Chapter 24: The Role of Real
Estate Investment Trusts
(REITs)
Andrew Davidson
Anthony B. Sanders
Lan-Ling Wolff
Anne Ching
Chapter 24
REITs


Real estate investment trusts (or REITs) are essentially closedend funds that hold real estate in their portfolios instead of
stocks and bonds.
 As a consequence, they represent an alternative form of
securitization.
 REITs can hold real property (e.g., shopping center, hotels and
office buildings); shareholders in the REIT then share in the cash
flows to the REIT as well as capital appreciation (upon sale of the
asset).
Hence, REITs represent one of the earliest example of
securitizing real properties into securities.
Chapter 24
Real Estate Investment Trusts (REITs)


Primary Advantages:
 REITs are not subject to double taxation
 limited liability to shareholders
 REITs allow investors liquidity and
diversification
Primary Disadvantages:
 income is portfolio income
 tax losses do not pass through to the
shareholders
 REITs must meet substantial operating
restrictions
Chapter 24
A Closer Look at
Real Estate Investment Trusts (REIT)
A (REIT) is a corporate form of ownership
engaged in real estate investment, but
with no taxation at the corporate level.
 Basic operations
 REITs invest primarily in real property
and mortgages.
Chapter 24
Qualifying as a REIT


A REIT is a trust legally established to raise capital from investors
(in the form of common stock and bond issuance) and borrow from
lenders in order to buy income-producing properties or make
mortgage loans in varying maturities.
A REIT is allowed a special tax status; that is, it is only taxed at
corporate rates on its retained earnings (annual) if it meets the
following general conditions:
(1) A REIT is legally required to pay virtually all of its taxable
income (90 percent) to its shareholders every year.
(2) A REIT’s assets are primarily composed of real estate held for
the long term,
(3) A REIT’s income is mainly derived from real estate,
Chapter 24
Tax Ramifications for REITs

Generally, most REITs will adhere to the above rules to
reduce taxes in the event operating income is realized
during a particular year.
(1) It should be pointed out that since some REITs
own properties, they are entitled to depreciate them
and consequently may show an operating loss for the
year for tax purposes, while producing actual cash
available for distribution. However, since REITs are
tax-exempt, the value of this deduction is questionable.
(2) Tax laws allow REIT’s to distribute any losses to
shareholders to the extent of showing a zero net
income for the year.
Chapter 24
Types of REITs




Equity Trusts
Mortgage Trusts
Hybrid Trusts
Specialized Trusts
Chapter 24
REIT Structures

UPREIT





An UPREIT is an Umbrella Partnership REIT.
In an UPREIT structure, the partners of the existing
partnerships and a newly-formed REIT become partners in a
new partnership which is termed “The Operating Partnership.”
The partners contribute the properties from the existing
partnership and the REIT contributes the cash proceeds from
its public offering.
Typically, the REIT is the general partner and the majority
owner of the Operating Partnership Units.
DownREIT

