The effect of sector diversification on SA REIT Returns

Abstract

With the introduction of REIT legislature in South Africa in 2013, investors are encouraged to invest in South African REITs as they are now comparable with REITs internationally. This report assesses the effect of sector diversification on South African REIT returns and value. The findings show that there is no statistically significant difference between the return on assets of diversified REITs and specialised REITs, which is in line with Ziobrowski & Ro (2009), however the findings reveal that specialised REITs are better valued by the market than diversified REITs, mirroring the results of Capozza & Seguin (1999) who found that value is reduced by sector diversification and Lang & Stulz (1994) who found that diversified companies trade at a discount to undiversified firms and have the lowest Tobin’s Q ratios. We also find that specialised REITs have statistically significant higher gearing than diversified REITs and this does not align with the findings of Lewellen (1971) who is in support of diversification, contending that diversified companies achieve higher leverage (Lewellen, 1971). In terms of risk we find that diversified REITs’ Tobin’s Q values and return on assets are more volatile than that of specialised REITs, however when we adjust for risk through the coefficient of variation we find that the ROA for diversified REITs has greater dispersion than that of specialised REITs. Specialised REITs also outperform the market over the sample period whilst diversified REITs slightly underperform when compared to the market, although specialised REITs’ share price returns are more volatile than those of diversified REITs when not adjusted for risk. We find that specialised REITs were mostly invested in retail property over the sample period, which has contributed to the value and outperformance. We find that the worst performing REITs over the sample period were mostly invested in the office sector. This research report contributes to the body of knowledge in South Africa and will aid analysts making diversification decisions and encourage them to rather maximise value by investing in a number of specialised REITs than investing in diversified REITs