Determinants Of The Capital Structure Of Residential Property Companies

The concept of financial leverage is a paradigm in real estate investment and vital to most investment decision making. Financial theory suggests that the amount of leverage indicates the degree of risk tolerance associated with an investment. Clearly, leverage increases the buying power of an investor and therefore the range of attainable investment opportunities. At the same time, however, this may lead to a potential bid-up in prices and introduces interest rate risk to an investment. It also increases subjection to financial institutions that may limit entrepreneurial activities. The cost of capital more and more defines the radius of action for all kinds of institutions, particularly property companies. Clearly, debt offers a variety of benefits and downsides that affect financial performance in multiple ways. This paper analyzes the determinants of the capital structure of residential property companies. Built on previous research in finance and established theories of capital structure the analysis uses financial data from a sample of >1,400 residential property companies in Germany. Both the Pecking Order Theory (POT) and the Trade Off Theory (TOT) are empirically modeled and tested. The results show that residential property companies only partially adjust their capital structure systematically according to POT or TOT.