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PRACTICE BRIEFING Practice briefing:

Real estate
Market valuation of real estate finance mergers
finance mergers: a note
79
Marc Kirchhoff
Institute for Mergers and Acquisitions, University of Witten/Herdecke,
Witten, Germany, and
Dirk Schiereck and Markus Mentz
European Business School, International University Schloss Reichartshausen,
Oestrich-Winkel, Germany

Abstract
Purpose – Real estate finance institutions as well as the mortgage banking landscape have
undergone a profound restructuring since the late 1980s. This study seeks to examine the value
implications of 69 domestic and cross-border merger and acquisition (M&A) deals of exchange-listed
real estate finance institutions.
Design/methodology/approach – To identify relevant M&A transactions between 1995 and 2002
the following data sources are used: Thomson Financial SDC (Securities Data Company – Mergers
and Acquisitions Database), Bloomberg, and Computasoft M&A Data. To assess the value
implications of M&A standard event study methodology is used, which relies on the market adjusted
model and the market model. Cumulated abnormal returns stemming from the market model and the
market adjusted model are calculated for four different event windows.
Findings – The results document that shareholders of targets earn, at least in the closest analyzed
interval, significant positive abnormal returns. There are no significant abnormal returns accruing to
the shareholders of the bidders in any of the analyzed intervals. CARs are slightly negative in two of
the four event windows, and positive in the remaining two. Hence, M&A transactions cannot be
considered a clear success. Nor, however, is any significant evidence found that they destroy value.
Originality/value – Since market valuations of mergers and acquisitions depend on
industry-specific circumstances, this paper explores value effects for a specific sector, namely the
real estate finance sector. It shows that real estate finance transactions are beneficial for target
shareholders. In addition, the results indicate that these transactions do not significantly destroy value
for bidding companies. This result contradicts prior evidence for the related banking industry.
Keywords Banks, Acquisitions and mergers, Real estate, Financial institutions
Paper type Research paper

Introduction
Real estate finance institutions as well as the mortgage banking landscape have
undergone a profound restructuring since the late 1980s. The industry continues to
change rapidly. This change is driven by technological innovation, deregulation, and
an increasing competition within the sector triggered by non-bank financial
Journal of Property Investment &
intermediaries (see Bank for International Settlements, 2001; Belaisch et al., 2001; Finance
Vol. 24 No. 1, 2006
Smith and Walter, 1998)). Individual real estate institutions have increasingly pp. 79-86
responded to these developments by climbing aboard the mergers and acquisitions q Emerald Group Publishing Limited
1463-578X
(M&A) treadmill. Consolidation activity among mortgage banks and other real estate DOI 10.1108/14635780610642980
JPIF finance institutions has increased significantly during the last decade, and particularly
24,1 within the last three years. Despite the consolidation, hardly any empirical research
analyses the value implications of M&A activity in the real estate finance sector up to
now.
To uncover the capital markets’ reaction to the announcements of M&A
transactions in the real estate finance industry, we study a data set of 69 international
80 transactions that occurred between 1995 and 2002. Our findings suggest that mergers
and acquisitions between real estate finance institutions create value on average.
Significant positive cumulated abnormal returns can be observed for the target firms,
while shareholder value is neither created nor significantly destroyed on the part of the
acquiring companies. This result contrasts with empirical evidence from US bank
M&A during the 1990s.
We start our analysis by providing a short review of the extensive prior research on
M&A in the related financial institutions sector. Section three presents the data sample
and the statistical methodology that we employed. In section four we discuss the
results. Section five summarizes the findings and draws conclusions.

Prior research
Evidence on the wealth effects of real estate finance mergers is very limited. In a
sample of real estate investment trust (REIT) transactions that took place between
1977 and 1983 Allen and Sirmans (1987) found an increase in shareholder wealth upon
the announcement of a merger both for the acquired and acquiring firms. However, this
positive assessment does not hold over time. Based on a sample of REIT mergers in the
period between 1988 and 1994, Campbell et al. (1998) found large negative returns for
the acquirers. Campbell et al. (2001) analyzed the stock market reaction to 85 REIT
mergers and observed significantly negative but small stock market returns.
Considerably more empirical investigations have dealt with M&A in the related
international banking industry. Most of these studies focus almost exclusively on the
US stock market. The results of these studies are mixed (see Rhoades, 1994; Berger
et al., 1999). Only roughly a quarter of the event studies of the last 20 years conclude
with a fully positive assessment of banking M&A (see, for example, Houston et al.
2001; Brewer et al., 2000; Becher, 1999; Cybo-Ottone and Murgia, 2000). In all other
studies the results are either mixed or negative, reporting significant negative
cumulative abnormal returns (CARs) for the bidding banks in particular, or observe
different outcomes across the analyzed subsamples (see, for example, Karceski et al.,
2000; Kane, 2000; Cornett et al., 2000; Toyne and Tripp, 1998; Subrahmanyam et al.,
1997; Pilloff, 1996; Siems, 1996).
Against the background of globalization in the financial services market, it is
remarkable that only a few studies have looked into cross-border banking M&A.
Examples in this context are the analyses of Tourani-Rad and van Beek (1999),
Cybo-Ottone and Murgia (2000), and Beitel et al. (2004). Interestingly, these studies
have a distinct European focus, and all conclude with a positive assessment. The
studies observe significant value creation for the shareholders of the target banks and
no significant value destruction for the shareholders of the bidding banks. Cybo-Ottone
and Murgia (2000) find that European banking M&A create significant value for the Practice briefing:
combined entity of the bidder and the target. Based on the aforementioned results for Real estate
banking M&A, our analysis sheds light on the value implications of a related industry
– the real estate finance industry.
finance mergers

