Effects of Regulatory and Market Constraints on the Capital Structure and Share Value of REITs: Evidence from the Italian and European Market

Abstract

In contrast to the US experience, most international (European) REITs are subject to prudential regulation. This paper investigates the effects on capital structure and, consequently, on REITs’ share value of the major legal and market constraints (i.e. leverage limitations, market discount on NAV, tax controls) affecting non-US REITS. Italian market data are used for the empirical analysis.

Our hypothesis is that in a constrained environment the effects on share price significantly depend on the adopted valuation perspective, i.e. if shares are valued following a NAV or a financial approach. The logic for this hypothesis is that the two valuation methodologies perceive leverage and implied financial risk differently. In particular, we argue that NAV valuation techniques incentivise REITs to maximize leverage regardless of financial theory indicating a contrasting impact of debt on shares’ market value. Differences in financial risk perception could also partially explain market prices discounts on NAV.

Keywords: REITs regulation, leverage, NAV discount, constraints, REITs capital structure, REITs valuation

JEL Classification: G32, G23, G28, G30, G38