A n E x a m i n a t i o n o f P r i m a r y a n d S e c o n d a r y M a r k e t R e t u r n s i n E q u i t y R E I T I P O s

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1 A n E x a m i n a t i o n o f P r i m a r y a n d S e c o n d a r y M a r k e t R e t u r n s i n E q u i t y R E I T I P O s A u t h o r s Sinan Gokkaya, Michael J. Highfield, Kenneth Roskelley, and Dennis F. Steele, Jr. A b s t r a c t We examine primary and secondary market returns for real estate investment trust (REIT) initial public offerings (IPOs). Consistent with theories regarding compensation for information production during the roadshow, we find offer-to-open returns are directly related to partial adjustment and are significantly lower for REITs holding assets in a single property type. Matching REIT IPOs to comparable non-reit IPOs, we also find evidence consistent with demand uncertainty. Specifically, after controlling for issue and firm characteristics, REITs post significantly lower secondary market returns despite similar primary market returns. This indicates that demand uncertainty resolves more quickly for REITs, possibly due to higher relative transparency. There have been a multitude of studies examining the initial market returns of initial public offerings (IPOs); however, as in Loughran and Ritter (2004), most of these studies focus on total underpricing, or offer-to-close returns (e.g., Ruud, 1993; Aggarwal, Krigman, and Womack, 2002; Loughran and Ritter, 2002; Lowry, Officer, and Schwert, 2010). In the first study of its kind, Barry and Jennings (1993) dissect total IPO underpricing into primary (offer-to-open) and secondary (open-to-close) market returns and find that virtually all of the initial return is consumed on the opening transaction, leaving no exploitable secondary market returns for non-real estate investment trust (REIT) IPOs. More recently, Bradley, Cooney, Jordan, and Singh (2009) find statistically and economically significant open-to-close returns for a more recent sample of non-reit IPOs and show that both primary and secondary market returns are positively related to the degree of information asymmetry associated with the IPOs. 1 Unfortunately, as is common in the general IPO literature, all of the above papers exclude REIT IPOs from their studies. In fact, while there is a considerable J R E R V o l. 3 7 N o

2 2 4 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e literature documenting economically and statistically significant underpricing for REIT IPOs (Ling and Ryngaert, 1997; Buttimer, Hyland, and Sanders, 2005; Hartzell, Kallberg, and Liu, 2005; Chan, Chen, and Wang, 2013), no previous study dissects REIT IPO underpricing into its primary and secondary market components. 2 Although one could argue that a better understanding of the equity REIT IPO underwriting market is an important question in itself due to the size of REITs as an asset class (Capozza and Seguin, 2003), equity REITs should also serve as a unique laboratory for investigating the implications of theories for underpricing in the primary and secondary markets. Given that information asymmetry is not directly observable, most non-reit empirical studies employ a wide range of proxies that are distinctly different and might be contaminated by firm and industry-wide effects (Ljungqvist, 2006; Lee and Masulis, 2009). Consistently, Bradley, Gonas, Highfield, and Roskelley (2009) note that their information asymmetry variables may actually proxy for unmodeled firm- and industry-specific characteristics. Limiting a sample to equity REIT IPOs might mitigate the concerns about unobserved firm- and industry-specific heterogeneity due to the equity REIT business model and regulatory requirements. While equity REITs vary in property focus, these minor differences in underlying asset structures are standardized and easily classified. Furthermore, unlike technology companies, equity REITs invest in tangible, income-generating assets, which are relatively easy to value. A REIT s real assets are typically listed in annual reports, in SEC filings, and often on firm websites. Furthermore, equity analysts typically develop estimates of asset values through standard conventions for occupancy and rental rates based on observable geographic and other property information. That is, compared to most other industries, REIT revenue estimation and overall firm valuation is less problematic. 3 In addition, due to the 95% dividend payout requirement put in place by the Real Estate Investment Trust Tax Provision of 1960, which was revised down to 90% with the REIT Modernization Act of 1999, expected dividends are modestly predictable. Although the REIT market is constantly changing, these factors should theoretically reduce the agency problem of asset substitution and weaken the asymmetric information problem between investors and issuers. 4 This paper contributes to the existing IPO literature in several ways. First, in an effort to shed more light on the REIT IPO underwriting market, and in contrast to previous REIT IPO studies examining only underpricing, we focus on the primary and secondary market components of underpricing. Examining primary (offer-to-open) market returns, the findings show that, on average, about 97% of the initial market return is consumed on the opening transaction for REIT IPOs between 1993 and As a result, we find that the average secondary market (open-to-close) return for equity REITs is not significantly different from zero.

