WHY DEVELOPERS GO PUBLIC: THE USE OF REAL ESTATE
INVESTMENT TRUSTS IN THE DEVELOPMENT PROCESS
by
JUDSON D. JACOBS
Bachelor of Architecture
The University of Texas at Austin
1984
Submitted to the Department of Architecture in
partial fulfillment of the requirements for the degree of
MASTER OF SCIENCE IN REAL ESTATE DEVELOPMENT
at
THE MASSACHUSETTS INSTITUTE OF TECHNOLOGY
September, 1990
©
Judson D. Jacobs
The Author hereby grants to M.I.T.
permission to reproduce and to distribute publicly
copies of this- thesis document in whole or in part.
Signature of the Author
n
Depa(tme t of
n.
rc
J
Certified
by
Jacobs
tecture
6,
1990
_________W_____
Associate Protessor of Planning and
Real Estate Development, Thesis Advisor
Accepted
by
Gloria Schuck
Chairperson, Interdepartmental Degree
MASSACHUSETTS I-pptram in Real Estate Development
SEP 19 1990
LIBRARNES
1
WHY DEVELOPERS GO PUBLIC: THE USE OF REAL
ESTATE INVESTMENT TRUSTS IN THE DEVELOPMENT PROCESS
by
JUDSON D. JACOBS
Submitted to the Department of Architecture on
July 26, 1990 in partial fulfillment of the requirements of
the degree Master of Science in Real Estate Development at
the Massachusetts Institute of Technology
ABSTRACT
At its original inception in 1960, the Real Estate
Investment Trust (REIT) was created as a vehicle for
passively holding and overseeing properties for the benefit
of its
shareholders.
In
that context,
real estate
development seems like an unlikely pursuit for a REIT.
Nevertheless, a
small number
of REITs
have adopted
value-creation strategies to build their portfolios, either
through development or substantial renovation of existing
properties. Out of 117 tax-qualified REITs listed on the
major stock exchanges, at least 13 were identified as
following some type of value-creation strategy.
Some have
been remarkably successful, while others face losses that
threaten
continued
operation.
REITs,
as
investment
vehicles, are generally not well understood. Little, if
any, research on value-creation REITs, as a category, has
been published. REITs also represent an alternative source
of capital for development, an important concern in current
U.S. markets where many traditional sources of both debt and
equity have retreated from real estate investment.
One of two basic value-creation strategies is typically
followed.
First, some REITs acquire existing properties,
then initiate
renovation, redevelopment,
expansion of
existing structures and, in some cases, development of new
buildings on vacant land.
Second, other REITs have engaged
in development
s through
the use of
joint venture
partnerships with developers.
Chapter One profiles the
legislative changes that have enabled REITs to pursue these
more flexible investment strategies. Chapter Two presents
the advantages and disadvantages of the REIT format for
development and discuses the two basic approaches. Tracking
the performance of six case-study REITs in Chapter Three
indicates that the Acquisition & Redevelopment REITs have
outperformed the younger Joint Venture group.
It explores
differences in the two approaches and other factors that
lead to the variance in performance, both as developers and
as market securities.
The Conclusions section summarizes
the findings and presents new alternative uses of the REIT
in the development process.
Thesis Supervisor:
Title:
Lynne B. Sagalyn
Associate Professor of Planning and
Real Estate Development
ACKNOWLEDGEMENTS
Research for this topic would not have been possible
to the
am indebted
I
interviews.
without personal
and
time
their
for
paper
this
in
cited
professionals
insicht. Thanks to Lynne Sagalyn, whose guidance, diligent
editing, and genuine interest vastly improved the quality of
this thesis.
Special thanks to Lisa, for her love, support and sacrifices
this year, and to Weldon Jacobs, who has always made great
things possible.
TABLE OF CONTENTS
ABSTRACT.................................................2
LIST OF EXHIBITS.........................................5
CHAPTER ONE
VALUE CREATION AND REITS-- A RECENT UNION
6
From Passive Investor to Active Manager:
A Brief Legislative History of the REIT..
9
The REIT as a Source of Capital..........
18
CHAPTER TWO
UNDERSTANDING DEVELOPMENT EQUITY REITs... ...........
23
Advantages of the REIT Format............
23
Disadvantages of the REIT Format.........
32
Development as a REIT: Two Approaches....
38
The Joint Venture REITs...............
41
The Acquisition & Redevelopment REITs.
46
Other Applications of REITs
in the Development Process............
48
CHAPTER THREE
EVALUATING THE REIT AS A VEHICLE FOR DEVELOPMENT.... 52
Contrasting Track Records:
Performance as a Security........................55
Building the Bricks and Mortar:
Performance as Developers........................59
Management Ability:
Performance Measured Through Cash Flow............64
Raising Capital:
Availability and Affordability....................76
The Struggling Class of '85:
Strategies for the Future........................82
CHAPTER FOUR
CONCLUSIONS........................................87
Current Trends and New Applications of the REIT.....90
LIST OF EXHIBITS
Exhibit 1.1
The Value Creation REITs:
By NAREIT Categories.......................22
Exhibit 1.2
The Value Creation REITs:
Reclassified by Investment Strategy........22
Exhibit 2.1
The Concept of Current Yield...............27
Exhibit 2.2
Comparison of Actual Current Yields........28
Exhibit 2.3
The Case Study REITs
The Joint Venture REITs.................39
The Acquisition & Redevelopment REITs... 40
Exhibit 3.1
Annual Shareholder Returns
of Value Creation REITs..............
...
56
Securities Market Price vs.
Appraised Real Estate Value..........
...
58
Exhibit 3.2
Exhibit 3.3
Development and Renovation Activity-The Joint Venture REITs.................62
The Acquisition & Redevelopment REITs... 63
Exhibit 3.4
Condensed Annual Cash Flow Data............68
Exhibit 3.5
Summary of Cash Flow from Operations
and Dividend Coverage Ratios......... .. 71
Exhibit 3.6
Capital Market Activity:
The Acquisition & Redevelopment REITs. .. 77
Exhibit 3.7
Graphs of Changing Capital Structure..... .. 79
CHAPTER ONE:
VALUE CREATION AND THE REIT--
At
its original
Investment
Trust
inception
(REIT)
was
in 1960,
created
passively holding and overseeing
of its
shareholders.
restrict
REITs to
A RECENT UNION
the Real
as
a
vehicle
for
properties for the benefit
Enabling legislation was
that limited
Estate
agenda.
In
designed to
that context,
real estate development seems like an unlikely pursuit for a
REIT.
Nevertheless,
a small
number of REITs
value-creation strategies to
through
development or
properties.
major
Out
stock
build their portfolios, either
substantial renovation
of 117
at
least 13
successful, while
threaten continued operation.
an
were
increasingly
strategies; yet
others face
diverse
They
as
Some have
losses that
REITs today are being used to
range
of
as investment vehicles, they
not well understood.
on the
identified
type of value-creation strategy.
been remarkably
deploy
of existing
tax-qualified REITs listed
exchanges,
following some
have adopted
investment
are generally
attract a much smaller following
in the investment community
than other securities.
Little,
if any, research on value-creation REITs, as a category, has
been published.
With broader
has proven to
three simple
Based
on
usage and
be a flexible vehicle which
of
Real
of
real
Estate
estate assets,
Investment
the REIT
has outgrown the
categories widely recognized in
the type
Association
more specialization,
the industry.
the
National
Trusts
(NAREIT)
categorizes
its
member
REITs into
three
REITs, which
invest primarily in real
REITs, which
invest primarily in mortgage
real estate;
and Hybrid REITs, which
of debt
and equity investments.
three simple
hold some combination
adequate to describe
investment strategies employed among
REITs are adopting highly specialized
strategies
investment
rather
than
A
portfolios
notable
creation-- REITs
by
holdings.
geographic region,
small, but
through value
their
diversified
be by property type,
activity.
specialization is
to
notes secured by
categories are no longer
Specialization can
value
properties; Mortgage
have suggested these
REITs. 1 More and more
or
Equity
Some
the broad diversity of
investment
groups:
participating
area
of
that add
in
the
development or renovation of property.
Each value-creation REIT is unique,
strategies is typically followed.
existing
properties,
but one of two basic
First, some REITs acquire
then
initiate
renovation,
redevelopment, expansion of existing structures and, in some
cases,
development
Historically,
activities
of
new
REITs have
(within the
been
day-to-day
property
second way
development
is
through
that
the
use
When REITs enter
creation process
land.
profit from
these
the Internal
management
The
independent developers,
of
vacant
Revenue
or an independent management firm
activities.
partnerships.
on
able to
confines
Code) by using an advisor
for
buildings
REITs
of
construction
have engaged
joint
in
venture
into such partnerships with
they can
by providing
and
participate in
development capital
the value
for new
generally motivates
type of vested interest
This
product.
the final
equity stake in
exchange for an
construction in
REIT management to take an active part overseeing the design
the
of
efforts
leasing
and
construction
development,
properties.
Those companies that develop or renovate property under
the
format
REIT
structure to pursue a
very non-passive investment strategy,
The REIT offers a
thus they are interesting cases to study.
developer
notably
wide access
at the
corporate laws
Exchange Commission.
equity
and
by
forth
set
restrictions,
Internal
the
This thesis
that
of
set
Revenue
Code,
and the
Securities and
seeks to
identify those
state level
hybrid REITs
complex
a
with
that
from
REIT vehicle
But the
appeal.
management
encumbers
also
portions, most
offerings;
equity
has financial
standpoint it
in large
to capital
public
through
passive
traditionally
a
chosen
have
create
value through
real
estate development or renovation, to discuss their rationale
and
limitations
of using
the
REIT
development.
Findings indicate
REIT vehicle
effectively supports
strategies,
evaluate the successes
REIT status, and to
behind choosing
providing
format to
that, in
long-term
facilitate
some cases,
the
lucrative value-creation
access
to
capital,
a
favorable cost of capital, and adequate operational latitude
to achieve development goals.
From Passive Investor to Active Manager:
A Brief Legislative History of the REIT
The
Congress in
to
estate
real
investment
1960 to permit small
invest in
professionally
publicly traded securities.
be the
trust
mutual funds
created
was
by
investors the opportunity
managed
real estate
through
REITs are considered by many to
of the
real estate
industry.
Unlike
other corporate entities, REITs pay no federal income tax on
income
that
or gains
they
passed through
meet
requirements.
specific
From
with
capital outlays
individual
organizational
investor's
and illiquidity
property
perspective the REIT can be
a wide array of
and
ownership.
provided
operational
perspective
in real estate without
permits investment
large
an
to shareholders,
the
REIT
the obstacles of
normally associated
From
management's
a flexible vehicle that permits
strategies to invest in
virtually any form
of real estate including fee interests, mortgages secured by
real estate, leaseholds, options,
or securitized real estate.
and shares in other REITs
The REIT vehicle can also serve
as a tool to raise public and private capital, both debt and
equity, to fund investments.
The Ground Rules for REIT Status
The basic organizational requirements have changed only
slightly
since 1960.
The current
requirements are:
1) A
REIT must distribute at least 95% of net taxable earnings to
shareholders;
2) A
REIT must
be
managed by
one or
more
directors
or trustees;
3)
During the
last
half of
each
taxable year, no more than 50% of the shares can be owned by
five
or fewer
individuals;
4)
A REIT
must
calender year basis;
5) Subject to changes in
Reform
must
Act,
a REIT
professionals
engage
(i.e. independent
report on
the 1986 Tax
independent real
contractors) to
certain management activities; 6) A
a
estate
carry out
REIT must have at least
100 shareholders.
Creating a Special Mutual Fund
The original proponents who lobbied for the creation of
the REIT vehicle in the
late 1950s were property management
companies wanting to securitize and sell equity interests in
existing-owned properties,
their
contemporaries
drafting the
the real
seek
could
mutual
a hotel
business, like
the proceeds
untaxed. 2
stipulated that a
was
The concern
To
industry.
made certain
property," not
if a
that
be exempt
real
for example,
from the
In
that only
services, would
prohibit such
REIT must be a
advantages as
fund
"rents from real
property management
REIT status,
go
the
legislation, Congress
taxation.
intensive
in
estate income or
profit from
from
with the same tax
estate
elected to
hotel operations
loopholes
the
law
passive investment entity
and not an operating company.
The resulting
stand today, are:
income requirements
as they
1) "The 75% Income Requirement" which
means that 75% of the gross
derived from
of a REIT,
rents from
annual income of a REIT must be
real property,
mortgage interest,
gains
from sale
or other
dividends or other
of shares in
property,
distributions of
distributions on and gain
other REITs, income and
or
mortgage
Requirement" holds
loan
that at
other interest, dividends
securities.
that less
3)
fees.
2)
"The
of the
95%
and gains from the
annual gross
sale of stock
Income Limitation"
annual gross income must
from the gains from sale
Income
the items set forth above, plus
"The 30%
than 30% of
from the sale
gain from foreclosure
least 95%
income must be derived from
and
real property,
requires
be derived
of certain property held less than
four years and short term
gains from sale of securities and
other miscellaneous items.
Congress'
resulted in
itself.
concern
The
its
holding properties
to
taxation.
were
reforms, home
intensive
real
estate
property
from
been acquired.
companies, would
sales,
not escape
several rounds of legislative
a REIT.) Congress
naively, modeled the REIT
is
the
independent
speculative
builders cannot qualify as
mutual fund.- This was naive
stocks,
from
for
restricted
after they had
home building
intentionally, perhaps
by
income
the REIT
REIT arrange
severely
that gains
(Even today, after
a
holdings
also
for sale
insure
particularly by
that
portfolio
REITs
management
management role from
law required
of
contractors.
was
isolating
casting off the
management
This
for
after the
because, unlike a portfolio of
a physical
management.
asset
The
that
requires
restrictions
on
management activities have served as a source of frustration
and, in some cases, litigation for REIT managers ever since.
Only in recent years have
properties
such
and operations.
as interior
parking,
REITs been allowed to self-manage
among
finish
Yet, certain
construction
others,
are
tenant services,
and fee
still
automobile
forbidden
by
REIT
regulation.
What a REIT can and cannot
law
is suggested
attorneys
856-860
than spelled
specializing in
of the
vague on
the
rather
operating,
less
however a
Code ("The
The strictest
Code would
much
out exactly.
counsel consider
Internal Revenue
indicate
investment vehicles, are
practice
REIT
certain points.
current
do within the letter of the
that
Even
sections
Code") to
be
interpretation of
REITs, as
passive
prohibited from directly managing,
developing
number of
real
REITs are
properties.3
In
now self-managed,
which means they can lease and operate their own buildings.
Problems Push Reforms in the 1970s
Over
time,
and
reforms
subsequent
through
small
incremental interpretaions of the Code, the REIT has evolved
from a legislative skeleton
to a flexible operating entity.
As flexibility increased, REIT managers have also discovered
more
creative
within the
came
ways
to exploit
confines of
in 1975
when REITs
foreclosure properties.
into
a prohibited
penalty,
immediate
corporate taxation.
