̽��ֱ�� of Cambridge - real estate

Debt level analysis could help investors make sharper choices about real estate

tdk25 — Wed, 15 Jun 2016 04:00:48 +0000

Investors who buy stocks of Real Estate Investment Trusts in search of a “defensive security” should be careful to check those firms’ levels of debt before they commit, a new study suggests.

Real Estate Investment Trusts, or REITs, are publically listed companies that generate income by owning and operating large property portfolios. By purchasing stocks in these companies, investors can share in that income and any capital appreciation, without having to buy the capital-intensive properties themselves.

These stocks are often considered to be low-risk, because they typically generate high dividends for investors and used to be only moderately affected during periods of economic turmoil. As a result, they are often also attractive to the managers of pension and endowment funds looking for high, reliable long-term returns, and are often referred to as “defensive” stocks.

In the new study, however, two researchers from the Universities of Cambridge and Sydney point out that the performance of individual REIT stocks is not always as consistent as this suggests. Instead, they argue that investors should look carefully at certain characteristics within the specific firms.

In particular, they warn that investors should examine these firms’ overall leverage, or the amount of debt that they use to finance their assets. ̽��ֱ��more indebted the firm is, they suggest, the less robust these so-called defensive stocks are likely to prove, in particular during periods of economic downturn.

̽��ֱ��study was co-authored by Dr Eva Steiner, a Fellow and Director of Studies in Land Economy at St John’s College at the ̽��ֱ�� of Cambridge, UK, and Dr Jamie Alcock, from the ̽��ֱ�� of Sydney Business School.

“Investors sometimes think that because stock is generally classified as defensive, not much is going to happen to it in a downturn, but that may not be the case,” Dr Steiner said. “ ̽��ֱ��sensitivity of any stock to variation in the broader market environment will fluctuate over time and investors need to know more about the drivers of this sensitivity so that they can make sensible choices. We found that this depends, among other factors, on the overall financial position of the firm.”

̽��ֱ��idea that firm characteristics can be used to predict the overall sensitivity of its stock to market downturns has not been extensively investigated empirically until now. Most research has looked at the impact of broader, macro-economic trends, such as real and monetary conditions, on returns from real estate stocks, and this data suggests that they are, on average, quite resilient.

̽��ֱ��new study, however, shows that the state of a specific REIT can offer investors a more nuanced and accurate picture. Steiner and Alcock looked at a large sample of historical data about the returns and overall characteristics of numerous REIT firms in the United States, covering a 20-year period from 1993 to 2013. On average, they examined data for 55 firms during each quarter over the course of the two decades.

Unlike any previous study, they found that leverage was one of the sharpest means of predicting the likely stability of stocks in these companies – especially during downturns. ̽��ֱ��more debt a firm had, the more its stock proved sensitive to periods of recession – without any additional gains on the upside. ̽��ֱ��impact of this relationship seemed to be particularly pronounced during periods of extreme difficulty, such as the 2007/8 sub-prime mortgage crisis.

Other company characteristics also proved important predictors of stock sensitivity. For example, more defensive, lower-risk stocks were consistently associated with small, high-growth firms that were less intensively traded.

Similarly, the researchers found that companies which demonstrated strong growth opportunities were less sensitive to such change. This pattern, they suggest, may recur because such opportunities were often circumstantial, one-off prospects specific to those companies alone, meaning that they would not be affected by broader market fluctuations – making an investment in them more secure.

Although the findings could help investors to construct more robust portfolios capable of weathering an economic storm, the researchers point out that they could also offer guidelines for managers within REITs themselves.

“There are implications for investors at two levels – the ones who buy the stock, who need to know that they are making sensible choices, but also the REIT managers, for whom this has implications regarding the risk management of their firms,” Steiner said. “These results could help guide decisions about the investment risk of their firm, for example by choosing the appropriate level of leverage.”

̽��ֱ��research was funded by the Real Estate Research Institute. ̽��ֱ��paper, Fundamental Drivers of Dependence in REIT Returns, is published in ̽��ֱ��Journal of Real Estate Finance and Economics.

Retail and institutional investors alike often buy stocks in Real Estate Investment Trusts, because they are known as defensive stocks, able to withstand periods of economic downturn, but a new study explains why some of these companies could prove a much safer bet than others.