3 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 2 5 Thus, unlike recent evidence for non-reit IPOs, the underpricing of REIT IPOs is, on average, consumed in the primary market, leaving no opportunities for profit in the secondary markets. Second, investigating the cross-sectional determinants of underpricing in the primary and secondary markets, we find that offer-to-open returns are directly related to partial adjustment and demand uncertainty, but secondary market returns are unrelated to these characteristics. The results also indicate that offer-to-open returns are lower for REITs holding a portfolio of real estate assets in a single property type at the time of issue, potentially due to fewer information asymmetry problems, leading to lower price uncertainty for the REIT IPO. Overall, these findings are consistent with the theories based on compensation to primary market participants for information production and risk taking during the roadshow. 5 Third, we compare the primary and secondary market returns of equity REIT IPOs with traditional non-reit IPOs in an effort to focus on the potential differences in the relative transparency between the two types of issuers. Consistent with previous studies, we find that total underpricing for REIT IPOs is significantly lower than that observed for comparable non-reit IPOs. Simply breaking underpricing into its primary components, offer-to-open and open-to-close returns, does not affect this result. However, after considering other factors known to influence initial returns, our multivariate analysis shows that, in contrast to our expectations, while primary market returns for REIT IPOs are not statistically different from non-reits after controlling for factors known to influence underpricing, secondary market returns for REIT IPOs remain significantly lower than those observed for their non-reit IPO counterparts. This finding is robust to alternative model specifications and could imply that price uncertainty regarding the IPO resolves more quickly for REIT than non- REITs, an important issue because of the growing debate on the greater transparency of REITs as an asset class (Feng, Ghosh, and Sirmans, 2007). Dolvin and Pyles (2009) find smaller underpricing and price revisions for REIT IPOs and attribute this finding to reduced information asymmetry. 6 Thus, in line with Ljungqvist (2006), when comparing REITs and non-reits, the share price of a typical equity REIT should be more easily ascertained in both the primary and secondary markets than the stock price of the average non-reit, potentially because of greater information transparency and the tangible nature of REIT asset holdings. As a final component to our analysis, an examination of the secondary market returns of REIT IPOs reveals a negative relation between open-to-hour and hourto-close returns, suggesting an aftermarket reversal that is not present in non-reit IPOs. In addition, these results persist only for the cold REIT IPO subsample, consistent with the notion that intraday reversal might be due to price support by underwriters. J R E R V o l. 3 7 N o

4 2 6 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e L i t e r a t u r e R e v i e w I P O U n d e r p r i c i n g The apparent underpricing of common shares in IPOs is well documented in academic literature. The evidence indicates that this anomaly has been fairly persistent through time. For example, Loughran and Ritter (2002) find an average offer-to-close return of just over 14% for a sample of 3,025 firms for the period 1990 to 1998, while Ljungqvist (2006) finds an average first day return of around 19% since the 1960s. More recently, Bradley, Gonas, Highfield, and Roskelley (2009) find an average total underpricing of just under 31% for the period. Many theorists and empiricists have long pondered why, on average, issuers and their underwriters leave so much money on the table for investors in IPOs. Numerous researchers have attempted to explain this well-documented finding. As noted by Chan, Wang, and Yang (2009), most work in this area has been based on asymmetric information between (1) issuers and underwriters, (2) between issuers and investors, and (3) among underwriters, informed investors, and uninformed investors. Unfortunately, the IPO literature almost exclusively reports this topic in the context of underpricing, the percentage difference between the offer price and first-day closing price. This is problematic because most theoretical models used to explain this initial return typically build on asymmetric information, institutional structure, or behavioral arguments, which are concentrated in either the primary or secondary market. The Primary Market. Building on Rock s (1986) winner s curse hypothesis, Benveniste and Spindt (1989) develop a theory of IPO underpricing based on information generation during the bookbuilding process. This partial adjustment model considers underpricing as compensation to investors for revealing to the underwriter private information, namely their true demand for an issue. 7 The idea is that the expected compensation to an investor who reveals honest information about his or her demand for an issue must be greater than that of revealing dishonest information, where the magnitude of compensation for information generation should be higher for IPOs with greater ex ante information asymmetry (Beatty and Ritter, 1986). In order to reward primary market investors who truthfully reveal positive information during the bookbuilding process, underwriters only partially adjust up the final offer price, thus leading to an underpricing phenomenon. Therefore, in line with the information acquisition theory, the reward to primary market investors for truthfully revealing their demand should be realized upon the first trade in the open market, leaving little to no subsequent average intraday returns for secondary market participants.

5 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 2 7 The Secondary Market. While the partial adjustment model can be used to explain underpricing in the context of the primary market, some IPO models are predictive about the behavior of allocated shares in the secondary market. In this study, we group research regarding the initial secondary market trading of an IPO into two broad categories: price support and demand uncertainty. Benveniste, Busaba, and Wilhelm (1996) argue that underwriters may choose to price support IPOs to bond with uninformed secondary market investors. This price support censors the left-tail of the price distribution, thus generating a positive secondary market return (Bradley, Gonas, Highfield, and Roskelley, 2009). Alternatively, Lowry, Officer, and Schwert (2010) argue that a portion of IPO underpricing in the primary market may be related to the uncertainty of the market s aggregate demand for an IPO s shares. They document that the level of IPO underpricing is associated with the volatility of IPO initial returns and tends to be higher in firms that are more difficult to value. Consistent with this hypothesis, Bradley, Gonas, Highfield, and Roskelley (2009) document that, on average, investors that purchase shares at the start of trading return 2.3% over the day. They note that almost the entire abnormal secondary market return occurs in the first 30 minutes of trading as the demand uncertainty for the IPO shares is resolved. They also document that IPOs that are more difficult to price tend to have higher secondary market returns. Since price support can obscure relations between IPO initial returns and firm and market characteristics by truncating initial returns at zero, Bradley, Gonas, Highfield, and Roskelley (2009) also report results for the top quartile of firms sorted by offer-to-open returns. They find that the relation between initial secondary market returns and beta is stronger in this sample, making price support an unlikely explanation for the secondary market returns they observe. However, they caution that beta may proxy for unobservable firm and industry heterogeneity, not information asymmetries or aggregate demand uncertainty. P r e v i o u s I P O U n d e r p r i c i n g S t u d i e s I n v o l v i n g R E I Ts In one of the earliest REIT IPO studies to consider underpricing, Wang, Chan, and Gau (1992) find a significant 2.82% offer-to-close return for the period. 8 Below, Zaman, and McIntosh (1995) examine a similar time period and find an insignificant 0.89% offer-to-close return for the period. These researchers found REIT IPOs were typically overpriced, but subsequent legislative acts, including the Tax Reform Act of 1986 (TRA86), which allowed active management under the self-advised, self-managed structure, directly changed the operations and investment attractiveness of the REIT industry. As noted by Ling and Ryngaert (1997), the TRA93 allowed for increased institutional ownership in REITs, bringing on an intense period of growth in the REIT industry and creating a more diverse market of investors distributed among J R E R V o l. 3 7 N o

