The effect of capital structure on the profitability of listed real estate invesment trusts (reits) in the united kingdom from 2007 to 2014

Explanation of the choice of short-term debt ratio STDR and long-term debt ratio LTDR and total debt ratio TDR as indicators of capital structure of Real Estate Investment Trusts REITs i

THE EFFECT OF CAPITAL STRUCTURE ON THE PROFITABILITY OF LISTED REAL ESTATE INVESTMENT TRUSTS (REITS) IN THE UNITED KINGDOM FROM 2007 TO 2014

ABSTRACT

The regulation for real estate investment trusts (REITs) in United Kingdom is introduced in January 2007 with the expectation that the REITs will be the solution for the scarcity of reasonably priced rental housing in UK and so many listed property firms

in UK chose to become REITs (Leone, 2011; Park, 2009) Many property companies have chosen to convert to REITs or many new REITs have been established since 2007 The objective of this study is to analyse the effect of capital structure on the profitability of listed Real Estate Investment Trusts (REITs) in United Kingdom from 2007 to 2014

A sample of 15 REITs in United Kingdom from 2007 to 2014 has been collected from the database Osiris, which is the database provided by University of Huddersfield Short-term debt ratio, long-term debt ratio and total debt ratio will be used as the indicators of capital structure of REITs in United Kingdom Return on asset and return

on equity will be used as the indicators of profitability of REITs in United Kingdom

This study finds out that there is a significant and negative effect of long-term debt ratio and total debt ratio on return on asset of REITs in United Kingdom There is the negative effect of short-term debt ratio on return on asset; however, this effect is insignificant In addition, it also finds out that there is a significant and negative effect of short-term debt ratio, long-term debt ratio and total debt ratio on return on equity of REITs

in United Kingdom These results may indicates that REITs in United Kingdom should use lest debt by reducing either short-term debt or long-term debt in order to increase their profitability

ACKNOWLEDGEMENT

I would like to express my sincere gratitude to my supervisor Pamela Anderson for her guidance, patience, motivation, and most importantly, her immense knowledge Her support in the learning sets helped me in all the time of research and writing of this dissertation I could not have imagined having a better supervisor for my master study

I would also like to thank Kay Smith for her comments in the learning sets Her comments has contributed a lot to the writing of this dissertation Finally, I would like to thank the Business School, University of Huddersfield has supplied the research resources like the Osiris database and the learning sets, which have helped me a lot in finishing this dissertation

TABLE OF CONTENTS

ABSTRACT i

ACKNOWLEDGEMENT ii

LIST OF TABLES vii

LIST OF FIGURES viii

LIST OF ABBREVIATIONS ix

CHAPTER ONE: INTRODUCTION 1

1.1 Background of the study 1

1.2 Research aims and objectives 4

1.3 Structure of the study 4

CHAPTER TWO: LITERATURE REVIEW 5

2.1 Introduction 5

2.2 The legislation of the Real Estate Investment Trusts (REITs) industry in United Kingdom 5

2.3 Profitability of Real Estate Investment Trusts (REITs) in United Kingdom 6

2.3.1 Previous studies about the indicators of profitability of Real Estate Investment Trusts (REITs) 6

2.3.2 Explanation of the choice return on asset (ROA) and Return on Equity (ROE) as indicators of profitability of Real Estate Investment Trusts (REITs) in United Kingdom 7

2.4 Capital structure of Real Estate Investment Trusts (REITs) in United Kingdom 8

2.4.1 Theories on capital structure of Real Estate Investment Trusts (REITs) 8

2.4.2 Explanation of the choice of short-term debt ratio (STDR) and long-term debt ratio (LTDR) and total debt ratio (TDR) as indicators of capital structure of Real Estate Investment Trusts (REITs) in United Kingdom 10

2.5 Previous studies on the relationship between short-term debt ratio (STDR) and profitability of Real Estate Investment Trusts (REITs) 12

2.5.1 Previous studies about the indicators of short-term debt ratio (STDR) 12

2.5.2 Previous studies about the relationship between short-term debt ratio (STDR) on the return on asset (ROA) 12

2.5.3 Previous studies about the relationship between short-term debt ratio (STDR) and return on equity (ROE) 13

2.6 Long term debt ratio (LTDR) 14

2.6.1 Previous studies about the indicators of long-term debt ratio (LTDR) of Real Estate Investment Trusts (REITs) 14

2.6.2 Previous studies about the relationship between long-term debt ratio (LTDR) and return on asset (ROA) 14

2.6.3 Previous studies about the relationship between long-term debt ratio (LTDR) and return on equity (ROE) 15

2.7 Total debt ratio (TDR) 16

2.7.1 Previous studies about the indicators of total debt ratio (TDR) 16

2.7.2 Previous studies about the relationship between total debt ratio (TDR) and the return on asset (ROA) 17

2.7.3 Previous studies about the relationship between total debt ratio (TDR) and return on equity (ROE) 18

2.8 Size as control variable 19

2.8.1 Explanation of choosing size as control variable 19

2.8.2 Previous studies about the indicator of size of Real Estate Investment Trusts (REITs) 20

2.8.3 Previous studies about the relationship of size and return on asset (ROA) 20

2.8.4 Previous studies about the relationship between size and return on equity (ROE) 21

2.9 Conclusion 21

CHAPTER THREE: RESEARCH DESIGN AND METHODOLOGY 22

3.1 Introduction 22

3.2 Research objectives and questions 22

3.3 Research approach 22

3.4 Sample selection 23

3.5 Data collection methods 23

3.6 Data analysis 24

3.6.1 Definition and measurement of variables 24

3.6.2 Descriptive statistics 25

3.6.3 Correlation coefficients 26

3.6.4 Multicollinearity 26

3.6.5 Multivariate linear regression 27

3.7 Hypothesis development 28

3.8 Conclusion 29

CHAPTER FOUR: DATA ANALYSIS AND DISCUSSION 30

4.1 Introduction 30

4.2 Descriptive statistics 30

4.2.1 Descriptive statistics of return on asset (ROA) and return on equity (ROE) 31

4.2.2 Descriptive statistics of short-term debt ratio (STDR), long-term debt ratio (LTDR) and total debt ratio (TDR) 33

4.2.3 Descriptive statistics of size 37

4.3 Results of correlation and expected relationship between capital structure and profitability of Real Estate Investment Trusts (REITs) in United Kingdom 38

4.3.1 Expected relationship between the indicators of capital structure and return on asset as the indicator of profitability of Real Estate Investment Trusts (REITs) in the United Kingdom 39

4.3.2 Expected relationship between the indicators of capital structure and return on equity (ROE) as the indicator of profitability of Real Estate Investment Trusts (REITs) in United Kingdom 39

4.4 Regression analysis and discussion of the effect of short-term debt ratio (STDR) on the profitability of Real Estate Investment Trusts (REITs) in United Kingdom 39

4.4.1 Effects of short term debt ratio (STDR) on profitability of on return on asset (ROA) 39

4.4.2 Effect of short-term debt ratio (STDR) on return on equity (ROE) 42

4.5 Effects of long-term debt ratio (LTDR) on profitability of Real Estate Investment Trusts (REITs) in United Kingdom 45

4.5.1 Effect of long- term debt ratio (LTDR) on return on asset (ROA) 45

4.5.2 Effect of long-term debt ratio (LTDR) on return on equity (ROE) 48

4.6 Effects of total debt ratio on profitability of Real Estate Investment Trusts (REITs) in United Kingdom 51

4.6.1 Effect of total debt ratio (TDR) on return on asset (ROA) 51

4.6.2 Effect of total debt ratio (TDR) on return on equity (ROE) 53

4.7 Size as control variable 56

4.7.1 Relationship between size and return on asset (ROA) 56

4.7.2 Relationship between size return on equity (ROE) 57

4.8 Hypothesis outcome 57

4.9 Conclusion 58

CHAPTER FIVE: RECOMMENDATIONS AND CONCLUSIONS 60

5.1 Introduction 60

5.2 Summary of the study 60

5.3 Limitations of the study 62

5.4 Recommendations for future studies 62

REFERENCE 64

APPENDICES 70

Appendix 1: Table of 40 listed REITs in UK from Osiris database 70

Appendix 2: Table of 28 listed REITs in UK chosen for the check of date of becoming REITs in UK 72

