Option Market-Based Predictors of REIT Leverage Changes

Abstract

We create market-based measures from options data to predict changes in REIT capital structure. REIT capital structure differs from that of typical listed firms: REITs have high leverage ratios of about 50 percent, their use of short-term debt is higher and more volatile, and debt issuance and reduction are much higher and more volatile than the typical Compustat universe. Given that REITs have high leverage and a volatile capital structure, predicting REIT capital structure change should be valuable. We do so using market-based measures which update at higher frequency than traditional accounting characteristics.Realized volatility and forward-looking risk expectations from option prices are significant predictors of both debt and equity issuance in REITs. Realized volatility is also a significant predictor of net changes in REIT leverage. Consistent with Borochin and Yang (2015), we find that REITs with higher historical volatility or fewer option contracts are less likely to increase leverage in the following quarter. Increases in the perception of REIT equity risk, measured by the spread between implied and realized volatilities, are negatively associated with equity issuance. The spread between call and put volatilities, a measure of expected REIT performance, is correlated with future debt issuance. Our explanation for these behaviors is that REIT managers use market information about risk as an input into their capital structure decisions.