Cornell’s Eva Steiner on REIT Capital Structures

REIT magazine: November / December 2017

Eva Steiner is an assistant professor of real estate at Cornell University. She co-authored a paper recognized as the “Outstanding Paper” submitted at the 2017 Nareit-AREUEA Real Estate Research Conference.

Q: One of your research projects focused on whether listed REITs that foresaw and prepared for the 2008-2009 liquidity crisis by strengthening their capital structures were rewarded by investors during and even after the crisis. Can you summarize your main findings?

We know that capital structure risks, especially high leverage and a high share of short-term debt, significantly reduced the cumulative total return of U.S. REITs in the 2007-2009 financial crisis. In this study, we found that reducing those risks ahead of the crisis, specifically by reducing leverage and extending debt maturity in 2006, was associated with a significantly higher cumulative total return 2007-2009, even after controlling for the levels of those variables at the start of the financial crisis.

Intrigued by those findings, we further identified two systematic cross-sectional differences between those REITs that reduced capital structure risks prior to the financial crisis and those that did not: the riskiness of capital structure positions and the strength of corporate governance. On this basis, we believe that adjustments to capital structure ahead of the crisis were an important component of managerial skill and discipline that supported firm value during the crisis.

Q: Another paper addressed a similar issue—active management of the capital structure—but among private equity real estate funds, rather than listed REITs. What were your findings in that context, and how did private equity funds differ from REITs in terms of leverage choices?

In this article, we studied the performance of a sample of 169 global private equity real estate investment funds across the core, value-add and opportunistic investment style categories over the period 2001 to 2011. With regards to leverage choices, we found that leverage was unable to help funds enhance performance in the long run. Moreover, attempts to time leverage choices to the expected future market environment did not appear to add significantly to fund excess returns. This is in contrast to the REIT findings we just discussed, where timely adjustments to capital structure prior to the financial crisis supported firm performance during the crisis. Of course, the sample periods differed substantially across the two studies.

Q: In another recent research project you ask a simple question: What explains the use of secured versus unsecured debt listed in REITs? How do these choices affect investors?

In this paper, we use equity REIT data to show empirically that the use of unsecured debt is associated with lower leverage outcomes. We believe this is the case because unsecured debt contains standardized covenants that place limits on total leverage and the use of secured debt. We then show that firm value is sensitive to leverage levels, where lower leverage is associated with higher firm value.

Eva Steiner

Our results suggest that unsecured debt covenants commit REIT managers to preserving the firm’s debt capacity by limiting especially secured borrowing. Therefore, we find that the use of unsecured debt by REIT managers is associated with lower leverage and higher remaining debt capacity. This improves financial flexibility and supports firm value.

Q: Previous research suggested that REIT executives were affected by “loss aversion,” a hesitancy to sell properties at a loss. One of your current research projects, though, disputes this interpretation. Can you explain your finding?

Yes, exactly. Research on the disposition effect in real assets to date has ignored the active management component of these investments. Active management in real estate notably includes decisions about follow-up investments in the form of capital expenditures, as well as strategic disposition choices.

We find that once we account for capital expenditures, their underlying fundamental drivers and the implications for asset value and disposition decisions, the observed disposition patterns are in line with a value-maximizing investment strategy. 

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