Real Estate Investment Trusts REITs

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Real Estate Investment Trusts (REITs)Real
Estate Operating Companies(REOCs)
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What is a REOC?

• A company that derives its income from real
  estate investment.
• A company that lists its primary business as real
  estate.

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What is a REIT?

• Securitized real estate investment
• Ownership form created by IRS code

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Requirements

• Assets
• 75 of assets must be real estate, cash, and
  govt. securities
• other REIT shares are considered real estate
  assets
• not more than 5 of assets can be from 1 issuer
  if not covered under above test
• may not have more than 10 of voting securities
  of 1 issuer if not covered under 1st test

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Requirements

• Income
• 95 of gross income must be from dividends,
  interest, rents, or gains from sale of certain
  assets (real estate, cash, or govt securities).
• 75 of gross income must be derived from rents,
  interest on mortgages, gains from sale of certain
  assets, or income from other REITs

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Requirements

• Income
• No more than 30 of gross income can be derived
  from
• sale or disposition of securities held less than
  6 months
• sale or disposition of real estate held for less
  than 4 years, except those involving
  foreclosures.
• properties held for sale in the normal course of
  business (anti-dealer provision)

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Requirements

• REIT Modernization Act of 1999 (effective 2001)
• REITs allowed to own 100 of a Taxable REIT
  Subsidiary (TRS). TRS can provide services to
  REIT tenants and others (previously, this was not
  allowed). Debt and rental payments from TRS to
  REIT are limited to ensure that the TRS actually
  pays income taxes.

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Requirements

• Distribution
• must distribute 90 of all taxable income to
  investors
• mandates fairly low retained earnings policy
• has important implications for firm size
• Note prior to 2001, minimum distribution
  requirement was 95.

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Requirements

• Management
• REIT managers must be passive
• REIT trustees, directors or employees may not
  actively engage in managing or operating REIT
  properties (includes providing service and
  collecting rents from tenants).
• Managers may set policy rental terms, choose
  tenants, sign leases, make decisions about
  properties.

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Requirements

• Anti-concentration rule
• 5 or fewer entities may not own 50 or more of
  the outstanding shares
• Exceptions
• look-through provision for US pension funds
• UPREIT structure (umbrella partnership)

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Tax Treatment

• Accelerated depreciation is allowed for
  determining taxable income
• 40 year asset life required for calculating
  income available for distribution to investors

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REIT Types

• Equity
• Mortgage
• Hybrid

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Equity REITs

• Blank Check
• does not disclose investments to shareholders
  prior to acquisition.
• Specified Trusts
• purchase a specific property (Rockerfeller Center
  Properties)
• Mixed Trusts
• invests in both blank check and specific
  properties

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Equity REITs

• Leveraged v. Unleveraged
• Finite-life v. Nonfinite-life
• finite-life is self-liquidating

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Equity REITs

• Closed-End v. Open-End
• closed-end protect shareholders from future
  dilution
• Exchange Trusts
• tax-free exchange of property for shares in the
  REIT

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Equity REITs

• Developmental-Joint Venture
• funds construction costs
• lower cost of capital for developer

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Mortgage REITs

• Invests in mortgages
• earn the spread between costs of funds and
  mortgage loan rates

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REIT Benefits

• invest in a diversified RE portfolio managed by
  professionals
• higher liquidity

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REIT Disadvantages

• possible conflicts of interests between sponsor
  and REIT shareholders

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REITs for Tax-Exempt Investors

• Unrelated business taxable income (UBTI)
• REIT structure allows tax-exempt entities to
  leverage their investments without being subject
  to income tax from UBTI
• Eligible investors
• no restrictions on eligible investors
• Limited liability
• Transferability

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UPREIT

• REIT formed by consolidating limited-partnerships
• partnerships allocated REIT shares based on
  appraised value of partnership property

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Taubman UPREIT
Taubman 75 ownership
Affiliates 25 ownership
GM Pension Trust Convertible debt
Taubman Realty Group (TRG) Partnership owns 19
shopping malls