reit and commercial real estate returns: a postmortem of

2015 V43 1: pp. 8–36

DOI: 10.1111/1540-6229.12055

REAL ESTATE

ECONOMICS

REIT and Commercial Real Estate Returns:A Postmortem of the Financial CrisisLibo Sun,* Sheridan D. Titman** and Garry J. Twite***

In the years surrounding the financial crisis, the share prices of equity RealEstate Investment Trusts (REITs) were much more volatile than the underlyingcommercial real estate prices. To better understand this phenomenon we ex-amine the cross-sectional dispersion of REIT returns during this time periodwith a particular focus on the influence of their capital structures. By lookingat both the debt ratio and the maturity structure of the debt, we separate thepure leverage effect from the effect of financial distress. Consistent with lever-age and financial distress costs amplifying the price decline, we find that theshare prices of REITs with higher debt-to-asset ratios and shorter maturity debtfell more during the 2007 to early-2009 crisis period. Although REIT pricesrebounded with the bounce back in commercial real estate prices, financialdistress costs had a permanent effect on REIT values. In particular, we findthat REITs with more debt due during the crisis period tended to sell moreproperty and issue more equity in 2009, when prices were depressed.

In the years surrounding the financial crisis, the share prices of equity RealEstate Investment Trusts (REITs) were extremely volatile. The National As-sociation of Real Estate Investment Trusts (NAREIT) All Equity REITs Indexfell from a high of 10,256 in January 2007, to a low of 3,337 in February 2009,a cumulative loss of 67%, with the largest fall of 60% between September2008 and February 2009. The index subsequently recovered much of the lossin value, closing at 9,039 at the end of December 2011.

As illustrated in Figure 1, the NAREIT index was substantially more volatilethan the National Council of Real Estate investment Fiduciaries (NCREIF)Property index over this time period. For example, over the period September2008 to February 2009 the NCREIF Property Index only fell by 15% in com-parison to the 60% fall in the NAREIT index. With respect to the subsequent

*College of Business Administration, Cal Poly Pomona, Pomona, CA 91768or [email protected].

**McCombs School of Business, University of Texas, Austin, TX 78712or [email protected].

***McCombs School of Business, University of Texas, Austin, TX 78712or [email protected].

C© 2014 American Real Estate and Urban Economics Association

REIT and Commercial Real Estate Returns 9

Figure 1 � Cumulative return of NAREIT and NCREIF indices.

This figure plots the cumulative returns of both the NAREIT All Equity REITs Index (levered andunlevered) and the NCREIF Property Index over the period January 2000 to December 2011.

reversal, the NCREIF Property Index fully recovered the loss by December2011, but the NAREIT index was still 10% below its precrisis high.

Finally, as we show in Figure 2, the magnitude of the price changes were dif-ferent for different property types. Residential REITs were particularly volatilein this time period; from January 2007 to February 2009 residential REITs fell53% and then recovered 90% of their previous value over the period February2009 to December 2011.1 In comparison, industrial REITs fell by only 40% butrecovered only 31% of their value over the period February 2009 to December2011.

The question that we address in this article is why REIT prices, both generallyand within specific sectors, were so much more volatile during the finan-cial crisis than the underlying commercial real estate. There are a number ofpossible explanations. Of course, part of the reason that REIT prices reactedmore to the financial crisis than the underlying commercial real estate is be-cause REITs are leveraged investments. However, as illustrated in Figure 1,the leverage-adjusted returns of REITs are also much more volatile than the

1Over the same period the NCREIF Residential Index only fell by 24% and had fullyrecovered its value by December 2011.

10 Sun, Titman and Twite

Figure 2 � Cumulative return of REIT by property type.

This figure plots the cumulative return of a sample of REITs classified by property type: (i) healthcare, (ii) hotel, (iii) residential, (iv) office and industrial, (v) shopping centers, regional malls andretail, (vi) speciality and (vii) diversified.

NCREIF index, suggesting that a pure leveraging of returns cannot be the wholestory.

Another possibility is that the NCREIF index, being based on appraisals, is bothslow to react and tends to underreact to major price changes. We know that thisis at least part of the story, and the fact that the NCREIF index turned downsix quarters after the NAREIT index and then rebounded with a six-quarterdelay, as evidenced in Figure 1, is suggestive of this. It is also possible that theNAREIT index tends to overreact to changes in property prices. Whether or notthis is true, in general, is controversial and is beyond the scope of this study.However, given the subsequent reversal, one can argue that REITs did in factoverreact in this particular case.

It should also be noted that the values of REITs represent more than justtheir underlying properties, so it is possible for their values to decline muchmore than the values of their underlying properties, even after accountingfor their debt obligations. Specifically, many of them have large pipelines ofdevelopment deals as well as platforms that allow them to exploit positive netpresent value opportunities in the future. It is likely that during the financialcrisis the perceived values of those opportunities evaporated or even turnednegative. However, because these growth opportunities represent a small partof REIT values, even in good times, we expect that fluctuations in the ability


Figure 3 � Beta of NAREIT index.

This figure plots the beta of monthly rates of returns on the NAREIT All Equity REITs Indexagainst the S&P500 Index over the period January 2000 to December 2011. Betas are estimatedusing a rolling 36-month window.

to exploit the growth opportunities probably played only a small role in thedecline and rebound of REITs during this period.

Another possibility is that the riskiness of REITs dramatically increased aroundthe crisis period, causing REIT prices to decline, as required rates of returnincreased. As shown in Figure 3, REIT betas increased substantially prior toand during the crisis period, suggesting that this could explain at least part ofthe decline. However, the increase in the betas of REITs should be related tothe underlying risk of commercial real estate in general, not just the REITs,and as such cannot explain why REITs declined more in the crash than theunderlying real estate. In addition, the fact that REIT betas stayed high did notseem to dampen the subsequent rebound.

The analysis in this article focuses on the financial leverage explanation, butour analysis goes beyond the simple amplification effect of corporate debt. Inparticular, we consider the potential financial distress costs that arise for thoseREITs that are unable to meet their debt obligations. Specifically, we considerthe possibility that a combination of a downturn and high leverage can leadto increases in general administrative expenses, losses of growth opportunitiesand losses associated with being forced to either raise capital or sell propertiesat unattractive terms. An analysis of these potential financial distress costs isthe central focus of our analysis.


