The Relationship between Tenant Quality and REIT Risk & Performance

Posted: 1 Dec 2010

See all articles by Crocker H. Liu

Crocker H. Liu

Arizona State University

Peng Liu

Cornell University - S.C. Johnson College of Business - School of Hotel Administration

Date Written: November 29, 2010

Abstract

This paper studies the micro-foundations of commercial real estate risk and performance. Specifically, we analyze the linkage between tenant quality and the performance of commercial real estate. A commercial real estate asset can be valued as the sum of the discounted future cash flows of commercial lease contracts. The value of leases is in turn determined by the financial stability and business growth of the tenants. Ex-ante, the operating and capital market performance of real estate having higher quality tenants e.g., AAA tenants should exceed the performance of properties having riskier tenants, ceteris paribus. Alternatively, we expect that tenant defaults or deterioration of tenant credit profiles will negatively impact the propertys performance. Real Estate Investment Trusts, a transparent ownership structure, regulated to hold commercial properties, provide a venue to test this hypothesis. We construct a metric to measure tenant quality by combining tenant credit information, such as credit rating, Altman Z-score, the earnings per share (EPS) forecast and the price performance of publicly traded tenants, as well as a tenant mix index. Using risk-adjusted stock returns and the corresponding betas of all equity REITs between 2000 to 2010, we show that tenant quality plays a significant role in explaining the cross-sectional variations of REIT returns and market exposure, even after controlling for other factors that influence REIT performance such as capital market conditions, firm characteristics, and REIT management.

JEL Classification: G1

Suggested Citation

Liu, Crocker H. and Liu, Peng, The Relationship between Tenant Quality and REIT Risk & Performance (November 29, 2010). 46th Annual AREUEA Conference Paper, Available at SSRN: https://ssrn.com/abstract=1717000

Crocker H. Liu (Contact Author)

Arizona State University ( email )

W.P. Carey School of Business
P.O. Box 873906
Tempe, AZ 85287-3906
United States
480-965-3259 (Phone)
480-965-8539 (Fax)

HOME PAGE: http://www.public.asu.edu/~chliu1

Peng Liu

Cornell University - S.C. Johnson College of Business - School of Hotel Administration ( email )

448 Statler Hall
Ithaca, NY 14853
United States
6072542960 (Phone)

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