Chapter 21:
Real Estate Investment Trusts
(REITs)
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Real 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
21-2
Real 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”)
21-3
Real 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
21-4
Exhibit 21-1
21-5
Real Estate Investment Trusts
 Equity trusts
– Specializations
 Property type
 Trust duration
– Investment appeal
 Diversified portfolio
 Liquidity
21-6
Real Estate Investment Trusts
 Equity trusts
– Investment appeal
 Mutual funds
 Exchange traded funds
 International REITs
 Closed-end funds
21-7
Real Estate Investment Trusts
 Equity trusts
– Caveats
 Purchase of original property not arm’s length
 Conflicts of interest
– Safeguards
 Appraisals
 Sarbanes-Oxley
21-8
Real 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
21-9
Real 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.
21-10
Real Estate Investment Trusts
 Expansion & Growth
– Little Free Cash Flow
 Income distribution rules
– Secondary Stock Offering
 Dilution vs. accretion
– Debt Financing
21-11
Real Estate Investment Trusts
 Growing income
– Existing properties
 Rental income
 Redevelopment
– Acquisitions
 Purchase properties with cash at positive spreads.
 Swap shares for property interests.
21-12
Real Estate Investment Trusts
 Growing income
– Development
– Provision of services
 Property management, brokerage, development,
etc.
– Financial engineering
 Improve financing terms and lower capital costs.
21-13
Real 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
21-14
Real 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
21-15
Real Estate Investment Trusts
 Mortgage REITs
– Does not own real property. Does own
mortgage paper.
21-16