By looking at the maturity structure of the debt as well as the debt ratio, we areable to separate the amplification effect of leverage from the effect of financialdistress. The maturity of the debt is not relevant for the amplification effect—inthe absence of financial distress, short-term and long-term debt will similarlyamplify the price changes of the underlying properties. However, because ofadded costs associated with rolling over maturing debt in bad times, REITs thathad significant amounts of debt coming due during the financial crisis wereclearly disadvantaged relative to REITs with the same debt-to-asset ratios butwith longer duration debt.2

To explore these issues, we examine the cross-section of cumulative REITreturns in two separate time periods; the January 2007 to February 2009 timeperiod, when REIT prices collapsed, and the March 2009 to December 2011period—the rebound period. Consistent with the amplification effect, we findthat after controlling for property type and other REIT characteristics, the shareprices of REITs that had higher debt-to-asset ratios at the end of 2006 fell moreduring the initial time period. In addition, controlling for the total debt-to-assetratio, REITs with shorter maturity debt (debt due in 2008 and 2009 and variableinterest rate debt) experienced larger price declines during the January 2007to February 2009 time period, suggesting that a significant part of the declineswere due to concerns about the financial distress costs that arise because ofrollover risk. Further, we find that these effects hold over the full January2007 to December 2011 sample period, suggesting that financial distress had apermanent effect on these REITs even though very few went bankrupt.3

To further explore the impact of financial distress costs, we examine whetherfirms with more debt due in 2008 and 2009 made choices that diluted thevalue of existing shares. In particular, we examine how their capital structuresinfluenced how much equity they raised and the extent to which they soldproperties during the distress period. Consistent with an increase in financialdistress costs, we find that after controlling for property type and other REITcharacteristics, including the total debt-to-asset ratio, REITs with more debtmaturing in these years raised relatively more equity capital and sold moreproperties (sales exceeded acquisitions) in 2009.4

2Diamond (1991, 1993) provided the earliest analysis of rollover risk. More recently,Acharya, Gale and Yorulmazer (2011), Choi, Hackbarth and Zechner (2012) and Heand Xiong (2012) discuss these issues in the context of the recent shock to the financialsystem.3Both General Growth and Innkeepers filed for Chapter 11 bankruptcy protection duringour sample period— General Growth in 2009 and Innkeepers in 2010.4A recent empirical study by Almeida et al. (2012) examined the effect of maturitystructure on investment during the financial crisis. The article found that firms whose


The article is organized as follows. The second section describes the sample.The third section examines the influence of leverage and financial distress onREIT returns surrounding the financial crisis. The fourth section examines therelationship between debt maturity, equity issues and property sales. The fifthsection draws some conclusions.

Data and Summary Statistics

This section describes the sample and presents univariate summary statistics.

Sample

The primary source of our REIT data is SNL Financial (SNL), which containsfinancial and property data on U.S. REITs. We restrict the sample to thoseREITs listed on the stock market as of December 31, 2006, and to ensure thatREITs are publicly traded, the SNL sample includes only firms with Center forResearch in Finance (CRSP) share codes of 18 or 48. Our total sample included138 REITs.

Our explanatory variables are measured as of financial year-end 2006 andinclude firm size measured as the natural logarithm of total assets (Size), Qis the ratio of firm market value (market capitalization plus total assets lessbook value of equity) to total assets, Cash/Total Assets, the ratio of cash andcash equivalents to total assets, and FFO per Share, funds from operations pershare. As proxies for leverage, we use Market Leverage, the ratio of total debt(defined as the book value of short-term and long-term interest bearing debt,where short-term debt is defined as debt due in one year) to market value ofthe firm (defined as total debt plus book value of preferred stock plus marketcapitalization), and Preferred Stock, the ratio of the book value of preferredstock to total capital. As proxies for the maturity structure of the debt, we useVariable Rate Debt/Total Debt as the ratio of variable interest rate debt to totaldebt, Debt Due in 2007/Total Debt as the ratio of debt due in 2007 to total debtand Debt Due in 2008 or 2009/Total Debt as the ratio of debt due in 2008 or2009 to total debt. In addition, we include indicator variables set equal to onewhen a REIT is classified as a property type: Health Care, Hotel, Residential,Office and Industrial, Retail, Specialty or Diversified as of financial year-end2006.

The dependent variables used in the analysis below are the cumulative monthlyrates of return, equity issues and property sales for each REIT. Monthly rates

debt was largely maturing right after the third quarter of 2007 reduced investment by2.5% more per quarter than otherwise similar firms whose debt was scheduled to maturewell after 2008.


of return for each REIT over the full sample period, January 2007 to December2011, are obtained from CRSP. We estimate the cumulative monthly rates ofreturn for the time periods January 2007 to February 2009 (Cumulative Return2007–2009), the time period March 2009 to December 2011 (Cumulative Re-turn 2009–2011) and the full sample period January 2007 to December 2011(Cumulative Return 2007–2011). Equity issues for each REIT are estimated for2009 as the sum of common stock and preferred stock issues over the marketvalue of invested capital (book value of short-term debt plus book value oflong-term interest bearing debt plus book value of preferred stock plus marketcapitalization) (Stock Issues/Market Value of Invested Capital). For each REIT,property sales for 2009 are estimated as property sales less acquisitions overtotal assets (Net Property Sales/Total Assets).

Summary Statistics

Table 1 presents summary statistics for the sample of 138 REITs. As of financialyear-end 2006, the mean market leverage ratio for the sample is 38.20%.Preferred stock represent only 4.1% of total capital, defined as total debt plusbook value of preferred stock plus market capitalization. Variable rate debt,debt due in 2007 and debt due in 2008 or 2009 is on average 15.5%, 12.3% and20.3% of total debt, respectively.

Over the initial period January 2007 to February 2009, the mean cumulativerate of return of our sample of listed REITs was −60.77%, while the meancumulative rate of return over the second period March 2009 to December2011 was 182.14%. It should also be noted that the cumulative returns in thesecond subperiod were substantially more dispersed than those in the initialperiod. Over the full sample period, January 2007 to December 2011, themean cumulative rate of return of our sample of listed REITs was −6.46%.As a consequence of the existence of outliers in the distribution of cumulativereturns, we winsorize the cumulative returns of the individual REITs at the 2%level in all three time periods.

