An Investigation of Current Debt Levels of Equity REITs

By Oppenheimer, Peter H. | Journal of Real Estate Portfolio Management, July-September 2000 | Go to article overview

An Investigation of Current Debt Levels of Equity REITs


Oppenheimer, Peter H., Journal of Real Estate Portfolio Management


Executive Summary. This study investigates the current debt levels of equity real estate investment trusts (EREITs) and the ability of these companies to meet their interest and dividend payments. Critical financial ratios for the aggregate industry show that EREIT debt levels have consistently fallen since the recession of the early 1990s. In addition, lower debt levels and improved cash flows have reduced the risk of default as indicated by increasing debt coverage Levels. However, this trend significantly reversed in 1998 when the industry experienced sharp increases in debt and reductions in interest coverage ratios.

Introduction

In 1998, the Federal Reserve Board (FRB, 1998) issued a supervisory letter to its examination staff and banking organizations that included a cautionary reference on unsecured lending to equity real estate investment trusts (EREITs). The concern resulted from member institutions reporting unsecured lending to REITs as commercial and industrial loans, which may not have fully recognized the underling real estate risk associated with the loans. Although the FRB stated that "on balance, the overall quality of loans being made has in general not changed significantly over the period, due in large measure to favorable economic conditions," they also stated that these favorable economic conditions could not continue indefinitely. The FRB feared that its member institutions' loan assets would lose value if the real estate industry suffered another contraction similar to the mid1980s. Yet, it was unclear from the FRB's comments whether EREITs have actually increased their debt levels. This article examines debt levels and coverage of debt and dividend payments for the period 1994 through 1998 for EREITs trading on the New York Stock Exchange. Findings show that debt levels significantly increased in 1998 from 1997, although most debt measurements still remain below recession levels. The increase in 1998 debt levels reversed declining trends in EREIT debt levels. In addition, the ability of EREITs to meet interest and dividend payments declined in 1998. Recent data from 1999 indicates that both equity and debt borrowing has declined for the REIT industry. To facilitate a thorough investigation of debt levels, EREITs were separated into groups based on property specialization and whether an EREIT began public trading before or after 1992.

Past Research

Beginning in 1993, the EREIT industry experienced a significant increase in initial public offerings (IPOs) of EREITs and secondary stock offerings by existing EREITs. According to Ling and Ryngaert (1997), the relaxation of the Internal Revenue Code (IRC) five or fewer rule that in the past prevented institutional investors from purchasing large blocks of EREIT stocks helped fuel the growth of the industry in 1993. During this time, EREITs financed their growth from the sale of shares of stock. However, the equity markets have lately shown less interest in EREIT shares (Kirkpatrick and Templin, 1998). Consequently, EREITs in 1998 turned increasingly to debt to continue financing their growth and acquisition activities (Martinez, 1998).

Typically, publicly traded corporations have three basic methods for financing operations and growth: retained earnings (i.e., earnings after tax less dividends), debt borrowing (short or long term) and equity offerings (preferred and common stock). Yet, to avoid double taxation of dividends, federal tax laws require EREITs to distribute 95% of their pretax profits to shareholders as dividends. Hence, this reduces an EREIT's ability to finance growth through retained earnings.1 Also, it eliminates a potentially less expensive form of financing. Donaldson (1961) proposed a pecking order strategy that firms follow for financing their capital budgets. This theory suggested that firms first use retained earnings, then debt and finally equity for raising capital. The firms would base their order on the cost of the sources of capital, from lowest to highest. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

An Investigation of Current Debt Levels of Equity REITs
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.