Professor Finds Strong Effects of Leverage on REIT Values

Tim Riddiough, a professor in the Department of Real Estate and Urban Land Economics at the Wisconsin School of Business at the University of Wisconsin Madison, joined REIT.com for a video interview at REITWorld 2015: NAREIT’s Annual Convention for All Things REIT at the Wynn Las Vegas.

Riddiough discussed his recent research on the relationship between REITs and their capital structures. He explained that the motivation for the study came from the insufficient appreciation given to the value of REITs’ financial management.

During the financial crisis there was a renewed appreciation for financial management, Riddiough said. However, Riddiough saw the need to do a longer-term study to demonstrate some of the value effects.

“We found that there were very significant effects in terms of the relationship between leverage and firm value,” he noted.

As Riddiough explained, without controlling for other factors, a 15 percent increase in leverage translates to a 50 percent decrease in a firm’s market-to-book value. Taking a closer look, the research showed that within a particular firm, a 10 percent increase in leverage translated to a 10 percent decrease in the value of the firm.

“The bottom line is that leverage really matters with these firms,” Riddiough said.

The research also compared corporate unsecured debt with mortgage debt. Riddiough said the findings showed that unsecured debt is typically better than mortgage debt because the bond covenants that accompany unsecured debt create commitment on the part of management to maintain low leverage levels. “Shareholders seem to like that,” he noted.

In terms of areas for further research, Riddiough pointed to the need for additional work on the nuances of REIT capital structures, such as maturity schedules.