In 2009, mean equity issues (defined as the total of common stock and pre-ferred stock issues) were 13.39% of invested capital, while property sales onlyrepresented 0.21% of total assets.

It should be noted that our sample includes 22 REITs that delisted duringour sample period either because of a merger, privatization or Chapter 11bankruptcy. Seventeen REITs delisted as a consequence of a merger, fourteenin 2007, two in 2008 and one in 2011. Two REITs went private in 2008, and onein 2009. These REITs had similar leverage and debt maturity structures to thesurviving REITs in our sample. However, the two firms that filed for Chapter 11

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had higher debt-to-asset ratios and more debt due in 2007, 2008 and 2009 thanthe surviving REITs in our sample.

Table 2 summarizes our sample by property type, Health Care, Hotel,Residential, Office and Industrial, Retail, Specialty and Diversified, as at fi-nancial year-end 2006. We see from Table 2 that the sample is broadly dis-tributed across the seven property types and that all property types realizeda price decline between January 2007 and February 2009. However, REITsclassified as Hotel, Office and Industrial, Retail and Diversified had not re-covered their December 2006 levels by December 2011. While all propertytypes raised equity capital in 2009, only the Hotel, Residential, Retail andDiversified sectors were net property sellers in 2009, with sales exceedingacquisitions.

Table 3 presents the Pearson correlation coefficients between cumulative returnsand our proxies for leverage and debt maturity, together with indicator variablesequal to one when a REIT is classified in a property type: Health Care, Hotel,Residential, Office and Industrial, Retail, Specialty or Diversified as of financialyear-end 2006.

The results, reported in Table 3, suggest that firm size, leverage, debt maturityand property type are associated with both the price decline and the subsequentrebound for REITs. In particular,

� larger REITs experienced larger price declines and larger subsequentrecoveries;

� high Q REITs experience smaller price declines and smaller subse-quent recoveries;

� the more levered REITs experienced larger declines in the downturnand then greater return in the recovery period; and

� the larger the price decline, the stronger the price rebound.

The association between property type and price decline/rebound is significantfor all property types and differs across property types. As expected, HealthCare and Residential REITs, which tend to be less risky, were associated withsmaller price declines and subsequent rebounds.

Finally, leverage and debt maturity are associated with equity issues and prop-erty sales. Specifically, the more levered REITs and REITs with relatively moreshort-term debt raised proportionally more equity (both common and preferredstock) and were net sellers of property (i.e., sales exceeded acquisitions) in2009.


Tabl

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730.

140.

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060.

02F

FO

per

Shar

e[8

]−0

.015

−0.0

01−0

.023

0.08

30.

007

0.14

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.138

−0.6

490.

890.

990.

820.

400.

940.

120.

130.

00M

arke

tLev

erag

e[9

]−0

.191

−0.3

970.

275

0.19

20.

370

0.08

4−0

.655

−0.1

45−0

.062

0.05

0.00

0.00

0.04

0.00

0.33

0.00

0.09

0.50

Pre

ferr

edSt

ock

[10]

−0.0

24−0

.007

0.07

7−0

.029

0.02

00.

061

−0.0

82−0

.062

0.07

5−0

.209

0.80

0.94

0.42

0.75

0.83

0.48

0.34

0.47

0.42

0.01

Vari

able

Rat

eD

ebt/

[11]

−0.2

39−0

.141

−0.0

440.

163

−0.0

01−0

.186

0.07

5−0

.067

0.07

1−0

.086

−0.0

87To

talD

ebt

0.01

0.14

0.66

0.08

0.98

0.03

0.39

0.44

0.44

0.33

0.32


Tabl

e3

�C

ontin

ued

Cum

ulat

ive

Ret

urn

Var

iabl

es20

07–2

011

[1]

[2]

[3]

[4]

[5]

[6]

[7]

[8]

[9]

[10]

Deb

tDue

in20

07/

[12]

−0.0

620.

093

−0.1

300.

022

−0.2

36−0

.291

0.14

3−0

.006

0.04

2−0

.173

0.00

5To

talD

ebt

0.54

0.35

0.19

0.82

0.01

0.00

0.11

0.95

0.66

0.05

0.96

Deb

tDue

in20

08or

[13]

−0.1

39−0

.162

0.09

00.

371

0.23

10.

072

0.07

0−0

.205

0.06

8−0

.116

0.01

720

09/T

otal

Deb

t0.

170.

100.

370.

000.

020.

420.

440.

020.

480.

200.

85H

ealt

hC

are

[14]

0.27

00.

373

−0.1

45−0

.070

−0.2

42−0

.075

0.09

00.

025

0.01

7−0

.208

−0.0

240.

000.

000.

130.

450.

010.

390.

300.

770.

850.

020.

78H

otel

[15]

−0.2

28−0

.262

0.21

90.

084

0.02

9−0

.095

−0.2

13−0

.019

−0.0

240.

081

0.23

30.

020.

000.

020.

370.

760.

270.

010.

820.

790.

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01R

esid

enti

al[1

6]0.

235

−0.0

410.

226

−0.1

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141

0.10

80.

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−0.1

410.

058

0.13

0−0

.088

0.01

0.66

0.02

0.26

0.14

0.21

0.83

0.10

0.53

0.13

0.31

Offi

cean

dIn

dust

rial

[17]

−0.2

65−0

.080

−0.1

99−0

.024

−0.0

460.

121

−0.0

02−0

.064

0.06

60.

043

−0.0

830.

010.

390.

040.

790.

630.

160.

980.

460.

480.

620.

34R

etai

l[1

8]−0

.073

−0.0

940.

085

0.06

1−0

.002

0.02

80.

127

0.05

0−0

.159

0.01

2−0

.075

0.45

0.32

0.37

0.51

0.97

0.74

0.14

0.56

0.08

0.89

0.39

Spec

ialt

y[1

9]0.

292

0.19

40.

020

0.12

7−0

.027

0.04

60.

074

0.01

10.

022

−0.1

13−0

.101

0.00

0.04

0.84

0.17

0.77

0.59

0.39

0.89

0.82

0.19

0.24

Div

ersi

fied

[20]

−0.1

27−0

.016

−0.2

03−0

.068

0.12

7−0

.182

−0.1

150.