The first
the rules.
were
Prior to
transaction
opportunities,
new
granted the
still
major break
right to
sell
this reform, REITs forced
risked
disqualification
This and a few
the "sudden
as a
REIT
and
death"
full
other positive reforms
grew out of a negative set of circumstances-- The industry's
major debacle in
the early 1970s.
REITs were forced to
loans.
As a
During
that period many
foreclose on mortgage and construction
result, these
REITs suddenly
had properties
that they never intended to own; they became equity REITs by
default.
The Internal
Revenue
since 1960, was so restrictive
Code, basically
unchanged
that the REITs could neither
sell nor effectively manage the properties, without entirely
giving up the shelter of REIT status.
By necessity, reforms
recast opportunity in the troubled industry.
A
REIT boom
period
reforms.
Some of
organized
to invest
most
which
of
the
preceded the
1974
earliest REITs
in first
were
of
bust and
the 1960s
mortgage residential
insured
by
the
Federal
its
were
loans,
Housing
Administration or guaranteed by the Veterans Administration.
REIT
managers soon
asset
base and
realized
that they
could enlarge
increase the
return to
shareholders, from
these relatively secure loan
long-term
debt borrowed
portfolios, through the use of
at a
cost less
than the
return generated by the mortgage loan holdings.
leverage allowed
the
REITs to provide
rate of
Such use of
geometrically increasing
dividends from quarter to quarter.
As
REITs became
vehicles,
exponential
the
securities
growth.
portfolios evolved
loans,
shorter
established as
market
Eventually,
attractive investment
came
the
to
early
to include construction
term
Attractive short-term
mortgages
and
expect
conservative
and development
wrap-around
borrowing rates led to
such
loans.
the financing
of
through
investments
portfolio
term
shorter
these
revolving bank credit, commercial paper and other short-term
and
land leaseholds,
estate developers, with options
in the
ventures with
joint
of the underlying
born in
techniques,
basic
of these
Many
real
to purchase equity or share
anticipated appreciation in value
property.
ownership of
as outright
investments such
equity-oriented
property,
REIT managers moved into
Gradually, some
debt instruments.
the
still employed today by development
heyday of the boom, are
REITs.
the early
By
higher
demanded, REIT
routinely
compelled to
managers felt
REITs grew to
the industry
debt, REITs
conditions,
development loans.
and
party
When
was over.
reorganizations
aggregate
and radical
assets
to default
middle 1970s
trim unprofitable
REIT
and
short-term interest rates suddenly
began
The
large
with
construction
of
increased, REIT portfolios
their borrowers
debt and
REITs
those
short-term
changing economic
were extremely vulnerable to
portfolios
1.7:1 to about
of mostly
heavy allocations
interest-sensitive
and rapidly
that single year
During
debt-to-equity ratio rose from
particularly
make
total gross book assets of
exceed $20 billion.
With such
2.5:1.
now
rates and, in many
investments with increasingly attractive
cases, increased risks. 4 In 1973
market
securities
that the
returns
dividend
increasingly
of the
in pursuit
1970s,
became unprofitable
on mortgages.
saw drastic
measures to
portfolios.
tumbled
from $20
The
portfolio
reduce short-term
From 1974
billion
to 1975
to
$12
billion and continued declining each year through 1980.5
In the eyes of some investors, the drastic shake out of
the
1970s
industry.
still
Some
tarnishes
shook
framework.
into
Among
requirements
foreclosed
other
dividends
was
sale,
were
no
more
changes,
were relaxed,
property
REIT
the
statutory
qualifying
income
provisions allowed
difficulties
eased,
crisis also
flexible
safe harbor
longer
disqualification.6 Prior
the
in particular,
This industry
drafting a
property for
of
debacle and have since recovered
financial positions.
Congress
holding
reputation
REIT managers, equity REITs
performed well through the
to strong
the
and
of dealing
late
penalized
to the reforms
payment
by
with
of
complete
defining qualified
income, a REIT could not so much as sell breath mints in the
building
lobby without
risking complete
These changes helped REITs to
disqualification.
attract and retain tenants by
In 1976, another
becoming more effective property managers.
legal break was granted when Congress lifted the requirement
a
that
REIT
be
corporations could
REIT status.
as
organized
qualify for
a
the full tax
Now
advantages of
greater operational
Incorporating gave REITs
flexibility, allowing
trust.
business
state-level laws
relief from certain
that limited the activities of a business trust.
The Tax Reform Act of 1986
The
next major
legislation
to impact
historic Tax Reform Act of 1986 (TRA 86).
in the
real estate industry
were hit
REITs was
the
Most participants
hard by the
loss of
numerous tax deductions that
position
of
basically
the REIT
two
industry
ways.
First,
provisions
sought
additional
operational and
that
would
ease
year, however, the competitive
by
was
actually enhanced
TRA
NAREIT
86
that
included
would
several
grant
organizational flexibility
start-up
problems
for
in
REITs.
REITs
and
These
provisions included among others, a broadening of services a
REIT could provide to its tenants, and an increase from five
to seven in the number of sales per year a REIT is permitted
without
being
exposed
transactions.
Also,
to
REITs
were
liability protection
portfolio.
(In
tax
on
authorized
prohibited
to
and segmentation
other words, legal actions
project protected
the rest of
100%
conduct
wholly owned subsidiaries 7 , thus
certain operations through
enjoying
the
within the
taken against a
within a subsidiary would
not jeopardize
the portfolio properties.) Finally,
the TRA 86
enabled REITs to temporarily invest proceeds from securities
offerings in
non-real estate investments
while negotiating
long term investments or development projects.
The second
REITs was by
and indirect
the real
partnerships and other
investment
write-offs, investment
In contrast,
through tax
master limited
publicly traded partnerships.
flow through of tax losses
to investors.
portion of their
estate syndicators,
securitized
depreciation
pass
86 strengthened
basically eliminating a good
competition--
competing
way that TRA
losses,
vehicles
tax
These
relied
on
credits, and
the
to enhance the financial returns
REITs were never
only taxable
16
permitted to
income.
So,
when
were left standing
but vanished, and REITs
competition all
tax losses, the
the benefits of such
legislation wiped out
relatively favored under the new federal tax policy.
By
only
to satisfy the letter of
independent was a separate payroll
the
included
leasing,
Such
supervision.
private
handled by
not unlike those
tasks were
the last
In
firms.
development
real estate
construction
and
management,
property
performed
subsidiaries
these
duties that
The
law.
companies
internal management
made these
thing that
own
practice, the
In
firms.
independent management
in-house,
their
created
certain REITs
1980s
mid
the
two
years several REITs have been granted Private Letter Rulings
from
that permit
the IRS
owned "independent"
such wholly
management firms to be liquidated and absorbed by the trust.
As legislators
real estate
more
more familiar with
and investors have grown
consents that certain aspects
integral function
of
redevelopment
IRS
the
that
suggest
rulings
The
autonomy.
more and
have been granted
investments, REITs
now
of property management are an
of real estate ownership;
portfolio
renovation and
example.
for
properties,
Fee-driven development or development
for immediate sale is
not, and never has been, permissible.
Through joint venture
partnerships,
through
property
however,
development,
in its
they can
provided
own portfolio
required by the Code.
flexibility in
REITs
can
the
reap
the
that
for the
REIT
added
value
holds
four year
the
minimum
In these ways, REITs offer incredible
the types of assets
and business strategies
pursue, despite the technical
tax restrictions on
operations.
The REIT as a Source of Capital
Even in light of favorable
changes in the tax code and
more flexible private rulings, development is a more complex
process using the REIT vehicle instead of a private company.
REITs
are laden
layer
of
with additional
management
regulations and
concerns.
advantages, the primary incentive
this
path
is
for
access
Aside
an added
from
the
tax
for a developer to choose
to
equity
capital
through
generally
requires
outside
securitization.
The
sources
development
process
of capital.
Prior to
1986 developers
could rely
primarily on debt capital, which was then plentiful, to fund
When
projects.
leverage, equity
required
by
component to deal
became a more important
of
Some portion
structures.
to maximize
removed the incentive
TRA '86
developers and
equity, or
gap capital,
REIT is
A
entrepreneurs.
is
a
potential source for such equity capital.
also
became restricted.
Due
to
conditions in real estate markets,
overleveraged real
of
further real
problems
unfavorable
in
the
current soft,
overbuilt
high vacancy rates , and
estate deals of the
(and watchful federal
debt sources
access to traditional
late 1980s
In the
recent past lenders
regulators) are particularly cautious
estate
investment.
industry
attitude toward
have
The well
publicized
a
generally
created
real estate.
REITs, however,
can
place
debt
capital
without
appeasing
bank
the use of participating
Additionally, through
regulators.
federal
mortgages and convertible debt instruments, the line between
Today's
equity instruments
mid 1980s. 8
since the
become blurred
equity has
debt and
organized
under joint
venture
agreements can be tailored specifically to meet the needs of
the investor and
development
enough to
to cover the front-end cash
activity.
And
the
REIT
drains of the
vehicle is
provide capital for development
flexible
under almost any
conceivable deal structure.
Development REITs can be borrowers too.
Wiser from the
1974 debacle, many REITs use measured degrees of leverage to
strengthen
their
bank debt
the
and long-term
techniques
instruments
These
capital structures
of
corporate
such as
sources
can
attractive rates.
mortgages.
The
conventional
REITs can
also employ
finance
convertible
be
through
to
issue
debentures and
sometimes
be
warrants.
obtained
REIT is a potential
debt
at
very
source of debt,
equity and "hybrid" capital.
But commitment to the REIT format should not be entered
Once established, a
lightly.
shareholders each
and
and every quarter.
value of the stock
declining
stock values
reputation and impair a firm's
years.
high
Is
risks
A
company that plans
periodically to raise capital
to sell stock
keep the
public company must answer to
the real
and
long
high.
can
must strive to
Faltering distributions
tarnish
a REIT's
market
ability to raise capital for
with its
estate development business,
lead time,
well
suited
to
public
ownership?
Have REITs been employed to successfully develop
real estate?
Or is the REIT vehicle too cumbersome to allow
for timely, decisive
as
a REIT
be
creation?
entrepreneurial action?
an effective
What
are the
long-term
Can operation
strategy for
trade-offs a
firm must
value
endure to
Do REITs enjoy a lower cost of
have access to public funds?
capital than other private firms?
trade
advantages and
discusses the
Chapter Two
answers.
can provide
and experiences
whose activities
case studies
serve as
in the market to
only a few REITs
There are
as a
pursuing value-creation investment strategies
offs of
REIT.
It identifies actual
their
various
real
development REITs and describes
The
activities.
estate
major
two
strategies for value creation, "Acquisition & Redevelopment"
versus
Development
Venture
"Joint
of thirteen value creation REITs
discussed in more detail.
of research
identified in
the course
were selected
for closer study: Copley
Realty
Investment
Property
Company,
and
MSA Realty
Investors,
points of comparison
Discussion in
the following chapters will
broad
IRT
The
Plan Realty.
New
noted as
categories mask
paper, six
Properties, Federal
Property
ICM
Trust,
for this
remainder are
NAREIT's
are
Partnership,"
and contrast.
demonstrate that
differences in
investment
strategies.
Chapter
Three focuses
REITs
case-study
and
presents
demonstrate that the younger
internal
and
external
on the
performance of
empirical
the six
evidence
to
Joint Venture REITs have faced
difficulties
20
which
have
marred
performance,
while the
Acquisition
have performed more favorably.
several
ways--
ability
to
risks and
REITs
Performance is evaluated in
raise
property, to manage property and
as financial
& Redevelopment
capital,
to
develop
produce cash flow, as well
returns as securities.
The fourth
and final chapter presents the
conclusions of the study and
an outlook
of REITs in
toward future uses
process.
21
the development
TABLE 1.1
THE VALUE-CREATION REITS: NAREIT Categories
EQUITY REITS
HYBRID REITS
Chicago Dock & Canal Trust
Federal Realty Trust
Copley Properties, Inc.
1CM Property Investors
IRT Property Company
MSA Realty Trust
New Plan Realty Trust
PCA/Sammis Industrial Fund
PCA/Tishman Speyer, Inc.
United Dominion Realty Trust
Weingarten Realty Investors
MIP Properties
Western Investment Trust
Source: REIT Facts, NAREIT, 1988
TABLE 1.2
THE VALUE-CREATION REITS:
Reclassified by Investment Strategy
JOINT VENTURE DEVELOPMENT
ACQUISITION &
PARTNERSHIP REITS:
REDEVELOPMENT REITS:
---------------------------- -------------------------
Federal Realty Trust
IRT Property Company
New Plan Realty Trust
Copley Properties, Inc.
1CM Property Investors
Mortgage Investments Plus
United Dominion Realty Trust
Weingarten Realty Investors
Western Investment Trust
MSA Realty Trust
PRIVATE REITS:
PCA/Sammis Industrial Fund
PCA/Tishman Speyer, Inc.
Bold type: Indicates the six case study REITs examined in
Chapter Three.
22
CHAPTER TWO
UNDERSTANDING DEVELOPMENT EQUITY REITs
"The greatest advantage to being a REIT
else
everything
to capital;
access
is our
a
is
Is a REIT the right way to run
disadvantage. .
.
our business?
every day."
We
ask
ourselves that
question
Robert Wennett, Vice PresidentRealty
Federal
Acquisitions,
Investment Trust (June 4, 1989)
Given the
apply to
volume and complexity of
restrictions that
has to wonder why
an entreprenurial
a REIT, one
choose such a regulated
company would
section
trade-offs,
exceptions,
disclaimers,
attached
advantages, but
distinct
are some
There
public
to
of
which presents
the pros
and
with
they come
strings
other
following
The
cons of
value
Wherever possible, actual experiences
of the case-study REITs are
context to
and
corporate ownership.
highlights some
creation as a REIT.
lends
business structure.
cited to provide examples.
subsequent section
the
the two
primary value
of the
It
chapter
creation strategies
currently in use.
Advantages of the REIT Format
Pass-through Taxation
Tax exemption is the fundamental advantage of the REIT
format.
Technically
Revenue Code,
taxes have
distributed
the REIT, as defined
is a taxable entity.
to be paid
and
the
when 95%
by the Internal
However, no corporate
of net taxable
other income
tests
are
income is
fulfilled.
Investment
in a
beneficial
to
shareholders,
are
REIT
The
property.
in debt
investing directly
provides an
institutional
Certain nonprofits
pension plans.
such as
prohibited from
nonprofit
and
tax-exempt
particularly
tax advantages
REIT offers
opportunity
financed
for
these
groups to invest in leveraged real estate without penalty.
Access to Capital
This is perhaps the most obvious overriding incentive
for a development or investment entity to seek REIT status.
or development partner to sell
The ability for a developer
common stock to literally thousands of individual investors
in
single
a
offering
public
array of
offsetting the
prospect,
serves
an
as
attractive
operational headaches.
