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Published in: The Journal of Real Estate Finance and Economics 2/2019

12-01-2019

On the Determinants of REIT Capital Structure: Evidence from around the World

Authors: Yunus Yasin Dogan, Chinmoy Ghosh, Milena Petrova

Published in: The Journal of Real Estate Finance and Economics | Issue 2/2019

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Abstract

Using a sample of REITs from twelve countries around the world, we examine the determinants of REIT capital structure. We investigate firm-specific and country-specific factors, and account for the unique legal requirements that REITs face in each country. Our results suggest that legal requirements are significant determinants of the capital structure of REITs. Specifically, we find that REITs have the highest book debt ratio in countries where they must pay out most of their operating income. This result implies that REITs prefer debt financing to equity financing. Additionally, we find that in countries with no payout requirement, but leverage restrictions, REITs have lower book leverage, which suggests that internal financing is preferred to external financing. Our findings also indicate that country-specific factors do not have significant impact on REIT leverage.
Footnotes
1
Several other studies explore the capital structure of REITs. Recent studies include Brown and Riddiough (2003), Giambona et al. (2008), Boudry et al. (2010), and Hardin III and Wu (2010). These studies report similar leverage ratios for REITs.
 
2
Other notable studies that analyze REIT corporate policies in an international context include Giacomini et al. (2015), Pavlov et al. (2015), Brounen et al. (2012), Erol and Tirtiroglu (2011), and Brounen and Eichholtz (2001). Most of these studies focus on the impact of differential regulation on REITs’ risk and return. Interestingly, Giacomini et al. (2015) contend that although rules regarding REITs’ dividend distribution and leverage ratios vary across countries, there is significant commonality in these rules which has contributed to the growing cross-border investment in real estate assets.
 
3
Though there are leverage restriction in the UK and Turkey, they are not as strict (limiting) as in the other countries. Thus, we put the UK and Turkey in the group of countries with no restrictions on leverage.
 
4
Brown and Riddiough (2003) argue that as more stable cash flows support higher debt levels, debt capacity may vary across property types. Although, we control for property type in all models, we suppress their coefficients in the tables for brevity.
 
5
The excluded countries with established REIT regimes are Germany and New Zealand due to lack of sufficient data for analysis. We further include three countries (Belgium, South Africa and Turkey) who have an existing REIT structure, but in an emerging state.
 
7
This feature makes REITs an attractive investment, by providing REIT investors not only with a liquid vehicle to invest in real estate, but also with high income return through dividends.
 
8
Before the 2000s only few governments legislated the REIT system in their countries. REITs still do not exist in many countries, but their popularity continues to grow.
 
9
EY’s 2016 REIT report lists in addition to the eleven countries with established REITs, ten countries where the REIT structure has been adopted recently and the REIT regime is in an emerging stage (Belgium, Finland, Ireland, Italy, Malaysia, Mexico, South Africa, South Korea, Spain and Turkey). Finally, the REIT structure is in planning stage in fifteen countries (Bahrain, Brazil, Bulgaria, Costa Rica, Greece, Hungary, India, Israel, Kenya, Pakistan, the Philippines, Taiwan, Thailand, UAE, and Vietnam).
 
10
There are three companies covered by SNL in each, Germany and New Zealand, with a total of 14 and 22 usable observations, respectively. Further details on our sample selection are provided in the data section.
 
11
In South Africa, prior to the introduction of the REITs in 2013, two broad types of property companies existed - Property Unit Trust (PUT) and Property Loan Stock (PLS). Both PUTs and PLSs were exempt from income taxation and were required to distribute 100% of their taxable earnings. However, due to important differences in legal requirements and inconsistencies between the two property companies, foreign investors were hesitant to invest in these property vehicles. Consequently, PUTs and PLSs were replaced in 2013 by the widely-accepted REIT structure.
 
12
Due to the favorable tax treatment, REITs are required to distribute large amounts of taxable income as dividends. In most the countries where the REIT system is established the dividend payout requirement is at least 90% or more (e.g. for Singapore-, US-, UK-based REITs 90%, for Dutch REITs 100%). However, in practice REITs pay-out at least 100% of their taxable earnings to avoid paying taxes completely.
 
13
Consistent with the tradeoff theory, several studies report that growth opportunities – proxied by market to book ratio – are associated with lower leverage ratio (Myers 1977; Baker and Wurgler 2002; De Jong et al. 2008). Harrison et al. (2011) find similar results for U.S. REITs.
 
14
However, Fan et al. (2012) report that firms in countries with large government bond markets have lower debt ratios and shorter maturity debt. They assert that government bonds crowd out long-term corporate debt.
 
15
Considering Turkey and South Africa as emerging markets, it would appear that REITs in emerging markets have lower leverage ratios. Lower leverage ratio is consistent also with the fact that the securities markets in these countries are still developing. In addition, cultural and other differences in REIT regimes also affect firms’ leverage decisions, and definitive conclusions must await further analysis.
 
16
Note that currently there are no REITs with payout requirement, but no tax exemption. However, the base of the tax exemption varies. There are two broad considerations – qualified income (e.g. qualified real property income in Belgium, profit from tax-exempt property business in the UK, or income derived from RE outside of HK for Hong Kong REITs) and distributed income (e.g. taxable income from properties located in Singapore distributed within the year, taxable income distributed in the US). REITs would be tax exempt to the extent that their income is qualified or distributed, depending on their home country legislation.
 
17
Using this approach, we can easily capture the effect of the two possible regulations when leverage restriction is ignored – no payout requirement and corporate tax exempt or no payout requirement and non-exempt status. An alternative approach would be to include a dummy variable indicating no payout requirement and an interaction variable between no payout and non-exempt status. Our approach is favored when the expectation is that the effect between the two regimes may be different and we want to isolate each one, as opposed to looking at the effect of no payout restriction in general.
 
18
Note that by including these interaction variables it is easier to identify the effect of lack of leverage restriction in regimes with vs. without payout requirements. The comparison group is REITs with leverage restrictions. The alternative approach is to include a dummy variable for no leverage restriction and an interactive variable NOPAYOUT_NOLEVRESTRICT. Our approach, provides direct estimates of the effects without having to add coefficients in the case of no payout restrictions.
 
19
Business risk is usually defined as (levered beta)/(1 + (1-T)*(D/E)), where T is the corporate income tax rate, and D/E is the debt-to-equity ratio.
 
20
De Jong et al. (2008) use standard deviation of operating income over the book value of total assets as a proxy for risk for non-REITs. We do not include this variable because for majority of the countries in their sample, this variable is not significant. The literature discusses several other variables as potential determinants of capital structure. Our choice of variables is dictated by the availability of data and their relevance and significance.
 
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Metadata
Title
On the Determinants of REIT Capital Structure: Evidence from around the World
Authors
Yunus Yasin Dogan
Chinmoy Ghosh
Milena Petrova
Publication date
12-01-2019
Publisher
Springer US
Published in
The Journal of Real Estate Finance and Economics / Issue 2/2019
Print ISSN: 0895-5638
Electronic ISSN: 1573-045X
DOI
https://doi.org/10.1007/s11146-018-9687-7

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