Appendix 3: Table of 15 listed REITs in UK chosen for the study 73

Appendix 4: Table of explanation of how the variable is collected and calculated 74

Appendix 5: Table of raw data collected from Osiris 75

Appendix 6: Table of the calculated data of variables used in the study 75

LIST OF TABLES

Table 4.1: Descriptive statistics of dependent and independent variables 30

Table 4.2: Correlations between independent variables and dependent variables 38

Table 4.3: Summary of model 1 40

Table 4.4: ANOVA of model 1 40

Table 4.5: Result of the regression model 1 41

Table 4.6: Summary of model 2 42

Table 4.7: ANOVA of model 2 43

Table 4.8: Result of the regression model 2 44

Table 4.9: Summary of model 3 45

Table 4.10: ANOVA of model 3 46

Table 4.11: Result of the regression model 3 47

Table 4.12: Summary of model 4 48

Table 4.13: ANOVA of model 4 49

Table 4.14: Result of the regression model 4 50

Table 4.15: Summary of model 5 51

Table 4.16: ANOVA of model 5 51

Table 4.17: Result of the regression model 5 52

Table 4.18: Summary of model 6 54

Table 4.19: ANOVA of model 6 54

Table 4.20: Result of the regression model 6 55

Table 4.21: Hypothesis outcome 57

LIST OF FIGURES

Figure 4.1: Normality histogram of ROA 31

Figure 4.2: Normality histogram of ROE 32

Figure 4.3: Normality histogram of STDR 33

Figure 4.4: Normality histogram of LDTR 34

Figure 4.5: Normality histogram of TDR 35

Figure 4.6: Normality histogram of SIZE 37

LIST OF ABBREVIATIONS

REITs : Real Estate Investment Trusts

ROA : Return on asset

ROE : Return on equity

STD : Short-term debt

LTD : Long-term debt

STDR : Short-term debt ratio

LTDR : Long-term debt ratio

TDR : Total debt ratio

EBIT : Earnings before interest and taxes

CHAPTER ONE: INTRODUCTION

1.1 Background of the study

Over the last decade, there is a crucial rise of investment into the real estate industry in the world, especially in the Real Estate Investment Trust (Park, 2009) The Real Estate Investment Trust (REIT) is defined as “a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages” (Ciartano, 2012, p.32) In other words, it is an investment vehicle, which allows the real estate shareholders to be like the shareholders in mutual funds (Park, 2009)

Each country has slightly different legislation on REITs but in common, the REITs will be considered a different tax treatment; moreover, the shareholders usually receive high return and considered it as a highly liquid way of investment in real estate market (Alias & Soi, 2011; Ciartano, 2012) Although the REIT regime has been introduced in the United States and many countries from 1960, the UK has to wait until

2007 to introduce its REIT legislation (Park, 2009) The UK property industry has increased with this legislation (Alias & Soi, 2011)

There is also the increase in the interest in the capital structure of the real estate firms because they have unique features, which are “safe and low risk stocks, with high underlying collateral value” (Westgaard, Eidet, Frydenberg & Grosas, 2008) Moreover, real estate firms in the UK has a distinctive operating environment with the existence of

a richer legislation of REITs (Westgaard et al., 2008) Westgaard et al (2008) argued that for the UK real estate firms choosing to become REITs, they would avoid the double taxation and receive lower tax rate on financing with equity

Feng, Ghosh and Sirmans (2007) indicate that REITs would not pay the corporate tax if they distribute more than 90 percent of its profit as dividends This will lead to the nullification of the two crucial advantages of debt The first one is the loss of tax deductibility of interest (Feng et al., 2007) In addition, Howe and Shilling (1988) argue that with the loss of the tax benefits, REITs will also have difficulty in the debt markets because the other tax-paying firms, which have the tax deductibility on interest payment

on debt and can afford for higher interest than REITs, will be preferred over REITs in the debt markets The second one is because of the distribution of most of its profits, the

“debt servicing is not critical in mitigating agency cost of free cash flow” and the value

of debt financing will be decreased by the financial distress costs (Feng et al., 2007, p.85)

In addition, the high dividend payout in the case of REITs also decreases the retained earnings available for investment, which will limit the financing choice to debt or equity (Feng et al., 2007)

Morri and Cristanziani (2009) argue that the high dividend payout also made REIT difficult to keep “an adequate level of free cash flows able to finance possible future positive NPV projects” With the low level of free cash flow, in either the situation of high profitability or low profitability, REITs have to use debt to finance their investment, which will increase the leverage ratio of REITs (Morri & Cristanziani, 2009) In addition, Baum and Devaney (2008) indicate that high gearing ratio could affect the volatility of net income of REITs in UK Net income is one of the factors in calculating return on asset and return on equity, which can be used as the indicators of the profitability of REITs in

UK (Tang & Jang, 2008) Therefore, it can be indicated that the high gearing ratio could affect the volatility of profitability of REITs in UK

There are theoretical arguments to support both high and low gearing ratios Anwar & Ali (2014) imply that the relationship between capital structure and profitability could be explained by some theories like trade-off theory or pecking-order theory According to the trade-off theory, REITs will tend to have a low debt ratio because REITs

do not have to pay corporate tax so they lose the benefits of the tax deductibility of interest, which is a motivation for debt (Feng et al., 2007) Therefore, if REITs choose to have high debt ratio, they will face the cost of financial distress, which will not be offset

by the value of the tax deductibility of interest As a result, trade-off theory indicates that REITs will tend to have a low debt ratio (Feng et al., 2007)

The pecking order theory argues that firms will finance through retained earnings

as the first choice, debt as the second choice and new equity as the final option (Abor, 2005) REITs paying out 90% of profits will decrease the retained earnings so the financing choice of REITs is restricted to debt and equity (Feng et al., 2007) It is indicated that the valuation of REITs is quite complicated; therefore, financing through debt or retained earnings would be preferred over equity (Feng et al., 2007) In addition,

although the benefits of the tax deductibility of interest payment of debt is removed, pecking order theory argues that firms can still choose to use debt as the source of financing because the firms want to avoid the probable discount of the value of new equity due to the adverse selection and information asymmetry (Feng et al., 2007) Overall, pecking order theory implies that REITs will choose debt over new equity; therefore, REITs will have high leverage ratio (Feng et al., 2007)

Profitability is often affiliated with the internal cash flows available to the firms, which indicate lower debt ratio (Feng et al., 2007) However, Feng et al (2007) indicate that there could be a positive association between leverage and profitability because REITs will have to distribute most of its profit so they will not keep much cash The high leverage ratio of REITs is expected to have a positive impact on the profitability of REITs only when the interest rate is low and real estate returns are high; however, it will be uncertain when the interest rates increase and the profit margins reduce during the decreasing markets (Park, 2009) It can be seen that there is a mixed prediction on the impact of capital structure on the profitability of REITs

Most of the studies in the relationship between capital structure and profitability are often focusing on analysing the effect of profitability on capital structure of the companies or profitability as the determinant of capital structure of REITs like the study

of Morri and Beretta (2008) and the study of Chikolwa (2011) There are some researches

in analysing the effect of capital structure on the profitability of listed companies like the study of Abor (2005), the study of Anwar and Ali (2014), the study of Claudiu (2013), the study of Mehdi, Farimah, Forough, Seyed and Jamshid (2013) and the study of Salawu (2009) However, few studies have been done in analysing the effect of capital structure

on the profitability of listed Real Estate Investment Trusts (REITs) in United Kingdom Other literatures discuss the effect of capital structure on profitability of other industries but REITs industry is different from other industries and the REITs’s legislation in UK is quite different as well so there is a need for more attention and research to investigate that effect in the UK REITs Therefore, this study will analyse the effect of capital structure

on the profitability of REITs in United Kingdom

1.2 Research aims and objectives

The objective of this study is to analyse the effect of capital structure on the profitability of listed Real Estate Investment Trusts (REITs) in United Kingdom from

