WHY DO REITS ISSUE CONVERTIBLE DEBT?

Abstract

The objective of this dissertation is to investigate why REITs issue convertible debt and whether REITs view convertible debt as a substitute for straight debt and common equity. This is done by examining data from US REITs from 1986 – 2008 using trend analysis and security choice models. This dissertation first tracks convertible debt issues by US REITs over time and relate it to time varying conditions in the capital markets to test for possible market timing elements. We then employ both multinomial and binary logit models to examine the marginal financing decisions of REITs issuing convertible debt. The trend analysis provided evidence indicating possible market timing elements. Before 2002, REITs are noted to issue convertible debt over equity during downturns in general economy and poor performance of equity markets. They are also observed to issue convertible debt over debt when interest rates are low. After 2002, REITs begin to issue convertible debt during rising equity markets and when interest rates are high. This is consistent with the market timing theory. The multinomial logit regression showed strong support for the market timing theory and also, the view that convertible debt is a substitute for straight debt. The decision of REITs to issue convertible debt is strongly influenced by performance of NAREIT index and interest rate movements. Consistent with the risk insensitivity theory, REITs issuing convertible debt are found to be risky. The closer relationship of convertible debt issues with debt –related cost of financing can be attributed to the highly leveraged nature of REITs. Due to huge potential savings in interest expense, REITs are motivated to reduce debt-related costs of financing. Also, this dissertation shows that REITs issuing convertible debt belong to a unique category which is larger in size, highly profitable and more risky.