149

0.05

90.

012

0.17

20.

180.

870.

030.

470.

190.

030.

180.

080.

520.

890.

05


Tabl

e3

�C

ontin

ued

[11]

[12]

[13]

[14]

[15]

[16]

[17]

[18]

[19]

Deb

tDue

in20

07/T

otal

Deb

t[1

2]0.

362

0.00

Deb

tDue

in20

08or

2009

/[1

3]0.

213

−0.1

69To

talD

ebt

0.02

0.06

Hea

lth

Car

e[1

4]0.

271

0.08

20.

061

0.00

0.36

0.50

Hot

el[1

5]−0

.037

−0.0

270.

050

−0.1

210.

680.

760.

580.

16R

esid

enti

al[1

6]−0

.043

−0.0

97−0

.021

−0.1

25−0

.145

0.62

0.28

0.81

0.14

0.09

Offi

cean

dIn

dust

rial

[17]

−0.0

85−0

.021

0.00

3−0

.163

−0.1

89−0

.195

0.33

0.82

0.97

0.06

0.03

0.02

Ret

ail

[18]

−0.0

250.

221

−0.0

99−0

.174

−0.2

02−0

.209

−0.2

720.

780.

010.

270.

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020.

010.

00Sp

ecia

lty

[19]

0.01

0−0

.121

0.13

1−0

.113

−0.1

31−0

.135

−0.1

76−0

.188

0.91

0.17

0.14

0.19

0.13

0.11

0.04

0.03

Div

ersi

fied

[20]

−0.0

40−0

.095

−0.0

90−0

.117

−0.1

36−0

.140

−0.1

83−0

.195

−0.1

270.

640.

290.

320.

170.

110.

100.

030.

020.

14

Not

e:T

heta

ble

prov

ides

corr

elat

ion

mat

rix

for

our

sam

ple.

Pear

son

corr

elat

ion

coef

ficie

nts

for

all

inde

pend

ent

vari

able

s,cu

mul

ativ

ere

turn

sst

ock

issu

esan

dne

tpr

oper

tysa

les,

toge

ther

with

each

pair

ing

ofin

depe

nden

tva

riab

les

are

pres

ente

d.V

aria

bles

are

asde

fined

inTa

ble

1.C

umul

ativ

ere

turn

sar

ew

inso

rize

dat

the

2%le

vel.

Inad

ditio

n,w

ein

clud

ein

dica

torv

aria

ble

equa

lto

one

whe

na

RE

ITis

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are,

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el,R

esid

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al,O

ffice

and

Indu

stri

al,R

etai

l,Sp

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orD

iver

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das

atfin

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ar-e

nd20

06.p

-Val

ues

are

inita

lics.


To investigate whether these variables are likely to be subject to collinearityproblems in our later regression analysis, we examine the correlations betweenthe explanatory variables that are used in our analysis. From Table 3, we seethat several variables are highly correlated with each other, in particular, ourmeasures of debt maturity. This multi-collinearity makes it difficult to interpretthe impact of some of the individual variables; hence we examine these variablesin separate regressions to mitigate this problem.

Leverage, Debt Maturity and REIT Prices

This section examines the relation among leverage, debt maturity and propertytype, and also examines the price collapse and subsequent rebound of REITs.Table 4 presents the results of the regression of firm characteristics, marketleverage, debt maturity and property type as of financial year-end 2006 on cu-mulative monthly rates of returns for the sample of REITs. We report separateregressions for our different leverage and debt maturity measures to mitigatethe impact of multi-collinearity. Panel A of Table 4 reports the results forthe time period, January 2007 to February 2009 and Panel B of Table 4reports the regressions with the same independent variables, but with the returnsused as the dependent variable calculated over the February 2009 to December2011 time period. In addition, in Panel B we include the cumulative return overthe time period January 2007 to February 2009, as an explanatory variable. InPanel C of Table 4 we report the same regressions for the full sample period,January 2007 to December 2011. In all regressions we drop the Health Careproperty sector indicator variable and include a constant term.

An Analysis of the Collapse: January 2007 to February 2009

Panel A of Table 4 reports cross-sectional regressions of REIT returns in thecrash period on our independent variables. In addition to the property typedummies, the regressions reveal that the size, leverage and maturity structureof the REIT debt significantly influence the magnitude of the REIT declinesduring this time period.

As one would expect, the more levered REITs experienced the largest pricedeclines; however, the amount of preferred stock financing did not have a sta-tistically significant effect, perhaps because the magnitude and cross-sectionalvariation in the use of preferred stock was not sufficiently large. The coefficientof −0.507 on Market Leverage in column (6) implies that a one-standard-deviation increase in Market Leverage is associated with a 13.4% decrease incumulative returns. We also see that REITs with relatively more short-termdebt (i.e., more debt due in 2008 and 2009 and more variable rate debt) fellsignificantly more during this time period. This later evidence suggests that

22 Sun, Titman and TwiteTa

ble

4�

RE

ITch

arac

teri

stic

san

dcu

mul

ativ

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turn

s.

Pane

lA:J

anua

ry20

07to

Febr

uary

2009

Dep

ende

ntV

aria

ble:

Cum

ulat

ive

Ret

urn

2007

–200

9

Inde

pend

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aria

bles

[1]

[2]

[3]

[4]

[5]

[6]

Size

−0.0

48−0

.049

−0.0

49−0

.043

−0.0

41(3

.35)

***

(3.3

8)**

*(3

.57)

***

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2)**

*(3

.20)

***

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025

0.02

90.

039

0.00

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4)(0

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1)(0

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FO

per

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010.

011

0.00

7−0

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8)(0

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Cas

h/To

talA

sset

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1)(0

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5)M

arke

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erag

e−0

.371

−0.3

59−0

.33

−0.4

51−0

.507

(1.8

4)*

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0)*

(1.6

1)(2

.04)

**(2

.17)

**

Pre

ferr

edSt

ock

0.06

−0.4

08(0

.19)

(1.3

6)Va

riab

leR

ate

Deb

t/To

talD

ebt

−0.5

46−0

.340

(4.0

7)**

*(2

.07)

**D

ebtD

uein

2007

/Tot

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0.05

70.

