The Asset Price Incidence of Capital Gains Taxes:Evidence from the UPREIT Structure and the Taxpayer Relief Act of 1997

Todd Sinai and Joseph GyourkoReal Estate Department

The Wharton SchoolUniversity of Pennsylvania

This draft: October 15, 1998

Email: sinai@wharton.upenn.edugyourko@wharton.upenn.edu

This research was supported by the Research Sponsor Program of the Zell/Lurie Real EstateCenter at The Wharton School of the University of Pennsylvania. Donghoon Lee providedoutstanding research assistance. We are grateful to Bill Gentry, Barbara Murray, DougShackelford, and Joel Waldfogel for helpful comments and discussions.

Copyright: Todd Sinai and Joseph Gyourko, October 1998.

Abstract

In this paper, we examine the asset price incidence of the capital gains tax cut in the TaxpayerRelief Act of 1997. By comparing two organizational structures in the real estate industry thatdiffer only in how they should be affected by a change in capital gains tax rates, we isolate theeffect of the tax cut from industry trends and firm-level fixed effects. Our estimates indicate that,in this industry, the benefit of a capital gains tax deferral when selling appreciated propertyaccrued almost totally to the buyer of the asset, not the seller. Using share price data, we findthat real estate firms that experienced a reduction in their tax subsidy in TRA97, called“UPREITs,” had 8.6 percent less price appreciation in 1997 relative to 1996 than did thecompanies that had no tax change, known as “REITs.” Firms that appeared most likely to bepurchasers of property – and which thus received the most benefit from the tax subsidy before itwas cut – endured the largest relative decline in share prices. We also find suggestive evidencethat prices for new acquisitions rose for UPREITs relative to the REITs after TRA97. Weconclude that up to 25 percent of UPREITs’ share values is due to the remaining tax subsidy thatthey enjoy.

1

Asset price models of tax incidence predict that a change in the tax treatment of the return

on an asset should be captured to some degree in the price of that asset. While the theoretical

underpinning of these models is well-developed [e.g., Summers (1981), Poterba (1984)],

empirical research on asset price incidence is relatively rare and the results are mixed. An early

study by Cutler (1988) concludes that the market inefficiently prices tax information. Goolsbee’s

(1998) study of changes in the investment tax credit concludes that much of the investment

subsidy accrues to capital suppliers, at least in the short run. Lang and Shackelford (1998)

examine whether the decrease in the capital gains tax rate in TRA97 affected share prices since

investors would receive a higher after-tax return. They find that over one week in April and May

when a budget compromise was finally reached, share prices for companies that pay low dividends

rose more than share prices for companies that paid high dividends, the latter benefitting less from

the cut in the capital gains tax rate.

Our paper provides evidence that in at least one industry suppliers of capital bore the

incidence of the capital gains tax cut in the Taxpayer Relief Act of 1997. Good measures of

incidence are necessary to evaluate the impact of potential tax reforms and the distribution of

costs of the current tax system. By comparing two organizational structures in the real estate

industry that differ only in how they should be affected by a change in capital gains tax rates, we

are able to estimate a measure of incidence that is better identified than in previous work. The

empirical strategy employed results in an uncontaminated estimate of the asset price incidence of

the capital gains tax cuts in TRA97 at the expense of some loss of generality due to the focus on

the real estate industry.

Specifically, we examine a corporate structure unique to some publicly traded companies

2

in the real estate industry called an Umbrella Partnership Real Estate Investment Trust (UPREIT).

Building owners who sell properties to companies with this structure can defer paying capital

gains taxes if they take operating partnership units in exchange. Partnership units are convertible

one-for-one to common shares, with the seller of appreciated property able to defer paying capital

gains tax without penalty until she chooses to sell her stake in the UPREIT. Since an UPREIT

has no significant structural differences from a traditional real estate investment trust (REIT)

other than its ability to purchase property with its operating unit “currency,” the effect of the

change in the tax code is isolated from general real estate industry conditions by comparing

UPREITs to REITs. To the extent that REITs bear the incidence of the capital gains tax, they

will have to pay higher prices for properties relative to UPREITs.

The incidence question is investigated with two sources of data. We first analyze

property-transactions data to determine whether the prices paid by UPREITs for properties rose

relative to REITs after the reduction in the capital gains rate in TRA97. This provides a direct

test of whether the incidence is on UPREITs and their existing shareholders. The findings suggest

that UPREITs did pay higher prices, but the point estimates are too large to be taken at face value

and have wide confidence intervals. We suspect that deficiencies in the property-level data – the

absence of good building quality controls especially – make this a relatively weak test of the

incidence question.

When we examine the incidence question using much less noisy firm share price data we

obtain stronger results. Comparing UPREIT to REIT price changes over the period of the tax

legislation, we again find evidence that UPREITs and their current shareholders bore most of the

burden of the change in the capital gains rate. Potential self-selection of companies choosing to

3

incorporate as UPREITs is controlled for by comparing the excess return to the UPREIT form in

1997 (relative to REITs) to the excess return over the same time period in 1996. In our preferred

specification, UPREIT share price growth is found to be 8.6 percent lower than REIT share price

growth around the passage of TRA97, relative to the same time period in 1996. The

corresponding estimated tax elasticity of !0.93 (0.39) indicates that the bulk of the incidence of

the implicit subsidy to the UPREIT structure from sellers being able to defer gains taxes is borne

by the UPREIT. Further investigation reveals that share prices for relatively highly acquisitive

UPREITs respond more to the tax change than do highly acquisitive REITs, further reinforcing

our basic incidence conclusion.

Finally, this result provides insight into the contribution of the capital gains subsidy to

UPREIT market value. Assuming that the statutory capital gains tax rate on appreciated real

estate is 21 percent, we calculate the remaining benefit from being able to defer gains taxes

accounts for as much as 25 percent of UPREIT value, and possibly much more for higher growth

firms. Hence, a significant fraction of UPREIT value presently derives from its ability to capture

the benefits of allowing building sellers to defer taxes on sales to the UPREIT.

The rest of this paper proceeds as follows: Section 1 describes the REIT and UPREIT

structures for readers who are not familiar with the real estate industry. In section 2, we provide

an analytical framework that explains why UPREITs may receive a tax subsidy when they

purchase appreciated property. The circumstances surrounding the Taxpayer Relief Act of 1997,

which we use to identify our estimates, are outlined in section 3. In section 4, we examine data

on property purchases to see if there was a price response to changes in capital gains tax rates

while section 5 uses firm-level data to see if stock prices moved. Section 6 concludes.

1There are several other criteria a company must satisfy before it is allowed to be treated as a REIT,including a requirement that 50 percent or more of the REIT’s stock cannot be owned by five or fewer people, butthey are not germane to this research.

2The other type of REIT is a mortgage REIT. A mortgage REIT is a publicly traded company that makesmortgages rather than purchasing and operating properties.