6 2 8 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e a better mix of informed (institution) and uniformed (individual) investors. 9 Citing Rock s (1986) winner s curse hypothesis, Ling and Ryngaert (1997) observe a significant 3.60% offer-to-close return for equity REIT IPOs during the period. The next major change occurred through the REIT Simplification Act of 1997 (RSA97), which allowed REITs to provide non-customary services to tenants without disqualifying REITs from their tax-exempt status. As suggested by Buttimer, Hyland, and Sanders (2005), growth in the underlying real estate industry and the passage of TRA93 and RSA97 led to increased REIT IPO activity (waves). They document significant initial returns of 5.39% for the REIT IPO wave and 3.58% for the wave. The REIT Modernization Act of 1999 (RMA99) allowed REITs to establish taxable REIT subsidiaries (TRS) to provide services to REIT tenants and others, increasing efficiency and lowering expenses. 10 The RMA99 also reduced the minimum distribution requirement from 95% to 90% of taxable income. Five years later, the REIT Improvement Act of 2004 (RIA04) eliminated the barrier to foreign investors buying publicly listed REIT stock. It allowed REITs facing possible loss of REIT status to either fix the mistake or pay a monetary penalty for violations of REIT tax laws. Finally, the REIT Investment Diversification and Empowerment Act of 2007 (RIDEA) provides for more efficient asset management and increased the allowed size of taxable REIT subsidiaries. Using IPO data from the modern era, Chan, Chen, and Wang (2013) investigate the initial and long-run returns of 129 U.S. REITs and 241 international REITs for the period. They find a significant 2.78% raw initial return for their sample of U.S. REITs, and a larger 3.48% raw initial return for international REITs. Similarly, Bairagi and Dimovski (2011) find a 2.43% initial return for the period. They also find an insignificant overpricing of 1.19% for the period. Again, none of the REIT IPO studies discussed above segment total underpricing into primary and secondary market components. H y p o t h e s e s a n d D a t a D a t a S o u r c e s We collect a sample of 126 equity REIT IPOs from the Thomson Financial Securities Data Company (SDC) New Issues Database for the January 1, 1993 to December 31, 2007 period. 11 The size of the issue, exchange of listing, file range, offer price, names and number of lead underwriters, and other issue characteristics are obtained from the SDC database and verified by hand using SEC filings. The SNL Financial REIT Datasource (SNL) is used to identify UPREITS, as well as REIT property focus. Self-advised and self-managed REITs are identified in Ambrose and Linneman (2001) for REIT IPOs prior to 1997, and SEC filings are used for IPOs that take place after We also utilize SEC filings to determine if issuing firms are Blank Check REITs or hold assets in a single property type at the time of issue. 12

7 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 2 9 Open, close, and intraday hourly prices are obtained from the NYSE Trade and Quote (TAQ) Database. 13 Consistent with other IPO research, we use the Center for Research on Security Prices to obtain the CRSP value-weighted index and the (CRSP)/ Ziman Real Estate Data Series for our post-issue estimations of beta. The CRSP value-weighted index is also utilized to obtain the pre-issue standard deviation of the value-weighed CRSP REIT Index. We also obtain Carter and Manaster (1990) underwriter reputation rankings from Jay Ritter at the University of Florida. 14 S u m m a r y S t a t i s t i c s We utilize the pricing variables obtained from SDC and TAQ to compute five IPO return measures: total underpricing, offer-to-open, open-to-close, open-to-hour, and hour-to-close. Total Underpricing is the percentage change between the offer price and the close price on the first day of the IPO issue. While the mean and median price changes are relatively minor when compared to the 30.8% offer-toclose return observed by Bradley, Gonas, Highfield, and Roskelley (2009), the average underpricing for our sample is a statistically and economically significant 5.23%. 15 We next dissect total underpricing into a primary and secondary market component by utilizing the open price on the secondary market. Representing the return in the primary market, the Offer-to-Open is the percentage change between the offer price and the open price. We find an economically and statistically significant 5.09% offer-to-open return for our sample of equity REIT IPOs; thus, most underpricing is consumed in the first public trade on the market. While much smaller in absolute magnitude, the relative proportion of underpricing dedicated to the primary market for equity REITs ( ) is statistically larger than that noted by Bradley, Gonas, Highfield, and Roskelley (2009) for non- REIT firms ( ). 16 Representing the secondary market return, Open-to-Close is the percentage change between the open price and the close price on the first day of trading. Unlike the statistically significant 2.3% documented by Bradley, Gonas, Highfield, and Roskelley (2009), the open-to-close returns observed for equity REIT IPOs are not significantly different from zero. On average, an investor who purchases an equity REIT IPO in the secondary market should expect no abnormal return over the first trading day; however, examining the variations in open-to-close returns for REIT IPOs, the findings show a substantial variation, with a range of 11.98% and a sample standard deviation of 189 bps. Thus, we seek to investigate the source of this variation in open-to-close returns in addition to primary market returns, not to document that equity REIT secondary market returns are greater than zero. In fact, almost one-fourth of the 126 equity REIT IPOs in our sample (30) rise or fall by more than 2% over this first day of public trading. Next, we decompose the aftermarket return into Open-to-Hour, the percentage change between the open price and the transaction price observed closest to one hour after the firm opens for trading on an exchange, and its compliment, Hour- J R E R V o l. 3 7 N o