Furthermore, this competitive advantage of access to common
equity does not preclude a
sources
credit,
of funds.
Long term
joint-venture
sources and other
by REITs.
REIT from access to traditional
partnerships
of
term lines
debt, short
with
institutional
forms of private placement
are all used
Primary choices for capital include:
Equity Sources:
Common Stock: Common
equity, compared to alternative
debt sources, is the most expensive source of capital
available to a REIT.
Underwriting and printing costs
are high and new shares typically trade at a discount
from
the
estate.
appraised
Relative
value of
to
equity, however, certain
other,
the
underlying
private
real
sources
of
REITs enjoy a comparatively
low cost of capital through the issuance of stock.
24
Joint Venture Partnerships: REITs
enough to
invest in
that are not large
any one particular
project can
enter joint venture partnerships with institutions to
effectively pool their equity.
Certain institutional
investors perceive REIT stock ownership to be more of
a
stock
market
ownership.
investment than
Such institutions
venture partnership over
REIT's motivation
true
real
estate
would prefer the joint
common stock ownership.
for this type of
(A
joint venture is
to place capital and should not be confused developer
joint
venture
partnerships,
where
the
developer
typically brings expertise and seeks capital.)
Debt Sources
Convertible Debentures:
money
from the
rate,
pays coupon
investor at
with a
shares.
after
until a
date, and then pays
predetermined
number
These are categorized
conversion
to
REIT borrows
an attractive
rate interest
future conversion
back
In effect, the
equity.
interest
specified
the principal
of common
stock
as debt capital until
Most
REIT
managers
surveyed prefer the use of this versatile instrument.
They can
or private placements,
be public
foreign currencies on foreign
cases can
be issued
trade in
exchanges, and in some
without costly SEC
filings and
approvals.
Debt:
REITs have
access to
traditional debt capital,
of
credit
to
virtually all
forms of
from short-term bank lines
fixed-rate
mortgage
loans
from
institutional sources.
important
Since
their
debt in general is
unexpected drops
to cover
distributions
retain
Access to
are
in cash
mandatory,
earnings.
Short-term
frequently used to bridge
flow.
REITs
cannot
borrowings
are
negative cash flows.
Long
term debt can be used to free up capital in completed
projects in order to fund new developments.
Too much
debt on the balance sheet, however, will be perceived
as a risk in the market and could reduce the price of
the stock.
leases can give a
Leases: Real estate
end result as
debt, the use of
REIT the same
land or improvements
at the cost of incremental long-term payments.
Cost of Capital
Virtually all
public REITs
prabtice, however,
only certain REITs ever
In
this competitive advantage.
of
equity
common
is
capital.
low cost equity
gaining access to
desire of
actually enjoy
the
that
dividends
corporation must pay for all equity shares outstanding.
any point in
time then, a simple measure of
current yield.
a
At
cost would be
divided by the current market
the current dividend payment
price of the stock.
In
simplified terms, the cost
to
equal
with the
are established
Financial analysts call this ratio the
It is not a
true measure of the total cost
of equity since it ignores the fixed underwriting, printing
and marketing costs of a
a basis
companies
for
compariing
in Exhibit
public offering, but it serves as
stocks.Even
2.1 pay
though
annual dividends
26
all
three
of $1.00,
EXHIBIT 2.1
THE CONCEPT OF CURRENT YIELD
Dividend
Price
$1.00
1.00
1.00
$8.33
10.00
12.50
Stock A:
Stock B:
Stock C:
Company C
has a
lower cost of
dividend dollar buys
only gets $8.33.
12.0%
10.0%
8.0%
equity capital
the use of $12.50,
since each
whereas Company A
To make a profit, Company A must reinvest
their equity capital in something
that will bring a return
higher than the 12% current yield.
8%
Current
Yield
hurdle rate
to
profitably
equal distributions, the stock
Company C needs only an
reinvest.
Clearly,
given
with the higher share price
has a lower potential cost of equity capital.
As
Exhibit 2.2
illustrates, the
lower current yield
case of
an equity
share reflects
A&R group
than the Joint Venture
real estate
enjoys a
group.
company, market
arguably two things: first,
In the
price per
the underlying
value of the real estate and second, the performance of the
income
of
component
the return,
Dividends are a product of cash
dividends,
over
flow which, for a REIT, is
derived from net operating, or rental, income.
then, a
REITthat offers
sizeable
portfolio
boast
higher
a
currentyield.
our two
of
market
time.
Intuitively
competitive dividends and
owns a
property
should
income-producing
price
per
share,
and
a
lower
This raises an important distinction between
groups of development
REITs.
Those in
the Joint
Venture group started business with little or no income
EXHIBIT 2.2
COMPARISON OF ACTUAL CURRENT YIELDS
REIT
Annual
Dividend
Price
$1.44
0.48
0.40
0.60
$12.00
7.63
3.75
6.00
12.0%
6.3%*
10.7%
10.0%
$1.40
1.16
1.08
1.24
$20.25
11.25
17.25
16.13
6.9%
10.3%
6.3%
7.7%
Joint Venture REITs
Copley Properties
ICM Property Inv.
MIP Properties
MSA Realty
Acquis.
& Redevelopment REITs
Federal Realty
IRT Property Co.
New Plan
United Dominion
Current
Yield
Source: Wall Street Journal
Notes: Prices on June 29,1990. Dividends reflect total
distributions, previous twelve months.
* ICM lowered its quarterly
dividend from .34 to .12
in second quarter of 1989. Current yield at the
old rate ,annualized, would be 17.82%.
28
producing
properties;
flow
was
anticipated
debt, by the joint venture.
the same period of time, mid
and
period, through
the interim development
subsidized during
the use of
cash
In contrast, over
1980s to the present, the A&R
REITs subsidized their development
efforts with the rental
income of accumulated portfolios of property.
The Acquisition
to
raise
equity capital
occasion, New Plan
by
temporarily
securities,
at
very
reinvesting
a virtually
been able
the
levels
risk-free investment.
Since the
ICM, and MSA,
make any
that would
estate development.
a desired
able to profit
government
however, none
subsequent equity
because falling stock prices
to
money
On
into
of Copley,
to
been able
attractive rates.
Realty for example, was
initial offerings
have
& Redevelopment REITs have
offerings
have pushed up current yields
not
justify
reinvestment in
real
A low cost source of equity capital is
advantage
of
the
REIT
format,
but
not
a
certainty.
Flexibility
Most REITs can operate in any state or city where
management perceives an opportunity.
develop any
agreements
other
desired property
with virtually
entity, as
structured so
violate the
Inc.
and
diversified
long as
that the
types and
by
enter partnership
institution, or
any developer,
are carefully
those agreements
proceeds from partnerships
income tests of the
ICM
REITs can acquire or
Property
investing
in
Copley Properties,
Code.
Investors,
do not
for
office
example,
and
have
industrial
properties in several metropolitan areas across the country
with many
the
different development partners.
other hand,
investment
has a
plan
of
very specialized
investing
only
located in the midwestern United
venture
partnerships
with
MSA
Realty, on
and concentrated
in
retail
projects
States, and only in joint
its sponsor,
Melvin
Simon
&
Associates, Inc. as developer.
One limitation the format imposes is that REITs cannot
be "dealers" holding developed property for sale, as in the
case of, say,
flexibility
a single-family home builder.
of the
format does
profiting indirectly
opportunity
not prevent
from that
arises.
In
Even so, the
a REIT
sort of activity
1978 the
portfolio
of
from
when the
Federal
Realty, for example, was about 60% shopping centers and 40%
apartments;
today
shopping
center
complex.
A quick
management
REIT
which
describe
still
the
owns
portfolio
one
sell off of apartments in
a
apartment
the mid 1980s
resulted from an unforeseen market opportunity for windfall
profits.
Though REIT
limitations prohibited
the company
from converting these apartments into condos, inflation and
tax changes
and
in the
drove up
elected
to
mid-1980s stimulated
the
sell
demand for
such conversions
apartment assets.
their apartment
holdings
Federal
earlier
than
originally planned to take advantage of the inflated prices
offered by
allowed
condo converters.
Federal
to profit
market, but left the
the buyer.
Thus the REIT
from
trends
format still
in the
changing
prohibited retail sales activities to
Such creativity permits REITs to take advantage
of almost
any market
opportunity available to
other real
estate concerns.
Unique Market Opportunities
Because a REIT is motivated by different tax and
financial
objectives it
can sometimes
structure property
transactions that would not be feasible to other developers
or investors.
prior to
sell
off
Using Federal
1986 the
Realty again as
company would,
depreciation
an example,
in effect,
deductions
to
package and
buyers
that
were
taxable entities, because REITs were unable to pass through
to shareholders the benefits of
the Tax
Reform Act of
income.
The
the losses which, prior to
1986, were deductible
REIT format
from regular
allowed shareholders
to realize
the value of those tax losses, although indirectly.
More
recently,
seven shopping
than
a
Federal
Realty acquired
centers through a 49-year
fee-simple
purchase.
The lessor
individual who wanted to dispose
the capital gains and estate
the
proceeds
of
a
sale.
taxable
payments
income.
and
Because
cash-flow basis.
net taxable income
was
an
older
buyers
would
have
with leverage, and use the
depreciation
REITs
(REITs are
leasehold rather
of the property but avoid
Competing
taxes, Federal could evaluate
of
taxes that would be levied on
preferred to purchase property,
interest
control
expenses
are not
to
reduce
required to
pay
this transaction solely on a
required to distribute 95% of
but are actually able
to distribute up
to the entire before-tax cash flow.) Upon settlement of the
seller's
estate, Federal
Realty's management
31
anticipates
buying
the property
lease)
and
its
exercise
to
intends
end of
the
redevelopment
and
the
(prior to
outright
on the leased properties,
expansion strategies
just as if
they were owned.
Disadvantages of the REIT Format
Barriers to Entry
Firms
substantial
barriers to
new
a
establish
to
wish
that
Public Offerings
Initial
entry.
face
REIT
(IPOs) are very expensive and complex procedures, much more
expensive than subsequent
run about 14% to 15% of
printing, and other costs for IPOs
the
total
common equity
securities
reach the
offerings. 9
market,
only
in 1985,
offerings
original price
initial
price
financial
management
offerings
can
depressed
value
demonstrate
a
take
has
track
standpoint,
place
until
their
Property Investors'
no
additional
after
this
of
a
performance
a
From
share.
per
Typically,
passed.
record
fall
to quickly
never traded above the 1985
$20.00
of
new
trading above
ICM
one year later.10
offering
Further, once
51% to
Of 17 initial public
three were
common stock, for example, has
for
most tend
price.
below their original offering
6%
to
compared
offering amount;
subsequent
Underwriting,
equity offerings.
equity
period
stock
before
of
must
new
investors will support another offering.
Operational Expenses
Aside from start up costs, routine operating expenses
are
also high.
Operating a
REIT requires
an additional
layer
of
private
management beyond
the
development company.
As a
inherent fixed costs, another
a REIT is size.
costly way to
expensive
to produce
SEC
reports,
and
overhead
expenses must
these high
in public form is a very
smaller trusts, but
that without a threshold of
assets1 1 , it
million in
traditional
result of
There are
most industry analysts believe
about $100
of a
crucial factor in setting up
The smaller REIT
do business.
scope
is disproportionately
reports, quarterly
an investor-communications
be compensated
shareholder
program.
by higher
These
project
returns.
Stock Market Valuation
Another potential stumbling block for new and
established REITs alike is that the performance criteria of
the stock market may conflict
Ideally, the price of a
with the real estate market.
real estate equity security should
simply reflect the value of the underlying securitized real
estate; this
is seldom
dividend income
by the
hybrid
securities whose
those of
While
held
the
real estate,
REIT
price movements
stock market. 1 2
identify
attractive development
when its
stock values are depressed
to the real
of 1989,
shares are
Copley Properties
was $22.04
So, in a
truly
correlate highly
REIT management
opportunities
the appraised
true that
the cash flows
at a
may
time
for reasons unrelated
estate market or value of assets.
for instance,
about $12.00.
it is
streams relate directly to
earned
with
the case.
value per
while each share
At the end
share of
traded for
public offering, Copley would have
33
for each dollar of
received about $0.54
the
impairs
this situation
Obviously,
sold.
portfolio
their real estate
REIT's ability to raise capital in a timely manner.
Constant Capital Recuirements
to grow,
order
In
to utilizing
as opposed
So,
costly.
be much less
which would
retained earnings,
be
must
growth
income,
new capital
accommodated through
that REITs
the requirement
taxable
of
95%
distribute
constant
a
must become
REIT
Due to
of capital.
consumer
a
even though the cost of capital may be lower, the frequency
than some of
REIT must buy capital is higher
with which a
its competitors.
Dependence on Cash Flow
For a REIT to have access to the capital markets it
a favorable
must maintain
growth
Traditional developers
and income.
and
anticipation
of
shareholders
may understand
strategy, but the
decreasing
intolerance
stock.
is
the rationale
stock market at large
dividends
any
for
reflected in
Joint Venture
length
lower
REITs, in
will
with
the
in
project
Certain
returns.
long-term
favorable
a
of
periods
lease-up
construction
terms of
can and
associated
flows
cash
negative
tolerate
stock performance, in
behind such
a
will not tolerate
of
market
This
time.
value of
particular, must
the
either
endure depressed stock values during development periods or
find alternate
sources of
income to
flows.
34
offset the
low cash
Limitations on Capital Structure
Like other development entities REITs can take on debt,
employing leverage to enhance returns.
Debt is less costly
to a REIT in the short run due to lower underwriting costs,
and in
the long run
costly than
dividends.
REITs employ
the
value of
raise
the stock
acceptable
then the market
equity
the risk
of leverage.
debt-to-equity
the
to borrow and
capital.
can
The
market,
effectively limit
ratio
for
most highly
risk; if
will discount
limit the REIT's ability
rating agencies,
one of
generally less
leverage equates to
to offset
additional
specifically
Realty,
But
too much debt
Lower stock prices
to
interest payments are
a
REIT.
the
Federal
leveraged public
REITs,
maintains an ongoing dialogue with rating agencies, such as
Standard
and
Poor's
and Moody's.
claims that agencies' threats of
influence to
Federal's
lower ratings are a major
raise additional equity.
lowers its grade, a stock's
resulting in a
management
If
a rating agency
market value will likely fall,
higher cost of equity, and
thus offset the
advantage of leverage.
Limitations on Portfolio Turnover
To insure against speculative and short-term trading,no
more than
30% of a REIT's
the
of
sale
property
(excluding gains
gross income may be
held
for
from foreclosure).
less
than
There
gains from
four
years
are occasions,
often unforeseen, when an early sale of a project may be in
the best
can
interest of
hinder a
the shareholders.
REIT's ability
to maximize
35
This restriction
profits.
Gains
from such disallowed transactions are taxable and forfeited
stiff payment is
The alternative to the
IRS.