4

I. Background on the REIT industry and the UPREIT structure

REITs are publicly-traded real estate companies that elect a special tax status. What

distinguishes a REIT from a typical public corporation is that REITs do not pay income or capital

gains taxes at the corporate level. In exchange, they must pay out at least 95 percent of their

taxable incomes in the form of dividends to avoid entity-level taxation.1 Equity REITs, which are

firms that own and operate properties, are the focus of this research. These firms make up over

90 percent of the market capitalization of the REIT industry.2

Even though the legislation enabling REITs to be created was passed in 1960, only in the

last decade has the industry seen much growth. Figure 1 shows that the total market

capitalization of all REITs was just over $15 billion at year-end 1992, while five years later the

figure had risen to $140 billion. Nearly all of that growth was due to equity REITs, which ended

1997 with $128 billion in market capitalization. Figure 2 documents that the total number of

REITs has also grown, but not as quickly as market capitalization. Between 1992 and 1997 the

number of equity REITs doubled from 89 to 176.

The UPREIT structure itself is a recent 1992 creation. Effectively, it consists of a

publicly-traded REIT melded with an operating partnership. Figure 3 illustrates how a simple

UPREIT structure might be set up. The operating partnership owns all the properties directly

while the publicly traded portion owns at least some of the operating partnership. The UPREIT’s

equity consists of stock, which are shares in the REIT portion, and operating partnership (OP)

3Ten companies switched from being traditional REITs to UPREITs after 1992 and are excluded from thechart. Many of those companies created what has been labeled a “downREIT,” creating an operating partnershipto purchase specific properties while the REIT continues to own the original properties. Unlike the UPREIT form,the downREIT structure does not have the explicit blessing of the IRS.

4If the seller dies before converting the units, the tax basis is stepped-up.

5

units, which are shares in the partnership. UPREIT shareholders do not own the underlying real

estate directly, but indirectly through the REIT’s ownership of the operating partnership. Other

equity investors may only own OP units directly. Typically, one OP unit is convertible into one

share of common stock and receives the same dividend payments. In order to cash out, a unit

holder simply converts her OP units to common stock and sells the shares.

The creation of the first UPREIT by the Taubman Realty Group in December 1992

ushered in a wave of such firms. Figure 4 shows how many public real estate corporations were

formed each year and whether they were traditional REITs or UPREITs. By December 1992, 40

traditional equity REITs existed. In 1993 and 1994, 66 new UPREITs held their initial public

offerings while only 14 new traditional REITs did so. The numbers of new UPREITs declined

substantially in 1995 and now are being created at roughly the same rate as traditional REITs.3

The capital gains tax benefits of the UPREIT structure are particularly noteworthy for the

purposes of this paper. Transferring buildings to a traditional REIT is a taxable event, with the

seller receiving stock and/or cash from the firm. Transferring buildings to an UPREIT is not a

taxable event as long as the seller receives operating partnership units, not cash or stock. In this

case, the IRS treats the deal as a tax-free exchange and the building seller defers her capital gains

tax liability until one of the follow two events occurs: (a) she converts her OP units into stock and

sells the shares;4 or (b) the UPREIT sells the contributed properties.

5The Taxpayer Relief Act of 1997 instituted a two-part capital gains tax on real properties. Gains due toappreciation, V0 minus the purchase price, PP, are taxed at one rate while gains due to depreciation, PP-B, aretaxed at a higher rate. We abstract from this detail in this section.

6

SREIT'V0&JC(V0&B) (1)

SUPREIT'VH&JC(VH&B)

(1%r)H%j

H

t'1

V0(1%(1&*)rREIT)t&1@*@rREIT(1&JDIV)

(1%r)t(2)

II Analyzing the value of the UPREIT structure and the role of capital gains taxes

Consider a building owner who is deciding to which type of firm to sell a property. Sale

to a traditional REIT results in the seller receiving cash or liquid stock for today’s market value of

the building, V0. A capital gains tax at rate JC must be paid on any taxable gain, today’s value

minus the basis, B.5 The total after-tax proceeds from sale to a REIT, in today’s dollars, would

be:

If the owner were to sell to an UPREIT, capital gains taxes could be deferred until the

units were converted into shares and sold, but the seller would be locked in to holding the

UPREIT’s OP units. The value of this option in today’s dollars is the discounted value of today’s

sale price minus the discounted value of the capital gains tax liability plus the discounted after-tax

return from investing in the UPREIT by holding OP units. Defining H as the seller’s expected

holding period of the OP units, rREIT as the annual pre-tax return to an UPREIT OP unit, * as the

proportion of that return paid out as dividends, JDIV as the tax rate on dividend income, and r as

the equivalent-risk after-tax opportunity return, the total after-tax proceeds from a sale to an

UPREIT would be:

The first term (in brackets) reflects that both the cash flow and the capital gains tax payment are

7

SDIFF'SUPREIT&SREIT'JC(V0&B)&JC(V0&B)

(1%r)H%

V0

(1%r)H&V0 %

(1&JC)(VH&V0)

(1%r)H%K (3)

deferred for H years. Since the original property owner is selling the units farther in the future, a

higher price, , that includes the expected capital gain in the OP units isVH'V0(1%(1&*)rREIT)H

received. The capital gains tax (at unchanged rate JC) must be paid on the entire capital gain,

VH!B, rather than V0!B, but it does not need to be paid for H years.

The second term starting with the summation sign values the discounted cash flow from

the stream of dividend payments. The REIT generates a return of rREIT every year on the current

equity value of the company, * percent of which is paid out as dividends and taxed at the rate

JDIV. The remainder of the return, (1!*)rREIT, is retained by the company and creates capital

appreciation. The stream of dividend payments increases over time, with the dividend yield

remaining constant by assumption and the equity value of the company increasing due to capital

gains. All lump sums and flows are discounted at the after-tax opportunity cost rate, r.

The benefit created by deferring the capital gains tax can be seen more clearly by

decomposing equation (2) as follows. First, denote the summation term for the present

discounted value of the dividend stream as K (since it does not vary with JC), and subtract SREIT

(equation (1)) to obtain the additional value from taking UPREIT units:

The first term in brackets now reflects the lowered tax cost achieved by deferring the capital gains

tax liability: the building seller is able to invest the tax for H years instead of paying it to the

government today. Offsetting that benefit is the second term which measures the loss in value

from not receiving the cash value of the building for H years as well. However, that value, V0, is

invested in the UPREIT and yields a discounted after-tax return that is accounted for in the last

8

two terms: the after-tax value of the capital appreciation in the UPREIT units plus the discounted

value of the after-tax dividend payments.

Although nearly all of the variables in equation (3) are easily observed or estimated, the

optimal after-tax return the building seller would receive if she did not have to take UPREIT

units, r, is unknown. We do know that the seller would never make an equivalent-risk investment

that yielded less than the UPREIT units. The most favorable scenario for UPREITs then, is when

the building seller would have invested her proceeds in UPREIT units whether or not she sold to

the UPREIT. In that case, , and equation (3) reduces to theV0'[(1&JC)(VH&V0)%V0]/(1%r)H%K

first term in brackets.

In sum, if the UPREIT receives the full benefit of the subsidy, it should pay SDIFF less for

the property than would a REIT. If it pays more than SUPREIT but still less than SREIT, it does not

bear the full incidence of the subsidy.