8 3 0 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e to-close, the percentage change between the transaction price closest to one hour after the open of a firm s stock on an exchange to the close price on the first day of trading. 17 As one would expect, these values are relatively small, with median values of zero, but the range remains relatively large. Descriptive statistics for other conditioning variables previously shown to influence underpricing are also presented in Exhibit 1. The proceeds of the offer (Proceeds) for the average REIT IPOs during our sample period is $202 million, with the largest issue bringing in just over $1.43 billion and the smallest garnering only $10.8 million. The average percentage difference between the offer price and the mid-point of the original file range, Partial Adjustment, is 3.59%, indicating that firm underwriters, on average, set the offer price 3.59% below the mid-point of the file range set in the initial prospectus. Again, there is a large amount of variation in the sample with respect to partial adjustment, but the average observed here for equity REITs is much lower than values observed for non-reit IPOs. 18 Bradley, Gonas, Highfield, and Roskelley (2009) suggest that an ex post beta coefficient effectively proxies for the price uncertainty of an IPO. Accordingly, building on the method employed by Bradley, Gonas, Highfield, and Roskelley (2009), we utilize the CRSP REIT index and the six month (26 week) T-bill rate to estimate the mean coefficient of the daily market risk premium. 19 The resulting ex post beta coefficient (Beta) serves as a proxy for the price uncertainty of the IPO and averages only for our sample of equity REITs. While the level of volatility in the market is a gauge of the general level of uncertainty in the market, Lowery and Shu (2002), Bradley, Gonas, Highfield, and Roskelley (2009), and Chen, Fok, and Kang (2010) suggest that underpricing is increasing in market volatility. Thus, similar to Chen, Fok, and Kang (2010), we compute the daily standard deviation of the CRSP/ Ziman REIT Index over the 125 trading days prior to the IPO [ 125, 1] to be approximately 66 bps. Similar to Friday, Howton, and Howton (2000), only 7.1% of our sample of equity REITs is listed on the NASDAQ (NASDAQ), and approximately 61% of our sample is priced on an integer (Offer Integer), a finding consistent with most other IPO studies. 20 It also appears that REITs typically retain highly active underwriters as documented by an average underwriter reputation ranking of 8.08 on the Carter and Manaster (1990) scale for the highest rated lead underwriter in the underwriting syndicate. Lead Managers is the number of lead underwriters listed on the IPO prospectus. We find that no issuer claimed more than three lead managers, while most IPOs had only one. Turning to organizational structure, 84.1% are structured as an umbrella partnership REIT (UPREIT) at the time of offering, while 78.6% of the REITs in the sample are classified as self-advised and self-managed (SASM) at the time of their IPO. We also find that 71.6% of the firms held real assets of a single property type, which is also consistent with the self-reported property focus on the prospectus. The remaining 28.4% held multiple types of real estate assets (i.e.,

9 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 3 1 Exhibit 1 Descriptive Statistics Variable Mean Median Std. Dev. Minimum Maximum Offer Price ($) Open Price ($) Hour Price ($) Close Price ($) Total Underpricing (%) Offer-to-Open (%) Open-to-Close (%) Open-to-Hour (%) Hour-to-Close (%) Proceeds ($M) , Size (Ln($M)) File Range (%) Partial Adjustment (%) Beta () Volatility (%) NASDAQ (binary) Offer Integer (binary) Reputation (ordinal) Lead Managers (cardinal) SASM (binary) UPREIT (binary) Single Property Type (binary) Notes: The sample includes 126 equity REIT IPOs obtained from Thomson Financial s SDC Platinum New Issues Database for the period January 1, 1993 to December 31, The number of observations is 126. Offer Price is the price per share offered to primary investors. Open Price is the price per share at the open of the secondary market the day of the REIT IPO. Close Price is the price per share closest to 4:00 P.M. on the first day of trade in the secondary market. Total Underpricing is the percentage change between the offer price and the closing price on the first day of trading. Offer-to-Open is the percentage change from the offer price to the open price in the secondary market on the first day of trading. Open-to-Close is the percentage change in the open price to the close price in the secondary market on the first day of trade. Open-to-Hour is the percentage change from the offer price to the market price closest to one hour after the IPO opens for public trading in the secondary market. Hour-to-Close is the percentage change in the market price closest to one hour after the IPO opens for public trading in the secondary market to the close price in the secondary market on the first day of trade. Size is the natural logarithm of Proceeds (millions) generated from the sale of securities in the IPO. File Range represents the difference in the high and low prices in the prospectus file range divided by the midpoint of that file range. Partial Adjustment is the percentage change from the middle of the original file range to the offer price. Beta is the mean coefficient of the daily market risk premium as estimated on J R E R V o l. 3 7 N o

