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The Determinants of REIT Cash Holdings

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Abstract

The factors influencing the cash holdings of REITs are examined with the view that the REIT industry should yield new information regarding the drivers of corporate cash policy due to their unique operating conditions. The availability of REIT line of credit data also allows us to test the association between cash holdings and line of credit access and use. Data constraints in prior investigations have left this an unresolved empirical question in the cash holdings literature. The baseline results show that REIT cash holdings are inversely related to funds from operations, leverage, and internal advisement and are directly related to the cost of external finance and growth opportunities. Cash holdings are also negatively associated with credit line access and use. The results imply that REIT managers elect to hold little cash to reduce the agency problems of cash flow thereby increasing transparency and reducing the future cost of external capital.

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Notes

  1. 1.

    See Appendix 1 in Damodaran (2005) at http://pages.stern.nyu.edu/∼adamodar/pdfiles/papers/cashvaluation.pdf.

  2. 2.

    A REIT must meet three other provisions, in addition to the dividend payout restriction, to maintain their tax-exempt status. First, five-or-fewer shareholders may not hold more than 50% of the REIT’s stock. Second, at least 75% of the total assets of the REIT must consist of real estate, mortgages, cash, or federal government securities, and a minimum of 75% of the REIT’s gross annual income must be derived from the ownership of real estate properties. Last, REITs must derive their income from passive sources such as rents and mortgage interest and not from the short-term trading or sale of property assets. Prior to 2001, the dividend requirement was 95% of taxable earnings. The analysis presented uses REITs from the United States.

  3. 3.

    Wang et al. (1993) and Bradley et al. (1998) report similar results. Hardin and Hill (2008) examine the factors associated with REIT dividends in excess of the mandatory distribution.

  4. 4.

    In addition to the previously mentioned cites, please see the following for a full review of the corporate cash literature: Dittmar and Mahrt-Smith (2007), Faulkender and Wang (2006), Harford (1999), Harford et al. (2008), Mikkelson and Partch (2003), and Pinkowitz et al. (2006).

  5. 5.

    The following quote from page 104 of Feng et al. (2007) summarizes the issue well: “[s]ome authors assert that real estate assets are easier to value than other industries because they do not derive significant value from human capital and growth opportunities. Further, high dividend payment forces REITs to raise investment capital externally where scrutiny and monitoring by investment bankers enhance information dissemination. Others hold the contrarian view that real estate assets are illiquid and less transparent.”

  6. 6.

    The various agency problems caused by the use of external advisors are documented by Sagalyn (1996).

  7. 7.

    In a similar paper Capozza and Seguin (2000) find that the agency problem inherent to external advisement causes externally-advised REITs to underperform their internally-advised counterparts based on stock returns and Tobin’s Q.

  8. 8.

    Almeida et al. (2004) show, for a sample of non-REITs, that less financially constrained firms hold less cash than their financially constrained counterparts.

  9. 9.

    The SNL database has become more expansive over time as the REIT industry has matured and demand for extensive data has increased. While SNL continues to update its database with historical records, data prior to year-end 1999 is limited at present.

  10. 10.

    The null hypothesis of the equality of variance is rejected at the 1% level, so the t-test is calculated assuming unequal variances.

  11. 11.

    The null hypothesis of the equality of variance is rejected at the 1% level, so the t-test is calculated assuming unequal variances.

  12. 12.

    The following provides the SNL keyfields (in parentheses) for the variables used in the analysis: Cash (3727), Assets (220), FFO (6116), Market Value of Equity (6111), Total Liabilities (18083), Revenues (823), Total Debt (845), Amount Available from Credit Lines (6164), Amount Drawn From Credit Lines (6165), Property Sector (6270), and Advisor Type (63).

  13. 13.

    Multi-Family is used as the reference case in the regression models due to the findings in Table 2 showing that Multi-Family REITs post the lowest average cash-to-total assets ratio: 0.95%.

  14. 14.

    Endogeneity between cash holdings and line of credit use could be a concern since firms could determine line of credit use based on their cash position. Accordingly, we estimate a two-stage least squares model where line of credit use is instrumented with the lagged value of line of credit use. Although unreported, the estimated coefficient for DRAWN using 2SLS is similar to that reported in Models 3 and 4 and is still significant at the 1% level. The results are available upon request.

  15. 15.

    Alternatively, the effect of credit lines on REIT cash holdings can be modeled using unused line of credit capacity, calculated as lines of credit available minus amounts drawn and scaled by total assets. Similar to the results for DRAWN, unused line of credit capacity is negative and significant. Furthermore, the remaining results are robust upon the replacement of DRAWN with unused line of credit capacity.

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Acknowledgements

This paper is derived in part from the Ph.D. dissertation of M. Hill at Mississippi State University. The authors thank Chuck Beauchamp, Randy Campbell, Ken Cyree, Greg Nagel, Robert Van Ness, an anonymous referee, and seminar participants at the University of Mississippi, the 2006 American Real Estate Society (ARES) Annual Meeting Doctoral Consortium, the 2007 Eastern Finance Association Conference, and the 2007 Financial Management Association Annual Meeting for helpful comments and suggestions. Financial support and research assistance for this project was provided by the College of Business and Industry and the Warren Chair of Real Estate at Mississippi State University. All errors remain the sole property of the authors.

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Correspondence to Matthew D. Hill.

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Hardin, W.G., Highfield, M.J., Hill, M.D. et al. The Determinants of REIT Cash Holdings. J Real Estate Finan Econ 39, 39–57 (2009). https://doi.org/10.1007/s11146-007-9103-1

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Keywords

  • REIT
  • Cash
  • Liquidity
  • Cash flow
  • Working capital

JEL Classification

  • G12
  • G14
  • G24