A DownREIT is structured in a similar fashion to an UPREIT,
however the REIT owns and operates properties directly
rather than only its interest in a controlled partnership that
owns and operates separate properties.
Chapter 24
Constituent Companies and Relative Weights in the
NAREIT Index for May 1, 2002
Number
of REITs
34
19
7
8
42
27
10
5
24
19
5
20
16
3
12
8
20
13
7
179
Company
Summary by Property Sector
and Subsector
Industrial/Office
Office
Industrial
Mixed
Retail
Shopping Centers
Regional Malls
Free Standing
Residential
Apartments
Manufactured Homes
Diversified
Lodging/Resorts
Self Storage
Health Care
Specialty
Mortgage
Home Financing
Commercial Financing
Industry Totals
Equity Market Capitalization1
Millions of
Percent of
dollars
Total
48,697.1
29,699.9
28.5891
17.4362
9,594.1
9,403.1
36,870.5
17,815.3
16,491.7
2,563.4
33,350.8
30,822.6
2,528.2
13,747.6
10,291.2
5,864.2
8,509.4
6,934.4
6,069.4
4,247.5
1,822.0
170,334.7
5.6325
5.5204
21.6459
10.4590
9.6819
1.5049
19.5796
18.0953
1.4842
8.0709
6.0417
3.4428
4.9957
4.0711
3.5632
2.4936
1.0696
100.0000
Chapter 24
Largest REITs in the Office Sector
Property Sector: Industrial/Office
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
19
Equity Market Capitalization1
Ticker
Millions of Percent of Percent of
Symbols dollars
Subsector Total
Equity Office Properties Trust
EOP
Boston Properties, Inc.
BXP
CarrAmerica Realty Corporation
CRE
Mack-Cali Realty Corporation
CLI
Arden Realty Group, Inc.
ARI
Highwoods Properties, Inc.
HIW
Prentiss Properties Trust
PP
HRPT Properties Trust
HRP
SL Green Realty Corp.
SLG
Brandywine Realty Trust
BDN
Alexandria Real Estate Equities, Inc. ARE
Glenborough Realty Trust Incorporated GLB
Koger Equity, Inc.
KE
Parkway Properties, Inc.
PKY
Corporate Office Properties Trust
OFC
Great Lakes REIT
GL
Prime Group Realty Trust
PGE
AmeriVest Properties, Inc.
AMV
Maxus Realty Trust Inc.
MRTI
Subsector Totals
Chapter 24
11,868.5
3,538.6
1,994.0
1,867.1
1,795.8
1,487.3
1,281.2
1,118.1
1,054.5
848.9
738.7
618.3
389.0
338.8
307.0
267.9
131.1
41.2
13.7
29,699.9
39.9616
11.9146
6.7139
6.2865
6.0466
5.0078
4.3139
3.7645
3.5505
2.8583
2.4873
2.0817
1.3099
1.1407
1.0336
0.9020
0.4415
0.1387
0.0462
100.0000
6.9678
2.0775
1.1706
1.0961
1.0543
0.8732
0.7522
0.6564
0.6191
0.4984
0.4337
0.3630
0.2284
0.1989
0.1802
0.1573
0.0770
0.0242
0.0081
17.4362
Largest REITs in the Industrial Sector
1
1
2
3
4
5
6
7
Equity Market Capitalization
Ticker
Millions of Percent of Percent of
Property Sector: Industrial
Symbols dollars
Subsector Total
ProLogis Trust
PLD
3,932.7 40.9910 2.3088
AMB Property Corp.
AMB
2,360.0 24.5982 1.3855
First Industrial Realty Trust, Inc.
FR
1,309.9 13.6535 0.7690
CenterPoint Properties Trust
CNT
1,250.1 13.0293 0.7339
EastGroup Properties, Inc.
EGP
401.1
4.1804
0.2355
Keystone Property Trust
KTR
278.3
2.9003
0.1634
Monmouth Real Estate Investment Corp. MNRT.A 62.1
0.6474
0.0365
9,594.1 100.0000 5.6325
Chapter 24
Relative Performance of REITs
4,500.00
4,000.00
3,500.00
3,000.00
2,500.00
2,000.00
1,500.00
1,000.00
500.00
S&P 500
Chapter 24
NAREIT Equity
Dec-01
Dec-99
Dec-97
Dec-95
Dec-93
Dec-91
Dec-89
Dec-87
Dec-85
Dec-83
Dec-81
Dec-79
Dec-77
Dec-75
Dec-73
Dec-71
0.00
Ju
-9
0
n9
De 1
c91
Ju
n9
De 2
c92
Ju
n9
De 3
c93
Ju
n9
De 4
c94
Ju
n9
De 5
c95
Ju
n9
De 6
c96
Ju
n9
De 7
c97
Ju
n9
De 8
c98
Ju
n9
De 9
c99
Ju
n0
De 0
c00
Ju
n0
De 1
c01
De
c
A closer look at relative performance
700
600
500
400
300
200
100
0
NAREIT Equity
Chapter 24
S&P 500
REIT initial public offering history
Time Period
Entire Sample
1980-1988
1990-1994
After 1994
By Year
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Initial Return
2.00%
-1.61%
2.70%
3.87%
t-stat
4.34
-2.09
4.95
3.63
Observations
205
49
98
58
-4.69%
.
0.62%
6.45%
-7.82%
-2.42%
-0.26%
-0.30%
0.52%
.
.
-0.63%
1.03%
2.68%
3.26%
2.07%
0.74%
7.26%
1.11%
2.06%
.
.
.
.
-1.12
-2.33
-0.30
-0.63
1.38
.
.
-1.00
1.10
3.52
3.42
1.25
0.21
4.01
0.71
.
1
0
1
1
4
21
8
5
8
0
0
3
7
48
40
8
6
25
18
1
Chapter 24
Ave First Week Volume
in 1,000’s
790
3,073
5,117
.
.
786
259
317
1,172
389
1,101
299
.
.
582
1,525
3,847
2,621
1,627
3,606
7,010
4,104
10,012
Real Estate Returns, February 1990 to
December 2001
Country
Australia
Belgium
France
Germany
Hong Kong
Italy
Japan
Netherlands
Singapore
Spain
Sweden
Switzerland
U.K.
U.S.
MSCI Global
Mean
0.879
-0.105
0.328
0.381
0.909
0.236
-0.702
-0.065
-0.244
0.108
-1.167
0.175
0.200
1.211
0.595
Std Dev
4.701
4.859
4.618
6.510
11.533
7.693
10.328
3.628
12.964
8.183
10.335
5.023
5.369
4.066
4.079
Skew
-0.315
-0.292
-0.040
-0.019
-0.066
1.108
-0.021
-0.214
-0.054
-0.304
0.039
0.289
-0.298
0.148
-0.789
Chapter 24
[p-val]
0.27
0.28
0.47
0.49
0.45
0.01
0.48
0.33
0.46
0.27
0.47
0.28
0.28
0.38
0.06
Ex Kurt
0.522
1.757
0.457
3.525
2.817
2.652
0.904
0.257
2.733
0.589
4.159
0.595
-0.292
0.594
1.211
[p-val]
0.40
0.19
0.41
0.04
0.08
0.09
0.33
0.45
0.09
0.38
0.02
0.38
0.44
0.38
0.27
International Real Estate Returns, February
1990 to December 2001
Country
i
 iw
Australia
Belgium
0.354
-0.562
0.559
0.259
**
**
0.23
0.04
France
Germany
Hong Kong
Italy
Japan
Netherlands
Singapore
Spain
Sweden
Switzerland
U.K.
U.S.
-0.143
-0.011
0.199
-0.275
-1.349
-0.523
-1.047
-0.492
-1.774
-0.276
-0.286
0.728
0.320
-0.032
1.385
0.499
1.106
0.264
1.799
0.898
0.926
0.229
0.384
0.372
**
0.08
-0.01
0.24
0.07
0.19
0.08
0.32
0.20
0.13
0.03
0.08
0.14
*
*
Adj
**
**
**
**
**
**
**
*
**
**

