Regulatory and Market Constraints' Effects on REITs' Capital Structure and Share Value. Debt Incentive and NAV Discount Effects

In contrast to the US experience, most international (European) REITs are subject to prudential regulation. This paper investigates the effects (i) on capital structure and, consequently, (ii) on REITs’share value of the major legal and market constraints (i.e. leverage limitations, market discount on NAV, tax controls) affecting REITS. Italian market data are used for the empirical analysis. Our hypothesis is that the effects on share price significantly depend on the adopted valuation perspective, i.e. if shares are valued following a NAV or a financial approach. The logic for this hypothesis is that the two valuation methodologies perceive leverage and implied financial risk differently. In particular, we argue that NAV valuation techniques incentivise REITs to maximize leverage regardless of financial theory indicating a contrasting impact of debt on shares’ market value. Differences in financial risk perception could also partially explain market prices discounts on NAV