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(0.4

7)(0

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Deb

tDue

in20

08or

2009

/Tot

alD

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−0.4

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−0.4

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Res

iden

tial

−0.2

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(4.0

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Offi

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−0.2

96−0

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−0.2

29−0

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−0.2

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REIT and Commercial Real Estate Returns 23Ta

ble

4�

Con

tinue

d

Pane

lA:J

anua

ry20

07to

Febr

uary

2009

Dep

ende

ntV

aria

ble:

Cum

ulat

ive

Ret

urn

2007

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Obs

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tion

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2011

Dep

ende

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Cum

ulat

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Ret

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2009

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24 Sun, Titman and TwiteTa

ble

4�

Con

tinue

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arch

2009

toD

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2011

Dep

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ive

Ret

urn

2009

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[4]

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Obs

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180.

300.

310.

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60**

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01**

*


Tabl

e4

�C

ontin

ued

Pane

lC:J

anua

ry20

07to

Dec

embe

r20

11

Dep

ende

ntV

aria

ble:

Cum

ulat

ive

Ret

urn

2007

–201

1

Inde

pend

entV

aria

bles

[1]

[2]

[3]

[4]

[5]

[6]

Size

−0.0

12−0

.014

−0.0

15−0

.002

0(0

.30)

(0.3

6)(0

.41)

(0.0

4)(0

.01)

Q0.

055

0.09

50.

044

0.04

10.

058

(0.3

0)(0

.49)

(0.2

4)(0

.22)

(0.3

0)F

FO

per

Shar

e0.

045

0.04

90.

034

0.02

90.

031

(1.7

1)*

(1.7

9)*

(1.3

5)(0

.95)

(0.9

9)C

ash/

Tota

lAss

ets

1.97

32.

088

1.29

11.

122

0.97

3(2

.76)

***

(2.8

1)**

*(2

.02)

**(1

.30)

(1.1

4)M

arke

tLev

erag

e−0

.282

−0.1

59−0

.335

−0.5

49−0

.478

(0.6

1)(0

.32)

(0.7

4)(1

.11)

(0.9

1)P

refe

rred

Stoc

k0.

622

−0.2

56(0

.87)

(0.3

7)Va

riab

leR

ate

Deb

t/To

talD

ebt

−1.2

50−0

.984

(4.4

9)**

*(3

.16)

***

Deb

tDue

in20

07/T

otal

Deb

t−0

.243

−0.2

55(0

.72)

(0.8

1)D

ebtD

uein

2008

or20

09/T

otal

Deb

t−0

.742

−0.3

71(2

.68)

***

(1.2

4)H

otel

−0.7

24−0

.787

−0.7

97−0

.919

−0.8

19−0

.905

(3.7

4)**

*(4

.99)

***

(5.0

4)**

*(6

.79)

***

(4.8

3)**

*(6

.37)

***

Res

iden

tial

−0.1

07−0

.026

−0.0

32−0

.163

−0.0

66−0

.171

(0.6

6)(0

.15)

(0.1

9)(1

.07)

(0.3

7)(1

.08)


Tabl

e4

�C

ontin

ued

Pane

lC:J

anua

ry20

07to

Dec

embe

r20

11

Dep

ende

ntV

aria

ble:

Cum

ulat

ive

Ret

urn

2007

–201

1

Inde

pend

entV

aria

bles

[1]

[2]

[3]

[4]

[5]

[6]

Offi

cean

dIn

dust

rial

−0.6

64−0

.591

−0.5

92−0

.676

−0.6

4−0

.716

(4.1

6)**

*(3

.68)

***

(3.7

4)**

*(4

.67)

***

(3.7

5)**

*(4

.73)

***

Ret

ail

−0.4

64−0

.405

−0.4

12−0

.565

−0.4

38−0

.536

(2.7

7)**

*(2

.37)

**(2

.43)

**(3

.97)

***

(2.3

9)**

(3.4

8)**

*

Spec

ialt

y0.

033

0.04

20.

04−0

.122

0.00

8−0

.135

(0.1

7)(0

.20)

(0.1

9)(0

.62)

(0.0

3)(0

.61)

Div

ersi

fied

−0.5

73−0

.584

−0.6

09−0

.676

−0.6

17−0

.665

(3.1

8)**

*(3

.36)

***

(3.5

0)**

*(5

.13)

***

(3.5

3)**

*(4

.65)

***

Con

stan

t0.

336

0.41

10.

316

0.81

40.

637

0.71

1(2

.39)

**(0

.63)

(0.4

9)(1

.32)

(0.8

6)(1

.00)

Obs

erva

tion

s11

110

010

099

9494

R2

0.31

0.4

0.41

0.49

0.48

0.52

F-t

est

8.46

***

9.63

***

9.58

***

9.31

***

9.55

***

8.41

***

Not

e:T

his

tabl

epr

esen

tsre

gres

sion

sof

cum

ulat

ive

retu

rns

onR

EIT

char

acte

rist

ics

asde

fined

inTa

ble

1.T

hefu

llsa

mpl

epe

riod

(Pan

elC

)is

divi

ded

into

two

subs

ampl

es:J

anua

ry20

07to

Febr

uary

2009

(Pan

elA

)an

dM

arch

2009

toD

ecem

ber

2011

(Pan

elB

).C

umul

ativ

ere

turn

sar

ew

inso

rize

dat

the

2%le

vel.

Thi

sta

ble

also

repo

rts

the

adju

sted

R2

and

num

bero

fobs

erva

tions

.Sta

ndar

der

rors

are

Whi

te–c

orre

cted

.T-s

tatis

tics

are

give

nin

pare

nthe

ses.

*,**

and

***

are

sign

ifica

ntat

the

10%

,5%

and

1%le

vel,

resp

ectiv

ely.

F-t

esti

sfo

rthe

hypo

thes

isth

atth

eco

effic

ient

son

allp

rope

rty

type

indi

cato

rva

riab

les

are

equa

l.


a significant part of the decline was due to concerns about financial distresscosts. In particular, the coefficient of −0.340 on Variable Rate Debt/Total Debtin column (6) implies that a one-standard-deviation increase in Variable RateDebt/Total Debt is associated with an 8.9% decrease in cumulative returns.The coefficient of −0.310 on Debt Due in 2008 or 2009/Total Debt in col-umn (6) implies that a one-standard-deviation increase in Debt Due in 2008 or2009/Total Debt is associated with a 7.6% decrease in cumulative returns. It isinteresting to note that the amount of debt maturing in 2007 had no influenceon the price decline over the crisis period, reflecting the fact that it was mucheasier to roll over debt that came due early in the crisis period.

