REIT and Commercial Real Estate Returns: A Postmortem of the Financial Crisis

Abstract

In the years surrounding the financial crisis, the share prices of equity Real Estate Investment Trusts (REITs) were much more volatile than the underlying commercial real estate prices. To better understand this phenomenon we examine the cross-sectional dispersion of REIT returns during this time period with a particular focus on the influence of their capital structures. By looking at both the debt ratio and the maturity structure of the debt, we separate the pure leverage effect from the effect of financial distress. Consistent with leverage and financial distress costs amplifying the price decline, we find that the share prices of REITs with higher debt-to-asset ratios and shorter maturity debt fell more during the 2007 to early-2009 crisis period. Although REIT prices rebounded with the bounce back in commercial real estate prices, financial distress costs had a permanent effect on REIT values. In particular, we find that REITs with more debt due during the crisis period tended to sell more property and issue more equity in 2009, when prices were depressed.

REIT Capital Structure Choices: Preparation Matters

“…Table presents pairwise correlation coefficients between the variables in our study. We find significant inverse correlations between the cumulative total return and a number of firm characteristics in the United States, especially leverage and debt maturity, consistent with the observations in Sun, Titman and Twite (). In addition, we find inverse relationships between a reduction in leverage and a reduction in debt maturing in the 2007–2009 period, which is inconsistent with our hypothesis.…”

“… is the change in market leverage during 2006. is the level of market leverage at the end of 2006, capturing the effect documented in Sun, Titman and Twite (). is the log of firm size, Q is Tobin's Q and is the cash‐to‐assets ratio, all measured as of the end of 2006.…”

“…Similarly, little definitive evidence is available on the relationship between leverage and returns in real estate firms. Again, some find an inverse relationship (Cheng and Roulac , Ling and Naranjo , Sun, Titman and Twite , Giacomini, Ling and Naranjo ), while others find a positive relationship (Giacomini, Ling and Naranjo ), and others yet find no evidence for a significant relationship (Pavlov, Steiner and Wachter ).…”

“…REIT managers are able to mitigate capital structure risk in two fundamental ways: They can always be conservative, or they can dynamically adjust capital structure in anticipation of future market conditions. Sun, Titman and Twite () find that firms with a conservative capital structure at the start of the 2007–2009 financial crisis performed better during the financial crisis. On the other hand, their findings suggest that risky capital structure characteristics, such as high leverage and a high share of short‐term debt, significantly reduced the cumulative total return of U.S. REITs over the 2007–2009 financial crisis period.…”

Debt, labor markets, and the creation and destruction of firms

“…For instance, Almeida, Campello, Laranjeira, and Weisbenner (2012) show that firms with long-term debt maturing right after the third quarter of 2007 cut their investment-to-capital ratio by 2.5 percentage points more on a quarterly basis than otherwise similar firms whose long-term debt was scheduled to mature after 2008, and Sun, Titman, and Twite (2015) show that real state investment trusts (REITs) with maturing debt during the crisis were more likely to liquidate assets. While financial economists have traditionally viewed the link between capital structure and investment and liquidation from the perspective of firms seeking financing, macroeconomists and policy makers view this link much more broadly, expressing concern about how this linkage spills over to labor markets and the aggregate economy.…”