Depreciation-Related Capital Gains, Differential Tax Rates, and the Market Value of Real Estate Investment Trusts

31 Pages Posted: 26 Jun 2016

See all articles by Dan W. French

Dan W. French

Lamar University; University of Missouri at Columbia

S. McKay Price

Lehigh University - Perella Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: June 22, 2016

Abstract

We develop a model for valuing U.S. real estate investment trusts (REITs) that considers the tax liability impounded in REITs’ property portfolios. This liability is a function of the portfolio’s accumulated depreciation and is driven by different tax rates applied to individual components of the total gain from property sales. These two components are the capital gain resulting from the sale of property at a price higher than its cost and the gain due to the recapture of depreciation taken during the use of the property. Our measure of value is the REIT’s net asset liquidation value (NALV). The metric of REIT value currently used by analysts is a REIT’s net asset value (NAV), but a REIT’s NAV will always be greater than the NALV and therefore overestimate market value, all else equal. Finally, using observed market prices for REITs, we provide evidence that NALVs give superior estimates of REIT market prices than do NAVs.

Keywords: depreciation, valuation, real estate investment trusts, REITs

JEL Classification: G12, G14, G18, G20, M40

Suggested Citation

French, Dan W. and Price, S. McKay, Depreciation-Related Capital Gains, Differential Tax Rates, and the Market Value of Real Estate Investment Trusts (June 22, 2016). Journal of Real Estate Finance and Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2799883

Dan W. French (Contact Author)

Lamar University ( email )

PO Box 10745
Beaumont, TX 77710
United States
409-880-8603 (Phone)

University of Missouri at Columbia ( email )

Columbia, MO Columbia 65211
United States

S. McKay Price

Lehigh University - Perella Department of Finance ( email )

621 Taylor Street
Bethlehem, PA 18015
United States
610-758-4787 (Phone)

HOME PAGE: http://www.mckayprice.com

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