However, the regressions also suggest that the larger REITs suffered the largestdeclines. In particular, from column (6) a one-standard-deviation increase inTotal Assets is associated with a 9.7% decrease in cumulative returns. Weconjectured that the larger REITs are likely to be less subject to rollover risk andprobably have lower financial distress costs,5 so this last finding is inconsistentwith our original conjecture. This last observation is somewhat puzzling andwill be discussed below.

The results with respect to the influence of property type on price declinesreveal that all property groups experienced a price decline and that the extentof the decline varied significantly across groups. Further, the significant differ-ences across property types persist even with the inclusion of our measures forleverage and financial distress.

Price Rebound: February 2009 to December 2011

Panel B of Table 4 reports cross-sectional regressions of REIT returns in therebound period on our independent variables. Our interest here is the extentto which the effect of leverage and maturity structures, which amplified thedownturn in the crisis period, was reversed when the market rebounded. Thealternative hypothesis is that high leverage in the precrisis period had a perma-nent effect on REIT values.

The cross-sectional dispersion of returns in this second time period is extremelyhigh, and, as a result, the level of statistical significance is relatively low eventhough the magnitudes of many of the coefficients in these regressions are sub-stantially larger than their counterparts in the regressions for the crash period. Inany event, the regressions reveal that size, leverage and the maturity structure of

5While this is intuitive, there is evidence to suggest that with respect to rolling over syn-dicated loans, credit worthy firms tend to be more sensitive to credit market conditions(Mian and Santos 2011).


the REITs influence the magnitude of the REIT returns during this time period.In particular, the coefficient of 3.485 on Market Leverage in column (6) impliesthat a one-standard-deviation increase in Market Leverage is associated witha 30.8% increase in cumulative returns. While the coefficient of 1.81 on DebtDue in 2008 or 2009/Total Debt in column (6) implies that a one-standard-deviation increase in Debt Due in 2008 or 2009/Total Debt is associated witha 14.9% increase in cumulative returns. The results on leverage and maturitystructure are consistent with the idea that the prices of the weakly capitalizedREITs overreacted to the threat of financial distress, and thus rebounded whenthe threat was not realized (indeed, only two REITs went bankrupt).

The fact that the larger REITs experienced stronger returns in the reboundperiod is consistent with the idea that, at least with the benefit of hindsight, thelarge REITs may have overreacted to the negative events in the earlier period. Itshould also be noted that the returns of REITs in the earlier period are stronglynegatively related to returns in the rebound period, which is consistent withunobserved characteristics that may have been associated with forced portfolioliquidations causing overreactions in the crisis period. It is worth noting thatthe coefficients of the size and capital structure variables decline substantiallywhen past returns are included in the regression.

The results with respect to the influence of property type on the price reboundare mixed. While all property types experience a price rebound, the differencebetween property types is weaker than that observed in the initial period.

Performance Over the Entire Time Period: January 2007 to December 2011

Panel C of Table 4 reports cross-sectional regressions of REIT returns over theentire period on our independent variables. This regression provides estimatesof the effects of capital structure on prices over the entire cycle. Recall, as weshowed in Figure 1, commercial real estate prices, as measured by the NCREIFindex, had fully recovered by the end of 2011. Hence, the returns measuredover this entire period provide estimates of the extent to which the turmoilexperienced during the crisis period had a permanent effect on REIT equityvalues.

The most noteworthy result in this table is that the REITs with substantialamounts of debt that matured during the crisis period did significantly worseover the entire time period. There are a number of potential explanations. Theymay have been forced to sell properties or issue equity at unattractive prices,they may have lost key personnel, or they may have been forced to divert theirattentions to dealing with a financial crunch, leaving less time to spend on theircore business. It is also noteworthy that there was no size effect over the entire


period, suggesting that the decline of the large REITs in the crash period maynot have been due to fundamentals. Finally, it should be noted that the REITswhich had the most cash, and which were generating the most cash (those withhigher FFO), realized higher stock returns over the entire cycle.6

Prior Two-Year Windows

We now turn to the examination of the robustness of our results to both modelspecification and sample period. Specifically, for two-year nonoverlapping sam-ple periods from 1993 to 2006, we replicate our cross-sectional regressions ofcumulative monthly REIT returns on firm characteristics, market leverage, debtmaturity and property type as of financial year-end prior to the commencementof the respective sample period. The purpose of this exercise is to determinewhether the strong cross-sectional relation between debt maturity structure andreturns only occurs during periods of financial turmoil, as we expect, or whetherthis is a statistical artifact that appears in other years as well.

It should be noted that the mean cumulative rate of return of our sample oflisted REITs was positive in each of the two-year sample periods, suggestingthe leverage should have a positive effect on returns in each of the two-yearregressions. We do, in fact, find a positive relation between leverage and returnsin three periods, but the effect is weak. However, it is noteworthy that we findno significant association between debt maturity and returns in any of thesetwo-year periods.

Debt Maturity, Equity Issues and Property Sales

Because of their financial distress, a number of REITs were forced to sell assetsand issue equity during the crisis period when commercial real estate and REITprices were depressed. In this section we explicitly examine the extent to whichtheir capital structures influenced these choices. In particular, we examine therelationship between the proportion of the REIT’s total debt due in two or threeyears from 2006 and the level of equity issues and property sales in 2009.

Table 5 presents the results of the regression of firm characteristics (includingmarket leverage), debt maturity and property type as of financial year-end 2006on equity issues and net property sales in 2009 for the sample of REITs. Inall regressions, we drop the Health Care property sector indicator variable andinclude a constant term.

6In unreported regressions, we re-estimate our regressions excluding debt due in 2008or 2009 and variable rate debt. Consistent with the results we report in Table 4 debt duein 2007 remains statistically insignificant in all specifications.


Table 5 � Debt maturity, equity issues and property sales.

