A new study by a group of European researchers shows that a diversified debt structure provides benefits to listed real estate companies through lower costs of debt and independence from single lending source.
From an investor perspective, investing in real estate companies with a diversified debt structure is advantageous since they have a better ability to seize investment opportunities, particularly in the presence of tight credit supply, the researchers claim.
European listed real estate investment companies have traditionally relied on bank lending, whereas the use of alternative funding sources has remained modest. However, this changed after the global financial crisis (GFC) and in recent years a large number of European listed real estate companies have started to diversify their debt sources.
While private borrowing has remained the most important source of financing for the listed real estate companies analysed in the survey during the period from 2001 to 2016, its relative role is decreasing. At the end of the period, the average share of private borrowings constituted 70%, the average share of the borrowings from capital markets was 22% and the shares of other debt sources, such as capital leases, convertible debt and money market instruments, were below the 5% level, having remained relatively stable over the whole examined period.
The results are based on an analysis of the debt structures of 102 European listed real estate companies, constituents of the EPRA Developed Europe Index, during the period from 2001 to 2016. According to the study, the maximum relative usage of private borrowing coincided with peaks of economic crises in 2001 and 2008. After both crises, private borrowing declined, while the volumes of borrowings from capital markets, including both bonds and money market instruments, increased.
However, the variation in debt diversification between companies is large, the study found. Almost one-third of the companies surveyed use just one type of debt, typically private loans. ‘This indicates that a significant number of the companies have not yet benefited from debt diversification,’ the researchers say.
Their analysis of the relationship between debt diversification and performance metrics shows that in the presence of credit supply constraints, debt diversification is associated with a lower cost of debt for the European listed real estate companies. In particular, one standard deviation increase in debt diversification level is associated with a 0.3 percentage point decrease in the cost of debt.
A second key metric affected by the degree of debt diversification is the level of investment activity. Listed real estate companies, and especially REITs, are dependent on debt financing in their acquisitions due to their limited ability to generate capital internally, the researchers point out. ‘Having a diversified debt structure could lead to competitive advantages if the companies are able to seize opportunities when their competitors face credit constraints.’
Their analysis of the relationship between debt diversification and investment ratios of the companies shows that in the presence of credit constraints, companies with a more diversified debt structure have significantly higher investment ratios. ‘A company with just one source of debt on average would have a 2.4 percentage point lower investment ratio than its peer with a perfectly diversified debt structure,’ they conclude.
This is an abridged version of an article that first appeared in the EPRA Industry Magazine. The article was written by Ranoua Bouchouicha, Lecturer in Real Estate Finance at the Henley Business School, University of Reading; Heidi Falkenbach, Assistant Professor in Real Estate Economics at Aalto University, Helsinki; and Alexey Zhukovskiy, doctoral student at Aalto University, Helsinki.