III. Taxpayer Relief Act of 1997

The Taxpayer Relief Act of 1997 (TRA97) lowered the top tax rate on capital gains due

to appreciation from 28 to 20 percent for assets held more than 18 months. For assets held longer

than five years, the top tax rate fell to 18 percent but that rate cannot be applied until 2003. For

capital gains due to depreciation, the tax rate only fell to 25 percent. There were no other

changes in the legislation that should have affected UPREITs differently than REITs.

Ideally, there would be some identifiable day or week where Congress surprised everyone

by creating and passing the tax rate change. In Cutler’s (1988) work, he identified two crucial

and unexpected Congressional votes that resolved a number of the changes in the Tax Reform Act

6Lang and Shackelford (1998) argue that the May 3, 1997 tentative budget agreement between the ClintonAdministration and Congressional Republicans constituted the bulk of the news about the capital gains provisionsin TRA97.

9

of 1986. By looking at stock excess returns around those days, Cutler tried to identify the asset

price effect of TRA86. One of his identifying assumptions was that since the time period under

study was so short, few alternative hypotheses could explain any pattern of excess returns.

Unfortunately, the capital gains tax provisions of TRA97 were the subject of speculation

and debate for several months before the final passage of the legislation.6 Table 1 lists the series

of events leading up to the enactment of the bill. Even in early February, newspapers were

reporting that there was a possibility of a capital gains tax cut. However, throughout February,

March, and into April, speculation remained as the Clinton Administration and Congressional

Republicans locked horns over whether Clinton would agree to cuts in the top capital gains rate

to 20 percent or lower. In mid- to late-April, the negotiations moved towards reducing the capital

gains tax rate. On April 30, the Congressional Budget Office reduced its estimate of the

forthcoming budget deficit, reportedly the last event that enabled the Administration to reach a

compromise with the Republicans. On May 3, a capital gains tax cut was announced, although

the size of the cuts was still to be negotiated. On May 7, it was announced that whatever capital

gains tax cuts were agreed to would take effect on that day.

Until early- to mid-June, Congress debated how much to cut various taxes. On June 14,

the House Ways and Means committee endorsed a plan to cut the top capital gains tax rate to 20

percent and, except for a Clinton “last stand” at the end of June, the next six weeks were spent

nailing down the details of the bill that was finally passed on August 1.

7As far as we can determine, the failure to report is random. We also eliminate 95 transactions inproperty sectors other than retail, office, or residential. The results do not change when we include them but itmakes for a clearer exposition to limit the number of property types.

10

IV. Investigating the Incidence Question with Property Transactions Data

If UPREITs bore some incidence of the tax subsidy, the capital gains tax rate reduction

should have increased the expected prices UPREITs would have to pay for future acquisitions

relative to REITs. Data on property acquisitions by REITs since the beginning of 1997 are

examined to see whether this in fact occurred.

Unfortunately, the available property transactions data are not ideal for our purposes. We

observe only the prices reported by the companies that purchased the properties, not how much of

the purchase was in cash or OP units. The only building quality controls are size (square footage)

and age (year built), and they are not always reported. Table 2 outlines how the sample was

constructed. Equity REITs purchased 4,442 properties between January 1, 1997 and May 31,

1998–the beginning and end of our sample period. Of that total, 2,430 observations in the SNL

data were missing one of our three primary characteristics: acquisition price, square footage, or

date built.7 Table 3 reports the means and standard deviations of the transactions-level data. On

observable characteristics, REITs and UPREITs tend to purchase similar-looking properties, with

UPREITs buying a higher proportion of residential buildings and traditional REITs more likely to

invest in retail. UPREITs also purchase much more property than traditional REITS: nearly 90

percent of the acquisitions in our sample were made by REITs.

The specification estimated regresses building i’s transaction price at time t (Pit) on an

intercept term, an indicator variable denoting UPREIT status, time dummies corresponding to

periods before and after TRA97, interactions of UPREIT status with the period dummies, and a

8Due to the lack of good data, we use the following: square feet, square feet2, age, age2, indicatorvariables for two of the three property sectors, the interaction of the property type dummies with square feet, theinteraction of the property type dummies with age, the interaction of the property type dummies with period 2, andthe interaction of the property type dummies with period 3. The results are not sensitive to the inclusion of thesecovariates. Including indicator variables for company, state, or metropolitan area, or state or metropolitan areainteracted with period has virtually no effect on the results.

11

ln(Pit)'(%*1@UPREITi%(2@PERIOD2t%(3@PERIOD3t%

(4@UPREIT×PERIOD2it%(5@UPREIT×PERIOD3it%(6Zit%µ it(4)

series of covariates, Z.8 Below, we use January 1, 1997-May 7, 1997 -- before the capital gains

cut was decided -- as our baseline, denote May 7, 1997-December 31, 1997 as Period 2, and call

January 1, 1998-May 31, 1998 Period 3. May 31, 1998 is the end of the sample period. The

precise specification is given by equation (4), with Table 4 reporting the results.

In this specification, (4 provides an estimate of the difference between percent change in prices

paid by UPREITs between periods 1 and 2 and the percent change in prices paid by REITs over

the same time period. The estimated coefficient, (5, measures the relative difference between

periods 1 and 3.

The first column of Table 4 reports results using weighted OLS and acquisition price as

the left-hand-side variable. The estimates of (4 and (5 are of most interest and are in bold-face.

They indicate that prices paid by UPREITs rose 41 percentage points more than for REITs in the

latter half of 1997. In the first half of 1998, UPREITs were paying 32 percentage points more

than they were before TRA97, relative to REIT prices. While these results indicate that UPREIT

shareholders themselves bore the incidence of the capital gains cut, the point estimates themselves

strike us as too large to be believed. If taken literally, they imply that the incidence on UPREITs

9We do not mean to imply that it is not possible for the true incidence to be greater than one. Forexample, if the capital gains change were to reduce building sellers’ desire to hold UPREITs’ OP units (beyond thedecrease in value), the incidence could be greater than one. However, other factors probably are at work to reducethe measured price response–and, hence, the implied incidence. We only observe transactions that occurred beforeJune of 1998. Long lead times on deals may have locked in pre-TRA97 pricing on transactions that appear to havebeen consummated after the legislation was finalized. In addition, if UPREITs do not purchase properties onwhich the price has risen too much, the estimated coefficient again would be lower.

12

was three to four times the tax subsidy.9 The large standard errors suggest that poor data quality

and our inability to control completely for property level characteristics are a problem.

Repeating the estimation using median regression instead of OLS yields the results

reported in column two. The point estimates imply an incidence on UPREITs of between 50 and

80 percent, but the standard errors are so large that the coefficients are indistinguishable from

zero or one. These results are statistically different from the point estimates in specification one,

suggesting that outliers may be responsible for the large OLS estimates. The basic results are

unchanged if we use price per square foot as the dependent variable (column three) or if we

elaborately control for all of the property-level characteristics through a system of interacted

dummy variables (in results not reported here.) If we compare before and after the passage of

TRA97, the estimated incidence falls to 200 percent on the UPREITs (column four) , but the

standard error is so large that the result again is not distinguishable from zero or one.

