Secured Debt Financing and Leverage: Theory and Evidence

Banking Relationships and REIT Capital Structure

“…Moreover, REITs with banking relationships use less leverage. This finding is consistent with Brown and Marble (2007), which show that firms with lower secured debt ratios also have lower leverage. The rationale is that asset substitution problem decreases in the proportion to the original debt that is secured.…”

“…The finding that REITs with banking relationships have lower leverage supports research by Brown and Marble (2007), which shows that firms with lower secured debt ratios also have lower leverage. Also, the finding is consistent with Brown and Riddiough (2003) in that, if public debt issuers tend to target leverage to maintain their credit ratings, it is not surprising that REITs with banking relationships have lower leverage 28 .…”

“…The findings suggest that at least one reason for REITs to use debt is to obtain financial liquidity through banks to take quick action in property acquisitions. Third, the finding that REITs with banking relationships have lower leverage supports Brown and Marble (2007), which shows that firms with lower secured debt ratios also have lower leverage. This finding is also consistent with Brown and Riddiough (2003).…”

“…Given REITs do not pay corporate taxes and thus there exist no tax benefits from borrowing, the standard trade-off theory would predict that REITs with banking relationships should use less leverage. More important, Brown and Marble (2007) show that the asset substitution problem decreases in the proportion of the original debt that is secured implying that firms with lower secured debt ratio would also have lower leverage. This is especially relevant to REITs as REITs have experienced a dramatic wave of industry growth with property acquisitions and mergers being the core growth strategies employed.…”

“…As banking relationships mitigate capital market frictions that would force firms to have lower leverage, REITs with banking relationships should have better access to the debt markets in general (Johnson 1998). 7 On the other hand, Brown and Marble (2007) show that the asset substitution problem decreases with the proportion of the original debt that is secured, and thus firms with lower secured debt would have lower leverage due to the concerns related to asset substitution. The characteristics associated with secured lending underwritten to a single property and the ability to more readily assess the value of real estate collateral and to control the cash flow from a collateral property also point toward lower leverage with the use of unsecured bank lines of credit.…”