100% to the
to surrender REIT status.
Takeover Risks
Because security values typically trade at a discount
underlying real estate,
market value of the
from the fair
REITs are susceptible to hostile takeover attempts by other
covenants that
so that 50% of
transfer of shares,
cannot fall
Some
the right
enabling the
the outstanding shares
fewer individuals.
of five or
into the hands
REITs reserve
stock,
restrict the
organizational documents to
to the
built in
company
be
provisions can
For example,
stock purchases.
volume
against large
employ to protect
REITs can
strategic
certain
are
There
investors.
estate
real
special preferred
to issue
large block
a
to place
of
voting shares into friendly hands. 1 3
In
REIT
vehicle
circumstances.
a publicly
lease-up period.
and
development through
under
only
certain
estate business and running
management
present
with
The business of real estate development
construction capital
development
advantages
of
total
positive
corporation
held
relentless debt
the
is
Running a real
conflicting goals.
requires
sum
pursuing real estate
disadvantages of
the
the
summary,
outlays at
the front
income during
service payments, no rental
period
and
After a ride
developer's desired end
limited
end,
income
during
the
on that roller coaster, the
result is a steady
36
stream of cash
flow from a fully operating structure, whose value is worth
more than
its original
cost.
To
reach the
developers must
tolerate low or negative
for
income
attractive
accustomed to
are
not.
that trade
The
Developers
a steady
a
running
a
development" and
publicly
that
would
held
(a value-creation
stream of increasing
paradox
are
equity shareholders
development corporation
REIT) requires
implies
of
cash flows, now,
later.
off; common
business
income-oriented
This
streams
desired end,
make
cash flows.
"real
"publicly held securities"
estate
seem mutually
exclusive.
The
market
for
gratification in
per share.
income
the form
stocks
demands
of dividends,
Investors will pay
immediate
or distributions
more for a proven source of
dividend income, raising the market price of the stock.
If
the value-creation REIT is to serve as a well from which to
the value
draw capital,
time,
or
the
well
illustrate that this
Venture
case
study
run
may
dry.
Chapter
was largely the case
If
REITs.
maintained, REITs involved in
enhanced over
must be
per share
share
will
Three
among the Joint
value
is
to
the development process must
find ways to supplement inherent negative cash flows.
is
especially true
Acquisition
portfolios
in an
and Development
of existing
be
uncertain leasing
REITs
have
properties to
cash drains of renovation projects.
market.
relied on
fund dividends
This
The
large
and
Development as a REIT: Two Approaches
The REITs
chosen for
illustrate the
used to
this analysis were
various ways that
the REIT vehicle
facilitate the development of
are two notable basic
partnership with
Some REITs
strategies,
the
There
the strategy
and/or expansion of existing
employ a combination
companies selected
demonstrated a
over the other.
real estate.
independent developers, and
built property.
historically
can be
strategies: the joint venture equity
of acquisition, redevelopment
but
selected to
preference
The remainder
for
of both
study
for one
have
approach
of this chapter, as well as
Chapter Three, will focus primarily on the six case studies
profiled in Exhibit 2.3.
Within the context of these two fundamental investment
strategies
REITs
can
another.
individual
there are
further
The
a
variety of
differentiate
important
strategy
ways that
themselves
characteristics
include
the type
and
of
individual
from
a
one
REIT's
diversity
of
investment property; the size of the real estate portfolio;
the percentage
of the
portfolio under development
at any
one time; the capital structure or use of leverage; and the
means
employed
to access
new
Logically, age of the REIT will
portfolio size-- building a
time.
Further,
and equity
capital.
also have an impact on the
portfolio of real estate takes
the climate of
the inception of a REIT
debt
the real estate
market at
may have had significant influence
on the chosen development agenda.
EXHIBIT 2.3:
THE CASE STUDY REITS
JOINT VENTURE EQUITY PARTNERSHIP REITS
Name of REIT:
Copley Properties,
Inc.
IA
u.
ICM Property
Investors
Incoroporated
MSA Realty
Corporation
Year
Founded:
Real Estate
Portfolio:
Capital
Structure:
1985
$68,098,507 Assets
12 Properties
Debt-to-Equity
0.1:1
Warehouse
Office
R&D
Residential
Debt 8%
Conv. Debent. 0%
Equity 92%
1985
1984
73.7%
11.6%
10.4%
4.3%
$131,077,000 Assets
11 Properties
Debt-to-Equity
1.0:1
Office/R&D
Debt 51%
Conv. Debent.
Equity 49%
100%
$79,410,043 Assets
18 Properties
Debt-to-Equity
0.7:1
Shopping Centers 100%
Debt 27%
Conv. Debent. 15%
Equity 58%
Sources: 1989 annual reports and NAREIT Fact Book.
Description:
Company invests in to-be-built
properties with a number of developers
as an equity partner or a lender with an
equity option in the completed project.
Projects are Located in several
geographically diverse markets in the
U.S.
ICM invests as a general partner in
joint venture partnerships with a number
of developers in geographically
diversified markets. The trust wholly
owns two properties. Presently
negotiating a stock-for-property
purchase of an existing industrial
portfolio.
The company invests as a general partner
in joint venture partnerships with
Melvin Simon & Associates,Inc.,
exclusively. MSA typically contributes
all of the capital required by each
joint venture to develop, acquire and/or
expand a shopping center. The company
has right of first refusal to invest in
any properties Melvin Simon & associates
proposes to acquire or develop.
EXHIBIT 2.3:
THE CASE STUDY REITS (continued)
ACQUISITION AND DEVELOPMENT/REDEVELOPMENT REITS
Name of REIT:
Federal Realty
Investment Trust
IRT Property
Company
New Plan Realty
Trust
Year
Founded:
1962
1979
1962
REIT
Since
1972
Real Estate
Portfolio:
------ ------$514,552,000 Assets
43 Properties
Capital
Structure:
-- -------Debt-to-Equity
2.9:1
Shopping Centers 99.1%
Apartments .9%
Debt 46%
Conv. Debent. 28%
Equity 25%
$150,455,715 Assets
71 Properties
Debt-to-Equity
1.3:1
Shopping Centers
Apartments 9%
Industrial 2%
Other 1%
Debt 44.0%
Conv. Debentures
Equity 43.4%
88%
$116,518,612 Assets
59 Properties
Debt-to-Equity
0.1:1
Shopping Centers 60%
Cash and Securities 25%
Apartments 6%
Real Estate Securities 5%
Other Real Estate 4%
Debt 8.7%
Conv. Debentures
Equity 91.0%
----
12.6%
0.3%
Description:
----------------------------------------------------Federal invests primarily in prime community and
neighborhood shopping centers. The redevelopment
strategy is to upgrade older centers in prime locations
through reconfiguration, expansion and modifying tenant
mix. The company does its own property management and
leasing.
Real estate investments consist principally of
neighborhood and community shopping centers, located in
the Southeastern United States and anchored by major
grocery, drug and variety stores. IRT renovates,
expands, manages and leases acquired properties. The
company also participates in development as a
construction lender on new projects. IRT oversees
design and construction, participates in anchor tenant
lease negotiations and controls leasing standards and
rates.
New Plan Realty Trust evolved from New Plan Realty
Corp., a pooled real estate investment vehicle founded
by Morris B. Newman that first went public in 1962.
Newman family members still direct the REIT, which is
primarily an equity owner of fee and leasehold
interests in income producing real properties.The
investment strategy is to purchase seasoned well
Located shopping centers and apartment complexes, at a
discount to replacement costs, and seek to achieve
income growth through a program of expansion,
renovation, re-leasing and/or re-merchandising.
Sources: 1989 annual reports and NAREIT Fact Book.
The Joint Venture REITS
1985 was a record setting
With 29
year for the REIT industry.
offerings totaling $
initial public
industry followers
nicknamed this group the
REITs
quite
had
become
development
mid-1980s
business
popular
was
market, all
and
booming.
three
Class of '85.
the
In
of the
2.9 billion,
real
this
estate
thriving
Joint Venture
REITs
issued their initial public stock, each without the benefit
of an established real estate portfolio.
Traditional
equity REITs
income-producing property.
invest in
proven, existing
Most of the underlying value of
their stock is attributable to cash flow generated from the
steady flow of rental income, less operating, investing and
financing
expenses.
development
Unlike
REITs set
out
traditional
to capture
equity
REITs,
the value
created
immediately when a new building leases up, making the
transition
from
generator.
To
Venture REITs
a construction
the
achieve
rely on the
project
desired
to
a cash
results
the
expertise and abilities
flow
Joint
of the
developer partner to identify the opportunity, build, lease
and manage the
monitor and
project.
As a money partner,
influence these
efforts but they
the REIT can
are clearly
not internal functions of the company.
Copley Properties, Inc.
Copley
Properties
typifies
representative of this group.
the underlying value of the
a result
of increased
asset
the
general
strategy
Its founders envisioned that
common stock would increase as
value
realized through
the
management
outset,
the
At
process.
development
specifically targeted real estate development as a key part
Funding real property in its
of their investment strategy.
Copley to
would enable
they reasoned,
development phase,
invest at the cost of raw land and improvements rather than
at
the
price,
or
estate.
The
retail
developed real
development projects
The
original deals.
that the
it,
through
enable
in
future
while retaining its interests
in the
capital
300% of the net
of leverage to no more than
book assets.
The Copley prospectus represented
property or acting
(as
Test
Income
from
long-term profit
anticipated
the 30%
as dealers by
Chapter
in
described
and 12
REITs are prohibited
investment.
years after the original
that sale
between 8
generally occur
property would
from "flipping"
set up to
bylaws of the company were
limit the use
of each
fully
of
value
Company anticipated
additional
invest
to
refinancings,
market
would
appreciation
resulting
fair
but
1),
Copley
appreciation would
be
realized through capital gains.
The
investment
identical
intentionally
successfully employed
Advisors,
Inc., since
format was chosen
previously
institutions.
advisor also
At
to
by the
its
chosen
inception in
available
only
the inception of
1982.
The
REIT
for small investors
pension
the REIT in
believed that securitized real
42
strategy
of investments
to
was
Real Estate
advisor, Copley
same sort
REIT
the
for
investment
the
to provide a market
in the
to participate
been
strategy
that had
funds
and
1985, the
estate was an
important
area
for the
company
to
addition, management of the REIT
diversify into.
In
served as a source of fee
revenue for the advisor.
Capitalization of
the
form of
the joint ventures is
a construction
project with an
the building
loan
option to acquire an
is completed.
would loan
at the
office/R & D
an option
when the
building was
and buying
million.
returns ran
to acquire
limited partnership
Excercising
the partnership position would
Interest on
the construction
at about 12%.
Copley
example, Copley
time, for $100,000,
a 60%
completed.
a
an 80,000-square foot
building and at the same
purchase
beginning of
equity position when
In a routine
$10 million to construct
typically in
the option
cost another $2
money and
equity
also funded development
buy purchasing land and then leasing it back to the seller,
with ground rent based on
of the gross receipts.
rent
base payments
In
a fixed amount plus some portion
a typical 60-year lease, ground
resembled
about 12%, and additional rent
service amortized
debt
at
equaled 50% of gross rental
reciepts after rent payments.
ICM Propety Investors
The strategy for ICM
that of Copley Properties.
Propety Investors was similar to
Although in their first year of
operations, besides investing
projects,
ICM paid
all cash
buildings, independently.
in joint venture development
to purchase
(The seller
the lease-up period and gauranteed
flow
by "master-leasing"
two new
office
assumed the risk in
a minimum level of cash
the entire
buildings for
three
years.) ICM
categorizes their
partnerships
as
two types of
"mortgage-equity"
joint
"equity gap" funding joint ventures.
a general partner provides first
equity
contribution to
estate.
developer form a
partner.
and ICM
for a
makes an
priority
effort
boost
negotiating
a
party financing,
in the venture.
the
sale of
lagging
in exchange
ICM stipulates
must be paid before any funds
to the developer-partner.
interest in
to
developer contributes
existing third
that its own required return
real
as a general
initial equity contribution
preferred interest
are distributed
holding the
venture, the company and a
partnership, the
subject to
and
mortgage financing and an
partnership with each party
To this
the property,
ventures
In the former, ICM as
the partnership
In an equity-gap joint
joint venture
cash
stock-for-property
the
flow
ICM
also has a
property.
ICM
is
purchase
In
an
presently
of
several
existing industrial properties from a west coast developer.
This will be discussed further in later chapters.
MSA Realty
MSA Realty provides an important contrast to the other
Joint Venture
invests in
REITs, for two reasons.
community shopping centers and
as opposed to office
the sponsor
wholly
of this REIT
provide staff
the investment
for the
is a developer.
of
Melvin
In
Simon &
REIT's entire scope
advisor, the
company.
regional malls,
and industrial properties and second,
owned subsidiaries
management
First, the company
All
MSA
fact, three
Associates
of operations:
development company,
projects
44
and the
are developed
by
by a
for preffered returns during the
joint venture in exchange
in the finished
and an equity postion
construction period
construction
capital required
provides all
MSA routinely
loans;
of
by guarantees
or
contributions
capital
through
the REIT
by
funded
Projects are
sponsor.
the
project undertaken by
to participate in any
first refusal
right of
has had
and the REIT
& Associates
Melvin Simon
product ranging from 42.5% to 50%.
MSA was founded
status until the 1987 tax
investments, did not attain REIT
After six
year.
leasing success,
of limited
years
of short-term
due to an excess
a REIT, but
qualifying as
stated intention of
in 1984 with the
the
company is presently trying to liquidate and again may face
Nevertheless, the company has
disqualification as a REIT.
participated in
community shopping
of 18
the development
centers, each one a seperate joint venture partnership with
developer, totaling over 4.5
the same
of
shortages
market
were
properties.
(presented
that the
illustrate
other two
Joint
MSA's leasing difficulties and cash
Venture REITs studied.
flow
the
than
significantly more
space,
million square feet
recent
not limited
Historically,
the
in
problems in
to
only
the
chapter)
following
the real
office and
older equity
estate
industrial
REITs
with
concentrated retail portfolios, like Federal Realty and New
Plan,
well. 14
have
weathered
MSA's
short
previous
history
recessions
would
comparatively
indicate
that
concentrated retail holdings, alone, do not insure success.
45
The Acquisition & Redevelopment REITs
"Renovations
and
modernizations
do
not
automatically create additional income this
must come
from new leases.
Our expansion
programs must be complete and paid for before
these stores can be leased and produce income.
Although future cash flows can be expected and
the portfolio
enhanced by
these additions,
increases in cash flow from these programs may
not be immediately reflected."
Donald MacLeod, Chairman
Property Company (1989,
Report to Shareholders)
These companies invest
some
with
primarily in shopping centers,
diversification
properties.
in apartments
Renovation
efforts
immediately after the acquisition of
typical community
Reconfiguration
necessary,
be
Upon completion, these
to
quite
with substantial
new construction.
re-tenant
and
industrial
generally
happen
a property and, for a
center, can be completed
can
of IRT
Annual
within a year.
extensive,
additions
phased
to rentable
if
area.
projects are indistinguishable from
Then the second
the space
with
part of the strategy is
those
merchants that
will
attract the most business.