Data sample and methodology 81

Data sample
To identify relevant M&A transactions between 1995 and 2002 we use three data
sources: Thomson Financial SDC (Securities Data Company – Mergers and
Acquisitions Database), Bloomberg, and Computasoft M&A Data. Bloomberg only
provides data for deals back to 1997, and Computasoft only back to 1996. Accordingly,
SDC represents our most important data source. In order to verify the deal data we use
additional press research in the Financial Times. Return data of the stocks, market
indices, and market capitalizations, respectively, are taken from Datastream (also
provided by Thomson Financial). Transactions are selected according to the following
criteria:
.
the transaction was announced between 1 January 1995 and 31 December 2002;
.
the target or acquirer derives a significant share of its earnings from services
associated with real estate finance;
.
the target or the acquiring company was exchange-listed at the announcement
day;
.
the transaction volume exceeded US$10 million;
.
the transaction has been closed (the deal status is “completed”); and
.
a change of corporate control has occurred in the transaction, i.e. the bidder
exercised full control (. 50 percent) over the target only after the transaction.

As Pilloff and Santomero (1998) encouraged, we have not purged deals from our
sample that saw multiple bidder activity.
Table I summarizes the 69 transactions in our sample. The number of deals
increased from 1995, reaching a peak in 1999. The M&A activity declines afterwards
but remains above the level of 1997 when the Riegle-Neal Interstate Banking and
Branching Efficiency Act abolished the restrictions on interstate branching and
banking in the US. This led to an immense merger wave within the US financial
institutions industry after the year 1997. We assume that the Riegle-Neal Act also had
an important impact on the real estate finance industry, and explains why 80 percent of
all transactions in the sample were executed within the US. Overall, 88 percent of the
deals are national. The average transaction volume per year is US$233.5 million, which
is rather small compared to M&A volumes in other sectors of the financial institutions
industry.
Table II illustrates the geographical distribution of the sample. Obviously, the main
global transaction activity in the real estate finance industry took place within US
borders (55 out of 69 transactions were closed within US borders).
JPIF
Geographical focus
24,1 Year Number of transactions B value per transactiona National International

1995 3 142 2 1
1996 5 136 4 1
1997 9 71 7 2
82 1998 12 562 11 1
1999 18 184 16 2
2000 8 164 8 0
2001 6 394 6 0
2002 8 215 7 1
Total 69 233.5 61 8
Table I. Total (percent) 100 88.41 11.59
Summary overview of
identified deals Notes: aIn millions of US$

Country of bidder
Country of target AT BE CA FR IR SW UK US Total

AT 1 1 2
BE 0
CA 0
FR 2 1 3
IR 1 1
SW 1 1
UK 4 1 5
US 1 1 55 57
Total 2 1 1 0 0 1 6 58 69
Table II. Notes: AT, Australia; BE, Belgium; CA, Canada, FR, France; IR, Ireland; SW, Switzerland; UK, United
Geographical distribution Kingdom; US, United States

Methodology
To assess the value implications of M&A we use standard event study methodology,
which relies on the market adjusted model and the market model put forward by Dodd
and Warner (1983), and Brown and Warner (1985).
For the event study, expected returns R̂jt for stock j at time t are computed based on
the market model:

R^ jt 2 a^j þ b^j RMt þ 1t : ð1Þ

OLS regression methodology for a time series of 252 trading days (one full trading
year) prior to the event window yields the model parameters âj and b̂j. As for the
market return RMt, we employ the respective national banking index offered by
Datastream. However, 252 daily returns prior to the transaction were not available for
all stocks in the sample. For those stocks without complete estimation period data we
simply calculate market adjusted returns assuming a^j ¼ 0 and b^j ¼ 1. Abnormal Practice briefing:
returns (ARs) of a stock j in the event window are calculated by subtracting the Real estate
expected stock return R̂jt from the observed stock return Rjt in the event window
(returns include dividend payments and other corporate action):
finance mergers

