The Role of Debt Covenants in the Investment Grade Bond Market - The REIT Experiment

Posted: 14 Apr 2016

See all articles by Yongheng Deng

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

Erik Devos

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance

Shofiqur Rahman

University of Texas at El Paso

Desmond Tsang

McGill University - Desautels Faculty of Management

Date Written: April 12, 2016

Abstract

In general, investment grade bonds do not offer covenant protection. However, in the case of Real Estate Investment Trusts (REITs), investment grade REITs tend to include a covenant package that outlines limits on leverage and requires maintaining certain fixed charges and interest coverage ratios. This unique debt financing structure of REITs offers a natural environment to examine the importance and the need of debt covenants in the investment grade bond market. Our research aims to answer the following questions: 1. How common are debt covenants in the investment grade REIT bond market? 2. Are debt covenants binding in this market? 3. Do debt covenants affect the cost of debt? Our findings indicate that, in the REIT market, debt covenants are indeed common practice among investment grade REITs and, surprisingly, we find higher use of covenants by investment grade REITs compared to non-investment grade REITs. We show that debt covenants are seldom binding in this market, as investment grade REITs choose covenants provisions based on accounting ratios for which they seem to have enough slack. Finally, the cost of debt is lower when these investment grade REIT bonds are issued with covenants.

Keywords: Debt covenants; Investment grade bond; REIT

JEL Classification: G12, G32, R30

Suggested Citation

Deng, Yongheng and Devos, Erik and Rahman, Shofiqur and Tsang, Desmond, The Role of Debt Covenants in the Investment Grade Bond Market - The REIT Experiment (April 12, 2016). Journal of Real Estate Finance and Economics, Vol. 52, No. 4, 2016. Available at SSRN: https://ssrn.com/abstract=2763766

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison ( email )

4110 Grainger Hall
975 University Avenue
Madison, WI 53706
United States
+1 (608) 262-4865 (Phone)

HOME PAGE: http://https://bus.wisc.edu/faculty/yongheng-deng

Erik Devos (Contact Author)

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance ( email )

500 W. University Ave.
El Paso, TX 79968
United States
915 747 7770 (Phone)

HOME PAGE: http://utminers/utep.edu/hdevos

Shofiqur Rahman

University of Texas at El Paso ( email )

El Paso, TX TX

Desmond Tsang

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

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