While the Joint Venture category of REITs each started
their
operations from
scratch with
build the portfolio through
Redevelopment
REITs
a stated
development, the Acquisition &
typically
evolved
developers,
adding value
renovation.
Development strategies in
of
day-to-day
properties.
management
strategy to
to purchased
that,
46
active
properties through
this group grew out
activities of
owners realized
into
if
existing
income
the location
was
right, aesthetic
shopping
and functional
center would
generate higher
shopping
attract better
rents.
center,
improvements to
retail tenants
The acquisition price
or
apartment
an older
and
of an older
complex,
would
be
substantially lower than the market value after renovation,
expansion, and
re-tenanting.
category follow
this
building
and
development
an
holding
Typically, the
strategy focused
investment
an
companies in
income-producing
and redevelopment
efforts are
on
portfolio;
a supplemental
means to that end.
Some
of
renovation and
these
REITs
have,
projects.
to
into ground-up
in their portfolio with the
of constructing new retail
expressed intention
conditions
IRT,
permit.
developers,
with
their
Weingarten Realty Investors,
for example, holds vacant land
partnerships
addition
expansion efforts, ventured
development of new
market
in
joint
through
has
centers as
built
new
venture
shopping
centers and taken an active role in overseeing their design
developed
new industrial
Federal Realty added
275,000-square
forbidden by
has independently
United Dominion also
and construction.
buildings
the ground
a 5-story hotel on the
foot Grovenor
a REIT,
from
so the
lease for that portion of
Plaza.
site of their
Hotel operation
company structured
the site.
up.
is
a ground
Also, it receives all
rental income from the 10,000-square feet of lobby retail.
Development,
activities all
redevelopment, and
add value
market repositioning
to the properties.
Within this
group of REITs, however, that value is usually passed on to
shareholders
rather
through dividend
than gains
toward cash
from
income
from higher
higher sales
prices.
flow and long-term ownership
transactions
distinguishes the
rents,
This
bias
over disposition
A&R REITs
from the
Joint
Venture group in another way.
These REITs employ their own
property
rather
management
forces,
development
partner
management.
In August
absorbed
to
its long-time
handle
than
relying
initial
1988, for
on
leasing
example, when
independent agent,
a
and
New Plan
it became
the
first listed REIT to be self administered and self-managed.
Ironically, the
by
property
very first REITs of
management
companies,
independent contractors.
conversion
that
management
as
the
an
ownership, and
IRS
formally
integral
directly
Private
Letter
self-manage their
themselves
by a
as
until New Plan's
recognized
function
thus permissible
received
with
Yet it was not
1990 respectively, Federal Realty
each
1960 were established
of
real
REIT.
In
property
estate
1989 and
and IRT Property Company
Rulings from
properties.
the
Federal
IRS
to
Realty's
extensive internal operations include separate divisions in
Leasing, Marketing,
Development, Property
Acquisitions.
in cases where management
Even
handled through
independent contractors,
Management, and
is, or was,
the relationship
is usually very close and exclusive of any other management
clients.
Other Applications of REITs in the Development Process
There
are
other
REITs
that
participate
in
the
development of property and offer unique differences worthy
of
mention,
even though
Property
typology.
this
Capital
listed joint venture
equity
developers
REIT
The
traditionally
funded
has
on certain
portfolio.
new
avoided
only
from other
group.
outside my
(PCT),
proposed
for
example,
similar to those
Since the
in
close
projects for
difference
is
late 1960s
contact
upon
sources.
approved
owner.
the
that
PCT
has
risk
and
completion,
as
a
Construction loans were
PCT also
long-term investments subject to
with
addition to
development construction
permanent lender or equity
funded
Trust
worked
key
projects
fall
strategy that is very
represents another
of the
they
only funded
these
minimum occupancy so that
the developer would bear the initial leasing risks.
been utilized in other
REITs have
to provide
by developers,
raising common
Instead of
development
equity
projects,
REITs to
some
cash out
stock equity prior
to starting
have
established
developers
management
of
offerings,
market.
Crow Real
Trammell
this
strategy
traditionally done private placements
public
public-securities
the fee-generating
Through
property.
developers, who have
than
properties, while
of completed
financial interest through
rather
their portfolio.
liquidity for
retaining a
the
ways, most notably
Estate
gain a
Lincoln
foothold
Realty
N.C.
in
Fund and
for example,
Investors,
the
were
designed to serve this purpose. 1 5
Chicago
REIT
that
entered
Dock &
seems to
joint venture
Canal Trust
deny
is a
unique development
classification.
partnerships with
While it
has
developers, this
own, some of the most challenging
REIT has assumed, on its
tasks
of
the
approvals,
process--
and
developing
downtown development
that
most of
masterplanning,
infrastructure
site.
its assets
underdeveloped land.
This trust is
are
tied up
hub 135 years
was assembled as a
original
a
major
also unusual in
in undeveloped
or
the north bank of the
shipping and industrial
ago, just prior to the
Lincoln was one
for
city
Chicago Dock's original land holding,
a 46-acre tract that stretches along
Chicago river,
obtaining
Civil War.
of the attorneys who
land trust.)
Today the
located in the city, bound
(Abraham
helped structure the
site is
remarkably well
on the west by the "Magnificent
Mile," North Michigan Avenue, and on the east by Lake Shore
Drive.16
Revamped
closely
in
1962
held Chicago
200-for-1
stock
encourage
more public
area as part
York's
Battery
trading.
with
when it
its
Equitable
share
and
Shortly thereafter,
the
infrastructure.
Chicago
tract
in
1986
and
venture
Society,
for obtaining
and
after New
short-lived
Life Assurance
Dock
shipping pier
60-acre, 12.5 million
design approvals to redevelop
masterplan and
public
price
a
responsible
the
tendered a
be fashioned
In
City.
REIT,
into the
develop the old
project to
Park
was primarily
the
lower
of Cityfront Center, a
foot mixed-use
divided
to
plans to
square
partnership
not move
the mid-1980s
split
company announced
equity-oriented
Dock did
arena until
investment
trust
as an
necessary
the land and
Equitable
have
the
amicably
developed
their
respective parcels independently but
plan.
Chicago Dock has used
joint
venture
partnerships
apartments, hotels,
Development of
the
trust
has
ground leases, fee sales, and
with
public open
the tract is still
also
under the same master
acquired
developers
spaces and
underway.
properties
Indianapolis, Tampa and Lansing, Michigan.
51
to
create
office space.
In addition,
in
Denver,
CHAPTER THREE
EVALUATING THE REIT AS A VEHICLE FOR DEVELOPMENT
"We were masters of poor timing.
We are not
recovering because we never had the opportunity
to get started."
Arthur Viner, Chairman,
ICM Property Investors
(June 22, 1990)
Generally
speaking, the
Acquisition &
Redevelopment
REITs have
performed more successfully over
the last five
years than
those in the
such a
statement we must
evaluate a
basic
Joint Venture group.
in
performance.
in a cycle
define the criteria by
value-creation REIT's success.
areas
which
These four
To warrant
these
REITs
There
can
areas can be thought
that a REIT must complete in
which to
are four
demonstrate
of as steps
order to succeed,
as a real estate security, and grow.
The steps are (1) the
ability
ability
to raise
capital;
(2) the
to put
that
capital to productive use, that is, to develop in line with
its investment
flow, or to
enhance
strategy; (3) the ability
manage the properties; and (4)
shareholders' returns,
performance
as a
security.
Successful
the
will grow in
cycle
maintain attractive
the fourth
is
in the cycle
previous step,
asset base and share
the
step
at step one and raise more
of the
time the cycle is completed.
through
the ability to
completion of each step
is dependent- on completion
equity REIT
or to
Completing
enables the REIT to begin again
capital.
to generate cash
and an
value each
Perhaps the most crucial run
initial
one.
Since
their
inception in the mid-1980s, none of the Joint Venture REITs
have successfully
chapter,
with
cycle, seeks
REITs
completed their first full
empirical data
to explain
and, in
tracing
the plight
contrast, the
the
of the
cycle.
This
steps of
the
Joint Venture
stronger performance
of the
Acquisition & Redevelopment group.
Some of the reasons for
Joint Venture group
REIT vehicle.
the difficulties faced by the
are not linked to their
Specifically, the nationwide downturn in the
commercial real
estate market
time
fledgling
for these
in the
unwise
that
to conclude
development
fell at a
REITs.
market's volatility
particular
choice of the
Given
last five
the
most inopportune
years, it
use of
strategy is
the real
the
estate
would be
REIT for
ineffective.
this
Market
conditions have caused many of the problems.
The overbuilt
condition of
has not
changed dramatically
years.
Commercial real
over the
estate
distressingly high levels for
Due
to
reductions in
new
highest
vacancy rates
have
turnarounds have
expanding
high
vacancy rates
rental
tenants.
rates
as
construction,
improved
rates remain
development
of vacant
slightly, but
activity is
space.
has flattened
owners have
areas with
Even in those
at
the
real
areas with
still
low
estate continues to
The impact
or depressed
competed
High vacancy rates have
property which
to three
most regions of the country.
supply of commercial real
outpace absorption
estate markets
past two
vacancy
yet to occur.
economies,
because the
U.S. real
of these
effective
aggressively
for
also placed a premium on
is significantly leased
versus development
projects.
Even
if new
leasing efforts
are successful,
cash flow may be delayed due to expensive rent concessions,
including free rent, now common in the marketplace.
The Joint Venture REITs
crest of a
been
wave of real estate development,
operating
Compared
in
to the
the
Joint
Redevelopment REITs
established
projects.
all started operations at the
declining
portfolios, some
With
overbuilt, and
the
nature
market with
debt-free
spanning 25
years or
when many real estate markets
1981-82 when
tighter, aggregate construction volume
to
&
New Plan have survived major
second in
demand was strong.
since.
the Acquisition
which include
operating histories
recessions, first in 1974-75
ever
present soft
of
more, both Federal Realty and
were
market
Venture group,
entered the
and they have
markets were
was heavy, and user
This resilience could be attributable
of
the
investment
portfolios.
The
Acquisition & Redevelopment typically invest in low glamor,
high utility
demand
for
retail shopping centers and
consumer
necessities
and
apartments.
affordable
The
rental
housing remain generally constant, even during recessionary
periods.
Commercial
office space,
more like a commodity.
on the other
hand, is
That is to say that, during periods
of economic hardship, firms
can contract by reducing staff
or reducing office space per worker and thus cut down their
consumption of space.
difficulties
faced
As a matter of timing,
by
the
attributed to their recent
Joint Venture
many of the
REITs
can
be
start-up followed soon after by
depressed conditions in real estate markets.
Contrasting Track Records: Performance as a Security
Security returns, the last step listed in the cycle of
growth
REIT
and
and
yields
share
performance over time is a
indicates that over
REITs.
in Exhibit
3.1
group have cut
time the Joint Venture
prices have fallen
turn, share
dividends; in
group of
performance shown
of security
Evaluation
previous point in the cycle,
Joint Venture
the
case with
is the
Poor
observe.
to
the
likely tip-off that the REIT in
question has stumbled at some
as
in
security
its
determine
tougher
are
however,
performance,
Dividend
activities of
The internal
ultimately
that
REIT
sees.
monitored
easily
basis.
first
the
generally
shareholder
are
prices
a daily
newspaper, on
the
the
indicator
performance
are
success,
and returns
have been flat.
Another
performance
proportionate
estate.
This
measure
potential
is the
the
value
of
the underlying
the
real
obtain since
properties is published only at
Real estate
REIT's discretion.
security
relative to
more difficult
information is
the appraised value of the
REIT's
a
each share
value of
fair market
of
securities generally
trade at a discounted value from that of their real estate.
This
is not
always the
demonstrated- a
particularly successful
record and a history
trade at
market
a premium.
value
REITs that
case, however.
management
have
track
of attractive shareholder returns don
their own
Based on
of outstanding
shares
of
appraisals, the
New Plan
Realty
Trust, for example, was greater than the current value of
55
EXHIBIT 3.1 : ANNUAL SHAREHOLDER RETURNS OF VALUE-CREATION REITS
JOINT VENTURE REITS
1984
1985
1986
1987
1988
1989
Copley Properties, Inc.
Share Price
Distributions Paid
Annual Return
$20.00 IPO,
July 29, 1985
$17.25 $18.38 $16.75 $17.00 $12.00
$0.69 $1.65
$1.68
$1.68
$1.50
-10%
16%
0%
12%
-21%
ICM Property Investors
Share Price
Distributions Paid
Annual Return
$20.00 IPO,
Jan. 25, 1985
$14.81 $14.38 $11.00
$1.21
$1.39
$1.48
-20%
6%
-13%
MSA Realty Corporation
Share Price
Distributions Paid
Annual Return
$9.00 IPO,
Apr. 5, 1984
ACQUISITION &
REDEVELOPMENT REITS
1980
1981
1982
1983
$9.00 $8.63 $10.81
$0.48
$0.84
$0.95
5%
5%
36%
1984
1985
1986
$8.56
$1.00
-12%
1987
$9.44
$7.63
$1.36
$0.70
-2%
-12%
$8.38 $8.75
$1.00
$0.60
9%
12%
1988
1989
Federal Realty Trust
Share Price
Distributions Paid
Annual Return
$6.88
$0.53
18%
$8.50 $10.38 $12.50 $15.25 $17.13 $18.38 $21.00 $22.25 $24.00
$0.59
$0.68 $0.75
$0.89
$0.98 $1.05
$1.11
$1.23
$1.36
32%
30%
28%
29%
19%
13%
20%
12%
14%
IRT Property Company
Share Price
Distributions Paid
Annual Return
na
$0.41
na
$5.40
$0.53
na
$6.37 $8.32
$0.63 $0.68
30%
41%
$9.52 $10.15 $13.50 $12.55 $14.50 $13.19
$0.75
$0.90
$1.16
$1.04
$1.10
$1.15
23%
16%
44%
1%
24%
-1%
New Plan Realty Trust
Share Price
Distributions Paid
Annual Return
$3.71
$0.30
23%
$3.92
$0.34
15%
$5.09
$0.39
40%
$8.50 $11.50 $13.75 $17.25 $14.75 $17.50
$0.57 $0.65
$0.73
$0.81
$0.89 $1.02
13%
43%
26%
31%
-9%
26%
$8.00
$0.51
67%
Source: Annual reports and 10-Ks.
NOTES:
Share Price = Avg. 4th Quarter Closing Price
Distributions Paid = Total annual dividends for calender year.
(Change in share price from previous year + Distributions)
Annual Return =
----------------------------------------------------------
Previous year's share price
Prices and distributions have been adjusted to reflect stock splits where necessary.