In sum, we interpret Table 4 as being consistent with at least some, and possibly all, of the

incidence being borne by UPREITs. Unfortunately, the underlying data are not good enough to

provide truly convincing evidence on this matter. Hence, we proceed to a detailed analysis of

relative share price movements that are implied by UPREITs having to pay more for properties

following the reduction in the capital gains rate.

V. Investigating the Incidence Question with Firm Data

10Forty-six companies were created during or after our 1996-1997 sample period and had to be discarded. Two other firms were discarded because no stock price information could be obtained for them. Of the remaining154 companies, 12 were mortgage or hybrid REITs. Since those types of REITs perform quite differently thanequity REITs, they are not an appropriate comparison for UPREITs and were dropped from the sample. Finally,eleven REITs adopted either an UPREIT structure or a close substitute, the downREIT structure, during our sampleperiod. Because our estimation strategy requires that the UPREIT form be exogenous during the period of analysis,we dropped those firms that switched structure in 1996 or 1997. Removing the switchers may create a bias in thatREITs may endogenously decide not to switch to the UPREIT form. The most plausible scenario would be thathigh growth REITs switch to UPREIT status. Since we delete the switchers, the remaining pool of REITs would belaggards and would have lower and lower growth over time. This bias would work against us finding anycapitalization.

11Dividend flows are so stable that using total return on the left-hand-side, which we compute as, where t and s correspond to specific months, makes no difference in%RET'(Pt&Ps%(annualdividend)@(t&s)/12)/Ps

the results.

13

a. Sample and Variable Construction

To investigate whether the capital gains changes in TRA97 were capitalized into firm

prices, we begin with a list of all 202 existing REITs as of the first quarter of 1998 that was

obtained from SNL Datasource, a computerized database that reports a wide variety of

information culled from SEC filings of publicly-traded real estate companies. Table 5 shows how

this sample ultimately is reduced to 129 companies.10 We also obtained a variety of corporate

characteristics from SNL such as whether the company used the UPREIT form, dividends

declared each year, property focus, the date of the initial public offering, several measures of

company size, and measures of institutional and insider ownership.

This firm information is then matched to daily stock price data for 1996 and 1997 from the

Center for Research in Securities Prices (CRSP) database. The price variable used is the average

of the closing bid-ask prices, with the daily price averaged over a month before constructing the

percent growth in share price. Thus the left-hand-side variable in the specifications reported

below is where 0 and 1 refer to calendar months.11 Taking the monthly average%)P'lnP1&lnP0

captures large, fundamental movements in share prices while minimizing sensitivity to the start

12Unweighted regressions yield slightly higher elasticities.

14

date by reducing contamination from daily price fluctuations. Regressions are weighted by market

capitalization at the beginning of the sample period, January 2, 1996, computed by multiplying the

shares outstanding by the share price as reported by CRSP.12

b. Empirical Approach and Basic Specification

Due to the long gestation period of TRA97, share prices before the legislation was

discussed are compared to prices after the bill was passed. This ensures that we measure the

change in price between a period when the tax cut was completely unexpected and when it was

known with certainty. Even if one could identify an event that was a “surprise,” it is impossible to

know how much information was actually revealed during that period. Although comparing

returns over a multiple-month time frame increases the possibility of spurious correlation with

some other event, we are confident that comparing UPREITs to REITs will control for any

factors that affect the REIT industry.

More specifically, excess UPREIT share price growth (defined as above REIT share price

growth) around the time of the tax change is compared to the excess UPREIT share price growth

in the previous year. Assuming that UPREIT price growth relative to REIT price growth would

otherwise be constant, any relative decline in UPREIT price growth around the time of the tax

change must be due to the change in the value of the capital gains tax subsidy.

Figure 5 plots the weighted average share price for REITs and UPREITs in 1996 and

1997. Comparing the first seven months of each year (i.e., the period around the passage of

TRA97), UPREITs grew faster than REITs in 1996 but failed to do so beginning around February

1997. In addition, UPREIT share prices appear to change relative to REIT prices at certain key

15

%)P'(%)PUPREIT,97&%)PUPREIT,96)&(%)PREIT,97&%)PREIT,96) (5)

%)Pt1&t0,it'"%$1@UPREITi%$2@Y1997t%$3@UPREIT×Y1997it%$4Xit%,it (6)

points in 1997: the end of April, when a tentative budget agreement was reached; the end of June

when Clinton held out for a higher top marginal capital gains tax rate; and the end of July when

the bill finally was passed. It is impossible to tell from the chart, however, whether or not those

changes are due to noise or whether other factors might be affecting the share prices. It is also

difficult to measure elasticities from a chart. Thus, we proceed with a more formal analysis.

The effect of a capital gains tax change on UPREIT share prices can be written as follows:

where %)P is the average percent change in price for each company over the time period

examined, UPREIT and REIT indicate the organizational form, and 96 and 97 refer to the year.

This specification compares the percent difference between the mean percent growth in UPREIT

prices and the mean percent growth in REIT prices in 1997 to 1996.

To estimate equation (5), we rewrite it in deviations form and run the following

regression:

where the left-hand-side variable is the percent growth in the average share price of company i

from period t0 to period t1 in year t. UPREIT is an indicator variable for whether the company is

an UPREIT and Y1997 takes a value of one if the year is 1997. X is a vector of covariates that

may affect the relative growth rate of UPREITs and REITs over time.

With this specification, fixed effects that affect the level of a company’s share price are

controlled for by looking at company-specific share price growth. If the real estate sector

performed differently in 1997 than in 1996, the Y1997 indicator variable controls for that effect.

If UPREITs grow faster than REITs on average, the UPREIT indicator variable nets that effect

16

out. Thus, the estimated coefficient, $1, will measure the additional return to the UPREIT

structure relative to REITs in 1996, $2 corresponds to the average additional return to REITs in

1997 relative to 1996, and $3 is an estimate of the percent change in UPREIT share price growth

relative to REITs between 1996 and 1997 described in equation (5). If the lower capital gains tax

rate led to a decline in UPREIT share prices, the estimated $3 should be negative.

The identification strategy employed here is well-known in the labor and public economics

literatures (for examples, see Gruber (1994), Gruber and Poterba (1994), and Eissa (1995)). We

think our application is especially appropriate because, unlike some other studies, we do not have

to artificially divide a continuous distribution into discrete groups. Instead, we naturally have

three binary categories: a company is either a REIT or an UPREIT, the year is either 1996 or

1997, and the time period within a year is either before or after the tax change. Further, we avoid

a problem endemic to the “event study” literature -- having to estimate a market model to

calculate excess returns -- by comparing UPREIT returns to those of REITs.

c. Summary Statistics and Results

Table 6 presents summary statistics on key variables used in the analysis. Table 7 then

reports the results from estimating equation (6) over a number of different time periods. The

dependent variable is the percent change between the average share price in the first month and

the average share price in the second month listed in each column.

