Shuffling through the Bargain Bin: Real-Estate Holdings of Public Firms
Irem Demirci, Umit G Gurun, Erkan Yönder
Review of Finance, Volume 24, Issue 3, May 2020, Pages 647–675, https://doi.org/10.1093/rof/rfz010
Collateral is an important aspect of debt contracts, and particularly when the borrower falls short on liquidity or defaults on its debt, asset-specific factors that determine the liquidation value of the collateral become a concern for the lender. Our paper investigates whether a firm’s financial health affects the liquidation value of its real estate assets. We assemble a unique dataset of real estate portfolios of nonfinancial public firms in the U.S. and identify each real estate property’s location, type, and other property-specific features. We obtain commercial real estate transactions data from Real Capital Analytics database which has tracked commercial property and portfolio sales in the U.S. since 2000.
We find that financially troubled firms sell their real estate assets at a significant discount relative to their healthy peers. One-standard deviation decrease in interest coverage ratio is associated with a 17% decrease in the transaction price. Our results are robust to using book leverage and a high leverage/low current asset dummy as alternative distress proxies and controlling for a battery of property and seller characteristics including market-by-year fixed effects and firm fixed effects. We find that the impact of a firm’s financial distress on the transaction price is exacerbated when the firm’s industry peers are also liquidity-constrained. There is also considerable cross-industry variation in the distress discount: the distress discount in commercial real estate is less prominent in machinery-heavy industries.
We analyze whether there is heterogeneity in the distress discount related to property-specific and sellers’ industry-specific characteristics. Two of these factors studied are asset redeployability and availability of potential buyers. While a distribution center with a specific layout can only be utilized by certain buyers, an office space can be purchased and used by buyers both within and outside the seller’s industry. We find that, unlike their more specialized counterparts, redeployable assets do not suffer large discounts. Shleifer and Vishny (1992) suggest that significant discounts in asset prices can occur if a financially distressed seller is forced to seek transaction opportunities during times when the best potential users of the asset are also liquidity-constrained. With the advantage of observing both seller characteristics and property location, we identify potential buyers from the same industry as the seller located in the same state as the property, and find that increasing number of potential buyers alleviates the discount on distress sales up to 50%.
Finally, we investigate whether a bank’s pricing of a loan reflects these determinants. To do so, we first estimate the value of the real estate asset holdings of the firms in their sample, and then calculate the fraction of assets with desirable redeployability characteristics. We show that a one-standard-deviation decrease in the interest coverage ratio is associated with a 0.15-standard-deviation increase in loan spreads for firms with below-median portfolio redeployability and potential buyers. Overall, these findings suggest that the property-specific factors that can affect collateral value are priced in debt markets.