Investors sometimes think that because stock is generally classified as defensive, not much is going to happen to it in a downturn, but that may not be the case

Eva Steiner

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Houses on British money

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Capital structure used to gauge firms’ foundations

tdk25 — Mon, 09 Feb 2015 08:37:13 +0000

An analysis which shows how the financing activities, or “capital structure”, of real estate firms can be used as a barometer of their overall value has been published online.

̽��ֱ��research provides the first evidence-based assessment of which capital structure characteristics are common to successful firms in the US and several European countries. It promises to provide financial decision-makers with a model for enhancing company value, while also offering potential investors a litmus-test from which they can make sounder judgements about a firm’s overall strength.

̽��ֱ��work represents a break from traditional approaches to gauging company value, which often deliberately presume that a firm’s financing activity is irrelevant to the value of the firm itself. By making this presumption, economists can account for real-world stresses that might affect the financial decision-making that goes on inside a company, such as taxation, or fluctuations in capital markets.

By contrast, the new research argues that stronger firms nevertheless display consistent characteristics in how they finance their activities and manage debt, and that these can be used as a basis of gauging their value overall.

In particular, it suggests that low leverage – a low ratio of debt to the overall value of shares and assets – is a particularly strong and dependable indicator of the value of a firm.

̽��ֱ��study was commissioned by the European Public Real Estate Association (EPRA), and carried out by Dr Eva Steiner, a member of the Department of Land Economy and Fellow of St John’s College, ̽��ֱ�� of Cambridge, and Dr Timothy Riddiough, from the Wisconsin School of Business in the US.

“Most financial managers pick investments and look at how they can generate value; we look at how the manager can generate value themselves by making the right financial choices,” Dr Steiner said.

“Optimal capital structure is a multi-dimensional problem, and this is the first research to look at what combination of characteristics give, on the strength of the available evidence, the best firm value.”

̽��ֱ��study assessed all real estate firms covered by the SNL financial database, which collects and disseminates corporate, financial, market, and mergers and acquisitions data. Real estate companies are a good subject for a study of capital structure management because they own and operate large, long-term assets with changeable value, and need to be set up to handle a large amount of debt.

For US firms, the data covered the period from 1993 to 2012, while information was also collected about companies in Germany, France, the UK and the Netherlands between 2001 and 2012. ̽��ֱ��strength of these firms was measured using a standard rating called “Tobin’s Q”. Having organised the list of companies according to their annual Q ratios, the researchers then compared the capital structure characteristics of firms with the highest Q ratios with those of the lowest.

̽��ֱ��process revealed several features of financial strategy that were common to the highest-value firms. In particular, the strongest companies in the sample group maintained low levels of leverage, at a ratio of approximately 35%, whereas weaker firms had on average a higher leverage ratio of approximately 59%.

This inverse relationship between leverage and firm value was the strongest finding of the whole survey. “ ̽��ֱ��general robustness of this finding raises the question why firms deviate from what appears to be a clear, characteristic-informed optimal leverage ratio that is associated with significantly stronger firm value,” the authors note.

̽��ֱ��study also found several other strong indicators of company value. Stronger firms have longer debt maturity, matching the typically longer-term maturity of their assets, and a higher proportion of fixed-rate, rather than variable-rate debt.

Higher-value companies also tend to have lower levels of secured debt, whereas weaker firms typically pledge collateral when borrowing capital. “We found that stronger firms tend to be able to borrow on grounds of their overall creditworthiness,” Steiner said. “They can access capital markets trading on the quality of the firm, without having to rely on collateral to mitigate lender concerns.”

While all of these factors were indicative of value among companies in the US, in Europe the relationship between leverage and firm value was far more significant than the others. ̽��ֱ��authors suggest that this indicates that capital structure has a more consistent and decisive impact on company value in the US.

̽��ֱ��study is ongoing, with Steiner and Riddiough due to publish further analysis from their research in 2015. “Overall our findings suggest that a defensive, prudent capital structure with low leverage, aimed at matching debt and asset maturity and managing interest rate risk through utilising fixed-rate instruments, is able to make a significant contribution to firm value,” Steiner added.

̽��ֱ��full report can be found on the EPRA website.

Patterns in the financing activities of firms could be used as a litmus-test to determine company value, according to a new report.

Most financial managers pick investments and look at how they can generate value; we look at how the manager can generate value themselves by making the right financial choices

Eva Steiner

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Stock exchange workers. Typically the valuation of companiespresumes that capital structure does not influence value, but the new study identifies several consistent features among the financing activity of real estate firms

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