25% office, and 21% residential properties where we have 35%, 21%, and 23% respectively. The similarity can be associated with the overlap in the timeframe, even though the sample differs in size (87 to 165). However, the application areas are mostly in the classical property types with specialty only accounting for less than 2% of observations. Table 3:

JV Property Type by JV Type

JV Property ALLJV DistribuAJV DistribuDJV DistribuType tion AllJV tion AJV tion DJV Retail 411 35.9% 354 36.1% 57 34.5% Residential 245 21.4% 210 21.4% 35 21.2% Office 198 17.3% 159 16.2% 39 23.6% Industrial 136 11.9% 119 12.1% 17 10.3% Mixed Use 81 7.1% 71 7.2% 10 6.1% Social 32 2.8% 31 3.2% 1 0.6% Specialty 19 1.7% 18 1.8% 1 0.6% Other 24 2.1% 19 1.9% 5 3.0% Total an1146 100.0% 981 100.0% 165 100.0% nouncements Source: own illustration Note: The original raw data was obtained by SNL Financial. The authors reviewed all transactions and manually coded for property type. Where necessary, the authors classified different property types.

Table 4 shows the value composition of those 646 transactions where transaction details contain deal volume, thereof 528 AJVs and 118 DJVs . The average deal value in the sample is USD 209 million for AllJV (median value of USD 69 million) in a transaction value range from USD 1 million (smallest announced value) to USD 3.95 billion in the largest transaction with a standard deviation (SD hereafter) of USD 378 million. This corresponds to the JV sample of Campbell, White-Huckins, et al. (2006) comprising an average value of USD 208 million in a range from USD 15 million to USD 1.4 billion with a SD of USD 242 million. In our sample, AJVs are on average bigger than DJVs with USD 229 million compared to USD 122 million, median values have comparable sizes with USD 70 million for AJVs and USD 58 million for DJVs given that the AJV transaction value range exceeds DJVs’ range with USD 2 million to aforementioned USD 3.95 billion compared to a DJV range which implies a higher SD of USD 408 million for AJV compared to USD 171 million for DJV structures. In total, there are 36 AJVs with values greater than USD 1 billion.

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4 REIT Joint Venture formations as means for financial flexibility

Table 4:

JV Transaction Value per JV type

JV Value Minimum value (in USDm) Maximum value (in USDm) Average value (in USDm) Median value (in USDm) SD (in USDm) No. of JV Value