10 3 2 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e Exhibit 1 (continued) Descriptive Statistics the daily excess return for the first six months of trading, where the market rate of return is proxied by the CRSP REIT index and the risk-free return is proxied by the six month (26 week) T-bill rate. Volatility represents the daily standard deviation of the CRSP REIT Index over the 125 trading days prior to the IPO [125, 1] multiplied by 100 to represent a percentage. NASDAQ is binary variable with a value equaling one if the firm was initially listed on the NASDAQ, zero otherwise. Integer is a binary variable equal to one if the offer price is an integer, zero otherwise. Reputation is the highest Carter and Manaster (1990) reputation ranking for the lead underwriters of the issue. Lead Managers is the number of lead managers in the underwriting syndicate. SASM is a binary variable equal to one if the REIT is listed as both self-advised and self-managed on the S-3 filing, zero otherwise. UPREIT is a binary variable equal to one if the REIT is listed as an UPREIT on the S-3 filing, zero otherwise. Single Property Type is a binary variable equal to one if all properties owned by a REIT at the time of the IPO are in a single property classification, zero otherwise. IPO characteristics, offer prices, open prices, hour prices, and close prices were obtained from SDC Platinum, CRSP, and TAQ. Carter-Manaster reputation rankings were collected from Jay Ritter s IPO website. diversified REITs), held real estate assets inconsistent with the stated property focus on the prospectus, or had no real assets at the time of issuance (i.e., blank check REITs). M e t h o d s a n d R e s u l t s U n i v a r i a t e A n a l y s i s : E q u i t y R E I T S a m p l e We begin our analysis of equity REITs by performing a series of univariate sorts to examine differences in the sample across time. 21 In Panel A of Exhibit 2, we show that in each sampled year, there is a non-negative value for total underpricing, as well as an offer-to-open return for the average REIT IPO. Unlike Bradley, Gonas, Highfield, and Roskelley s (2009) findings for non-reit IPOs, we find that an average secondary market participant purchasing a REIT IPO immediately after the opening earns no statistically significant return over the first trading day for any year in the sample period. Panel B of Exhibit 2 reports average IPO underpricing during the REIT IPO waves documented by Buttimer, Hyland, and Sanders (2005) and Chan, Chen, and Wang (2013) during our sample period. We also report average underpricing for the IPOs issued during non-wave periods. In all windows considered, the total underpricing consists primarily of the offer-to-open return. Although the mean value is large, like Buttimer, Hyland, and Sanders (2005), we find no statistical

11 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 3 3 Exhibit 2 Univariate Analysis: Sorts by Time N Total Underpricing Offer-to-Open Return Open-to-Close Return Hour-to-Close Return Panel A: Returns by year * 6.048* *** 3.099*** * *** 6.477*** * * ** Full sample of REIT IPOs *** 5.093*** Panel B: Returns by REIT IPO waves Wave A: *** 4.614*** Wave B: *** 6.184*** Wave C: ** 2.058** Non-Wave Years Full sample of REIT IPOs *** 5.093*** Notes: The sample includes 126 equity REIT IPOs obtained from Thomson Financial s SDC Platinum New Issues Database for the period January 1, 1993 to December 31, Total Underpricing is the percentage change between the offer price and the closing price on the first day of trading. Offer-to-Open is the percentage change from the offer price to the open price in the secondary market on the first day of trading. Open-to-Close is the percentage change in the open price to the close price in the secondary market on the first day of trade. Hour-to-Close is the percentage change in the market price closest to one hour after the IPO opens for public trading in the secondary market to the close price in the secondary market on the first day of trade. Panel A presents returns by the year of issue, and Panel B presents returns for the three REIT IPO waves ( , , ) documented by Buttimer, Hyland, and Sanders (2005). IPO characteristics, offer prices, open prices, hour prices, and close prices were obtained from SDC Platinum, CRSP, and TAQ. Carter-Manaster reputation rankings were collected from Jay Ritter s IPO website. *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. J R E R V o l. 3 7 N o

