The Impact of Covenant Strength on Property Pricing

Norman E. Hutchison, Alastair S. Adair, Nicky Findlay

    Research output: Contribution to journalArticlepeer-review

    9 Citations (Scopus)


    Recent volatility in the commercial property markets has brought into sharp focus the importance of the cash flow security in property pricing. The explicit contribution of income risk factors, such as covenant strength, to the pricing model does not have a major coverage in the literature.This paper evaluates, from a conceptual perspecitve, how the property industry should treat and price covenant strength risk and considers whether the risk premium associated with this risk factor can be calibrated. It includes a quantitative analysis of insolvency and delinquency data and the impact of covenant strength on equivalent yields using Investment Property Databank (IPD) data. The paper also reports on a survey of UK institutional investors, carried out in 2008, which examined both the approach and the pricing of default risk.Evidence emerges of mispricing of both the systematic and specific risk as the UK market was swept along by a wave of cheap money and short-term investment outlook. The quantitative analysis shows that the risk default was largely ignored in a buoyant market. Investors appear guilty of pricing at a point in the cycle rather than taking the longer view and pricing through the cycle. Investors need to be aware of the fundamental relationship between covenant strength and the business cycle, lease length and sector.

    Original languageEnglish
    Pages (from-to)167-188
    Number of pages22
    JournalJournal of Property Research
    Issue number2
    Early online date18 Apr 2011
    Publication statusPublished - 2011


    • risk premium
    • covenant strength
    • default risk


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