2007 to 2014

1.3 Structure of the study

This study will consist of the following chapters

Chapter One is the introduction, which will present the background of the research and its objective

Chapter Two is the literature review, which will review the prior studies relating to profitability and capital structure of REITs in United Kingdom

Chapter Three is the research design and methodology, which will explain how the data

is collected and the methodology is used to analyse the data

Chapter Four is data analysis and discussion, which will present the analysis and discussion of the results

Chapter Five is conclusions and recommendations, which will provide the main lessons learnt from this research and indications that need for further research

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This chapter of the study will review the previous literatures, which are related to this area, to include them into the research with the aim of achieving the objectives of this study

Since the purpose of this research is to examine the effect of capital structure on the profitability of listed real estate investment trusts in United Kingdom, the second part

of this chapter will present the overview of legislation of the REITs industry in United Kingdom In the third part, previous literatures about the profitability of REITs in United Kingdom will be presented The fourth part will present the previous studies on the capital structure The fifth, sixth and seventh part will present the literature review on the relationship of the indicators of capital structure and the profitability of REITs in United Kingdom The eight part will present previous studies about size as control variable The final part will be the conclusion of this chapter

2.2 The legislation of the Real Estate Investment Trusts (REITs) industry in

United Kingdom

The regulation for UK real estate investment trusts (REITs) is introduced in January 2007 with the expectation that the REITs will be the solution for the scarcity of reasonably priced rental housing in UK and so many listed property firms in UK chose to become REITs (Leone, 2011; Park, 2009) Although the introduction of REITs legislation

in UK is later than other countries but the UK REITs sector quickly becomes the largest real estate securities sector in Europe and the fourth largest in the world in terms of size and market capitalization (Alias & Soi, 2011; Liow, 2010) When becoming a REITs in

UK, they have to distribute more than 90 percent of its profits as dividends so the REITs

in UK will not pay the corporate tax (Gaut, Featherstone, Heilpern, & John, 2006; Park, 2009) In addition, the REITs in UK are also required to satisfy the interest cover test which the interest cover ratio must be higher than 1.25 (Alias & Soi, 2011; Gaut et al., 2006) The interest cover ratio is the ratio of profit divided by the financing cost (Alias & Soi, 2011; Gaut et al., 2006) The aim of this test is that the REITs in UK will be not allowed to have high leverage ratio, “or at least subject to finance costs which reduce the

amount of profits available for distribution to shareholders” (Luck & Cant, 2008, p.4; Park, 2009 ) The reason for this restriction on leverage ratio of REITs in UK is because the high gearing ratio of REITs is argued to increase the profitability when there is low interest rate and high real estate returns; however, it will be uncertain when the interest rates increase and the profit margins reduce during the decreasing markets (Park, 2009)

Luck and Cant (2008) show that this test does not restrict the money that REITs

in UK want to borrow, however, the REITs in UK will be charged a tax if they violate the test This mean the ratio will indirectly not let the gearing ratio of UK REITs to be high

or exceed more than 80% (Alias & Soi, 2011; Gaut et al., 2006; Park, 2009) However, if the UK REITs do not satisfy the interest cover test and have the interest cover ratio less than 1.25 or they have the leverage ratio more than 80 %, the UK REITs, they will be fined by being charged on tax in accordance to the excess of debt (Alias & Soi, 2011) Park (2009) argues that the limitation on the legislation of REITs in UK is a crucial factor, which affected on the decrease of market value of REITs in UK Furthermore, some UK-REITs started “trading at discounts to net asset value” (Park, 2009, p.6)

Overall, it can be seen that the REITs will not pay corporate tax if they distribute more than 90 percent of its profits as dividends and they satisfy with the interest cover test; (Alias & Soi, 2011; Gaut et al., 2006; Park, 2009) However, these legislations reduce the retained earnings and restrict the level debt ratio, which may have impact of the profitability of REITs (Bers & Springer, 1997)

2.3 Profitability of Real Estate Investment Trusts (REITs) in United Kingdom 2.3.1 Previous studies about the indicators of profitability of Real Estate

Investment Trusts (REITs)

There are different views on the indicators of profitability of REITs Tang and Jang (2008) indicate that return on asset (ROA) and return on equity (ROE) could be used

as the indicators of profitability of REITs Similarly, Ho, Rengarajan, and Lum (2013) also use ROA and ROE as the indicators of the profitability of REITs

On the other hand, Morri and Beretta (2008) only use return on asset, which is calculated by dividing EBIT to total assets Similarly, Morri and Cristanziani (2009) use return on asset, which is the ratio of earnings before interest and taxes (EBIT) divided by total asset, to measure the profitability of European REITs Rovolis and Feidakis (2014)

also use the ratio of earnings before interest and taxes (EBIT) divided by total asset to measure the profitability of REITs

Zarebski and Dimovski (2012) only use return on equity, which is calculated as net income or net profit after interest and tax divided by total equity to measure for the profitability of REITs in Australia Similarly, Ambrose, Highfield and Linneman (2005) also use return on equity as the measure the profitability of REITs in the United States, which is calculated as the ratio of net income divided by total equity To measure for the profitability of listed firms in Malaysia, Salim and Yadav (2012) also use return on equity, which is calculated as the ratio of the net income divided by total equity

Overall, it can be seen that some studies use ROA or ROE while some studies uses both ROA and ROE as the indicators of the profitability of REITs ROA and ROE are two main indicators of the profitability of REITs

2.3.2 Explanation of the choice return on asset (ROA) and Return on Equity

(ROE) as indicators of profitability of Real Estate Investment Trusts (REITs) in United Kingdom

According to Tang and Jang (2008), return on asset indicates the profitability of a firm in related to its total assets, which include equity and liability, while return on equity indicates the profitability of a firm relative to its equity Therefore, a company with higher leverage ratio will probably have higher profitability with the same amount of return if using ROE as the indicator of profitability (Tang & Jang, 2008) Therefore, it is argued that ROE could a better measure for the profitability of the firms in analysing the effect of capital structure on the profitability (Tang & Jang, 2008) In addition, Gatsi (2012) argues that return on equity will imply the amount of the profit that will be given

to shareholders, who are extremely interested in the value maximization of the firms REITs have to distribute most of its profit to shareholders so shareholder will be more concerned of the profit distributed (Feng et al., 2007) Therefore, ROE is another important indicator of profitability of REITs in United Kingdom

Tang and Jang (2008, p.618) use return on asset as the indicator for profitability because their study wants to measure the profitability of hotel REITs and ROA can reflect

“management’s effectiveness in utilizing all available assets to create profit” This research will investigate the whole REITs sector in UK, which includes the hotel REITs

and other REITs sector, and the effect of capital structure on the profitability of REITs in UK; therefore, both ROA and ROE will be used as the indicators for the profitability of REITs in UK

2.4 Capital structure of Real Estate Investment Trusts (REITs) in United

Kingdom

2.4.1 Theories on capital structure of Real Estate Investment Trusts (REITs)

The capital structure of a company is about the how the company uses the debt, equity to finance for its business (Abor, 2005) Bers and Springer (1997) argue that the level of gearing will have the effect on the profitability of REITs The two main theories

on capital structure are the trade-off theory and pecking order theory, which support both high and low level of gearing (Anwar & Ali, 2014; Morri & Beretta, 2008)

2.4.1.1 Trade-off theory

According to the trade-off theory, REITs will tend to have a low debt ratio because REITs do not have to pay corporate tax so they lose the benefits of the tax deductibility

of interest, which is a motivation for debt (Feng et al., 2007) Therefore, if REITs choose

to have high debt ratio, they will face the cost of financial distress, which will not be offset by the value of the tax deductibility of interest As a result, trade-off theory indicates that REITs will tend to have a low debt ratio (Feng et al., 2007)

