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March 2000, Should Corporations Disgorge Their Real Estate Property Holdings?

Yongheng Deng
Around the world, corporations are among the largest owners of real estate assets; and in the United States, they own more than $1 trillion of real estate or at least five times the value held by publicly traded real estate companies. Corporations not only own their production facilities, but also frequently own their offices, warehouses, and retail outlets. A debate has emerged as to whether it is harmful to these companies to commit so much of their scarce capital to investments outside their core competencies. Many suggest that companies with high capital costs should not own relatively low-return buildings because this creates negative arbitrage (e.g., see Linneman (1998)). However, capital budgeting principles do not support this argument. In truth, the cost of capital depends upon the use to which the capital is put. Thus, a company with a highly cyclical product line and a relatively high capital cost that owns its real estate has less risk exposure than an equivalent firm that leases its space short term.