OPTIMAL REIT SIZE - AN APPLICATION OF INVENTORY THEORY

Abstract

The real estate industry has recently witnessed an explosive growth for real estate investment trusts (REITs) which acquire properties to grow the size as large as possible and as quickly as possible. For the trend towards REIT growth, there are probably because of motivating economic factors, such as the presence of economies of scale or other form of efficiency gain. The dissertation has adopted an inventory model to develop a systematic and comprehensive framework for the optimal size of a REIT. The model establishes functional relationships between REIT size and its related costs. The model shows a U-shaped average cost function which is consistent with the argument that there are some benefits to REIT growth because of economies of scale, i.e. the average costs decrease as the size increases. However, if a REIT becomes too big, the benefits of economies of scale will probably diminish, until the diseconomies of scale set in, i.e. the average costs increase as the size increases. It is then shown that the model on optimal REIT size and equity fund are dependent on the particular characteristics of the market conditions, the company and the REIT itself, which are captured by parameters such as the set-up costs, operating cost rate, acquisition pace, weighted average rental income, weighted average purchase price, market rent, average debt ratio, and average occupancy rate. Therefore, there is no fixed value for the optimal size of REITs. REIT managers should determine the size based on REIT's objectives, asset types, investment and management strategies, opportunities as well as constraints (Chan, Erickson and Wang, 2002). The inventory model is illustrated by using Ascendas REIT (A REIT) as a case study. The numerical results, which fit neatly into the empirical findings of previous studies, reflect the growth perspective and operating efficiency of a particular REIT.