REIT Leverage and Return Performance: Keep Your Eye on the Target

Abstract

This paper examines U.S. REIT leverage decisions and their effects on risk and return. We find that REITs are highly levered relative to industrial firms, with an average market leverage of 46 percent over our 1990-2012 sample period. Using partial adjustment models, we further find that the speed of adjustment at which REITs close the gap between current debt levels and target leverage levels is 17 percent annually, with over-levered REITs tending to adjust more quickly to their target leverage ratios than under-levered REITs. We also find that REITs that are highly levered relative to the average REIT tend to underperform REITs with less debt in their capital structure. However, REITs that are highly levered relative to their target leverage tend to perform better on a risk-adjusted basis than under-levered REITs. Taken together, our results show that REIT leverage has significant return performance effects conditional on deviations from target leverage.