In the first column, January is used as the start date because that was before any

speculation of possible capital gains tax cuts. September is employed as the end month since the

final legislation was passed on August 1 and we wanted to estimated a model that allowed

sufficient time for the market to incorporate the information about the tax change into its

13The statutory after-tax cost of purchasing a building rose 9.7 percent. In equation (3), this istantamount to assuming that building sellers prefer real estate shares to alternative investments, have an infiniteholding period or plan to die before selling the stock, and the building is fully depreciated. Since optimizinginvestors following a capital gains tax-minimization strategy should defer realizing their stock with the mostcapital gains tax liability as long as possible, we believe that UPREIT OP unitholders should be holding theirshares until death. We also suspect that many of the buildings sold to UPREITs were largely depreciated. However, to the degree that these assumptions are incorrect, the increase in the effective after-tax cost will be lessthan for the statutory cost.

17

valuations. The small estimated value of 0.009 for the coefficient on the 1997 year dummy in

equation (6), $2, indicates that the traditional REITs did not experience any higher growth over

January to September 1997 than they did during the same period in 1996. UPREITs, on the other

hand, had their share prices increase by 7.4 percent relative to REITs between January and

September 1996, as indicated by the 0.074 estimate of $1 reported in the second row. Around

the passage of TRA97, however, UPREIT share prices relative to REITs fell by 8.6 percent

relative to 1996, as indicated by the estimated for $3 reported in row three. Thus, UPREIT share

prices declined by 1.2 percent relative to REITs overall (8.6!7.4=1.2).

The tax elasticity of share prices can be computed assuming a given change in the capital

gains rate. Standardizing on a dollar’s worth of value, the after-tax cost of a purchase for a

traditional REIT is always $1 since it does not get any capital gains subsidy. If people thought

that the average top capital gains tax rate was going to decline to 21 percent from 28 percent due

to TRA97, the after-tax price of the same purchase for an UPREIT prior to May 7, 1997, can be

written as 1!0.28=0.72. After May 7, the after-tax price increased to 1!0.21=0.79. Under these

assumptions, the after-tax cost of purchasing a dollar’s worth of building increases by 9.7 percent

(0.07/0.72).13 To compute the tax elasticity reported in Table 7, we replace the UPREITx1997

interaction by log(after-tax price) and instrument with UPREITx1997.

The estimated tax elasticity of !0.93 in the first specification implies that nearly all of the

14As one check, our baseline specification was re-estimated around short periods of time when wesuspected new information may have been revealed. These results were mixed; during three of the five periods thatwe identified as being times when “news” was released relative share prices moved in the predicted direction. Inno case was any result statistically significant at conventional levels. We did not expect large or statisticallysignificant results since the tax bill was gradually developed over several months. However, short horizon relativeshare price movements in response to news consistent with our expectations provides additional evidence that ourresults are not due to spurious movements in UPREIT relative to traditional REIT share prices. However, it is farfrom clear that there was any real news released during these specific periods; the information could have leakedearlier or there may not have been any informational content at all.

18

statutory change in the capital gains tax subsidy to the UPREIT structure was capitalized into

UPREIT share prices. However, the standard error of 0.39 is large enough to make it impossible

to reach precise conclusions regarding incidence. Still, we can comfortably reject the null

hypothesis that the incidence on UPREITs is zero.

The remainder of Table 7 examines different time periods to determine the robustness of

the regression to the starting and ending dates. Comparing January to October makes virtually no

difference in the estimated elasticity (column two). Ending the sample period in August yields a

smaller estimated elasticity. Although the difference is not statistically significant, this result

suggests that the market took some time to incorporate the effect of the tax rate change into

market valuations. Moving the start date later, to February or March, reduces the estimated

elasticity, a change consistent with the perceived probability of a tax change increasing during that

period.14

Table 8 incorporates additional explanatory variables that might be varying over time in a

way that would affect UPREIT share prices relative to traditional REITs. This table suggests that

the results regarding relative UPREIT share price growth in 1997 versus 1996 are quite robust to

including a variety of covariates. For example, UPREITs may have changed their dividend payout

ratios over time in a way that traditional REITs did not. Since share prices reflect dividend

15Using a measure of total return on the left-hand-side that incorporates dividend payments does not haveany effect of the estimated elasticities.

16This result also could be due to the fact that institutions are more likely to invest when companies getlarger, not the other way around.

17We also estimated a specification that included the gross value of the company’s properties at the end of1995 as a proxy for company size. Companies with more than $2 billion in properties had higher than averageshare price growth rates, with smaller companies below average. However, because initial property value does notvary with year, it had no effect on the UPREITx1997 interaction term.

19

payments, that could induce a differential change between UPREIT and REIT share prices. In

column one, companies with higher dividend yields command higher share prices as expected.

However, including it has little effect on the relative growth of UPREIT share prices – the

estimated coefficient on the interaction term increases slightly in magnitude to !0.094 (0.036).

Since REITs have such little control over how much they pay out in the form of dividends, this

result should not be surprising. High return companies have to pay out more dividends since their

taxable incomes are higher on average and they also have higher share price growth.15

Column two includes the debt/asset ratio and return on assets, variables typically used as

controls in this type of analysis. Their coefficients are very small and imprecisely estimated, and

their inclusion has very little impact on the UPREITx1997 coefficient. Column three reports

results for a specification controlling for the fraction of shares owned by insiders and institutions,

as well as the vintage of the company (measured by the years since the firm’s IPO). The percent

of the company owned by insiders does not appear to affect share price growth at all. The

percent of the company owned by institutions seems to have a small effect but it is not statistically

different from zero.16 Older companies have lower share price growth, but the rate of decline

slows with age. However, including these covariates had little effect on the estimated coefficient

on the interaction term.17

18The OTHER property type is the omitted category.

20

Next, we further test the robustness of the specification by controlling for property type.

Table 9 shows that while the UPREIT structure exists in all property types, it is more heavily

concentrated in the hotel, office building, and multifamily sectors. If these property sectors were

at different stages of the real estate cycle, the different composition of UPREITs could generate a

different return over time versus traditional REITs. In the first column of Table 10, a baseline

specification is estimated that includes indicator variables for a number of property types -- health

care, hotel, industrial/warehouse, office, residential, retail, and self-storage.18 The point estimates

indicate that health care and office were relatively slowly appreciating sectors during the first

halves of 1996 and 1997.

In column two, the return to each property focus is allowed to vary by year. Given the

small number of firms in many property sectors, this specification asks a lot of the data as

identification comes from the share price appreciation of UPREITs relative to REITs in 1997

relative to 1996 within property types. That is, health care UPREITs are compared to health care

REITs, office UPREITs to office REITs, and so forth. The point estimate on the UPREITx1997

interaction term declines substantially, to !0.027 (0.039) and is not statistically different from

zero. It also is not statistically different from the point estimate in the previous column. Since

health care, office, and residential companies appear to have the greatest fluctuations in their

relative growth rates between 1996 and 1997, we re-estimate the regression lumping all sectors

but those three into the omitted category. The point estimate on the UPREITx1997 interaction

term increases only slightly as reported in the third column.

