Academic journal article Journal of Real Estate Portfolio Management

REIT Performance and Lines of Credit

Academic journal article Journal of Real Estate Portfolio Management

REIT Performance and Lines of Credit

Article excerpt

Executive Summary. Using a sample of equity real estate investment trusts (REITs) traded on major exchanges in the United States between 1990 and 2009, this study examines the relationship between REIT line of credit usage and subsequent firm profitability. The results, which are robust across multiple accounting measures of firm operating performance, indicate enhanced liquidity is strongly associated with better firm performance. Furthermore, the benefits of enhanced liquidity appear to be strongest for those firms identified as being capital constrained. These results also provide insight into, and a rational economic justification for, the previously documented positive borrower wealth effects associated with bank loan announcements.

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The extant literature consistently demonstrates that financial markets respond to lending decisions made by regulated financial intermediaries in predictable fashions. According to conventional wisdom, mandatory reserve requirements necessarily raise the cost of funds for regulated lenders. Thus, in order to effectively profit and survive in the highly competitive financial services marketplace, regulated firms must possess distinct competitive advantages in some aspect of the loan origination and/or approval process. For example, given the nature of their operations, banks and other traditional lending institutions are frequently viewed as being able to take advantage of economies of scale in both data collection and information processing. To the degree subsequent credit extensions (and other characteristics of the lending evaluation process such as unique or differential loan terms) made on the basis of such superior information may be transparently communicated to the marketplace, bank lending decisions may serve as an effective information conduit to the broader capital markets.

Consistent with this notion, a variety of empirical investigations have found significant wealth effects associated with the announcement of bank lending decisions. These results would tend to suggest banks possess, or gain access to, private information about the firms to which they lend money. Unfortunately, gaps in the underlying conceptual justification behind these previous studies leave a glaring hole in the literature, as the mechanism by which actionable information is communicated to the marketplace is not sufficiently justified. To this end, the intent of the current investigation is to further examine the relationship between access to, and usage of, bank credit facilities and subsequent firm performance. Unlike previous studies, which focus almost exclusively on wealth effects and the market reaction to loan announcements, the focus of this study is the linkages between access to liquidity and subsequent accounting profitability. To the extent the line of credit (liquidity) metrics presage enhanced firm profitability, the results provide unique insight into the mechanisms by which bank loans enhance shareholder wealth, and provide further conceptual justification for the previously documented positive wealth effects surrounding bank credit extensions.

The remainder of the paper is organized as follows. Section two reviews the existing literature on bank loan announcements, motivates the use of real estate investment trusts (REITs) as a unique laboratory in examining linkages between firm liquidity and operating performance, and introduces the key testable implications of the analysis. Section three outlines the methodology used to evaluate these hypotheses, while section four describes the data. Section five presents the results of the empirical analysis, while the final section (six) summarizes the key findings and concludes.

Literature Review and Motivation

Fama (1985) was among the first academicians to substantively investigate the competitive market dynamic influences of bank reserve requirements. Specifically, he argues the unique regulatory environment in which banking firms operate serves to inflate their cost of funds relative to their less highly regulated counterparts. …

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