Ertugrul and Giambona (2011) also indicate that REITs will tend to have a low debt ratio because the underlying assumption of pecking order theories and trade-off theory are weakened in part by the legislation requirement of REITs For instance, REITs will distribute most of its profits as dividends and it will not have to pay the corporate tax Otherwise, dead weight costs are involved with the financial distress so the trade-off theory would say that REITs would have zero leverage ratio (Ertugrul & Giambona, 2011) However, the leverage ratio average of REITs in practice are approximately 45%, which are twice the average leverage ratio of manufacturing companies (Ertugrul & Giambona, 2011; Faulkender & Petersen, 2006) Similarly, Morri and Beretta (2008) argue that there is no empirical evidence in the REITs sector to support the trade-off theory; therefore, there is not clear association between leverage and profitability Morri and Beretta (2008, p.24) indicate that with the trade-off theory, the gearing will lead to

an increase in the likelihood of the bankruptcy and it let the companies to reduce “interest expenses from taxable income, thus making convenient for highly profitable firms to take

on large amounts of debt” However, REITs do not have to pay tax so debt will not force the high-quality companies to have higher gearing ratio (Morri & Beretta, 2008)

Overall, it can be seen that different studies have different views on the application

of the trade-off theory in explaining the capital structure of REITs Ertugrul and Giambona (2011) and Feng et al (2007) argue that REITs will tend to have a low debt ratio On the other hand, Ertugrul and Giambona (2011) and Morri and Beretta (2008) indicate that trade-off theory is limited in applying for analysing the capital structure of REITs as there is no empirical evidence in the REITs sector to support the trade-off theory

2.4.1.2 Pecking order theory

The pecking order theory argues that firms will finance through retained earnings

as the first choice, debt as the second choice and new equity as the final option (Abor, 2005) This also means that when the retained earnings are not enough, the firms will prefer debt to equity (Mehdi et al., 2013)

REITs paying out 90% of profits will decrease the retained earnings so the financing choice of REITs is restricted to debt and equity (Feng et al., 2007) It is indicated that the valuation of REITs is quite complicated; therefore, financing through debt or retained earnings would be preferred over equity (Feng et al., 2007) In addition, although there benefits of the tax deductibility of interest payment of debt is removed, pecking order theory argues that firms can still choose to use debt as source of financing because the firms want to avoid the probable discount of the value of new equity due to the adverse selection and information asymmetry (Feng et al., 2007) Overall, pecking order theory implies that REITs will choose debt over new equity; therefore, REITs will have high leverage ratio (Feng et al., 2007) According to Myers (1984, cited in Ooi,1999b, p 469), the pecking order theory also argues that using more debt will lead

to lower profitability so REITs is expected to have lower profitability when using more debt Overall, the pecking order theory indicates that REITs is expected to have high leverage ratio, which will result to low profitability

On the other hand, Ertugrul and Giambona (2011) argue that the pecking order theories is limited in applying for analysing the capital structure of REITs like the trade-off theory This theory’s fundamental assumption is that outsider investor will have less knowledge of company’s investment opportunities than its management (Ertugrul &

Giambona, 2011) As a result, the manager will tend to finance new projects with equity when equity is believed to be overvalued (Ertugrul & Giambona, 2011) Nevertheless, the adverse selection is diminished for REITs because the requirement of payout more than 90 percent of its profits as dividends restrict REITs’s access to internal funding (Ertugrul & Giambona, 2011) As a result, the “external equity financing should be less constrained for them” (Ertugrul & Giambona, 2011, p 508) In conclusion, the pecking order theory is unable to analyse why REITs will have high gearing ratio because REITs are required to distribute most of their earnings as dividends so REITs have a very small amount of retained earnings (Ertugrul & Giambona, 2011)

Overall, it can be seen that different studies have different views on the pecking order theory Feng et al (2007) argue that pecking order theory predicts that REITs is expected to have high leverage ratio, which will result to low profitability Ertugrul and Giambona (2011) argue that the pecking order theories is limited in applying for analysing the capital structure of REITs like the trade-off theory

2.4.2 Explanation of the choice of short-term debt ratio (STDR) and long-term debt ratio (LTDR) and total debt ratio (TDR) as indicators of capital structure of Real Estate Investment Trusts (REITs) in United Kingdom

The first reason that this study use short-term debt ratio (STDR) and long-term

debt ratio (LTDR), total debt ratio (TDR) as indicators of capital structure of Real Estate Investment Trusts (REITs) in United Kingdom is because REITs with different characteristics will have different level of short-term debt, long-term debt and total debt

It is indicated that two sources of debts for property companies in UK are short-term debt and long-term debt (Ooi, 1999a) Listed firms in property sector in UK with bigger size will tend to use more long-term debt while firms with smaller size will tend to use more short-term debt (Ooi, 1999a)

On the other hand, Ertugrul and Giambona (2011) argue that there are normal two kinds of REITs’s capital structure in the retail property sector The safer REITs will choose to adopt capital structure with more long-term debt so the cash flows will be more stable but there will be fewer chances for them to take advantage of the possible market conditions in the future, which favours them (Giambona et al., 2008, cited in Ertugrul, & Giambona 2011, p 507) Unlike the safer ones, the aggressive REITs tend to adopt capital structure with more short-term debt, which will bear more unstable or volatile cash flows

because they will have to renegotiate the rental contracts more often (Ertugrul, & Giambona 2011) However, the aggressive REITs can have more chances to take advantage of the possible market conditions in the future, which favours them (Ertugrul,

& Giambona 2011) The aggressive REITs are anticipated to have higher leverage than the safer ones (Maksimovic & Zechner, 1991) Overall, it can be seen that there will be some REITs tend to use more short-term debt while there will be some REITs tend to use more long-term debt Therefore, there is a need to analyse how short-term debt or long-term debt affects on the profitability of REITs in United Kingdom

The second reason that this study use short-term debt ratio (STDR) and long-term

debt ratio (LTDR), total debt ratio (TDR) as indicators of capital structure of Real Estate Investment Trusts (REITs) in United Kingdom is because there is the gap of previous literature of not focusing on analysing the effect of capital structure on the profitability

of REITs Most of the studies investigating that profitability as the determinant of the capital structure in REITs use total debt ratio as the main indicator for capital structure of REITs (Erol & Tirtiroglu, 2011; Ghosh, Giambona, Harding, & Sirmans, 2011; Morri & Cristanziani, 2009) On the other hand, studies investigating the effect of capital structure

on profitability use total debt ratio, short-term debt ratio and long-term ratio as the indicators for capital structure of listed companies, which have sample size including all industries and not focusing on REITS (Abor, 2005; Gatsi, 2012; Salim & Yadav, 2012) Moreover, Ooi (1999a) implies that not only the total debt but also the use of short-term debt and long-term debt of firms in property sector has changed a lot over years Giambona, Harding and Sirmans (2008) argue that REITs that have high total debt ratio will tend to have high long-term debt ratio while REITs that have low total debt ratio will tend to have high short-term debt ratio It can implied that if REITs have high total debt ratio and there is an effect of total debt ratio on profitability of REITs, there could be also

an effect of long-term debt ratio on the profitability of REITs On the other hand, if REITs have low total debt ratio and there is an effect of total debt ratio on profitability of REITs, there could be also an effect of short-term debt ratio on the profitability of REITs Therefore, there is a need to analyse the short-term debt ratio and long-term debt ratio to understand the effect of capital structure on profitability of REITs in United Kingdom

In order to fill the gap of previous literature of not focusing on analysing the effect

of capital structure on the profitability of REITs, this study will examine the impacts of

total debt ratio, short-term debt ratio and long-term ratio, which will be used as the indicators for capital structure, on the profitability of REITs in UK In addition, not only the previous literatures about the relationship between total debt and profitability of REITs but also previous literatures about impacts of total debt ratio, short-term debt ratio and long-term ratio on the profitability of all listed companies will also be reviewed because REITs is listed company and also included in the sample of the literatures of listed companies (Abor, 2005; Gatsi, 2012; Salim & Yadav, 2012)

2.5 Previous studies on the relationship between short-term debt ratio (STDR) and profitability of Real Estate Investment Trusts (REITs)

2.5.1 Previous studies about the indicators of short-term debt ratio (STDR)

Short-term debts are debts that have the maturity less than one year (Fosberg, 2012) Morri and Beretta (2008) calculate short-term debt ratio of REITs by dividing short-term debt to total assets Capozza and Seguin (2001) also use ratio of short-term debt divided by total assets as the short-term debt ratio of REITs Similarly, Lim and Sing (2014) also use ratio of short-term debt divided by total assets as the short-term debt ratio

of REITs in three Asian countries, which are Hong Kong, Japan and Singapore

2.5.2 Previous studies about the relationship between short-term debt ratio

(STDR) on the return on asset (ROA)