Dependent Variable

StockIssues/Market Net PropertyValue of Sales/Total

Independent Variables Invested Capital Assets

Size 0.0123 0.0093(0.69) (1.89)*

Q −0.0330 0.0101(−0.55) (0.40)

FFO per Share 0.0151 −0.0029(1.13) (−0.48)

Cash/Total Assets 0.2304 −0.0999(0.64) (−0.50)

Market Leverage 0.2984 0.0939(1.29) (1.38)

Preferred Stock −0.1875 0.1030(−0.40) (0.88)

Variable Rate Debt/Total Debt 0.0969 0.0113(0.49) (0.27)

Debt Due in 2007/Total Debt 0.1115 −0.0413(0.85) (−1.18)

Debt Due in 2008 or 2009/Total Debt 0.4341 0.0794(2.78)*** (2.35)**

Hotel 0.0862 0.0417(0.91) (1.55)

Residential −0.0335 0.0444(−0.65) (1.73)*

Office and Industrial 0.0176 0.0382(0.34) (1.49)

Retail 0.0791 0.0436(1.22) (1.81)*

Specialty 0.1972 0.0288(2.48)** (1.05)

Diversified 0.0505 0.0394(0.94) (1.65)

Constant −0.2652 −0.2333(−0.69) (−2.07)**

Observations 94 91R2 0.30 0.32

Note: This table presents regressions of equity issues and net property sales on REITcharacteristics. The dependent variables are Stock Issues/Market Value of Invested Cap-ital and Net Property Sales/Total Assets, estimated for 2009. All other variables are asdefined in Table 1. This table also reports the adjusted R2 and number of observations.Standard errors are White–corrected. T-statistics are given in parentheses. *, ** and ***are significant at the 10%, 5% and 1% level, respectively.


These regressions indicate that the proportion of debt due in the short-termhas a significant influence on the financing and investment decision of REITfollowing the price decline in 2007 and 2008. Specifically, we find that in 2009,REITs with relatively more short-term debt in 2006 (i.e., more debt due in twoor three years) raised proportionally more equity (both common and preferredstock) and were net sellers of property (i.e., sales exceeded acquisitions). Inparticular, a one-standard-deviation increase in Debt Due in 2008 or 2009/TotalDebt in 2006 is associated with a 48.9% increase in the ratio of equity issues in2009 to the market value of invested capital and a 570.2% increase in the ratioof net property sales to total assets in 2009. The fact that they issued sharesand sold assets at what, ex post, can be viewed as unattractive prices providea plausible explanation for why these REITs performed poorly over the entirecycle.7

Robustness

In this section we examine the robustness of our results with respect to changesin how we measure and treat financial leverage as well as how we specifythe timing and the measurement of our independent variables. In addition, weconsider the effect of the REITs’ development pipelines on their returns.

The Measurement of Financial Leverage and Debt Maturity

In unreported regressions, we replace market leverage with book leverage,defined as the ratio of total debt to total capital (total debt plus book value ofpreferred stock plus book value of common stock). Consistent with the resultswe report for market leverage in Table 4, we find that the stock price of REITswith higher book leverage ratios and shorter debt maturity fell more duringthe initial time period. However, while the debt maturity effects persist overthe full sample period, we find no support for any persistence in the book

7In unreported regressions, we estimate separate regressions that include leverage ordebt maturity measures but not both. Consistent with the results we report in Table 5 wefind a significant relationship between the proportion of debt due in 2008 or 2009 andwhether the REIT issued shares or sold assets. In addition, we re-estimate our regressionof firm characteristics (including market leverage), debt maturity and property type asof financial year-end 2006 on equity issues, defining equity issues with respect to bookvalue as the sum of common stock and preferred stock issues over the book value ofinvested capital (book value of short-term debt plus book value of long-term interestbearing debt plus book value of preferred stock plus book value of common stock). Theresults with respect to leverage, debt due in 2008 or 2009 and variable rate debt arerobust to this change. We also replace market leverage with book leverage, defined asthe ratio of total debt to total capital (total debt plus book value of preferred stock plusbook value of common stock). Consistent with the results we report for market leverage(Table 5) we find no significant relationship between book leverage and whether theREIT issued shares or sold assets.


leverage effect. In addition, we reestimate our regressions excluding marketleverage and find that our results with respect to the three financial distressproxies (debt due in one year, debt due in two or three years and variable ratedebt) reported in Table 4 are robust to this change.8

We also reestimate our regressions replacing the three financial distress proxies(debt due in one year, debt due in two or three years and variable rate debt)with the proportion of total debt that is unsecured. We find that the proportionof unsecured debt is statistically insignificant in all specifications.

The Timing of Independent Variables

In estimating the cross-sectional regressions of REIT returns in the reboundperiod (February 2009 to December 2011) as reported in Panel B of Table 4, ourexplanatory variables are measured as of financial year-end 2006. We ran thesesame regressions measuring our explanatory variables as of financial year-end2008. As expected, the effect of market leverage on returns is stronger when amore timely measure is used.

The Influence of Property Type

We also examined the robustness of our result with respect to how we controlfor property type. Adjusted returns are calculated by demeaning cumulativereturns by property type mean returns, and property type indicator variablesare dropped from the regressions for the three time periods. The results withrespect to leverage, debt due in two or three years and variable rate debt arerobust to this change. In addition, we interact leverage and financial distressproxies with property type indicator variables. The results reveal no significantvariation in leverage and financial distress effects across property type.

Institutional Ownership

As we noted earlier, the larger REITs declined more than smaller REITs duringthe initial crisis period, but subsequently rebounded. One possible explanation,which we consider in this subsection, is that the larger REITs were held moreby institutions that were forced to liquidate their holdings in the crisis period.To explore this possibility, we examine the influence of the level of activeinstitutional ownership on our results. Using Thomson Financial 13-f filings,

8We also examined the importance of bank lines of credit, which is reported for aboutone-third of our sample. In particular, we included the available balance and found thatthis variable was only weakly associated with price behavior during the financial crisisand that our results were robust to its inclusion.


we identify the fraction of each REIT owned by active institutional investors atthe end of 2006. Following the earlier literature (e.g., Brickley, Lease and Smith1988, Almazan, Hartzell and Starks 2005), we classify investment companies(mutual funds and closed-end funds) and independent investment advisors(principally pension fund advisers) as active investors.9

We find that the level of active institutional investors is only weakly associatedwith price behavior during the financial crisis and that the size effect we observeis robust to the inclusion of active institutional ownership. This variable isinsignificant in all specifications and does not influence the effect of size onreturns during the crisis period.