ARjt ¼ Rjt 2 R^ jt : ð2Þ

83
Subsequently we only present the results for market-adjusted returns[1]. Abnormal
returns are averaged, which yields:

1 Xn
AR
t ¼ · ARjt ; ð3Þ
n j¼1

where n is the number of analyzed stocks, and t is the point of time to analyze, t [ T.
We calculate cumulated abnormal returns (CARs) for any interval [t1; t2] during the
event window T:
X X1 X n
CAR½t1 ;t2
¼ AR
t ¼ · ARjt : ð4Þ
½t 1 ; t 2
½t 1 ; t 2
n j¼1

The event window T is 161 days: T ¼ ½280; þ80
days, where t ¼ {0} denominates
the announcement day of a transaction. The event window is large enough to address
information leakage and lack of clarity with respect to the exact announcement day as
it covers the two months prior and past to the official announcement day (80 exchange
days). In addition, an event window of ½280; þ80
makes a direct comparison to most
of the aforementioned studies possible. To check the robustness of our findings and to
also compare our results to those of other studies for banking M&A we conducted
analyses with four additional event windows within the ½280; þ80
days interval:
½21; þ1
, ½25; þ5
, ½210; þ10
and ½220; 20
.
To test whether cumulated abnormal returns are significantly different from zero,
we follow the suggestions of Dodd and Warner (1983). The test statistic is adjusted to
reflect cross-sectional independence (see Brown and Warner, 1985; Dodd and Warner,
1983).

Results
Within our sample we identify valid share price data for 34 targets and 50 acquirers.
The returns of these 84 companies within the 161-day window are given in Tables III
and IV. The results document that:
.
Shareholders of targets earn, at least in the closest analyzed interval, significant
positive abnormal returns. Based on this result, M&A deals in the real estate
finance sector can be considered a success for the targets’ shareholders.
. There are no significant abnormal returns accruing to the shareholders of the
bidders in any of the analyzed intervals. CARs are slightly negative in the
½21; þ1
and ½220; þ20
window, for the ten- and 20-day interval CARs are
JPIF even positive. Hence, M&A transactions cannot be considered a clear success.
24,1 But neither do we find significant evidence that they destroy value[2].

Our results differ from the recent evidence from US-focused banking studies with
regard to the acquiring firms’ CARs. For example, Kane (2000) and Cornett et al. (2000)
find a significant negative CAR of 2 1.5 percent at the announcement day and 2 0.78
84 percent in the time interval ½21; þ1
. For a longer event window of ½210; þ10

DeLong (2001) presents significant negative wealth effects of 2 1.7 percent. But the
results are in line with early studies from the US banking sector (see, for example,
Beitel et al., 2004). This seems to warrant the belief that the real estate industry either
has distinct value drivers or is still in an early state of concentration.

Summary and conclusions

Real estate finance institutions and the mortgage banking landscape have undergone a
profound restructuring since the late 1980s and continue to change rapidly through
mergers and acquisitions. We find that the shareholders of target firms in the real
estate finance sector receive a considerable and significant positive revaluation of their
shares, whereas effects for bidders’ shareholders are insignificant. These results
contrast with most empirical research conducted in the US and suggest that real estate
financing is still different from traditional commercial banking with respect to the
capital markets’ assessment of M&A.

Targets
Event window CAR (percent) t-statistic Positive Negative

½220; þ20
23.86 20.47 16 18

½210; þ10
22.38 20.39 15 19
Table III. ½25; þ5
4.44 1.04 19 15
Abnormal returns to ½21; þ1
9.46 4.25 * * * 21 13
shareholders of target
firms Note: * * *Significant at the 1 percent level

Acquirers
Event window CAR (percent) t-statistic Positive Negative

½220; þ20
21.4 20.28 23 27

½210; þ10
1.91 0.36 29 21
Table IV. ½25; þ5
1.42 0.55 28 22
Abnormal returns to ½21; þ1
20.56 20.42 22 28
shareholders of acquiring
firms Note: *Significant at the 10 percent level
Notes Practice briefing:
1. Market-adjusted abnormal returns are separated from market-model abnormal returns since Real estate
we assume a possible bias in the beta estimates if estimation periods of varying lengths are
used. Yet, the results for this subsample (not reported here) are qualitatively identical to finance mergers
those for the market-adjusted sample.
2. An analysis of domestic transactions (N ¼ 61) shows no qualitative differences for the
targets and acquirers when compared to the entire sample and the cross-border subset. 85
Additionally there are no significant differences between transactions of US versus non-US
acquirers or targets.

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Corresponding author
Markus Mentz can be contacted at: markus.mentz@ebs.de

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