There are many studies finding a negative relationship between short-term debt ratio and return on asset of REITs (Chikolwa, 2011; Morri & Beretta, 2008) These results indicates that REITs choose to use short-term debt will have lower profitability measured by return on asset In addition, the negative relationship between short-term debt and return on asset can be explained by the argument that REITs do not have to pay tax so they will lose the benefits of tax shield of using debt (Feng et al., 2007) Therefore, there will be interest payment as the cost of using short-term debt This means using more short-term debt will result to lower profitability measured by return on asset because there will more costs associated with more short-term debt (Claudiu, 2013)

Chikolwa (2011) indicates that there is a negative relationship between short-term debt and return on asset for listed REITs in Australia from 2003 to 2008 Similarly, Morri and Beretta (2008) find out that there is a negative relationship between short-term debt and return on asset of REITs in US from 2002 to 2005 The similarity for the negative relationship between short-term debt and return on asset of REITs in two different

countries could be because both use the same formula for the indicators of short-term debt ratio and return on asset In addition, the size of REITs market in Australia is nearly the same the size of REITs market in the United States (Newell & Peng, 2009)

There are also other studies indicating about the negative relationship between long-term debt ratio and return on asset of listed companies, which include REITs in their sample Salim and Yadav (2012) find a significant negative relationship between short-term debt ratio and return on asset of listed firms in property sector in Malaysia from 1995-2011 Similarly, Ebaid (2009) also shows that short-term debt ratio will negatively affect the return on asset of listed companies in Egypt from 1997 to 2005 Olokoyo (2013) also finds that there is a negative relationship between short-term debt ratio and return on asset of listed companies in Nigeria from 2003 to 2007

This similarity between studies focusing only on REITs and studies including REITs in their sample could be because use the same measure for the short-term debt ratio and return on asset and the listed companies also include REITs (Chikolwa, 2011; Ebaid, 2009; Morri & Beretta, 2008; Olokoyo, 2013; Salim & Yadav, 2012)

2.5.3 Previous studies about the relationship between short-term debt ratio

(STDR) and return on equity (ROE)

Salim and Yadav (2012) find a negative relationship between short-term debt ratio and return on equity of listed firms in property sector, which includes REITs in the property sector, in Malaysia from 1995-2011 This result indicates that REITs in the property sector in Malaysia choose to use short-term debt will have lower profitability measured by return on equity The negative relationship between short-term debt and return on equity can be explained by the argument that REITs do not have to pay tax so they will lose the benefits of tax shield of using debt (Feng et al., 2007) Therefore, there will be interest payment as the cost of using debt This means using more short-term debt will result to lower profitability measured by return on equity because there will more costs associated with more debt (Claudiu, 2013)

It is indicated by many studies that there is a negative relationship between term debt ratio and return on equity of listed companies, which include listed REITs (Ebaid, 2009; Olokoyo, 2013) Ebaid (2009) shows that short term debt ratio will positively affect the return on equity of listed companies in Egypt, which include REITs

short-in its sample, from 1997 to 2005 Olokoyo (2013) fshort-inds that there is a negative

relationship between short-term debt ratio and return on equity of listed companies in Nigeria from 2003 to 2007 On the other hand, Abor (2005) indicates that there is a significantly positive relationship between return on equity and short-term debt ratio of listed companies in Ghana The potential reason for the difference in the result of the study of Abor (2005) with other studies could be because it is argued that the short-term debt in Ghana may be cheaper than other countries with lower interest rate; therefore, using more short-term debt could lead to higher return on equity

2.6 Long term debt ratio (LTDR)

2.6.1 Previous studies about the indicators of long-term debt ratio (LTDR) of Real Estate Investment Trusts (REITs)

Long-term debts are debts that will be paid off more than one year (Fosberg, 2012) Morri and Beretta (2008) calculate long-term debt ratio of REITs by dividing long-term debt to total assets Similarly, Lim and Sing (2014) also use ratio of long-term debt divided by total assets as the long-term debt ratio of REITs Harrison, Panasian and Seiler (2011) use ratio of long-term debt to total asset as the measure for the long-term debt ratio

of REITs Capozza and Seguin (2001) also use ratio of long-term debt divided by total assets as the long-term debt ratio of REITs

2.6.2 Previous studies about the relationship between long-term debt ratio (LTDR) and return on asset (ROA)

Morri and Beretta (2008) also find out that there is a negative and significant relationship between long-term debt and return on asset of REITs in US from 2002 to

2005 This finding indicates that if REITs finance their operation through long-term debt, their profitability measured by return on asset will decrease The negative relationship between long-term debt and return on asset can be explained by the argument that REITs

do not have to pay tax so they will lose the benefits of tax shield of using long-term debt (Feng et al., 2007) Therefore, there will be interest payment as the cost of using long-term debt This means using more long-term debt will result to lower profitability measured by return on asset because there will more costs associated with more long-term debt (Claudiu, 2013)

Erol and Tirtiroglu (2011) find similar results for the relationship between term debt ratio and return on asset of Turkish REITs in the period from 1998 to 2007, which is measured by the ratio of net income before interest and taxes over total assets

long-There is a negative but insignificant relationship between long-term debt ratio profitability of Turkish REITs; however, it is insignificant (Erol & Tirtiroglu, 2011) The difference in the results could be because Turkey may have the different legislation of REITs as the United States The Turkish REITs do not have to pay corporate tax like the REITs in the United States; however, the Turkish REITs are not required to distribute dividends (Erol & Tirtiroglu, 2011; Morri & Beretta, 2008)

There are also other studies indicating about the relationship between long-term debt ratio and return on asset of listed companies, which include REITs in their sample Liow (2010) argue that in real estate industry in general, the capital structure, which is measured by the ratio of long-term debt divided by total asset, negatively affect the profitability of 24 real estate companies in Asia, Europe and North America in the period

of 2000 to 2006, which is measured by the return on asset Salim and Yadav (2012) find

a negative relationship between long-term debt ratio and return on asset of listed firms in property sector in Malaysia from 1995 to 2011 Ebaid (2009) shows that long-term debt ratio will negatively affect the return on asset of listed companies in Egypt, which include REITs in its sample, from 1997 to 2005 Olokoyo (2013) finds that there is a negative relationship between long-term debt ratio and return on asset of listed companies in Nigeria from 2003 to 2007 According to Booth et al (2001), there is negative relationship between long-term debt ratio and return on asset as the indicator of the profitability of listed companies

The similarity in the findings of studies focusing only on REITs (Erol & Tirtiroglu, 2011; Morri & Beretta, 2008) and studies including REITs in its sample (Ebaid, 2009; Liow, 2010; Salim & Yadav, 2012) and could be because both use the same ration for long-term debt ratio and return on asset In addition, the real estate industry or all listed companies include the REITs and the period of investigation is nearly the same

2.6.3 Previous studies about the relationship between long-term debt ratio (LTDR) and return on equity (ROE)

Salim and Yadav (2012) find a significant negative relationship between term debt ratio and return on equity of listed firms in property sector, which includes REITs in the property sector, in Malaysia from 1995-2011 The negative relationship indicates that when REITs in property sector in Malaysia finance through long-term debt, their profitability measured by return on equity will decrease The negative relationship

long-between long-term debt and return on asset can be explained by the argument that REITs

do not have to pay tax so they will lose the benefits of tax shield of using long-term debt (Feng et al., 2007) Therefore, there will be interest payment as the cost of using long-term debt This means using more long-term debt will result to lower profitability measured by return on equity because there will more costs associated with more long-term debt (Claudiu, 2013)

It is also indicated by other studies that there is a negative relationship between long-term debt ratio and return on equity of listed companies, which include listed REITs (Ebaid, 2009; Olokoyo, 2013) Ebaid (2009) shows that long-term debt ratio will negatively affect the return on equity of listed companies in Egypt, which include REITs

in its sample, from 1997 to 2005 Similarly, Olokoyo (2013) finds that there is a negative relationship between long-term debt ratio and return on equity of listed companies in Nigeria from 2003 to 2007 Abor (2005) also indicates that there is a significantly negative relationship between return on equity and long-term debt ratio of listed companies in Ghana

