McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Chapter 21: Real Estate Investment Trusts

(REITs)

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Real Estate Investment TrustsReal Estate Investment Trusts Creation of the Internal Revenue Code Pass-through entity: No corporate taxes Asset requirements

– 75% test

Income requirements Distribution requirements

– 90% rule

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Real Estate Investment TrustsReal Estate Investment Trusts

Ownership requirements– 100 person minimum

Pre-1986: Management Activity Restriction 1986 Tax Reform Act relaxed the

restriction and led to vertically integrated operating companies

1991 Kimco Realty Offering Taubman Realty Offering

– Umbrella Partnership REIT (“UPREIT”)

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Real Estate Investment TrustsReal Estate Investment Trusts

Tax treatment– Accelerated depreciation– 40-Year asset life– REIT dividends

Taxed as ordinary income

1999 Real Estate Modernization Act– “Usual and customary” provision of services.

This was especially beneficial to REITs that owned hotels.

– Taxable REIT subsidiaries

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Exhibit 21-1Exhibit 21-1

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Real Estate Investment TrustsReal Estate Investment Trusts

Equity trusts– Specializations

Property typeTrust duration

– Investment appealDiversified portfolioLiquidity

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Real Estate Investment TrustsReal Estate Investment Trusts

Equity trusts– Investment appeal

Mutual fundsExchange traded funds International REITsClosed-end funds

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Real Estate Investment TrustsReal Estate Investment Trusts

Equity trusts– Caveats

Purchase of original property not arm’s lengthConflicts of interest

– SafeguardsAppraisalsSarbanes-Oxley

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Real Estate Investment TrustsReal Estate Investment Trusts

Private REITs– Targeted to institutional investors– Syndicated to investors– Incubator REITs

Mortgage REITs– Mortgage REITs have come back into favor

again. The last time Mortgage REITs were popular was in the 1970’s.

Hybrid REITs

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Real Estate Investment TrustsReal Estate Investment Trusts

Funds from Operations (FFO)– REIT equivalent to earnings per share– Depreciation impact

Adjusted Funds from Operations (AFFO) Funds Available for Distribution/Cash

Available for Distribution (FAD/CAD)– FAD/CAD is the amount of actual cash that is

left over.

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Real Estate Investment TrustsReal Estate Investment Trusts

Expansion & Growth– Little Free Cash Flow

Income distribution rules

– Secondary Stock OfferingDilution vs. accretion

– Debt Financing

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Real Estate Investment TrustsReal Estate Investment Trusts

Growing income– Existing properties

Rental incomeRedevelopment

– AcquisitionsPurchase properties with cash at positive spreads.Swap shares for property interests.

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Real Estate Investment TrustsReal Estate Investment Trusts

Growing income– Development– Provision of services

Property management, brokerage, development, etc.

– Financial engineering Improve financing terms and lower capital costs.

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Real Estate Investment TrustsReal Estate Investment Trusts

Additional issues– Tenant improvements & free rent– Leasing commissions & costs– Straight-line rents– Income from managing other properties– Types of mortgage debt– Ground leases

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Real Estate Investment TrustsReal Estate Investment Trusts

Additional issues– Lease renewal options– Occupancy numbers: occupied vs. leased

space– Retail REITs: Sales per square foot– Costs of being a public company

Sarbanes-Oxley

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Real Estate Investment TrustsReal Estate Investment Trusts

Mortgage REITs– Does not own real property. Does own

mortgage paper.