R2

Estimates from the single factor mode Rit  R ft   i  iw Rwt  R ft   it
are reported. The statistical significance of the coefficients is indicated beside
each estimate. ** indicates significance at 1% level and * indicates
significance at 5% level.

Chapter 24
REIT Valuation

As with most common stocks, the calculation of Net Income to
Common Shareholder is a straightforward exercise (revenues less
expenses).
 However, since the majority of REITs hold a large percentage of
their portfolio in depreciable assets (real property), the typical net
income calculation will greatly understate the cash flows.
 As a consequence, net income has to be adjusted for sales of
property plus depreciation and amortization; the resulting
calculation generates what is known as Funds from Operations
(FFO). Stated differently, FFO is equal to net income, excluding
gains or losses from sales of property, and with depreciation added
back.
Chapter 24
REIT Valuation


The next step is calculated Cash Available for Distribution (CAD).
CAD is a measure of the REIT's ability to generate cash and to
distribute dividends to its shareholders. CAD is derived by
subtracting nonrecurring expenditures.
A further refinement on the REIT’s cash flow is Adjusted Funds
From Operations (AFFO).

AFFO refers to a further adjustment by subtracting from Funds from
Operations (FFO) both (1) normalized recurring expenditures that are
capitalized by the REIT and then amortized, but which are necessary to
maintain a REIT's properties and its revenue stream and (2) “straightlining” of rents (straightlining averages the tenant’s rent payments over
the life of the lease).
Chapter 24

12/31/04 12/31/03 12/31/02 Diluted net income per
share $1.43 $0.89 $1.39 Add: Depreciation and
amortization 2.40 2.38 2.31 Less: Gain on sale of
properties (0.79) (0.25) (0.58) Minority interest
adjustment 0.20 0.26 0.30 Adjustment for share difference
(2) (0.15) (0.21) (0.21) Diluted funds from operations per share
(1) $3.09 $3.07 $3.21
Diluted funds from operations available
to common shareholders,
excluding
Preferred stock issuance costs $—
$0.14 $0.07 Impairment of real estate 0.04 0.12 0.04 HQ lease
guarantees — 0.01 0.14 Prepayment penalties on debt 0.08 — —
$3.21 $3.34 $3.46
Diluted net income per common share, excluding
Preferred stock
issuance costs $— $0.15 $0.08 Impairment of real
estate 0.05 0.14 0.05 HQ lease guarantees — 0.02 0.17 Prepayment
penalties on debt 0.09 — — $1.57 $1.20 $1.69
Chapter 24
From Carr Realty 2004 Annual Report
Diluted net income per share
12/31/04
$
1.43
Add: Depreciation and amortization
2.40
Less: Gain on sale of properties
(0.79
Minority interest adjustment
$
(0.15
12/31/02
0.89
$
2.38
)
(0.25
0.20
Adjustment for share difference (2)
Diluted funds from operations per share (1)
12/31/03
2.31
)
(0.58
0.26
)
(0.21
1.39
0.30
)
(0.21
$
3.09
$
3.07
$
3.21
$
—
$
0.14
$
0.07
Diluted funds from operations available
to common shareholders, excluding
Preferred stock issuance costs
Impairment of real estate
0.04
0.12
0.04
HQ lease guarantees
—
0.01
0.14
Prepayment penalties on debt
0.08
—
—
$
3.21
$
3.34
$
3.46
$
—
$
0.15
$
0.08
Diluted net income per common share, excluding
Preferred stock issuance costs
Impairment of real estate
0.05
0.14
0.05
HQ lease guarantees
—
0.02
0.17
Prepayment penalties on debt
0.09
—
—
$
1.57
Chapter 24
$
1.20
)
$
1.69
)