It is possible that the high estimated tax elasticity in the absence of property focus controls

19A number of real estate companies may have chosen the UPREIT form to obtain a one-time capital gainsdeferral for a large property owner who wanted to securitize his portfolio. A change in the capital gains tax ratewould not affect the share price for these companies if they were not planning on purchasing additional properties.

21

%)V'E[R]

V@%)E[R]% E[A]

V@%)E[A] (7)

may be reflecting different market factors. It is also possible that performance in these sectors

may be affected by the composition of UPREITs and REITs and the effect of the capital gains tax

change in TRA97. We think a more likely explanation is that including property sector dummy

interactions simply reduces the amount of variation to the point where it is impossible to discern

an effect of the tax code on share prices. That is, there just is not enough within-property type

variance to allow a reasonably powerful test of the incidence question.

The specifications so far treat all UPREITs as if they are equally acquisitive. However,

for an UPREIT’s share price to be adversely affected by the reduction in tax subsidy in TRA97

the firm had to at least be planning on purchasing new properties.19 Equation (7) below shows

that, all else equal, UPREITs that derived more of their market value from planned property

acquisitions should have been more adversely affected by the capital gains cut. Writing the

expected present value of the rental stream on currently owned properties as E[R] and the

expected rents from future acquisitions as E[A], the stylized market value of a firm is

V=E[R]+E[A]. Percent changes in V can be decomposed into the weighted average percent

changes in expected revenue from current or future properties:

To the degree that the incidence of the subsidy accrues to UPREITs, when the capital gains tax

rate changes E[A] will change proportionally. A change in capital gains rates should not affect

the expected rent stream on current properties. Thus, the effect on V should be an increasing

22

function of the weighting of future acquisitions in the market value of the company, E[A]/V.

This proposition is tested in Table 11. The sample of UPREITs is divided based upon

how “acquisitive” they were in 1995. Since one cannot measure expected acquisitions directly,

we replace E[A]/V with 1!E[R]/V. We proxy for expected rent with 1995 total rental revenue.

The denominator V is 1995 firm value (debt plus equity). Since a company with high E[R]/V

must have low E[A]/V, companies with below-median rent-to-value ratios are deemed the most

acquisitive.

In the first column of Table 11, the share price appreciation of acquisitive UPREITs is

allowed to vary relative to less-acquisitive UPREITs in 1997, but share prices are constrained to

move together in 1996. This specification captures the potentially different effect of the capital

gains tax change on the two classes of UPREITs. The least acquisitive “income” UPREITs

declined in value relative to traditional REITs between 1996 and 1997, but the 3.7 percent change

is small and not significantly different from zero. The share prices of the most acquisitive

“growth” UPREITs fell 11 percent (3.4 percent standard error) more than the other UPREITs,

relative to traditional REITs. All the share price response is coming through the channel we

would expect: UPREITs that appear likely to be highly valued for their expected future purchases.

In column two, we free up the specification to allow for the possibility that acquisitive UPREITs

always have a lower rate of price appreciation than less-acquisitive UPREITs. The results show

that although share prices for growth UPREITs rose slightly less than for income UPREITs in

1996 (!0.014), they declined substantially more relative to income UPREITs in 1997 than they

did in 1996 (!0.099).

One possible explanation for these results could be that prices for properties rose more in

20In addition, it appears from the rent-to-value distribution that the market expected that REITs areequally likely as UPREITs to be building purchasers ex ante. Even if REITs do purchase considerably less propertyex post, the market still expected them to be acquiring.

21A simple illustrative two-period example shows that leverage can cause share prices to fall by a greaterpercentage than the cost of a project increases. Assume that a firm uses the REIT industry average leverage, 35

23

1997 than in 1996 for some reason other than capital gains tax changes. If so, and if traditional

REITs do not purchase many properties, only share prices for acquisitive UPREITs would

decline. However, the results reported in column three cast doubt on this explanation. This

specification compares the change in share prices in 1997 for acquisitive UPREITs relative to

acquisitive REITs, all relative to less-acquisitive UPREITs and REITs and relative to 1996. Any

change in property prices should affect acquisitive UPREITs and REITs equally while a change in

capital gains taxes would reduce the share price of acquisitive UPREITs relative to acquisitive

REITs. The capital gains explanation seems to be primary, as acquisitive UPREITs saw their

share prices decline by a relative 14.6 percentage points (7.3 percent standard error).20

We consider this evidence in column (3) to be the most convincing that UPREITs bore

most of the incidence of the capital gains tax subsidy since this specification controls for every

alternative explanation of the results that we can come up with. The point estimate of the

incidence, however, is quite large – 154 percent of the benefit of the tax subsidy accrues to the

acquisitive UPREITs when we assume a 9.7 percent rise in the statutory after-tax cost of

purchasing a building. Even though the standard errors are large enough that we cannot

statistically distinguish this incidence from the 93 percent we measured earlier, a large share price

elasticity should not be surprising. Several factors can increase the measured incidence. For one,

levered firms should be more sensitive to changes in asset prices than we have assumed by using

the statutory tax change as our benchmark.21 Also, if the tax rate were to fall, building sellers

percent, and that debt costs 7 percent. The equity return on a $10 million building than generates $1 million inrevenue in the second period is 11.6 percent. ((1!3.5*0.07)/6.5) If the price of the building were instead $11million but the second period revenue remained at $1 million, the equity return would decline to 10.2 percent. ((1!3.85*0.07)/7.15) That is a 12.1 percent decline in E[A] when the price of the building rose only 10 percent.

24

would be likely to take a smaller proportion of units, diminishing the aggregate benefit of the

UPREIT structure. The change in the statutory tax rate does not capture that effect, thus

underestimating the potential change in UPREIT value with respect to changes in the capital gains

tax rate. Finally, a reduction in the tax subsidy may have a second effect on asset values: not only

will the price of new acquisitions rise for UPREITs, but the companies may reduce the amount of

property buying they undertake in responsed to the higher price. If returns on new acquisitions

are higher than on currently owner properties, firm value can fall even more than the tax change

would suggest when the UPREIT’s focus changes.

VI. Conclusion

By comparing the performance of two nearly-identical organizational forms of publicly-

traded real estate companies, we are able to estimate the effect of the capital gains tax rate

reduction in TRA97 on the share prices of UPREITs while holding all other industry-level and

time-varying changes constant. The result gives insight into the classic question of the asset price

incidence of taxes while minimizing the identification problems of previous work.

In our preferred specification, we find that the capital gains tax rate changes in TRA97 led

to a 8.6 percent decline in the share price of UPREITs relative to REITs, relative to the same time

period in 1996. Assuming that REIT investors thought that the tax rate was going to fall to 21

percent, the estimated tax elasticity of the UPREIT share price is 0.93, indicating that the bulk of

the incidence of the tax subsidy is borne by the buyer of properties, the UPREIT.

22This calculation presumes the estimated elasticity is constant across tax rates. Moreover,the true incidence could change over time with supply and demand conditions.

25

By comparing acquisitive real estate companies to less-acquisitive ones, we are able to

provide additional evidence that our results are not driven by spurious movements in property

prices. Also, these results are robust to changes in the sample time frame and to the inclusion of

alternative explanatory variables. And although our attempt to measure the effect of the capital

gains tax cut on the relative prices paid by UPREITs when acquiring property was disappointing

due to the large standard errors, we take the positive point estimates as evidence consistent with

high incidence on the property buyers.