12 3 4 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e evidence that REIT IPOs are underpriced when REIT IPO issuance is low (nonwave years). To further document any potential variation in our sample of equity REITs, in Exhibit 3 we report total underpricing, offer-to-open, open-to-close, and hour-toclose returns based on several firm- and issue-specific characteristics. As noted by Gokkaya, Hill, and Kelly (2013), it is possible that the level of information asymmetry or cash flow risk embedded in an equity REIT is a function of its property focus. 22 As a result, in Panel A of Exhibit 3 we segment the REITs into seven property focus categories. 23 With the exception of the Healthcare and Diversified/ Specialized property types, all property groups post significant, positive total underpricing and offer-to-open returns. We find no evidence of significant secondary market returns for any property class with the exception of the Residential group, which has a modest open-to-close return of 52.1 bps. Residential REITs also have a statistically positive hour-to-close return of 44.6 bps, while Diversified/ Specialized REITs have a statistically significant hour-toclose loss of 42.0 bps. Classifying the REIT IPOs based on the property structure, Panel B of Exhibit 3 shows that REIT IPOs with a single property focus are associated with the lower total underpricing relative to REITs IPOs investing in multiple property types. Breaking down the total underpricing into its major components, our results show that this result is driven by the primary returns and is unrelated to secondary market returns. Panel C of Exhibit 3 presents REITs based on their UPREIT classification. As noted by Dolvin and Pyles (2009), the implementation of the UPREIT structure in equity REITs may impact REIT IPO issuance costs and underpricing. A structure first utilized by the Taubman Centers IPO in 1992, UPREITs are created when one or more individuals provide the REIT with property holdings in exchange for limited partnership interests, or operating units. While not recognized formally as equity in the partnership, these operating units can be converted to shares of stock in the UPREIT upon demand of the limited partner (Han, 2006). Ghosh, Nag, and Sirmans (2000) find that seasoned equity offerings (SEOs) by UPREITs are underpriced relative to REITs not structured as umbrella partnerships. Chen and Lu (2006) find similar results for IPOs. These findings support Ling and Ryngaert s (1997) suggestion that the complexity of the UPREIT structure increases the price uncertainty of the firm. Consistent with these studies, we also find that UPREITs are significantly underpriced relative to ordinary REITs. As one would expect, most of this underpricing comes in the form of compensation to primary market participants through the offer-to-open return, which is also significantly higher for UPREITs than non-upreits. Prior to TRA86, a REIT was required to partner with external organizations to (1) receive investment recommendations and (2) manage the properties held by the REIT. These externally advised and externally managed REITs were

13 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 3 5 Exhibit 3 Univariate Analysis: Sorts on Issue Characteristics N Total Underpricing Offer-to-Open Return Open-to-Close Return Hour-to-Close Return Panel A: Returns by REIT property focus Healthcare Hotel * Industrial ** 4.213* Office ** 9.995** Residential *** 1.948*** 0.521* 0.446* Retail *** 3.037*** Diversified/Specialized * Full sample of REIT IPOs *** 5.093*** Panel B: Returns by REIT property focus: single vs. multiple A) Single Property Type *** 2.586*** B) Multiple Property Types *** *** Difference (A B) *** 8.701*** Full sample of REIT IPOs *** 5.093*** Panel C: Returns by UPREIT classification A) UPREITs *** 5.739*** B) Non-UPREITs ** Difference (A B) ** 4.069* Full sample of REIT IPOs *** 5.093*** Panel D: Returns by advisement/management combination (SASM) A) SASM *** 5.296*** B) Not SASM * 3.871*** Difference (A B) Full sample of REIT IPOs *** 5.093*** Panel E: REIT IPOs based on exchange of listing A) NYSE/AMEX *** 4.906*** 0.289* B) NASDAQ ** 2.050** 1.341** Difference (A B) *** 1.530*** Full sample of REIT IPOs *** 5.093*** J R E R V o l. 3 7 N o

14 3 6 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e Exhibit 3 (continued) Univariate Analysis: Sorts on Issue Characteristics N Total Underpricing Offer-to-Open Return Open-to-Close Return Hour-to-Close Return Panel F: Returns by offer price relative to initial file range A) Above File Range ** ** B) Within File Range *** 6.148*** C) Below File Range ** 0.745*** Difference (A B) * 9.632* * Difference (BC) ** 3.968** Difference (A C) *** *** ** Full sample of REIT IPOs *** 5.093*** Notes: The sample includes 126 equity REIT IPOs obtained from Thomson Financial s SDC Platinum New Issues Database for the period January 1, 1993 to December 31, Total Underpricing is the percentage change between the offer price and the closing price on the first day of trading. Offer-to-Open is the percentage change from the offer price to the open price in the secondary market on the first day of trading. Open-to-Close is the percentage change in the open price to the close price in the secondary market on the first day of trade. Hour-to-Close is the percentage change in the market price closest to one hour after the IPO opens for public trading in the secondary market to the close price in the secondary market on the first day of trade. Healthcare, Hotel, Industrial, Office, Residential, and Retail represent equity REITs with assets that are related to healthcare, hospitality, industrial, office rentals, multi-family rental units, regional malls, and shopping centers, respectively. Diversified/Specialized represents equity REITs with assets related to diversified real asset holdings, self-storage properties, and specialty properties, such as correctional facilities. Above File Range represents firms whose offer prices were above the original file range. Within File Range represents firms whose offer price was within the original file range, and Below File Range represents those firms whose offer prices were below the initial file range. IPO characteristics, offer prices, open prices, hour prices, and close prices were obtained from SDC Platinum, CRSP, and TAQ. Carter-Manaster reputation rankings were collected from Jay Ritter s IPO website. *Significant at the 10% level. **Significant at the 5% level. ***Significant at the 1% level. essentially pass-through investment vehicles. With the passage of TRA86, many REITs brought both the advisement and management functions in house to become self-advised/ self-managed (SASM) REITs. Building on Capozza and Sequin (2000), Chen and Lu (2006) find lower IPO gross spreads for SASM REITs, suggesting that SASM REITs are informationally more transparent than non-sasm REITs. Alternatively, as shown in Panel D of Exhibit 3, we find that total underpricing and offer-to-open returns are larger for SASM REITs as

