REIT Capital Structure Choices: When Does Preparation Matter?

Pavlov, Steiner and Wachter (2018) find that REITs which prepared by reducing leverage and extending maturity prior to the 2007-2009 financial crisis outperformed their peers during the crisis, a result that holds in the presence of leverage and maturity level controls. While the authors document this finding, they are unable to identify its cause. The recent COVID-related market downturn and subsequent recovery offers a unique opportunity to extend this work and to test for why leverage adjustments before a crisis matter. Specifically, we document that the capital structure adjustments that have strong predictive power for the 2007-2009 financial crisis returns have no impact on the REIT returns during the COVID pandemic of 2020. The relevant difference between the two events is that the 2007-2009 financial crisis was largely predictable, especially for members of the real estate industry, while the COVID pandemic was truly unpredictable. Therefore, preparation prior to the 2007-2009 crisis was seen as a signal for managerial competence, but had no information value during the recent pandemic. In other words, managers are expected to prepare for changes in the external environment if and only if those changes are predictable.