Investment and Capital Improvements in Commercial Real Estate: The Case of REITs

Land, capital, and labor constitute essential components of economic production. This axiom holds particular significance in commercial real estate, where an incorporation of prime land, meticulously executed capital improvements in building structures, and adept professionals significantly influence performance and returns. This study illuminates the critical role of capital investment intensity in synergy with strategic location choices (land) and proficient management. Drawing upon a dataset encompassing U.S. equity Real Estate Investment Trusts (REITs) spanning 1995–2022, the analysis uncovers a compelling correlation between a higher capital allocation towards property improvements and augmented market valuations. This association maintains its potency when utilizing an instrumental variable approach to mitigate potential endogeneity caveats. It remains robust even when the sample is streamlined to focus on a REIT's core property type. Further, by estimating a firm-level production function that accounts for endogenous input choices, the study reveals that initial and continuing investments in building capital constitute nearly half of a REIT's output. This underscores the pivotal role of initial and recurrent capital investments in building structures in generating commercial property revenue and overall productivity. The findings emphasize the indispensability of capital improvements that foster optimal property utilization and intensity in driving performance and returns.