Debt, Agency and Management Contracts in Reits: The External Advisor Puzzle

Posted: 18 Nov 1999

See all articles by Dennis R. Capozza

Dennis R. Capozza

Ross School of Business, University of Michigan

Paul J. Seguin

University of Minnesota - Twin Cities - Carlson School of Management

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Abstract

This study investigates why externally advised Real Estate Investment Trusts (REITs) underperform their internally managed counterparts. Consistent with previous studies, we find that REITs managed by external advisors underperform internally managed ones by over 7% per year. Property-level cash flow yields are similar between the two managerial forms; but corporate-level expenses and especially interest expenses are responsible for lower levels of cash available to shareholders in externally advised REITs. We document that the higher interest expenses are due to both higher levels of debt and to higher debt yields for externally advised REITs. We posit that compensating managers based on either assets under management or on property level cash flows creates incentives for managers to increase the asset base by issuing debt even if the interest costs are unfavorable.

JEL Classification: G31, G32, G34

Suggested Citation

Capozza, Dennis R. and Seguin, Paul J., Debt, Agency and Management Contracts in Reits: The External Advisor Puzzle. Available at SSRN: https://ssrn.com/abstract=181609

Dennis R. Capozza (Contact Author)

Ross School of Business, University of Michigan ( email )

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Paul J. Seguin

University of Minnesota - Twin Cities - Carlson School of Management ( email )

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Minneapolis, MN 55455
United States
(612) 626-7861 (Phone)

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