Applying this estimated elasticity to an assumed 21 percent capital gains tax rate on

appreciated property, the remaining capital gains subsidy to UPREITs accounts for 25 percent of

their equity value [0.21/(1!0.21)*0.93], and possibly more for “growth” UPREITs. Of course,

this calculation assumes that the estimated elasticity is constant across all tax rates. Also, it is

quite likely that the true incidence of the subsidy will vary over time as supply and demand factors

in the real estate markets change.22

A natural extension to this work is similar to a question posed in Goolsbee (1998). If the

after-tax cost of purchasing properties rose for UPREITs relative to REITs, did UPREITs

decrease the amount of their acquisitions relative to REITs? Using our data set of property

acquisitions, we are pursuing the answer to this question.

26

References:

Cutler, David. “Tax Reform and the Stock Market: An Asset Price Approach,” AmericanEconomic Review, v.78 no.5 (December 1988), pp.1107-1117.

Eissa, Nada. “Taxation and Labor Supply of Married Women: The Tax Reform Act of 1986 as aNatural Experiment,” NBER Working Paper #5023, (February 1995).

Goolsbee, Austan. “Investment Tax Incentives, Prices, and the Supply of Capital Goods,”Quarterly Journal of Economics, v.113 no.1 (February 1998), pp.121-148.

Gruber, Jonathan. “The Incidence of Mandated Maternity Benefits,” American EconomicReview, v.84 no.3 (June 1994), pp. 622-641.

Gruber, Jonathan and James Poterba. “Tax Incentives and the Decision to Purchase HealthInsurance: Evidence from the Self-Employed,” Quarterly Journal of Economics, v.109(August 1994), pp. 701-733.

Lang, Mark and Douglas Shackelford. “Capitalization of Capital Gains Taxes: Evidence fromStock Price Reactions to the 1997 Rate Reduction,” Mimeo, University of NorthCarolina, (July 1998).

27

Table 1: Taxpayer Relief Act of 1997 Timeline of Major Headlines

First week ofFebruary, 1997

Clinton says he might be willing to cut capital gains taxes to reach a budgetcompromise, but the Administration’s preference is for a capital gains taxincrease. Republicans want to lower rate to below 20 percent.

February 13 Senator Trent Lott says that Democrats’ opposition to capital gains taxcuts may be breaking down.

February 23 The New York Times reports that Democrats have reduced theiropposition to capital gains tax cuts.

March 2 Clinton Administration and Congress are still locking horns over potentialcuts.

Mid-April Republican budget negotiators keep heat on Administration to agree toreduce capital gains taxes

April 30 CBO reduces estimated size of budget deficit

May 3 Agreement reached to reduce capital gains tax rates, the size of the cuts isto be determined

May 7 Announcement that capital gains tax cuts would be effective May 7

Rest of May Republicans deciding whether to cut capital gains taxes or income taxes

June 10 Archer proposes reducing capital gains tax to 20 percent

June 14 House Ways and Means Committee approves Archer plan

June 18 Senate proposes capital gains tax cut to 20 percent

June 27 House passes capital gains tax cut

June 30 Clinton wants 27.72 maximum capital gains tax rate

July 23 House and Senate Republicans reach agreement on bill

July 29 Clinton Administration and Republicans reach consensus

August 1 House and Senate approve TRA97

Based on articles from the New York Times and the Wall Street Journal.

28

Table 2: Sample Construction for Property Transaction Regressions

NumberDeleted Total

Number of property acquisitions in the SNL Datasource 19,586

!Acquisitions by REITs that did not exist for the entiresample period:

3,794 15,792

!Acquisitions by hybrid REITs: 288 15,504

!Acquisitions by companies that switched from REITto UPREIT status during the sample period:

142 15,362

!Acquisitions before January 1, 1997: 10,920 4,442

!Observations with missing acquisition price, squarefeet, or date built:1 2,430 2,012

!Acquisitions not in the retail, office, or residentialsectors:

95 1,917

Total: 17,669 1,917

1For portfolio purchases where the property prices are not separately recorded, the acquisitionprice is imputed to each property on the basis of square footage.

29

Table 3: Sample Means for REIT Property Transaction Regressions

Traditional REITs UPREITs

Acquisition Price (000)12,204

[11,885]14,464

[45,034]

Age12.39

[10.83]13.59[8.61]

Square Feet (000)187.14

[181.41]167.92

[174.36]

Property Type:

Office/Industrial 53.2% 52.9%

Residential 19.7% 37.1%

Retail 27.1% 10.0%

Date of Acquisition

Period 1 21.1% 18.1%

Period 2 59.2% 67.2%

Period 3 19.7% 14.8%

Number of Companies 24 55

Number of Observations 218 1,699

Notes: Standard deviations are in square brackets. Observations are for January 1, 1997 throughMay 31, 1998.

30

Table 4: Baseline regression results for REIT transaction regressions

LHS: log(acquisition price)

LHS:log(price/sq.

feet)Before/After

August 1

OLS LAD OLS OLS

UPREIT dummy-0.056(0.119)

0.079(0.061)

0.022(0.096)

0.135(0.117))

Period 2 dummy-0.182(0.170)

0.140(0.078)

-0.211(0.115)

-0.101(0.167)

Period 3 dummy-0.027(0.161)

0.137(0.092)

0.069(0.134)

UPREIT*Period 20.412

(0.168)0.077

(0.072)0.430

(0.108)0.203

(0.172)

UPREIT*Period 30.315

(0.158)0.047

(0.088)0.224

(0.129)

Adj. R2 0.6962 0.1352 0.6882

Notes: White standard errors in parentheses. LAD regressions are median regressions withanalytic standard errors. Observations are weighted by the square footage of the acquiredproperty. Period 2 corresponds to May 7-December 31, 1997 and period 3 is after January 1,1998, except in the last panel, where period 2 is after August 1, 1997. The omitted period in thefirst two panels is January 1 through May 7, 1997 and is January 1 through August 1, 1997 in thelast panel. All specifications include the following variables that are not reported: square feet,square feet2, age, age2, an indicator variable for retail properties, the interaction of retail*period 2,the interaction of retail*period 3, the interaction of retail*square feet, the interaction of retail*age,an indicator variable for office properties, the interaction of office*period2, the interaction ofoffice*period3, the interaction of office*square feet, the interaction of office*age, and a constant. The omitted category is residential. Weighted regressions are weighted by square feet. There are1917 observations over the January 1997 through May 1998 period.

31

Table 5: Sample Construction for Share Price Regressions

NumberDeleted

Total

Number of REITs as of the first quarter of 1998, accordingto SNL DataSource:

202

!REITs that were formed after January 2, 1996: !46 156

!REITs with no CRSP matches: !2 154

!Remaining REITs that are not equity REITs: !12 142

!REITs that adopted UPREIT structure during sample1 !11 131

Total: !!71 131

1Eleven companies were dropped from the sample because they adopted an UPREIT orDownREIT structure between January 2, 1996 and December 31, 1997. Those companies are:American Industrial Properties REIT, Asset Investors Corporation, Boddie-Noell Properties, Inc,Brandywine Realty Trust, Burnham Pacific Properties, Inc, Franklin Select Property Trust,Ramco-Gershenson Properties Trust, Realty ReFund Trust, and Vornado Realty Trust.