2.7 Total debt ratio (TDR)

2.7.1 Previous studies about the indicators of total debt ratio (TDR)

Total debt is the sum of short-term debt and long-term debt Lim and Sing (2014) use ratio of total debt divided by total assets as the total debt ratio of REITs Similarly, Morri and Cristanziani (2009) also use ratio of total debt divided by total assets as the total debt ratio of REITs Huang, Liano and Pan (2009) also indicate the total debt ratio

of REITs as the ratio of total debt divided by total assets Capozza and Seguin (2001) also use ratio of total debt divided by total assets as the total debt ratio of REITs

On the other hand, Ho, Rengarajan, and Lum (2013) use the ratio of debt to equity

to measure the total debt ratio of REITs in Singapore The potential difference of the indicator for the total debt ratio of REITs of the study of Ho et al (2013) because this focus on a specific group of REITs which focus mainly on developing the green building, while other studies research on all kinds of REITs This study analyse the effect of capital structure on the profitability of all kinds of REITs; therefore, the total debt ratio will be used as one of the indicators of capital structure of REITs in the United Kingdom

2.7.2 Previous studies about the relationship between total debt ratio (TDR) and the return on asset (ROA)

The negative relationship between total debt ratio and ROA as the indicator for profitability of REITs is found in many different studies (Erol & Tirtiroglu, 2011; Ghosh, Giambona, Harding, & Sirmans, 2011; Morri & Cristanziani, 2009; Morri & Beretta, 2008) These findings from previous studies indicate that when REITs choose to use debt, the profitability of REITs measured by return on asset will decrease

According to Erol and Tirtiroglu (2011), there is a negative and significant relationship between total debt ratio and the profitability of Turkish REITs, which is measured by the ratio of net income before interest and taxes over total assets Ghosh, Giambona, Harding, & Sirmans (2011) also indicate that there is a negative relationship between total debt ratio, which is measured by the ratio of total debt divided by total asset, and profitability, which is measured by ROA, of 136 equity REITs from 1997 to 2006 Similar result is also found with the study of Morri and Cristanziani (2009), which imply that there is a negative relationship between total debt ratio and return on asset of REITs

in Europe from 2002 to 2006 Morri and Beretta (2008) also find out that there is a negative relationship between total debt ratio and return on asset of REITs in US from

2002 to 2005 The similarity in the findings of all the studies above could be because all

of them use the same formula for calculating the total debt ratio and return on asset and the legislation of REITs is quite similar in each country In addition, the negative relationship between total debt and return on asset can be explained by the argument that REITs do not have to pay tax so they will lose the benefits of tax shield of using debt (Feng et al., 2007) Therefore, there will be interest payment as the cost of using debt This means using more debt will result to lower profitability measured by return on asset because there will more costs associated with more debt (Claudiu, 2013)

On the other hand, Ho et al (2013) find out there is a positive and significant relationship between total debt ratio, which is measured by ratio of debt to equity and ROA of REITs in Singapore This finding contradicts to the results of (Erol & Tirtiroglu, 2011; Ghosh, Giambona, Harding, & Sirmans, 2011; Morri & Cristanziani, 2009; Chikolwa, 2011) The potential explanation for the difference is because the study of Ho

et al (2013) uses different ratio for the measure of total debt ratio, which is total debt divided by total equity In addition, the study of Ho et al (2013) researches on a specific

kind of REITs , which focus mainly on developing the green building, while other studies

of (Erol & Tirtiroglu, 2011; Ghosh, Giambona, Harding, & Sirmans, 2011; Morri & Cristanziani, 2009; Chikolwa, 2011) researches on all kinds of REITs

There are also other studies indicating about the relationship between total debt ratio and return on asset of listed companies, which include REITs in their sample (Booth, Aivazian, Demirguc-Kunt, Maksimovic, 2001; Ebaid, 2009; Olokoyo, 2013; Salim & Yadav, 2012; Salawu, 2009) Salim and Yadav (2012) find a significant negative relationship between total debt ratio and return on asset of listed firms in property sector

in Malaysia from 1995-2011 According to Booth et al (2001), there is negative relationship between total debt ratio and return on asset as the indicator of the profitability

of listed companies Ebaid (2009) shows that total debt ratio will negatively affect the return on asset of listed companies in Egypt, which include REITs in its sample, from

1997 to 2005 Olokoyo (2013) finds that there is a negative relationship between total debt ratio and return on asset of listed companies in Nigeria from 2003 to 2007 Salawu (2009) finds that there is a negative relationship between total debt ratio and return on asset of listed companies in Nigeria from 1990 to 2004

This finding shows that the negative relationship between return on asset and total debt ratio is found not only in REITs sector but also for other sectors as well The similarity in the findings of studies focusing only on REITs and studies including REITs

in its sample could be all of them use the same formula and the real estate industry or all listed companies include the REITs

This study analyses the effect of capital structure on the profitability of listed REITs in UK UK is in Europe and has similar legislation on REITs with other countries

in Europe; therefore, based on the literature review of Morri and Cristanziani (2009), a negative relationship between total debt ratio and return on asset as the indicator for the profitability of REITs in UK is expected

2.7.3 Previous studies about the relationship between total debt ratio (TDR) and return on equity (ROE)

There are different findings in the relationship between total debt ratio and return

on equity Salim and Yadav (2012) find a significant negative relationship between total debt ratio and return on equity of listed firms in property sector, which include REITs, in Malaysia from 1995-2011.This means that REITs in the property sector in Malaysia will

have lower profitability measured by return on equity when they choose to finance their operation through using debt The negative relationship between total debt and return on equity can be explained by the argument that REITs do not have to pay tax so they will lose the benefits of tax shield of using debt (Feng et al., 2007) Therefore, there will be interest payment as the cost of using debt This means using more debt will result to lower profitability measured by return on equity because there will more costs associated with more debt (Claudiu, 2013)

On the other hand, Ho et al (2013) find out there is a positive and significant relationship between total debt ratio, which is measured by ratio of total debt to total equity and ROE as the indicator of profitability of REITs in Singapore The potential explanation for the difference is because the study of Ho et al (2013) use different ratio for the measure of total debt ratio, which is total debt divided by total equity while the studies of Salim and Yadav (2012) use the ratio of total debt divided by total asset In addition, the study of Ho et al (2013) research on a specific kind of REITs , which focus mainly on developing the green building, while the studies of Salim and Yadav (2012) include all kinds of listed REITs in the property sector

There are also other studies indicating about the relationship between total debt ratio and return on asset of listed companies, which include REITs in their sample Olokoyo (2013) finds that there is a negative relationship between total debt ratio and return on equity of listed companies in Nigeria from 2003 to 2007 On the other hand, Abor (2005) argues that there is a positive relationship between total debt ratio and ROE

as the indicator of the profitability of listed companies in Ghana from 1998 to 2002 Ebaid (2009) also shows that total debt ratio will positively affect the return on equity of listed companies in Egypt, which include REITs in its sample, from 1997 to 2005 These findings of listed firms are contrast to the result of Salim and Yadav (2012) on property companies but similar to the finding of Ho et al (2013) on REITs

2.8 Size as control variable

2.8.1 Explanation of choosing size as control variable

Size is added in our study to control for the difference in size of different REITs

in UK because it is argued that size of REITs is a crucial determinant in deciding REITs‘s strategic policies; therefore, it may impact their profitability (Morri & Beretta, 2008) Ambrose and Linneman (2001) imply that there is a positive relationship between firm

size and profitability Similarly, Ertugrul and Giambona (2011) also find out that REITs with larger size are more profitable Larger REITs are also found out to have higher profitability in the study of Capozza and Senguin (1998) and the study of Bers and Springer (1997) On the other hand, McIntosh, Liang and Tompkins (1991) find that REITs will smaller size are more profitable

