The Role of Debt Covenants in the Investment Grade Bond Market – The REIT Experiment

The Role of Debt Covenants in the Investment Grade Bond Market – The REIT Experiment In general, investment grade bonds do not offer covenant protection. However, in the case of Real Estate Investment Trusts (REITs), investment grade REITs tend to include a covenant package that outlines limits on leverage and requires maintaining certain fixed charges and interest coverage ratios. This unique debt financing structure of REITs offers a natural environment to examine the importance and the need of debt covenants in the investment grade bond market. Our research aims to answer the following questions: 1. How common are debt covenants in the investment grade REIT bond market? 2. Are debt covenants binding in this market? 3. Do debt covenants affect the cost of debt? Our findings indicate that, in the REIT market, debt covenants are indeed common practice among investment grade REITs and, surprisingly, we find higher use of covenants by investment grade REITs compared to non-investment grade REITs. We show that debt covenants are seldom binding in this market, as investment grade REITs choose covenant provisions based on accounting ratios for which they seem to have enough slack. Finally, the cost of debt is lower when these investment grade REIT bonds are issued with covenants. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Real Estate Finance and Economics Springer Journals

The Role of Debt Covenants in the Investment Grade Bond Market – The REIT Experiment

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Publisher
Springer US
Copyright
Copyright © 2015 by Springer Science+Business Media New York
Subject
Economics; Regional/Spatial Science; Financial Services
ISSN
0895-5638
eISSN
1573-045X
D.O.I.
10.1007/s11146-015-9511-6
Publisher site
See Article on Publisher Site

Abstract

In general, investment grade bonds do not offer covenant protection. However, in the case of Real Estate Investment Trusts (REITs), investment grade REITs tend to include a covenant package that outlines limits on leverage and requires maintaining certain fixed charges and interest coverage ratios. This unique debt financing structure of REITs offers a natural environment to examine the importance and the need of debt covenants in the investment grade bond market. Our research aims to answer the following questions: 1. How common are debt covenants in the investment grade REIT bond market? 2. Are debt covenants binding in this market? 3. Do debt covenants affect the cost of debt? Our findings indicate that, in the REIT market, debt covenants are indeed common practice among investment grade REITs and, surprisingly, we find higher use of covenants by investment grade REITs compared to non-investment grade REITs. We show that debt covenants are seldom binding in this market, as investment grade REITs choose covenant provisions based on accounting ratios for which they seem to have enough slack. Finally, the cost of debt is lower when these investment grade REIT bonds are issued with covenants.

Journal

The Journal of Real Estate Finance and EconomicsSpringer Journals

Published: Jul 5, 2015

References

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