15 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 3 7 compared to non-sasm REITs, but the difference between the two groups is not statistically significant. 24 Turning to more traditional IPO underpricing variables, as shown in Panel E of Exhibit 3, the vast majority of REITs are listed on the NYSE/AMEX. Although not explicitly noted in previous REIT IPO studies, this finding is consistent with REIT SEO studies such as Friday, Howton, and Howton (2000). There is no statistical difference between NYSE/AMEX and NASDAQ issues in terms of total underpricing and offer-to-open returns, but big board REIT IPOs generate a positive and significant open-to-close return of 28 bps. On the other hand, the NASDAQ-listed REIT IPOs post an economically and statistically significant 2.05% (1.34%) open-to-close (hour-to-close) return. Both secondary market return measures are significantly lower for NASDAQ IPOs relative to NYSE/ AMEX IPOs. Finally, in Panel F of Exhibit 3 we report the relation between the offer price and the mid-point of the original file range established by underwriters. Hanley (1993) was the first to document that revisions to the IPO s file range are positively correlated to underpricing in the primary market. Consistent with her model, REIT IPO firms whose underwriters set the offer price above the original file range post a significant 16.7% total underpricing. This value declines monotonically as the offer price is placed within the original file range and then below it. Primary market returns virtually mirror the underpricing returns, and the differences in average underpricing and offer-to-open return between file range groups are statistically significant. Revisions to the file range also seem to be positively correlated to average open-to-close and hour-to-close returns, but the relation is not statistically significant. However, in examining intraday returns, we find that issues priced above the file range generate hour-to-close returns about 92 bps higher than those issues priced within or below the file range. M u l t i v a r i a t e A n a l y s i s : E q u i t y R E I T S a m p l e Bradley, Gonas, Highfield, and Roskelley (2009) document that, on average, primary market investors who purchase a non-reit IPO at the offer price earn an offer-to-close return of 30.78% over the first trading day. Segmenting this total underpricing, they find that the primary market investor who sold at the open earned an average return of 27.50%, leaving only 2.35%, on average, to the aftermarket investor who bought at the open and sold at the close on the first day of trading. 25 Consistent with the findings of Lowry, Officer, and Schwert (2010) on total underpricing, Bradley, Gonas, Highfield, and Roskelley (2009) show that more difficult to price IPOs experience larger returns on the first day of trading. They relate this relatively larger open-to-close return to the aggregate demand uncertainty for the IPO shares that specialists and dealers face as the IPO opens for trading. They also show that aggregate market volatility (market uncertainty), J R E R V o l. 3 7 N o

16 3 8 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e beta (information asymmetries), and firm size (firm risk) influence both the primary and secondary market returns for non-reit IPOs. They argue that these variables proxy for the difficulty in pricing a firm. However, they caution that beta may actually proxy for unmodeled heterogeneity and not information asymmetries for non-reit IPOs. Therefore, we construct the following multivariate regression model to estimate the determinants of total underpricing and its component returns: Return Partial Adjustment Size m,i m,i 1,m i 2,m i Integer NASDAQ 3,m 4,m i Reputation Lead Managers 5,m i 6,m i Beta Volatility 7,m i 8,m i UPREIT SASM 9,m i 10,m i Wave Single Property Type 11,m i 12,m i Heathcare Hotel 13,m i 14,m i Industrial Office 15,m i 16,m i Residential Retail, (1) 17,m i 18,m i m,i where Return m,i is the return measure m for REIT IPO i. 26 As discussed previously, the four individual return measures, m, are as follows: Total Underpricing, Offerto-Open, Open-to-Close, or Hour-to-Close. Turning to the independent variables, Bradley, Gonas, Highfield, and Roskelley (2009) show that the percentage difference in the offer price and the midpoint of the file range, Partial Adjustment, is positively related to the total, primary, and secondary market IPO returns, a finding documented for total underpricing by Hanley (1993) as based on the work of Benveniste and Spindt (1989). Consistent with Bradley, Gonas, Highfield, and Roskelley (2009), Lowry, Officer, and Schwert (2010), and Chen, Fok, and Lu (2011), Size, the natural logarithm proceeds (millions) generated from the sale of securities in the IPO, is included to proxy for smaller firms that are theoretically more difficult to price due to greater information asymmetry. 27 Given that Bradley, Cooney, Jordan, and Singh (2004) find that IPOs priced on an integer have greater underpricing, presumably due to uncertainty about the value of the firm and negotiations between the underwriter and issuer, we include Integer, a binary variable equal to one if the offer price is an integer, zero otherwise. Since the NASDAQ and NYSE have different IPO opening trade mechanisms and listing requirements, we include

