REIT Size and Earnings Growth: Is Bigger Better, or a New Challenge?

Executive Summary. 1995, 1996 and 1997 were explosive growth years for real estate investment trusts (REITs) to acquire properties and grow as large as possible, as quickly as possible. Property acquisitions were the easiest way to increase a REIT's total earnings; however the growth in earnings per share is the key to long-term stock price increases and this becomes more difficult as a REIT grows in size. Larger total size eventually causes the FFO per-share growth rate to decline, as additional acquisitions are such a small percentage of overall company earnings, and the additional shares that must be issued to acquire more properties makes per-share FFO growth more difficult. While prices seemed to be driven by size growth these last few years, in the long run, REIT prices should be driven by FFO per-share growth because the stock market's dividend discount model applies to REITs as well as all other stocks. The REIT growth race that began in 1992 has created a new mega-cap REIT group in 1998. These mega-cap REITs appear to be going through a “metamorphosis” where they will either, become an index proxy for the rental growth of their private real estate sectors or, start becoming operating companies with different characteristics and risks. This research questions whether Bigger total size is really Better as the earnings per-share growth rate slows down as the number of outstanding equity shares increases—a mega-cap REIT problem evidenced by a dramatic price decline in the first half of 1988. Only the future will tell whether the mega REITs can sustain earnings per-share growth. Some possible alternatives are to sell properties that do not have growth potential and reinvest in higher growth investments or that some of today's mega-cap REITs may be forced to break up into smaller regionally focused REITs to regain profitable growth, just like the 1980 conglomerates that are now spinning off highly focused and specialized companies to maximize shareholder value. At the other end of the size spectrum, small-cap REITs under 500 million have been just as profitable as the large-cap REITs in the past five years, because they can grow more profitably from a small base.