32

Table 6: Sample Means for Share Price Regressions

Traditional REITs UPREITs

Share Price25.49[9.73]

26.39[8.99]

Annual Dividends Declared1.59

[1.26]1.70

[1.13]

Years since IPO18.59

[13.11]6.10

[5.66]

% Insider Ownership8.89

[8.35]12.41

[10.32]

% Institutional Ownership35.08

[16.25]58.28

[18.05]

Shares Outstanding (000)38,354

[22,844]33,537

[25,860]

Gross Property Value (000)(Q4 1995)

735,031[412,857]

818,630[571,479]

Weight (Market Cap. on Jan 2, 1996 / 100,000)

3,616[3,708]

3,284[2,798]

Number of Companies 53 76

Number of Observations 26,871 38,623

Notes: Standard deviations are in square brackets. Observations are for all trading days in 1996and 1997 for 129 publicly-traded real estate companies. All rows except for the last threeare weighted by the reported weight variable.

33

Table 7: OLS baseline regression results for share price regressions

January -September January - October January - August

February -September March - September

1997 dummy0.009

(0.027)0.017

(0.027)-0.0004(0.025)

0.018(0.027)

0.002(0.023)

UPREIT dummy0.074

(0.026)0.086

(0.025)0.057

(0.024)0.058

(0.025)0.037

(0.022)

UPREIT x 1997-0.086(0.036)

-0.083(0.036)

-0.064(0.034)

-0.073(0.036)

-0.066(0.031)

Constant0.004

(0.019)0.011

(0.019)-0.005(0.018)

0.003(0.019)

0.021(0.016)

Adj. R2 0.038 0.043 0.029 0.016 0.027

Estimated taxelasticity1

-0.93(0.39)

-0.89(0.39)

-0.69(0.36)

-0.79(0.39)

-0.71(0.33)

Notes: The left-hand-side variable is log(average share price in the later month)!log(average share price in the earlier month). Standarderrors are in parentheses. The number of observations is 258, representing 129 companies over two years. Regressions are weightedby each firm’s market capitalization on January 2, 1996.1The estimated tax elasticity is calculated by setting the after-tax cost of purchasing a building to 1 for all REITs, to (1!0.28)=0.72 forUPREITs before August 1997, and to (1!0.21)=0.79 to UPREITs after July 1997. An IV regression is estimated where log(after-taxcost) is included as a right-hand-side variable in the place of UPREITx1997 and is instrumented by UPREITx1997.

34

Table 8: Alternate specifications

(1) (2) (3)

1997 dummy0.015

(0.027)0.022

(0.028)0.009

(0.027)

UPREIT dummy0.073

(0.025)0.069

(0.029)0.036

(0.031)

UPREIT x 1997-0.094(0.036)

-0.094(0.037)

-0.082(0.036)

Constant-0.089(0.030)

0.027(0.047)

0.149(0.055)

Dividend yield1.251

(0.319)

Lagged debt/asset ratio-0.000(0.060)

Lagged ROA-0.006(0.004)

% insider0.0004

(0.002)

% insider20.014

(0.046)

% institutions-0.003(0.002)

% institution2 0.033(0.022)

Years since IPO-0.016(0.005)

Years since IPO2 0.0004(0.0001)

Property size

Property size2

Adjusted R2 0.089 0.044 0.085

Notes: The left-hand-side variable is log(average share price in September)!log(average share price in January). Standard errors are in parentheses. The number of observations is 258, representing 129 companies over twoyears. Regressions are weighted by each firm’s market capitalization on January 2, 1996.

35

Table 9: UPREIT Form by Property Focus

Number of Firms

Property Focus Traditional REIT UPREIT

Diversified/Other: 8 4

Health Care: 7 1

Hotel: 2 10

Industrial: 5 5

Office: 0 6

Recreation: 2 1

Residential: 7 19

Restaurant: 1 1

Retail: 19 26

Self-storage: 2 3

Total: 53 76

36

Table 10: Controlling for Property Type

(1) (2) (3)

1997 dummy 0.009 (0.027) -0.044 (0.049) -0.036 (0.031)

UPREIT dummy 0.071 (0.028) 0.042 (0.028) 0.041 (0.027)

UPREIT x 1997 -0.086 (0.036) -0.027 (0.039) -0.034 (0.038)

Constant 0.028 (0.036) 0.055 (0.041) 0.045 (0.022)

Health Care -0.085 (0.045) -0.173 (0.057) -0.163 (0.046)

Hotel -0.028 (0.051) -0.003 (0.065)

Industrial -0.026 (0.047) -0.026 (0.045)

Office -0.076 (0.047) 0.028 (0.059) 0.039 (0.046)

Residential -0.015 (0.039) -0.058 (0.047) -0.047 (0.031)

Retail 0.0003 (0.051) -0.006 (0.044)

Storage -0.028 (0.051) -0.046 (0.065)

Health x 1997 0.177 (0.076) 0.169 (0.065)

Hotel x 1997 -0.049 (0.085)

Indus x 1997

Office x 1997 -0.207 (0.076) -0.209 (0.065)

Resid x 1997 0.086 (0.057) 0.082 (0.043)

Retail x 1997 0.012 (0.053)

Storage x 1997 0.036 (0.086)

Adj. R2 0.049 0.111 0.129

Notes: The left-hand-side variable is log(average share price in September)!log(average share price in January). Standard errors are in parentheses. The number of observations is 258, representing 129 companies over twoyears. Regressions are weighted by each firm’s market capitalization on January 2, 1996.

37

Table 11: Share Prices Respond Only for “Acquisitive” UPREITs

“Acquisitive” Means Below-Median Rent/ValueRatio in 1995

(1) (2) (3)

1997 dummy0.009

(0.027)0.009

(0.027)-0.017(0.042)

UPREIT dummy0.074

(0.025)0.080

(0.029)0.067

(0.037)

Acquisitive dummy-0.023(0.039)

Acquisitive x 19970.047

(0.055)

Acquisitive x UPREIT-0.014(0.034)

0.009(0.052)

UPREIT x 1997-0.037(0.039)

-0.043(0.041)

-0.016(0.053)

Acquisitive x UPREIT x 1997-0.113(0.034)

-0.099(0.048)

-0.146(0.073)

Adjusted R2 0.076 0.073 0.068

Notes: The left-hand-side variable is log(average share price in September)!log(average shareprice in January). Standard errors are in parentheses. The number of observations is 258,representing 129 companies over two years. Regressions are weighted by each firm’s marketcapitalization on January 2, 1996.

OperatingPartnership

UPREIT Equity Investors

BuildingSellers

Properties

OP Units,Cash

Cash

Shares

Figure 3: The UPREIT Structure.