17 M a r k e t R e t u r n s i n E q u i t y R E I T I P O s 3 9 NASDAQ, a binary variable with a value equal to one if the firm was initially listed on the NASDAQ, zero otherwise. Loughran and Ritter (2004) find that underwriters with more experience and greater reputation are more likely to underprice IPOs; thus, as a control, we include the variable Reputation, the Carter and Manaster (1990) measure of lead underwriter quality represented on an ordinal scale from one (lowest) to nine (highest) for the year the REIT went public. 28 Recognizing that multiple underwriters may generate more information during the due diligence process, we also include the natural logarithm of the number of lead underwriters of the issue, Lead Managers. Next, Bradley, Gonas, Highfield, and Roskelley (2009) suggest that the ex post beta coefficient proxies for the price uncertainty of the IPO. As a result, we include Beta, the mean coefficient of the daily market risk premium as estimated on the daily excess return for the first six months of trading. The market rate of return is proxied by the CRSP REIT index, and the risk-free return is proxied by the six month (26 week) T-bill rate. If Bradley, Gonas, Highfield, and Roskelley s (2009) results for Beta do not represent asymmetric information but instead reflect unmodeled firm heterogeneity, as they caution, then reducing the heterogeneity in the sample might eliminate the relations they document. Their warning is particularly resonant given they do not control for industry effects. We suggest that limiting our sample to equity REITs might reduce the impact of unobserved firm and industry-wide heterogeneity on inferences. Lowery and Shu (2002), Bradley, Gonas, Highfield, and Roskelley (2009), and Chen, Fok, and Kang (2010) suggest that underpricing is increasing in market volatility. Thus, similar to Chen, Fok, and Kang (2010), we include Volatility, the daily standard deviation of the CRSP REIT Index over the 125 trading days prior to the IPO [ 125, 1] multiplied by 100 to represent a percentage. 29 While restricting attention to equity REITs will reduce variation in the level of asymmetric information and unmodeled firm heterogeneity as compared to a typical sample of non-reit IPOs, the variation is not fully eliminated. For instance, Ghosh, Nag, and Sirmans (2000) and Dolvin and Pyles (2009), among others, have shown that REIT organizational structure impacts security issuance. To address these and other industry-specific concerns, we include a series of binary variables. UPREIT is a binary variable equal to one for UPREITs, zero otherwise, which controls for the unique tax advantages and added financing flexibility enjoyed by UPREITs (see Hartzell et al., 2008). Since Chen and Lu (2006) and Ambrose and Linneman (2001) note that the management structure may be related to agency problems which may impact security issuance, we also include the binary variable SASM, which is set equal to one for REITs that are self-advised and self-managed, zero otherwise. Consistent with Buttimer, Hyland, and Sanders (2005) and J R E R V o l. 3 7 N o

18 4 0 G o k k a y a, H i g h f i e l d, R o s k e l l e y, a n d S t e e l e Hartzell, Kallberg, and Liu (2005), we include a binary variable, Wave, to identify IPOs that take place in wave periods of and , as well as IPOs taking place in Recognizing that REIT IPOs holding assets in a single property subtype at the time of issuance may pose fewer information asymmetries than blank check REITs or REITs with property holdings in multiple property type classifications, we include the binary variable Single Property Type. 30 Similarly, building on Gokkaya, Hill, and Kelly (2013), who suggest that the riskiness of REIT cash flows and associated potential adverse selection problems may be a function of the type of underlying real assets held by the firm, we include controls for differences across property focus types. Specifically, Residential, Retail, Industrial, Office, Healthcare, and Hotel denote the respective conventional REIT property focus variables. The binary variable Diversified/ Specialized, which equals one for specialized or diversified REITs, zero otherwise, is the omitted reference group in our multivariate models. Finally, it is possible that large price changes in the first hour of secondary market trading may indicate greater aggregate demand uncertainty due to, among other things, the underwriter s underestimation of retail and/ or institutional demand. Therefore, we include the variable Open-to-Hour (not shown in Equation 1), defined as the percentage change from the open price to the market price closest to one hour after the IPO opens for public trading in the secondary market, when estimating the determinants of hour-to-close returns. Exhibit 4 provides the multivariate analysis for the first day returns of our sample of REIT IPOs. Consistent with the general IPO literature, we find that the percentage difference in the offer price, the mid-point of the IPO file range (Partial Adjustment), and risk (Beta) are positively correlated with underpricing and offerto-open, or primary market, returns. While the underpricing and primary market effects for these variables are economically significant, unlike Bradley, Gonas, Highfield, and Roskelley s (2009) examination of the non-reit market, neither of these variables provide explanatory power to the average open-to-close or hourto-close returns in the REIT IPOs secondary-market. 31 Consistent with the notion that smaller firms pose greater information asymmetries, the coefficient on Size is also negatively related to underpricing and offer-to-open returns but not related to either aftermarket return measure. In general, all of these findings are consistent with the information acquisition model of Benveniste and Spindt (1989) and show that primary market participants are rewarded for their information production during the registration process. Other results from Exhibit 4 also deserve attention. First, NASDAQ REITs post offer-to-open returns approximately 7.30% higher than that of NYSE/ AMEX returns after controlling for other characteristics of the IPO. This coefficient then reverses to a significant 1.90% for open-to-close returns. While the positive offer-to-open return is much larger than that observed in Bradley, Gonas, Highfield, and Roskelley (2009), the negative open-to-close return is consistent with what they observed for the period.