Initial year of operations are calculated assuming purchase at IPO and sale at 4th quarter.
56
the
In contrast,
Copley
discounted
market
a significantly
at
trades
properties
and 1989.
in 1987
real estate
price, as shown in Exhibit 3.2.
is
stock
"overvalued"
of
advantage
competitive
to
REIT
equity
an
For
holdings.
of its
the value
from
substantially discounted
estate
its cumulative stock
the asset value of
acknowledges that
the
REITs
Joint Venture
the
of
but each
REITs,
case-study
of
each
available for
not
is
data
Appraisal
real
enjoy
the
they
must
New Plan
demonstrate a long history of increasing returns.
Realty Trust is one of the few companies that has been able
to
estate.
real
underlying
the
of
worth
stock beyond
of their
market value
push the
situation is
found only among
demonstrated
steady
fortunate
This
which have
the older REITs
perceived
and
Youth
performance.
the net
disadvantage to the Joint Venture
inexperience have been a
group of REITs (even though each of the sponsors themselves
had
considerable prior
securities
clearly
group.
The
root of the
performance of the
the behavior of
lagging
value
of
the
the
"leverage"
of
have
Redevelopment
poor income
However, securitization (and
REITs by
augments the value of older
Hence,
Acquisition &
the market) compounds the
property.
Indeed,
Venture REITs
valuation problem is
property.
Joint Venture
of their
Joint
the
performance of
lagged that
estate expertise).
real
problem for the
driving prices
Whereas,
the market
below the
actually
workhorse REITs like New Plan.
going
vehiclecan be positive or negative.
public
with
the
REIT
The remainder of the
EXHIBIT 3.2
SECURITIES MARKET PRICE vs. APPRAISED REAL ESTATE VALUE
1989
(Dollars per Share)
1988
1987
Copley Properties Inc.
Market value:
Appraised value:
Premium (Discount):
$12.00
$22.44
-46.5%
$17.00
$23.37
-27.3%
$16.75
$23.37
-28.3%
New Plan Realty Trust
Market value:
Appraised value:
Premium (Discount):
$17.50
$16.67
5.0%
$14.75
$16.27
-9.3%
$18.10
$17.25
4.9%
Source: 1987 - 1989 annual reports of each company.
58
chapter
will
explore
the
other
examine the
these
behind
reasons
cycle
of the
steps
differences
to
in
performance.
Building the Bricks and Mortar:
Performance as Developers
Despite
their
performance as
poor
of
the Joint
In fact, their success
to do.
as prolific developers has since
All
Venture
the
to develop real estate-- as
Joint Venture REITs did manage
they had originally set out
securities,
proven to be a detriment.
REITs have
development
faced
difficulties leasing their newly completed space under weak
market conditions.
development strategies
For
upon
of the
Joint Venture
explain the
the Joint
one thing,
development property
while the
portfolios,
also key differences between
There are
groups that
two case study
unleased space.
REITs' glut of
Venture REITs
to be
relied primarily
the foundation
& Redevelopment
Acquisition
and renovation, in moderation,
used development
of their
group
to add to
In short, the
an existing foundation of income properties.
Joint Venture group developed too much too fast.
is
factor.
another
The
essentially raise 100% of
Acquisition
&
portfolio
as 100%
Redevelopment
the capital, debt and/or equity,
development project and complete
for a given
own
development process
participation in the
Third party
owners.
In
it for their
contrast, the
Joint
Venture REITs have been criticized for funding sometimes up
to
100%
of
the
development
capital,
through
either
construction loans,
exchange for
mortgages or equity
50% to 60% equity
developer. 19
the
developer/partner
contributions, in
partnership positions with
Nonperformance
represents an
by
the
outside
additional layer
of risk
faced by the Joint Venture REITs.
To
highlight
two
different
consider two
value-creation,
Realty and
the
Federal Realty.
approaches
shopping center
REITs-- MSA
in 1984
MSA began operations
with seven joint venture partnerships.
to
By the end of 1989
the company opened 17 shopping centers with one still under
development.
Yet
decreased from $98
the end
of 1989;
lost value.
total
assets
on
the
balance
million in 1984 down to
some partnerships
$97 million at
were sold
(The capital structure
sheet
and others
of these REITs over is
presented later in the chapter in Exhibit 3.8) In that same
time period
centers
$133
Federal Realty
of 23
million
renovated only
increased four-fold
acquired; assets
to
$564
seven shopping
In
million.
of
terms
from
aggregate
rentable area completed, MSA outperformed Federal Realty as
a retail developer.
joint
ventures
progressed
(during which the company
the developer) to the
began after the
The problems for MSA
from
the
construction
phase
received guaranteed returns from
early operational phase during which
the centers were not fully leased.
MSA's structure and
another
added
cost
not
higher development volume brought
faced
by
Redevelopment
REITs-- development
partners used
by MSA
and some
60
Acquisition
the
fees.
The
other Joint
&
development
Venture REITs
typically charge
above and
joint
fees at
beyond whatever
venture
partners.
Investors
and
motivated
to negotiate
various
the completion of
Copley
equity returns they
In
the case
Properties,
a
the projects,
of
REIT
lower fee
receive as
ICM
Property
management
structure for
independent developer/partners.
is
their
This may
or may
of MSA Realty because one third of
not be true in the case
its board is staffed by officers of the developer, the only
developer,
receiving
those
management is provided on a
of
Melvin
fee-driven,
fees.
property
fee basis by another affiliate
Simon
&
Associates.
it
a
potential
is
Similarly,
If
is
development
abuse
of
shareholders'
interests.
Exhibit 3.3 illustrates the higher risk exposure faced
ambitious Joint
by the
years
companies
these
portfolios
under
structured
so the
during
For
operated
building
As
a result,
from the
insulated
over
were
their
generally
prescribed lease-up
period.
this
could last
from
24 to
36
the REIT committed to the
initially the REITs
effects of
half
returns
months, depending upon how early
project.
Deals
their start-up
receive guaranteed
REIT would
and
In
with
development.
the construction
an office
Venture REITs.
were somewhat
the softening
market.
In
most cases, joint ventures generated lower cash flows after
transition
from
the
subsidized-return
periods.
The
Acquisition & Redevelopment REITs, on the other hand, could
complete a
months.
major renovation within
the course of 8
In some cases work could be phased so that a
to 24
EXHIBIT 3.3
DEVELOPMENT AND RENOVATION ACTIVITY
JOINT VENTURE REITS
COPLEY PROPERTIES, INC. (c)(d)
Total Properties:
Under Development:
1985
1986
1987
1988
6
5
10
7
13
10
12
6
1989
12
6
Total Square Footage:
2,012,000 2,981,000 4,201,000 4,235,000 4,068,000
Under Development:
1,171,000 1,914,000 2,887,000 1,931,000 1,474,000
Pct. Under Development:
58%
64%
69%
46%
36%
ICM PROPERTY INVESTORS (c)
Total Properties:
Under Development:
Total Square Footage:
Under Development:
Pct. Under Development:
MSA REALTY
Total Properties:
Under Development:
7
4
10
5
10
0
11
1
11
0
784,199 1,318,635 1,318,635 1,392,635 1,392,635
453,700
630,436
0
74,000
0
58%
48%
0%
5%
0%
7
5
12
7
13
4
18
6
15
4
Total Square Footage:
2,427,000 3,714,000 3,979,000 5,767,000 4,767,000
Under Development:
1,257,000 2,441,000
753,000 1,007,000
435,000
Pct. Under Development:
52%
66%
19%
17%
9%
SOURCE:
Based on information and narrative accounts of development
activity as presented in the annual reports and 10-Ks for
each company.
NOTES:(c) Properties may consist of multiple buildings or office parks.
(d) Property under development also includes planned projects;
and those completed, but still in budgeted lease-up period.
EXHIBIT 3.3
DEVELOPMENT AND RENOVATION ACTIVITY (continued)
ACQUISITION &
REDEVELOPMENT REITS
FEDERAL REALTY TRUST (a)
Total Properties:
Under Development:
1985
1986
1987
1988
26
5
31
2
34
3
41
3
1989
42
3
Total Square Footage:
5,650,000 6,895,000 7,246,000 8,620,000 8,936,000
Under Development:
1,442,000
812,000
974,000
778,000
749,000
Pct. Under Development:
26%
12%
13%
9%
8%
IRT PROPERTY COMPANY (b)
Total Properties:
Under Development:
31
3
55
3
66
0
68
1
68
3
Total Square Footage:
3,112,261 4,484,000 5,700,500 5,692,000 5,418,000
Under Development:
388,753
405,000
0
480,120
161,284
Pct. Under Development:
12%
9%
0%
8%
3%
NEW PLAN REALTY
Total Properties:
Under Development:
35
6
39
6
46
4
(Data not available)
Total Square Footage:
Under Development:
Pct. Under Development:
SOURCE:
4,500,000 5,272,000 6,250,000
94,200
692,300
638,000
2%
13%
10%
Based on information and narrative accounts of development
activity as presented in the annual reports and 10-Ks for
each company.
NOTES:(a) Includes retail portfolio only.
(b) Includes non-residential, equity investments only.
shopping
center
still
was
producing
These different
construction.
rent
approaches in
during
development
account for the differences in cash flows described below.
Management Ability:
Performance Measured Through Cash Flow
Management of
a REIT is a
significantly more complex
task than that
of, say, a stock and
bond portfolio.
property
tangible
that requires
is a
This property
day-to-day management.
construction,
and
leasing, repair
Whether
appearance.
independent contractors,
is to
investment
monitor and
asset managers,
a REIT's
of quality
or
in-house
through
ultimate responsibility
manage these activities.
must also
REIT executives
active
management includes
and maintenance
handled
Real
As portfolio
determine when
and how much capital should
be allocated to investment and
development,
properties.
decisions
and to
which
imposed upon
the
REIT,
All actions
from initial
and
business
strategy to building maintenance, constitute management.
Perhaps
a true
include a qualitative,
For
our purposes,
benchmark
management ability
measure of
and largely subjective, evaluation.
however, we
to compare
will
managements
use cash
and
securities market
approach and
takes a
recognizes good
extracted from the real
consistent proxy for cash flow;
a
what
One could argue
similar "bottom-line"
management by the
estate.
flow as
then discuss
factors might account for the differences.
that the
would
cash flow
Dividends are generally a
a REIT distributes most of
reflect cash flowing out, not
its cash, but dividends only
A REIT, for example, could take out a loan to
the sources.
of high
temporary periods
payments during
cover dividend
The original source of a REIT's cash flow for any
vacancy.
in understanding
is also important information
given year
performance.
Defining Cash Flow: Sources and Uses
As
industry
more widely,
followed
been
REITs have
analysts have tracked cash flow, rather than earnings, as a
income,
loans
deducted
not
are
from
securities.
estate
income from
is
operations"
depreciation
Thus,
an equity
more
the
applied to
relevance when
For
of
performance,
stock
the real
a
large
earnings.
of
has little
rental
actual net
principal repayments
from
measure
earnings-per-share,
operating
there are
other hand,
On the
conventional
real
when
particularly
deductions.
a REIT's
understate
tend to
which
As a measure of performance,
flow.
have no effect on cash
earnings
like depreciation,
charges
of non-cash
deductions
includes
typically
that
accounting term
an
is
income,
or net
"Earnings,"
performance measure.
more significant
REIT,
estate holdings
significant
the
net
or "cash
measure
of
Typically, REIT annual reports devote a great
performance.
deal of verbiage
to shareholders.
to make this point
The
numbers are harder to track, however.
After
a
Association of
long
period
of
debate,
Real Estate Investment Trusts
65
the
National
(NAREIT) has
yet
to
adopt
operations."
a
uniform
definition
The definition
generally defined
real estate
varies
as net income
less non-cash
mortgage amortization.
among
items such as
Some
that
the
component
of
from
REITs, but
is
sales of
depreciation and
REITs with particularly large
Plan Realty Trust among
on
"cash
before gains on
portfolios, New
gains
of
sale of
operating
property
them, would argue
are
activities,
rightfully
not
a
investing
activities, particularly if the REIT is large and routinely
sells property.
of
NAREIT
This issue is controversial.
feel that
including
gains
Some members
from the
sale
of
property as operational income provides a distorted picture
of
the business.
process of
For instance,
liquidation would
a troubled
REIT in
show a handsome
the
income from
operations if such a measure included gains from sales.
Cash from operations, however,
of
cash flow
financing,
to a
REIT.
either
Money
borrowings
Purchase or sale of property
is not the only source
can be
or
obtained through
equity
placements.
also affects REIT cash flows.
Following new regulations, REITs now provide a Statement of
Cash
in
Flow
their
group
statements
reports
cash
flows
to
shareholders.
into
three
These
somewhat
standardized categories:
Operating Activities: Generally including all
rental
income,
property
related
expenses
like
utilities, repairs and maintenance, real estate taxes
and
property management.
Funds to
ventures are also under this heading.
and from
joint
Investing Activities: Including investments in
real estate
the
and other
purchase
proceeds
and
from
assets, net of
sale of
debt assumed;
short-term
insurance
claims
investments;
and
other
such
investment cash flows.
Financing Activities: Including proceeds from
issuance
of
shares,
shareholders,
cash
borrowings
and
paid
repayments,
costs,
issuance
payments,
principal
distributions
to
mortgage
and
other
financial cash flows.
Cash Flow Tells the Story
in Exhibit
The tables
from the
Statements of
Annual Report
Exhibit 3.5,
case-study REITs.
dividend coverage ratios, (cash
REITs.
cash
The
Acquisition
observations are
on
REITs
Joint
from operations divided by
comparison of
the
that
the
have outperformed
the
easier
evidence
group
of
particularly relevant.
Venture
group,
(in 1989), all
cash
First,
flow.
Two
cash from
but generally declining among
and thus
declining dividends identified earlier.
of IRT
for the
is a one-page summary with
the basis
operations has been sporadic
the
Cash Flows
record holds
flow
& Redevelopment
Venture
Joint
for
paid) presented
dividends
information taken
3.4 present
accounts
for
their
With the exception
of the Acquisition
& Redevelopment
REITs recorded steadily increasing cash from operationsover
the same period.
Second, the level of cash from operations
of the Acquisition & Redevelopment REITs has largely
67
EXHIBIT 3.4
CONDENSED ANNUAL CASH FLOW DATA
COPLEY PROPERTIES, INC.
(thousands)
Net Income (Loss):
Adjustments to reconciLe net income
to net cash from operations:
Net Cash provided (used)
By operating activities:
By investing activities:
By financing activities:
(before paying dividends)
Distributions Paid:
Increase(Decrease) in Cash:
ICM PROPERTY INVESTORS:
(thousands)
Net Income (Loss):
Adjustments to reconciLe net income
to net cash from operations:
Net Cash provided (used)
By operating activities:
By investing activities:
By financing activities:
(before paying dividends)
Distributions Paid:
Increase (Decrease) in Cash:
Source: AnnuaL reports and 10-Ks.