Development Pipeline

Finally, we explore the extent to which the magnitude of the REITs’ develop-ment pipeline influenced the decline in REIT prices. REITs with large pipelinesmay have been especially hard hit by the crisis because options to develop lostmost of their value in this time period.10 This could also potentially con-taminate our analysis since REITs with active development pipelines tend tohave more short-term debt (perhaps to finance their development). REITs tendto disclose two measures of the magnitude of their development pipelines: thebook value of the development pipeline and projected development costs. Un-fortunately, the projected costs are reported by only about half of the REITs. Inunreported regressions we do not find a significant relation between the bookvalue of the development pipeline and the magnitude of the REIT declinesduring the crisis.11

9We also proxy for size using both an indicator variable that takes a value of one ifthe REIT was in the S&P500 index at the end of 2006 and zero otherwise and alsoan indicator variable that takes a value of one if the REIT was ranked in the top 25REITs by market capitalization as at the end of 2006. While we do not find a significantrelation between inclusion in the S&P500 index and returns during the crisis period,S&P 500 REITs experienced stronger returns in the rebound period, consistent withinstitutions recognizing that the forced liquidation in the crisis period may have beenan overreaction. However, when we utilize the top 25 indicator as our size measure weobserve that the effect of size is stronger in both the price decline and rebound periods.10This could potentially explain the significant price decline of the larger REITs as wewould expect the larger REITs to have larger development pipelines.11We do find a weak relation between projected development costs and the magnitude ofREIT price declines during the crisis period. However, given the limited availability ofthis data item and the correlation between projected development costs and short-termdebt, the importance of this variable is difficult to gauge.


Conclusion

It is clear that financial leverage played a large roll in the substantial decline inREIT prices during the financial crisis. Our regressions, which use debt maturitystructure to distinguish between the pure amplification effect of leverage andthe effect of financial distress, indicate that a significant part of the declinein REIT prices was due to anticipated costs associated with financial distress.Specifically we find that the share prices of REITs with higher debt-to-assetratios fell more during the crisis period, which is consistent with the pureleverage effect, and that the decline was greater for REITs with more variableinterest rate debt and more debt coming due in 2008 and 2009, which isconsistent with financial distress costs. Further, we find that these effects persistover the full sample period, January 2007 to December 2011, suggesting thatsome of the anticipated financial distress costs were realized even though veryfew REITs actually went bankrupt. Finally, REITs with more debt due in 2008and 2009 raised relatively more equity capital and sold more properties (salesexceeded acquisitions).

Although we are looking at an extreme event, to some extent our results under-estimate the potential effects of financial leverage. The first thing to note is ourregressions ignore the endogeneity of REIT capital structure choices. Specifi-cally, there is likely to be a tendency of the REITs that are best positioned tocope with the effect of financial leverage to have the highest debt ratios withthe shortest maturities.12 Moreover, legislation that allowed REITs to substitutestock dividends for cash dividends allowed those that were the most exposedto financial distress costs to conserve their cash, allowing them to mitigate thecosts of financial distress.13 If REITs had been forced to maintain their payouts,the effect of the financial crisis would surely have been worse.

Before concluding, we should note that we have identified two puzzles that maywarrant further investigation. First, we noted that REIT betas increased prior

12There is a large literature that examines how REIT financing choices are influenced bytheir characteristics (Casey, Sumner and James 2006, Morri and Beretta 2008, Ertugruland Giambona 2011, Harrison, Panasian and Seiler 2011). There is also evidence thathaving a strong banking relationship influences capital structure choices as well as theability of REITs to deal with financial downturns. For example, Hardin and Wu (2010)find that REITs with banking relationships are more likely to use more long-term debt,use less secured debt and have lower leverage. In addition, Hardin and Hill (2011)consider the utilization of credit lines and Ooi, Wong and Ong (2012) find that duringthe financial crisis bank lines of credit insulated REITs from the impact of tighteningcredit conditions.13See Case, Hardin and Wu (2012) for a discussion REIT dividend policies and dividendannouncement effects during this time period. They find that during the financial crisis,REITs with higher market leverage were more likely to cut dividends, suspend dividendsor pay stock dividends in lieu of cash dividends.


to the crisis; however, we do not know what caused the increase in beta andwhether a resulting increase in the cost of capital for REITs (and perhaps realestate more generally) contributed to the downturn. Perhaps the closer relationbetween the real estate cycle and the overall business cycle was apparent tomarket investors as early as 2006. Second, we provided evidence that largeREITs declined more than the smaller REITs in the 2007–2009 downturn, butthen rebounded in the later period. Our evidence suggests that the initial declinewas not due to selling by institutional investors. Another possibility, which wehave not been able to explore, is that many of the larger REITs were morelevered than was evidenced by their balance sheets.

Sheridan Titman is an advisor to Gerstein Fisher and a portfolio managerof the Gerstein Fisher Global REIT Fund. This article has benefited from theuseful comments and suggestions provided by Gregg Fisher, Brian Thomas,the Gerstein Fisher research team and an anonymous referee. The article alsobenefitted from discussion at the 2013 AREUEA/NAREIT Real Estate ResearchConference. We thank Parth Venkat for research assistance.

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Harrison, D.M., C. Panasian and M. Seiler. 2011. Further Evidence on the CapitalStructure of REITs. Real Estate Economics 39(1): 133–166.He, Z. and W. Xiong. 2012. Rollover Risk and Credit Risk. Journal of Finance 67(2):391–430.Mian, A. and J. Santos. 2011. Liquidity Risk and Maturity Management over the CreditCycle. Working Paper, U.C. Berkeley.Morri, G. and C. Beretta. 2008. The Capital Structure Determinants of REITs. Is It aPeculiar Industry? Journal of European Real Estate Research 1(1): 6–57.Ooi, J.T.L., W.C. Wong and S.E. Ong. 2012. Can Bank Lines of Credit Protect REITsAgainst a Credit Crisis? Real Estate Economics 40(2): 285–316.

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