US REITs capital structure determinants and financial economic crisis effects
| Pages | 556-574 |
| Published date | 04 September 2017 |
| Date | 04 September 2017 |
| DOI | https://doi.org/10.1108/JPIF-07-2016-0055 |
| Author | Giacomo Morri,Edoardo Parri |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
US REITs capital structure
determinants and financial
economic crisis effects
Giacomo Morri
SDA Bocconi School of Management, Milan, Italy, and
Edoardo Parri
Bocconi University, Milan, Italy
Abstract
Purpose –The purpose of this paper is to identify the capital structure determinants through an analysis of
74 All-Equity REITs listed in the US market from 2005 to 2014. Furthermore, the paper aims at understanding
the impact of the financial economic crisis (FEC) among the identified explanatory variables.
Design/methodology/approach –A fixed effect panel regression model is performed based on Trade-off
Theory (TOT) and Pecking Order Theory as a starting point to provide expectations on the relationships
incurring among the identified variables.
Findings –First, while tangibility of assets and crisis evidenced a positive relationship with REITs’financial
leverage, operating risk and growth opportunities variables displayed a negative relationship. Meanwhile,
size and profitability did not appear to influence the capital structure. Second, it appears that the positive
effects of tangibility of assets and profitability variables on US REITs’capital structure increased as a
consequence of the FEC. Operating risk and growth opportunities variables slightly increased theirnegative
relationship with US REITs’capital structure after the FEC. The TOT prevails when explaining the economic
reality underlying US REITs.
Practical implications –The paper contributes to the understanding o f US REITs’financing
decisions within the US market. The FEC also had a substantial indi rect impact on the financial leverage
determinants of US REIT s, the latter being nowada ys more oriented to maint aining a flexible
capital structure.
Originality/value –The paper provides a comprehensive view of the medium-term effect of the FEC on US
REITs’capital structure.
Keywords Capital structure, REITs, Leverage, Pecking Order Theory, Financial economic crisis,
Trade-off Theory
Paper type Research paper
1. Introduction
The Trade-off Theory (TOT) and the Pecking Order Theory (POT) are the most relevant
theories when explaining the capital structure drivers of firms. Property investment is a
capital intensive business where the capital structure has an important role. Several
studieshaveinvestigatedthedeterminantsof capital structure of real estate vehicles
based on these traditional theories, but the financial economic crisis (FEC) strongly
changed their financing strategies.
The paper first introduces the main characteristics of both theories in order to build
ex ante expectations on the relationships between selected variables and financing decisions
of REITs Then, the paper investigates the main determinants of the capital structure for US
REITS in a ten-year annual time frame ranging from 2005 to 2014 and then tracks the effects
of the FEC in the years 2008-2010 to understand the changes by identifying the two different
periods (2005-2009 and 2010-2014).
The following two main factors influenced the choice of specific variables to be
implemented in the model: an analysis of the most relevant measures influencing real estate
investment vehicles’financing decisions; and an analysis of the most relevant studies
conducted during previous years with reference to the specific issue the paper aims at
Journal of Property Investment &
Finance
Vol. 35 No. 6, 2017
pp. 556-574
© Emerald PublishingLimited
1463-578X
DOI 10.1108/JPIF-07-2016-0055
Received 22 July 2016
Revised 5 December 2016
4 February 2017
Accepted 5 February 2017
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
556
JPIF
35,6
addressing. Selected variables are those which are evidenced to be the most economically
and statistically significant in such research. From this perspective, the paper aims at
testing their application to the US REITs market as well as the impact of the FEC in their
ability to drive the financing decisions of REITs in the US market. FINANCIAL
LEVERAGE is chosen as the dependent variable measured as total debt-to-total assets ratio
at book value, similar to the loan-to-value ratio, a key measure widely used in property
financing. The explanatory variables, based on the two aforementioned theories, are
PROFITABILITY, measured as EBIT-to-total assets ratio, used to look at US REITs’ability
to generate operating profit out of their investments; TANGIBILITY OF ASSETS,
measured as tangible fixed assets-to-total assets ratio, used to track the presence of tangible
fixed assets (less risky and more transparent) in US REITs’balance sheets; OPERATING
RISK, measured as REITs’unlevered beta, used in order to look at the vehicle’s inherent risk
arising from its operating activities; SIZE, measured as the natural logarithm of total assets
at book values, used to verify each REIT’s relative SIZE and to examine whether this is a
relevant driver to explain the financing decisions of real estate vehicles; GROWTH
OPPORTUNITIES, measured as market price-to-NAV ratio, used to examine investors’
forward looking expectations about a specific REITs’growth potential and their impact of
REITs financing decisions. Finally, CRISIS, a dummy variable which is implemented in the
model in order to examine whether the FEC had a direct role in driving financing decisions
of US REITs and the magnitude of such impact.
Two analyses are performed based on a fixed effect panel regression model.
The first analysis is performed on 74 All-Equity REITs listed in the US market on the
whole ten-year period ranging from 2005 to 2014 and aims at providing an understanding of
the main drivers influencing capital structure decisions as well as examining whether the
FEC had a direct impact on the financing decisions of US REITs by means of the
implementation of the dummy variable CRISIS.
The second analysis aims at looking at the indirect effect of the FEC on US REITs
financing decisions, whether relationships among variables changed and to what extent this
was as a consequence of the FEC. The ten-year period is divided into two shorter periods,
2005-2009 and 2010-2014, identified as the pre-FEC period and the post-FEC period.
This break in time considers the lag in time which it takes for triggered market
contingencies (the FEC started in 2007-2008) to be transformed into managerial and
strategic decisions.
The paper is organised as follows: in Section 2, the TOT and the POT will be analysed in
order to build expectations regarding the relationships incurring between selected variables
and the capital structure decisions of firms. Furthermore, in Section 3, characteristics of the
fixed effects panel regression model and main variables selected are introduced. Finally,
in Section 4, models are performed and findings are analysed. Specifically, the main drivers
influencing REITs’capital structure are analysed in Section 4.1. Next, the indirect role of the
FEC is investigated throughout Section 4.2 by means of the implementation of the before
and after FEC models. Finally, results are compared against theories expectations in Section
4.3. In Section 5, the main conclusions are presented.
2. Literature review
Previous studies on the capital structure mainly refer to the TOT and POT; each theory is
introduced together with its relative applicability to the REITs industry.
2.1 TOT
The TOT of capital structure, first developed by Modigliani and Miller (1958), considers a
positive relationship between the market value of firms and their capital structure. However,
a question is raised regarding whether a 100 per cent debt capital structure could be
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US REITs
capital
structure
determinants
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