Decomposing Industry Leverage in the U.S.: the REIT Debt Puzzle

Abstract

Different industries exhibit significantly different leverage - the REIT sector is an extreme example. Their leverage ratio is twice as high as that of non-real estate firms in the U.S. We theoretically and empirically analyse why we observe a leverage ratio difference of 25.5 percentage points between these two groups. Firstly, we find that tangibility and operating risk are the most important capital structure determinants for deviation. By decomposing the difference into three channels (differences in determinants’ average values, varying sensitivities to changes in the values of the determinants and an industry-specific fixed effect), we find that the industry-specific channel explains around 67% of the difference. The value-based channel is mostly responsible for the remaining part. However, when comparing samples of REITs and non-real estate firms matched according to tangibility and operating risk in order to take non-linear influences of extreme values into account, the relevance of the industry-specific channel is considerably reduced. Therefore, the REIT debt puzzle is not mainly a consequence of an unexplainable industry-specific fixed effect but, with careful analysis, can ultimately be traced back almost completely to a value-based effect driven by the characteristics of tangible assets and stock returns’ risk.