2.8.2 Previous studies about the indicator of size of Real Estate Investment Trusts (REITs)

Morri and Beretta (2008) use the natural logarithm of total assets as the measurement for the firm size of REITs Similarly, Ghosh et al (2011) also take natural logarithm of total assets as the measurement for the firm size of REITs Ebaid (2009) uses the natural logarithm of total assets as the measurement for the firm size of listed firms in Egypt from 1997 to 2005 Salim and Yadav (2012) also use the natural logarithm

of total assets as the measurement for the firm size of listed firms in property sector, which includes REITs, in Malaysia from 1995-2011

2.8.3 Previous studies about the relationship of size and return on asset (ROA)

There are different views on the effect of size on the return on asset, which is the indicator of the profitability of REITs Morri and Beretta (2008) find out that there is a negative relationship between size and return on asset as the indicator of profitability of REITs This indicates that small REITs will tend to concentrate on accomplish their financial return instead of achieving economies of scale (Morri & Beretta, 2008)

There are also other studies indicating about the negative relationship between size and return on asset of listed companies, which include REITs in their sample Booth

et al (2001) show that there is a negative relationship between size and return on asset as the indicator of the profitability of listed firms in different countries This is similar to the study of Morri and Beretta (2008) The potential reason could be because the sample of study of Booth et al (2001) also includes listed REITs and they have the similarity in the legislation of REITs

On the other hand, Salim and Yadav (2012) find a positive relationship between size and return on asset as the indicator of the profitability of listed firms in property sector, which includes REITs, in Malaysia from 1995-2011 This is contrast to the findings of the study of Morri and Beretta (2008) The potential reason could be because Morri and Beretta (2008) find the negative relationship by looking at the correlation,

while Salim and Yadav (2012) run the regression model with return on asset as the dependent variable and size as the control variable In addition, the study of Morri and Beretta (2008) investigate in the sample of equity REITs, while the study of Salim and Yadav (2012) includes different kinds of REITs

2.8.4 Previous studies about the relationship between size and return on equity (ROE)

Ambrose et al (2005) indicate that there is a positive and significant relationship between return on equity as the indicator of the profitability of REITs and size of REITs

It is argued that large REITs usually have “relatively lower general and administrative fixed costs that reflect in an increase in profit margins” (Ambrose et al., 2005, cited in Morri, & Beretta, 2008, p 32) Similarly, Salim and Yadav (2012) find a positive and significant relationship between size and return on equity as the indicator of the profitability of listed firms in property sector, which includes REITs, in Malaysia from 1995-2011 The potential explanation for the similarity in the results could be because the both of studies use similar formula for the ratio of return on equity and size

2.9 Conclusion

This chapter provides a review of relevant literatures in the effect of capital structure on the profitability of listed real estate investment trusts in United Kingdom It shows that return on asset and return on equity can been used as the indicators of the profitability of listed Real Estate Investment Trusts (REITs) in United Kingdom Long-term debt ratio, short-term debt ratio and total debt ratio can be us used as the indicators

of the capital structure of listed Real Estate Investment Trusts (REITs) in United Kingdom There are different views on the relationship between the capital structure, which is measured by the short-term debt ratio, long-term debt ratio and total debt ratio, and the profitability, which is measured by return on asset and return on equity, of REITs

in United Kingdom The size variable will be included in the study to control for its impact

on the profitability The next chapter will be the research design and methodology

CHAPTER THREE: RESEARCH DESIGN AND

METHODOLOGY

3.1 Introduction

The research design and methodology is about how to collect and examine necessary data to solve the research objectives (Sekaran & Bougie, 2010) Therefore, this chapter will explain how the data is collected and develop the methodology to reach the solution of this research The second part of this chapter will be about the research objectives and questions The third part of this chapter will be about the research approach The fourth part of this chapter is about how the sample is selected The fifth part of this chapter is about the data collection methods The sixth part of the chapter is about how that data will be analysed The seventh part of this chapter is about the hypothesis development The eight part is the conclusion of this chapter

3.2 Research objectives and questions

The objective of this research is to analyse the effect of capital structure on the profitability of listed Real Estate Investment Trusts (REITs) in United Kingdom since

2007 With this objective, this research has only one main following question:

1 What is the effect of capital structure on the profitability of listed Real Estate Investment Trusts (REITs) in United Kingdom from 2007 to 2014?

3.3 Research approach

According to Saunders, Lewis and Thornhill (2009), there are two kinds of research approach, which are deductive approach and inductive approach With the deductive approach, the theoretical framework is developed first and then the data will be collected to test the research question With the inductive approach, the data will be collected first and then the theories will be developed later (Saunders et al., 2009) This study will use the deductive approach because from the literature chapter, it has developed the theoretical framework to analyse the effect of capital structure on the profitability of REITs in United Kingdom Therefore, this chapter will collect data and develop the methodology to answer the research question

3.4 Sample selection

Data will be collected from Osiris, which is the database provided by University

of Huddersfield Because the law for REITs in UK is introduced since January 2007, so some REITs are converted from property organizations and some established in year 2007 (Leone, 2011) Therefore, this research will use the year 2007 as the starting year The newest data for the REITs in UK from Osiris are up to 2014 Overall, this study will investigate the effect of capital structure on the profitability of listed Real Estate Investment Trusts (REITs) in United Kingdom from 2007 to 2014

Sample construction starts by identifying all REITs listed in UK from 2007 to

2014 This study will use the accounts with the year ending in that year although the data for each REITs in the United Kingdom will be published in different periods in a year, which can be in March, June, August, September and December The Osiris database provides that there are currently 40 listed REITs in the United Kingdom However, there

is one company, which is INVESCO PROPERTY INCOME TRUST LIMITED, has been suspended from listing since 28 July 2014 so there are only 39 listed REITs from 2007 to

2014 (INVESCO PROPERTY INCOME TRUST LIMITED, 2014) In addition, there are two companies listed in the United Kingdom, which are TALIESIN PROPERTY FUND LIMITED and GLOBALWORTH REAL ESTATE INVESTMENTS LIMITED, but their investment are in Germany and Romania (GLOBALWORTH REAL ESTATE INVESTMENTS LIMITED, 2015; TALIESIN PROPERTY FUND LIMITED, 2015) Therefore, these two companies are also excluded from our study

After dropping REITs with missing data, there are 28 REITs suitable for our research (See Appendix 1) However, each REIT has the different period of having REIT status Therefore, the researcher will identify which year the companies becoming the REITs and will only select REITs that have become REITs since 2007 and have the full data in all years from 2007 to 2014 (See Appendix 2) After dropping REITs with unsuitable data, the final sample consist of 120 observations from a total of 15 listed REITs, which were REITs for the full time period (See Appendix 3)

3.5 Data collection methods

There are two different kinds of data, which are primary and secondary data (Sekaran & Bougie, 2010) Primary source refer to “information obtained first-hand by

the researcher on the variables of interest for the specific purpose of the study” (Sekaran

& Bougie, 2010, p 180) On the other hand, the secondary data is the information which

is collected from existed sources and this data are “accessed through the Internet or perusal of recorded or published information” (Sekaran & Bougie, 2010, p 184) In addition, secondary data is less time-consuming and cheaper in acquiring information than primary data (Sekaran & Bougie, 2010)

This research will use the secondary data because all REITs are listed companies; therefore, it is easy to access the data from annual reports of REITs in UK, which are freely published on the Internet and is required to answer the research question

3.6 Data analysis

This research will examine the effect of capital structure on profitability of 15 listed REITs in United Kingdom from 2007 to 2014 Therefore, 120 observations will be examined in this study It is argued that the ratio of the minimum number of observations divided by the number of independent variables should be larger than 5 (Kinde, 2012) Therefore, with four independent variables, the minimum number of observations in this study should be higher than 20 so the number of 120 observations investigated is acceptable On the other hand, Hair et al (2006, cited in Kinde, 2012, p.4) also indicate that the desired ratio of number of observations divided by number of independent variables should be above 15 This means that the desired number of observations should

be larger 60 Therefore, according to Hair et al (2006, cited in Kinde, 2012, p.4), the number of 120 observations from 15 listed REITs in United Kingdom is also acceptable