1986
1987
1988
1989
$5,438
$4,268
$3,771
$2,262
1,083
------6,521
2,945
------7,212
3,149
------6,920
3,333
------5,594
(410) (14,682)
151
13,851
1,551
(1,334)
9,578
(9,056)
(6,619)
(6,713)
(6,733)
(6,252)
($356)
($331)
$404
($135)
1986
1987
1988
1989
$3,888
($5,198) ($4,113) ($1,753)
(340) 8,019
------------3,548
2,821
4,293
2,925
------------(1,188)
2,540
4,040
0
(1,912)
8,162
(149)
9,532
(4,657)
7,457
(7,835)
(8,642)
(7,719)
(5,039)
($247)
$429
$476
$301
EXHIBIT 3.4
CONDENSED ANNUAL CASH FLOW DATA (continued)
MSA REALTY TRUST
(thousands)
Net Income (Loss):
Adjustments to reconcile net income
to net cash from operations:
Net Cash provided (used)
By operating activities:
By investing activities:
By financing activities:
(before paying dividends)
Distributions Paid:
Increase (Decrease) in Cash:
FEDERAL REALTY INVESTMENT TRUST
(thousands)
Net Income (Loss):
Adjustments to reconcile net income
to net cash from operations:
Net Cash provided (used)
By operating activities:
1986
1987
1988
$3,213
$4,990
$68
($4,568)
(2,198) (4,745) (2,864) 3,941
------------------------1,016
245
(2,796)
(627)
6,145
8,495
(4,025)
$11,631
(18,831)
19,542
(8,511)
30,887
16,457
21,677
(10,354)
(8,584)
(5,183)
($7,555) $35,964
$5,513
1986
1987
1988
1989
$14,916
$6,045
$9,274
$11,997
(2,086) 12,285
------------12,830
18,330
9,187
------18,461
7,462
------19,459
By investing activities:
By financing activities:
(before paying dividends)
Distributions Paid:
(102,643) (84,075)
84,438 95,957
Increase (Decrease) in Cash:
($17,661) $15,952
Source: Annual reports and 10-Ks.
1989
(6,813) (35,143)
(69) 69,545
(12,286) (14,260) (16,788) (19,174)
($5,209) $34,687
EXHIBIT 3.4
CONDENSED ANNUAL CASH FLOW DATA (continued)
IRT PROPERTY COMPANY
(thousands)
Net Income (Loss):
Adjustments to reconcile net income
to net cash from operations:
Net Cash provided (used)
By operating activities:
1986
1987
1988
1989
$10,055
$7,898
$15,117
$8,911
102
------10,157
5,024
------12,922
By investing activities:
By financing activities:
(before paying dividends)
Distributions Paid:
(100,199)
80,890
(2,849)
24,403
Increase (Decrease) in Cash:
($21,008) $21,613
(826) 4,976
------------13,887
14,292
(403) (13,400)
2,452
3,698
(11,856) (12,864) (13,283) (13,973)
NEW PLAN REALTY TRUST
(thousands)
$4,303 ($11,033)
1986
1987
1988
1989
Net Income (Loss):
Adjustments to reconcile net income
to net cash from operations:
Net Cash provided (used)
By operating activities:
$15,618
$17,966
$23,450
$27,111
(114)
3,385
------------15,505
21,351
767
------24,217
1,922
------29,032
By investing activities:
By financing activities:
(before paying dividends)
Distributions Paid:
(12,085) (18,938) (34,210) (40,637)
34,787 (37,889) (48,698) 52,247
Increase (Decrease) in Cash:
$23,460 ($53,734)($82,470) $12,495
(14,747) (18,257) (23,780) (28,148)
Source: Annual reports and 10-Ks.
70
EXHIBIT 3.5
CASH FLOW FROM OPERATIONS AND DIVIDEND COVERAGE RATIOS
JOINT VENTURE REITS
(thousands)
1986
1987
1988
1989
COPLEY PROPERTIES, INC.
Cash from operating activities:
Distributions Paid:
Dividend Coverage Ratio:
6,521
$6,619
99%
7,212
$6,713
107%
$6,733
103%
5,594
$6,252
89%
3,548
$7,835
45%
2,821
$8,642
33%
(1,188)
$7,719
-15%
2,540
$5,039
50%
1,016
$4,025
25%
245
(2,796)
(627)
$8,511
$8,584 $5,183
3%
-33%
-12%
6,920
ICM PROPERTY INVESTORS:
Cash from operating activities:
Distributions Paid:
Dividend Coverage Ratio:
MSA REALTY TRUST
Cash from operating activities:
Distributions Paid:
Dividend Coverage Ratio:
ACQUISITION & REDEVELOPMENT REITS
(thousands)
1986
1987
1988
1989
FEDERAL REALTY INVESTMENT TRUST
Cash from operating activities:
Distributions Paid:
Dividend Coverage Ratio:
12,830
18,330
18,461
19,459
$12,286 $14,260 $16,788 $19,174
104%
129%
110%
101%
IRT PROPERTY COMPANY
Cash from operating activities:
Distributions Paid:
Dividend Coverage Ratio:
10,157
12,922
14,292
13,887
$11,856 $12,864 $13,283 $13,973
86%
100%
108%
99%
NEW PLAN-REALTY TRUST
Cash from operating activities:
Distributions Paid:
Dividend Coverage Ratio:
Source: Exhibit 3.4
15,505
21,351
24,217
29,032
$14,747 $18,257 $23,780 $28,148
105%
117%
102%
103%
covered
their dividends
paid.
REITs, ICM Property Company
distributed amounts
operations.
Two
of the
Joint Venture
and MSA Realty, have routinely
greater than their cash
received from
With a slightly cleaner bill of health, Copley
properties shows funds from operations that cover or exceed
distributions,
although dividends
have been
reduced over
time.
For
a
closer
compare the
New Plan
evaluation of
selected data
Realty in
cash
flow
for ICM Property
Exhibits 3.4 and
3.5.
performance
Investors and
While
the two
REITs are very different in their investment strategies and
portfolio
holdings,
significance
ratios
in
of
cash
excess of
consistently
the
earns
flow
100%
more
sources.
indicate
Dividend
than enough
cash
cash flow from operations
Realty
through
real
In the case of
covered, at best,
Most of their
the dividends paid.
half of
coverage
that Federal
estate operations to cover dividend payout.
ICM, however,
the
demonstrates
comparison
positive cash
flows did not come from the operating activities, i.e. real
estate.
Rather 75% to 100%
through
financing
of the incoming cash flow came
which, in
activities
case, were primarily bank loans.
is using borrowed
that ICM
Plan's
whopping $108
this
particular
In short, it would appear
dividends.
(New
activity in
1989
money to pay
million financing
reflects the proceeds of a public offering.)
Disparity of Cash Flow Performance: Reasons Why
Each
of the
their dividends
Joint Venture
as a result
REITs has
had to
of poor cash flows
reduce
from real
projects has
developed
newly
earlier, leasing
outlined
As
investments.
estate
more difficult
be much
proven to
If this is a reflection on management, then
than expected.
perhaps their most significant err was to start a REIT-- in
properties,
existing
no
with
1985--
recent
market
soft
shopping centers.
of existing
the renovation
Office and industrial properties
by
take much
developed from empty land,
industrial projects,
longer than
Office and
performance records.
account for the differing
an
types might also
The choice of product
overbuilt market.
into
line
on
product
bringing
thereby
income-producing
of
portfolio
have also been harder hit
retail
than
conditions
and
residential holdings.
of projects
The number
time
is
Venture
potential factor
another
REITs' reduced
example, Federal
cash flows.
explaining
Consider again,
demonstrated much
is the
ratio of
completed leased
42 centers, some
1984 to the present, at
two of
redevelopment.
out
of
18
(almost half)
MSA.
over the six-year life of
and generating income
or
for
centers, but Federal
those under construction in the portfolio.
one
Joint
the
Both invested in
higher cash flows
a portfolio of
any one
Realty and MSA Realty.
community shopping
difference
under development at
those
been owned
the 1960s.
From
any given point in time, typically
centers
MSA Realty's
total
projects to
Federal manages
of which have
for as far back as
One key
may be
substantial
portfilio is quite different;
investment properties
were either
under
in
under development
1988,
eight
or completed
within
that
year.
early
By
1990
almost
all
the
of
remaining MSA holdings not
under development were still in
the initial lease-up phase.
The other Joint Venture REITs,
with
office
their
equally
and
severe market
industrial
risks by
all
faced
much of
their
holdings,
having so
portfolios subject to lease-up during what turned out to be
a depressed real estate market.
A Typical Joint Venture Tailspin
This
actual example
of an
combined effect of the pitfalls
REITs;
an overbuilt
market,
unforeseen cash calls.
$250,000
position.
needed,
in
cover
construction loan.
11%
In
for
a 5%
The REIT agreed to
to
preferred
developer/partner risk,
any
and
Colonnades, a four story,
office building, was a typical
partnership.
exchange
illustrates the
faced by the Joint Venture
Maitland
252,000 square foot Florida
"equity-gap"
ICM deal
1986,
ICM
general
contributed
partnership
in
fund up to $8.25 million, if
gaps
above
the
third-party
As a partner, the REIT would receive an
return
on
its
equity
(even
during
construction and lease-up), 50% of net cash flows above the
preferred return, and 50% of
the
property.
developer was to
If
the $8.25
any net proceeds from sale of
million was
not enough
commit up to $1.25 million.
the
Then if the
project needed still more cash, the developer and ICM would
make equal contributions as required.
That was the plan.
By the end of 1988, the REIT had funded its full $8.25
million commitment.
The project
had gradually reached 90%
but
occupancy,
effective
rents; the
ICM assumed
partnership
privilege of greater and
receive
By the
greater equity ownership.
general partner
entitled to
net cash
sale and
gain from
both the
91.75% of
dubious
the
negotiated
ICM
was a "47%"
1989 ICM
for a
With each additional
position.
thereafter,
contribution
cash
meet its commitment.
obligation in exchange
the developer's
larger general partnership
end of
needed additional
developer was unable to
flow but the
lowered
substantially
had
concessions
flows above the preferred return.
31, 1990
On March
million
Unable
of June 1990, ICM
permanent financing as
obtain
to
had been granted
"workout" negotiation
involved in a
and was
an extension
came due.
loan
construction
partnership's $26.75
the Maitland
Terms could involve reducing
with the construction lender.
the loan amount by placing a mortgage on one of ICM's other
more stable properties.
If an agreement cannot be reached,
ICM stands to lose its interest in the property.
Problematic
low cash
Joint
Venture REITs
newly
developed
funding
to
the
concessions
in
projects at a
cash
flows, in
from a
stemmed
property
joint
the
flows from
in
the
ventures
lagging
large proportion
portfolio,
and
time of over supply in the
turn,
prohibited
raise capital.
75
of
additional
lease-up,
during
market,
of the
real estate
completion
market.
rent
of
The low
subsequent attempts
to
Raising Capital: Availability and Affordability
"When we started in 1985, I would have guessed
that by 1990 we would have made three or four
trips back to the capital markets, doubled our
equity base, and trade at a share price of
between $20 and $30."
Steve Anthony, President of
Inc.
Properties,
Copley
(June 20, 1990)
Due to
their share
the
to
to return
able
been
their capital
Some have added debt
completed properties,
could have been more
access to debt
short-term lines
structure, through
refinancing of
credit and
for
securities marketplace
equity since their initial offerings.
to
REITs have
the Joint Venture
prices, none of
value of
and the lagging
declining dividends
of
but even
advantageous with the
benefit of stronger securities.
years, consistent dividend records
Over the last five
annual returns
and strong
have enabled the
Redevelopment REITs to secure a
variety of lower cost debt
and subsequent public
instruments, convertible debentures,
equity
presents
illustrated
offerings, as
a
summary
of
issuing
Acquisition &
Exhibit 3.6,
market
capital
activities.
Redevelopment REITs added
through
shares
in
which
In
public and private offerings, each
addition to these major
of the
Acquisition &
automatic
plans available to shareholders.
dividend
equity by
reinvestment
Some of these REITs have
also issued shares, rather than cash, to fund acquisitions.
Exhibit
capital
3.7
graphically
structures of
last 10 years.
the six
the
changing
case-study REITs
over the
illustrates
Through frequent access to the
EXHIBIT 3.6
CAPITAL MARKET ACTIVITY: ACQUISITION & REDEVELOPMENT REITS
12/31/84 through 12/31/89
REIT
Year
Approximate
Net Proceeds
FEDERAL
REALTY
1989
$44,900,000
1987
$100,000,000
1986
$49,000,000
8.65% Senior Notes
1985
$40,000,000
8.75% Convertible subordinated
debentures.
Total:
PROPERTY
COMPANY
NEW PLAN
REALTY
Description
Commmon stock offering, 2 million
shares at $24 per share.
5.25% convertible subordinated
debentures. Issued to European
investors in Eurodollars, not
registered with the SEC.
$233,900,000
1987
$25,000,000
2%Convertible subordinated
debentures, Eurodollar bond issue.
(Actual cost of capital is estimated
to be 7.8% to 8% dependent on time of
redemption.)
1985
$19,127,000
Comnon stock offering, 1,305,000
shares at $15.75 per share.
Total:
$44,127,000
1989
$110,000,000
1985
$66,700,000
Total:
$176,700,000
Sold 6,315,000 new shares of common
stock in a public offering and
privately sold 1,100,000 shares to a
British pension fund.
8.375% convertible subordinated
debentures.
Source: Annual reports and 10-Ks.
Major debt and equity placements only:
Does not include shares issued through dividend reinvestment plans.
77
capitalmarkets
REITs
each
of
has increased
capital structure.
the Acquisition
its
asset base
base for
doubled.
each
The
infusions
of
to
A&R
the
Joint
the
This
REITs
of
has
is a significant
not number of
ventures,
than
level
Venture
paying dividends and
joint
REITs more
indicate that
in recent years.
After
its
the Joint Venture group, the
the dollar amount,
decreased.
and diversified
the three
also
equity
actually declined
point since
of
charts
shareholder's
Redevelopment
During the last five years that brought
such a challenging market for
asset
&
shares, has
additional capital
these
REITs
have
shown
cumulative annual deficits which have depleted the level of
equity.
obviously, if
shares could
this trend
were to
continue, the
eventually become worthless in
terms of book
value.
Debt Off of the Balance Sheet
REITs that
may
not
participate in joint
reveal
properties.
comparing
all
This
the
of
the
venture partnerships
debt
used
is an important point
capital
structure
employed by various companies.
(as
on
individual
to recognize when
in
Exhibit
Debt can be incurred by the
joint venture partnership, rather than the REIT itself.
course, in
annual
some cases
report data
example, would
almost
the REIT is
published
by
the lender.
Interviews
Of
The 1989
Copley Properties,
indicate that the REIT
all equity.
