Capital structure of listed property firms: Lessons from a property investment reform

Abstract

Background: In 2013, most South African listed properties converted from legal structures allowing unlimited leverage and tax-deductible interest to real estate investment trusts (REITs), which limit leverage and eliminate interest tax-shield benefits.

Aim: This study investigates listed property capital structure determinants in the context of capital structure-relevant regulatory changes to ascertain the importance of regulatory limits and the capital structure trade-off theory for listed property.

Setting: South African listed property provides a unique opportunity to investigate capital structure decisions when subject to regulatory limits.

Method: Variables theoretically related to capital structure were regressed against leverage, with property firm legal form as an indicator variable, for an unbalanced panel of Johannesburg Stock Exchange-listed property firms between 2005 and 2019.

Results: Under the unlimited leverage regime and tax-shield benefit, capital structure decisions are better explained by trade-off theory, but with leverage restrictions and reduced tax-shield relevance, such decisions are better described by market timing and pecking order theories. Share price volatility is the key leverage determinant across the sample. Unexpectedly, under the limited leverage regime, leverage peaked well below regulatory limits, which are therefore less important than distribution limits.

Conclusion: Trade-off theory and regulator leverage limits are irrelevant to understanding capital structure decisions of REITs.

Contribution: Our results imply that listed property firm capital structures are not fully determined by regulations. The REITs, whose capital structure determinants are share price volatility and REIT size, consistent with market timing and pecking order theories, differ from non-property firms, whose capital structure typically accords with trade-off theory-based determinants.