The raw data will be put into Excel to calculate the final data need for each variable Afterwards, the SPSS programme will be used in this study to run the descriptive statistics, the correlation matrix between dependent variables and independent variables and the regression models

3.6.1 Definition and measurement of variables

Based on the research on of the study of Tang and Jang (2008) and the study of

Ho et al (2013), both return on asset (ROA) and return on equity (ROE) will be chosen

as the indicators of profitability of REITs in the United Kingdom

Return on asset is calculated as the ratio of earnings before interest and tax (EBIT) divided by total asset like the studies of Morri and Beretta (2008), Morri and Cristanziani (2009) and Rovolis and Feidakis (2014)

Return on equity is calculated as the ratio of net income, which is profit after interest and tax, divided by total equity like the studies of Ambrose et al (2005) and Zarebski and Dimovski (2012)

Based on the research on different literatures of Abor (2005) and Ooi (1999a), short-term debt ratio (STDR), long-term debt ratio (LTDR) and total debt ratio (TDR) will be used as the indicators of capital structure of REITs in United Kingdom

Short-term debt ratio (STDR) is calculated as the ratio of short-term debt divided

by total asset like the studies of Capozza and Seguin (2001), Morri and Beretta (2008) and Lim and Sing (2014)

Long-term debt ratio (LTDR) is calculated as the ratio of long term debt divided

by total asset like the studies of Capozza and Seguin (2001), Harrison et al (2011), Lim and Sing (2014) and Morri and Beretta (2008)

Total debt ratio (TDR) is calculated as the ratio of total debt divided by total asset like the studies of Capozza and Seguin (2001), Huang et al (2009), Lim and Sing (2014) and Morri and Cristanziani (2009) Total debt is calculated as the sum of short-term debt and long-term debt

Size will be added in the regression model to control for the impact of size on the profitability (Ebaid, 2009) Size of REITs (SIZE) is calculated as the log of total assets like the studies of Ghosh et al (2011) and Morri and Beretta (2008)

3.6.2 Descriptive statistics

Descriptive statistics will help the study to identify the central tendency and the

dispersion of each variable (Saunders et al., 2009) The mean and median, of each variable

will be analysed to measure for the tendency of each variable (Saunders et al., 2009; Sekaran & Bougie, 2010) In addition, the minimum and maximum value, the standard deviation of each variables will also be examined to measure for the dispersion of each

variable (Saunders et al., 2009; Sekaran & Bougie, 2010)

The normal distribution of each variable will also be investigated in order to make sure that “the sample subjects are not chosen from extremes, but are truly representative

of the properties of the research” (Sekaran & Bougie, 2010, p.266) If the sample represents more the population, that results of the study can have higher generalizability, which indicates the larger range of the applicability of the results of the study (Sekaran

& Bougie, 2010) Saunders et al (2009) also indicates that distribution of the sample is more normal, it will be more robust

The normal distribution will be examined by looking at the normality histogram

of each variable (Saunders et al., 2009) There will be three kinds of distributions, which are skew more to the right, skew more to the left and normal (Saunders et al., 2009)

3.6.3 Correlation coefficients

This study include many variables so after examining the descriptive statistics, this study will investigate the relationships between variables by looking at the correlation coefficients (Sekaran & Bougie, 2010) The coefficient of correlation coefficient can be any value from -1 to 1 Saunders et al (2009)

The test of the correlation between variables will not help to identify whether the independent variables have the effect on dependent variable but it will help to identity the associations between variables (Sekaran & Bougie, 2010) The Pearson correlation coefficient will be used to test for the relationship between independent and depend variables, as it is “appropriate for interval- and ratio-scaled variables” (Sekaran & Bougie,

From the table 1, it can be seen that most of the correlation between independent variables are smaller than 0.7 The only exception is the case of the very high correlation between the long-term debt ratio and total debt ratio, which is 0.786 and significant at 1% level The high correlation between the long-term debt ratio and total debt ratio indicates that there could be the multicollinearity in this study if running a regression model with long-term debt ratio and total-debt ratio in the same model Therefore, to avoid multicollinearity of running long-term debt ratio and total-debt ratio in the same model, each debt ratio will be tested separately in different model

3.6.5 Multivariate linear regression

The regression model will be used to test the effect of capital structure on the profitability of REITs (Saunders et al., 2009) This research will utilize the regression model of Abor (2005), which analyses the effect of capital structure on profitability of listed companies in Ghana However, this study is to analyse the effect of capital structure

on profitability of listed REITs in United Kingdom so it will use different formula for the ratio of variables, which is suitable for the case of REITs There are two indicators for profitability, which are ROA and ROE and three indicators for the capital structure, which are STDR, LTDR, TDR, so the six following models of this study will be:

Model 1: ROAi = β0 + β1 * STDRi + β2 * SIZEi +ε

Model 2: ROEi = β0 + β1 * STDRi + β2 * SIZEi + ε

Model 3: ROAi = β0 + β1 * LTDRi + β2 * SIZEi + ε

Model 4: ROEi = β0 + β1 * LTDRi + β2 * SIZEi + ε

Model 5: ROAi = β0 + β1 * TDRi + β2 * SIZEi + ε

Model 6: ROEi = β0 + β1 * TDRi + β2 * SIZEi + ε

Where:

- ROAi is the return on assets for the ith observation;

- ROEi is the return on equity for the ith observation;

- STDRi is the short term debt ratio for the ith observation;

- LTDRi is the long term debt ratio for the ith observation;

- TDRi is the total debt ratio for the ith observation;

- SIZEi is the size for the ith observation;

- β0 is the intercept coefficient of the model;

- β1, β2 are respectively coefficients for each independent variables of each regression model;

- ε is the error term of the model

The R-square of each regression model will be examined to how many percent of the variability of the dependent variable can be explained by the independent variable (Saunders et al., 2009; Sekaran & Bougie, 2010) The analysis of variance (ANOVA) will

be used to checked the significance of the model (Saunders et al., 2009; Sekaran & Bougie, 2010) Afterwards, the coefficient of each independent variable will be examined

to consider whether that independent variables have the negative or positive effect on the dependent variables In addition, the significant level of the effect will be also analysed

to consider whether the effect is statistically significant or insignificant

3.7 Hypothesis development

This research examines the effect of capital structure in terms of short-term debt ratio, long-term debt ratio and total debt ratio on the profitability of REITs in United Kingdom, which will be measured by return on asset and return on equity Moreover, hypothesis development is to specify statements, which can be tested, as the predictions

of what are expected to find in the data (Sekaran & Bougie, 2010) Therefore, six null hypothesis will be examined:

Ho1: There is an effect of short-term debt ratio (STDR) on return on assets (ROA) of listed REITs in United Kingdom

Ho2: There is an effect of short-term debt ratio (STDR) on return on equity (ROE) of

Ho3: There is an effect of long-term debt ratio (LTDR) on return on assets (ROA) of listed REITs in United Kingdom

Ho4: There is an effect of long-term debt ratio (LTDR) on return on equity (ROE) of listed REITs in United Kingdom

Ho5: There is an effect of total debt ratio (TDR) on return on equity (ROA) of listed REITs

in United Kingdom

Ho6: There is an effect of total debt ratio (TDR) on return on equity (ROE) of listed REITs

in United Kingdom

3.8 Conclusion

This chapter clarifies on how this research is designed and which methodology will be used to analyse the impact of capital structure on the profitability of REITs in United Kingdom In addition, it also investigates how the data analysis will be done The following chapter will be about the analysis and discussion

CHAPTER FOUR: DATA ANALYSIS AND DISCUSSION

4.1 Introduction

This chapter will present the research empirical results and analyse the significance of the results In addition, this chapter also compare the results with the previous studies The second part of this chapter will present the descriptive statistics of dependent and independent variables The third part of will present the results of correlation and expected relationship between capital structure and profitability of REITs

in United Kingdom The fourth, fifth and sixth part will present the regression analysis and discussion of the indicators of capital structure on the profitability of REITs in United Kingdom The seventh part will analyse and discuss the result of size The eight part will present the hypothesis outcome The final part will conclude of the data analysis and discussion

4.2 Descriptive statistics

Table 4.1: Descriptive statistics of dependent and independent variables