The Cost of Debt for REITs: The Mortgage Puzzle
Journal of Real Estate Research, Forthcoming
Baruch College Zicklin School of Business Research Paper No. 2020-01-03
39 Pages Posted: 24 Feb 2020 Last revised: 28 Feb 2020
Date Written: December 28, 2018
Abstract
Established, low-leverage equity REITs with access to the public debt market rely on both non-recourse mortgages and full recourse bonds/notes as sources of long term debt. Interest rates on secured, non-recourse debt (mortgages) include a costly strategic default option premium and do not benefit from a firm's overall financial capacity. We find that use of non-recourse, mortgage debt is more likely for longer term, smaller borrowings, and during recessionary periods, consistent with REITs valuing financial flexibility in their capital structure. The higher rates for property level debt suggest a benefit to REITs versus single asset investors in terms of cost of capital. Since REITs also access debt at the corporate level, the spread between long-term non-recourse debt and long-term recourse debt implies a benefit to the REIT structure.
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