Corporate Diversification and the Cost of Debt
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Corporate Diversification and the Cost of Debt Evidence from REIT Bank Loans and Mortgages Irem Demirci1 · Piet Eichholtz2 · Erkan Y¨onder3
© Springer Science+Business Media, LLC, part of Springer Nature 2018
Abstract This paper investigates whether corporate diversification by property type and by geography reduces the costs of debt capital. It employs asset-level information on the portfolios of U.S. REITs to measure diversification and looks at two of their main sources of debt capital: 1,173 commercial mortgages and 952 bank loans. The paper finds that diversification across different property types does indeed dependably reduce the cost of these different types of debt. The effect is about 7 basis points for bank loans if a firm’s property Herfindahl Index is lowered by one standard deviation and this effect gets stronger for REITs with worse financial health – as measured by the interest coverage ratio. The corresponding effect for commercial mortgages is around 22 basis points for collateral diversification by property type. After the crisis, the salience of the collateral asset increases. For diversification across regions, we do not find a consistent relationship between real asset diversification and loan pricing. Keywords REIT · Diversification · Cost of debt JEL Codes G31 · L25 · R33 Erkan Y¨onder
[email protected] Irem Demirci [email protected] Piet Eichholtz [email protected] 1
Nova School of Business and Economics Campus de Campolide, 1099-032, Lisboa, Portugal
2
School of Business and Economics, Maastricht University, P.O. Box 616, 6200 MD, Maastricht, The Netherlands
3
Ozyegin University, Nisantepe Mh. Orman Sk. 34–36, Alemdag, Cekmekoy, 34794, Istanbul, Turkey
I. Demirci et al.
Introduction Diversification has been called the only free lunch in Finance, and for many assets, the risk-reduction effects of diversification have been well documented. But whether lenders reward the lower risk resulting from a well-diversified portfolio by a lower cost of debt remains an open question, especially so for real estate. Franco et al. (2010) investigate the effect of corporate diversification on the cost of debt and find that diversified firms have lower bond spreads, especially when firms diversify across unrelated industrial segments. Hann et al. (2013) document that the cost of capital is substantially lower for diversified firms than for a portfolio of comparable single-segment firms, especially if the different segments of the diversified firms have low cash flow correlations. There exists also some evidence showing that banks with (regionally) diversified loan portfolios face a lower cost of debt (Deng et al. 2007). In a more recent paper, Aivazian et al. (2015) study the impact of diversification on contract terms of bank debt and find that diversified firms have significantly lower loan rates than their focused counterparts. As far as we know, these are the only papers investigating the issue and it has not been studied at all for real estate. However, re
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