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REIT Financing Choices: Preparation Matters

Working paper #786
Andrey D. Pavlov, Eva Steiner and Susan M. Wachter

Sun, Titman, and Twite (2015) find that risky capital structure characteristics, such as high leverage, high share of debt due in the near future and high share of variable-rate debt, significantly reduce the cumulative total returns of US REITs over the 2007-2009 financial crisis. In this paper we show that preparing ahead of the crisis significantly influenced the cumulative return over the crisis period even when controlling for the levels at the start of the crisis. Specifically, we document that REITs which reduced leverage and increased maturity prior to the crisis fared better during the crisis. For instance, one standard deviation reduction in leverage generated five percent higher cumulative return during the crisis. We further find that US REITs with the highest capital structure risk (high leverage and short maturities) were more likely to take precautions by reducing leverage and extending maturity. This effect is especially large for REITs with strong governance. We also document that none of our findings hold for European REITs. This suggests that since European firms did not experience or observe the levels of market excess that occurred in the US before the crisis, whether they took precautions or not had no impact on their returns during the crisis

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