3.7)
for
is capitalized with
with management
revealed
that the properties are also encumbered by debt incurred at
Copley Properties,
Inca.
Ccbal 9Sructum
$190
9180
$170
61M
9 150
V140
$130
0 120
0110
0100
-
0.1:1
wo I70
610
0.6:1
1.0:
-
I
I
I
1
10819
I18
187
1988
1M
1987
19W
19M
Shcreblder Equity
Federal Realty Trust
CcpII btuctuum
$400
9100
1980
1981
1982
1983
1984
Z
Shcrhldw Equity
1985
198
Cornert. Deberttree
SDebt
(Exhibit 3.7: Graphs of Changing Capital Structure)
79
ICM Property Investors
CcHlbI StructuM
0200
6190
6170
o10
6150
0140
1.0
6 130
0120
6110
0
0
198
1986I
61%
- , 0.1:1
670
60
198I
1981
1982
193
19
84
1987
198
=~J Siehaeder Equity
IRT Property Company
Ccplbol Structui,
92CO
91W
V180
0170
010
iso
6140
0130
0120
s110
6100
'90
980
670
00
640
630
920
010
1980
1981
1982
198 1984
Shrebeldw Equity
19O5 198W 197
1988
Comrt. Debordwue
sM Det
(Exhibit 3.7: Graphs of Changing Capital Structure)
80
19
5
MSA Realty
SftructuM
CcitaI
120
o1eo
V180
9170
o1eo
6150
6140
V130
V 120
s110
9100
970
940
910
go
1980
198
1982
1903
1984
Sho-ehdder Equity
1985
1986
1987
198B
19M
Cornrt. Debenturwe
05M De&A
New Plan Realty Trust
Ccpital structum
$280
6300
0240
!6220
0200
1.1:1
0.2:1
0.2:1
ciao
6140
9120
9100
0.9:1
-1
0.8:1
11.5:1
0.5:1N
040
I
I
1080
10I81
1.1:
1.1:
1982
1983
1984
rShrblder Equity
19 M
118W
1 987
19mW
Corvmert. Debrntrm
0e
Debt
(Exhibit 3.7: Graphs of Changing Capital Structure)
81
19mf
In Copley's case, the
the joint venture partnership level.
outside debt
point to
was about $84
remember is
especially in
group of REITs.
balance
distort
the balance
on the actual
of the
a comparison
Since higher leverage
maintain a
The
Joint Venture
between debt on and off the
the desire to conceal additional
desire
1989.
debt on
the case
The disparity
sheet can
structures.
that corporate
nessecarily reflect the debt
sheet does not
properties,
million in June of
of REIT
capital
equates to higher risk,
debt could be driven by a
lower perception
of leverage
and thus
preserve existing market value of the security.
The Struggling Class of '85: Strategies for the Future
New Directions for Copley Properties, Inc.
clearly indicate Copley has
The symptoms
the poor
real estate market-- reduced
the
development
company
received a
guaranteed returns.
had
to rely
properties.
phases
significant portion
As the
on actual
Rent
real estate per share.
lease-up
and
of
During
projects,
of its
the
cash from
agreements expired the company
rental revenues
concessions
earlier proforma projections.
generated by
and higher
vacancy rates significantly reduced
shareholders attributes
cash flows, reduced
price that trades much lower
dividend payments and a share
than the appraised value of
been hit by
than
expected
the rental income from
Management's 1989 report to
the decline in reported
operations to this transition.
the
cash from
In
response management
several steps
taken
to
shore up
an effort to
First, in
company.
reposition the
has
cash flow, the company has imposed an operating expense cap
Expenses above
of $650,000.
in the advisor's
a reduction
offset with
will be
the cap
and beyond
management fee.
One expense to be eliminated is the annual appraisal of the
properties; few equity REITs
regular
actively repurchasing its own
use
effective
resources
of
market price
that
the
is so
far
this to be
will
benefit
the
to make strategic sales
Third, Copley plans
shareholders.
for
reason
stated
appraised value, management believes
below the
an
because the
is that,
repurchase
is
shares, up to 500,000 shares
The
stock.
its
of
12.5%
or
Properties
Copley
Second,
basis.
annual
provide this information on a
of portfolio holdings, particularly any land holdings which
have a long developmental time frame.
indicated that
property sales
will be used
As in the past,
mirrors
employs with
the
move away from
the
has
the original
from
gains
run,
short
that will
to purchase assets
income, i.e.
more current
buildings.
REIT
In
strategy.
development
generate
the REIT will
Copley
changes,
operational
the
from
Aside
completed and
leased
the investment strategy of the
that
investment strategy
its institutional accounts.
In
the
advisor
the years to
come, Copley intends to avoid pure multi-phased development
and concentrate instead
projects of
the past
investments
which
relatively
short-term
are
partially
renovation,
83
complete
on property
or
require
rehabilitation
or
development.
this change
Whether
market
renovation
the methods
closer toward
is moving
opportunities Copley
to current
focusing on
that by
appear
it would
forces,
on the
a response
just
strategy or
original
is a commentary
employed by the Acquisition & Redevelopment group of REITs.
MSA Realty Liquidation
public companies, markets itself
MSA, like most other
to
annual
reports.
cover,
the
At
In
an effort to
a
simply in
bound
reduce printing costs,
of the
simply a copy
report is
white paper
confirms that cash flow is
its
MSA
was
before opening to the first
suffering cash flow problems-page.
book by
that
signaled
report
annual
1989
judging a
of
the risk
full-color
well-designed,
glossy,
with
shareholders
10-K and a
cover.
the latest
cover letter,
The text
inside
indeed a problem and that MSA's
is to liquidate.
solution to the tough market
The company
has retained Morgan Stanley Realty Incorporated to seek out
purchasers.
potential
can
or not
fully
leased.
poses problems for selling out.
viable
company
strategy on
sells
basis, then
assets
it is
excessive income
an
of securitized
if the
particularly
be difficult,
development
Liquidation
The
assets are
also
Liquidation of a REIT is a
slowly, on
from gains
under
REIT format
all-or-nothing basis
at risk
assets
a
of losing
on sales.
If
only.
a
property-by-property
REIT status
MSA,
due to
for example,
sold its interests in four joint ventures to a wholly-owned
subsidiary of the advisor,
Melvin Simon & Associates.
84
If,
all the rest of its
however, MSA cannot sell substantially
right to buy
end, then it has retained the
assets by year
the four joint ventures right back again.
The Expansion of ICM Property Investors
As we saw earlier, cash flow from operations is also a
by
all of
of the apparent disadvantages shared
One
problem for ICM.
the
In a unique
get one.
existing
industrial properties
Peter B.
Bedford.
receive 1,000,000
transaction, still under
purchase of
through the
levels
cash flow
an
this writing, ICM is seeking to
negotiation at the time of
raise
lack of
the
ICM Property Investors' solution is to
existing portfolio.
go out and
is
Venture REITs
Joint
developer
from California
Bedford will
a cash price,
Instead of
stock, plus
shares of ICM
newly issued
several
notes secured by purchase-money mortgages on the properties
acquired.
Bedford
portfolio
of thirty
United States.
from the
the
ICM is
or more."
separate
properties
Bedford
to
outstanding
stock
currently inspecting
is presently assessing values
establish "asking
of
that could
which ones will be included
Bedford
transaction
a
to acquire about 15 properties
Bedford's properties to select
of
of
throughout the
with "an aggregate value
list of 30,
in the transaction.
choice
its
industrial properties
ICM expects
$30 million
reach
ICM
offered
has
has
Investors
also
prices."
purchased
Central
In
a
all
Management
Corporation, ICM's privately owned investment manager.
Given the
low stock
price, ICM
was unable
to raise
Strategically, the
means of financing portfolio expansion.
purchase also
The stated goals of
diversify the investment portfolio,
the transaction are to
flow, and
and cash
total assets
gap
present
from the
from the
shift away
represents a
original development investment plan.
increase
a private
the Bedford transaction as
management describes
ICM
means.
conventional
through
economically
capital
from
flow
cash
between
to narrow
the
operations
and
distributions.20
the added leased properties
cash flows from
will increase
new
million
money
mortgages, which
will require
net cash
Only
will
determine the
The
transaction
versatility
of
shares.
REIT
Also,
be
purchase
also reduce
of the
dividends and
deal will
share value.
underscores
however,
vehicle.
income
new
payments that will
impact on
of one
seller-financing,
the final outcome
itself,
the
the
are effectively
debt service
flow.
that
many more
over that
distributed
in the portfolio
rents, the issuance
requires
shares
While it
interesting questions.
shareholders, raises some
is true that
the other
final impact to
and its
This transaction,
If
ICM
the
management
accomplishes what they have described to shareholders, they
will have
found a
way to
finance a
$30-million purchase
through a REIT that has only declined in value out over its
five-year life.
CHAPTER FOUR
CONCLUSIONS
investment trust is a
A real estate
of
does not
alone
must be evaluated
its own
business.
describe a
how well that particular
as
Finally,
structure.
regulatory
Second, one
company can achieve
legislative and
of the REIT
within the confines
its goals
company based on
and practices.
individual strategies
must consider
particular REIT
Any
first, as a real estate
"REIT"
law.
and securities
Revenue Code
the Internal
simply a creature
a
traded
publicly
security, a REITs' operational and financial strategy can be
external condition of the stock
hindered, or helped, by the
market.
The Acquisition & Redevelopment REITs have successfully
used
development
primarily
their
because
broad
without interruption.
REITs a
successfully
means to
this,
in
portfolios
Renovation
of
moderation,
of
existing
to cover the
management's
The REIT vehicle has afforded these A & R
raise capital
in a
variety of
thereby continually increase their asset base.
have increased the volume
capital structures
their
and development have been
component
one
as
to
increase them,
dividends, and even
paying out
overall strategy.
value
of the development effort and
front-end negative cash flows
employed
to add
income that enabled them
properties generated
to continue
to
able
were
They
portfolios.
renovation
and
ways and
Each of them
and diversity of their individual
over the
past five years.
87
The primary
objective of these companies has been to amass portfolios of
manage them effectively to
attractive income properties and
profits.
tax code
has permitted freedom
that focus on finding
and
redevelopment
assets,
real
current
Given the
estate market environment, strategies
undervalued
goals more
to pursue these
aggressively.
and
independently
of the
expansive interpretation
Recent
maximize
property
diligent
management seem to make more sense than development from the
ground up.
Poor securities
problems today stemming
from low
real
their
from
flow
that the
REITs face
Joint Venture
cash
performance is one indicator
were
investments
companies'
during an
lease-up phase
entered the
After lengthy
periods, their first completed
development and construction
projects
new
between
not diversified
existing income properties.
development and
These
investments.
estate
unforeseen
tough real estate markets marked by oversupply and free-rent
concessions.
losses,
these
additional
capital
distributions
group,
the REIT
equity
capital
time
of
credit.
substantially without
only--
but
at
as a
the
throw
to
ventures and
shareholders.
served
has been
Debt capital
this
For
raise
means to
initial
added through
to
public
permanent
completed properties and short-term
mortgage refinancing of
lines
equity
vehicle has
one
joint
anemic
at the
to
choice
left no
were
REITs
reduce
offering.
properties to offset the
Without other leased
These
REITs are
new equity
Memories of 1974 and the
not
likely
to balance out
to
grow
the debt.
downside risks of highly leveraged
And as
followers and investors.
REITs still haunt industry
a result, the Class of '85 is not likely to raise additional
their
performance of
improving the
equity without
public
securities.
Since
Venture
Joe O'Connor, chairman of Copley
fronts by the soft market.
estate
"The real
claimed that,
Advisors, recently
Realty
two
hit on
hard
especially
have been
companies
the Joint
REIT stock ownership,
demand for
influences the
market
estate
real
of the
perception
public
market is just getting bad enough to where I feel good about
it
again."
His
investment
market
future
performance to fill the
takes
It
months preceding
index,
for
Equity
respectively.
Over
and
bandwagon with new investors.
fell
Hybrid REITs,
time period
REIT
For the
share price
the NAREIT
May 1990,
the same
to
past
positive
stocks are not gaining popularity as an investment.
twelve
stock
performance records
to previous
trends.
professional
But generally,
sense.
perfect
investors look
foreshadow
real estate
a
To
opportunities.
concept makes
this
can bring bargain
cyclical, then down times
conditions are
market
current
the
if
that,
is
point
10%
and
35%
aggregate twelve
month total returns were -2.36% for Equity REITs and -21.69%
for
Hybrids. 2 1
REIT
who
managers
identify
attractive
investment opportunities now, at what might be the valley of
a real
raising
estate
public
market cycle,
interest
will
for
have
a difficult
investment.
task
Furthermore,
current yields will be prohibitive for raising capital.
To
summarize, any
development
business, including
a
Interruption
to prosper.
depend on cash flow
traded REITs
Publicly
real estate market risks.
REIT, is susceptible to
in cash flow due to risk exposure in real estate markets can
The plight of the class of '85 Joint Venture
thus the REIT.
illustrates this,
REITs
could conceivably
Property Company,
retail
demand for
REITs
the
then
for example, attributes lower
anchor tenant
chains, Revco
Redevelopment
REITs have
Drugs.
a distinct
But the
IRT
cash flows
of their
the bankruptcy of one
to an externality;
Acquisition &
comes
advantage that
the Joint Venture development REITs
Start-up for
with age.
centers
some other
would face similar problems.
concentrated in that area
in 1989
in the
shopping
community
in
space
& Redevelopment
example, oversupply or
drastic change
caused a
factor
external conditions
but alternate
shake up the Acquisition
If, for
well.
REITs as
and
security's stability
on the
detrimental effects
have
to market risks since all
further compounded their exposure
of the initial portfolios consisted of unproven properties.
The REIT vehicle can
facilitate development, that much
alone, will
not
facilitate the income requirements of public ownership.
For
is
clear.
But
real
estate development,
REITs to be effective development machines, they need steady
reliable
they
cash flow
cannot
sources in
survive in
the
the portfolio.
highly
Otherwise,
cyclical real
estate
markets.
Current Trends and New Applications of the REIT
In
their
relatively
short
90
history,
the
definitive
chapter on REITs as developers
of the
analysis thus
discussion and
due
to
unforgiving
complexities
development and
share
associated
market.
a REIT vehicle can
There
operating costs--
high
public
offering
through the use
with
the
is, however,
facilitate real estate
circumvent the problems of
volatility,
centered on
far have
and costs
public securities
another way that
All
Many of the problems already covered
publicly traded REITs.
are
is still being written.
entry barriers,
costs
of a private
and
high
REIT.
The
use of private REITs, as a start-up technique, may allow for
a new
REIT
to weather
without forever
some
initial
tarnishing its
cash flow
track record in
shortages
the public
market.
Private REITs
It is important
private REIT vehicle
to note that the
is chosen primarily to enable its investors to circumvent an
onerous tax statute, not to
investors
in
capital.
Typically
institutions
most private
like
such
access public capital.
REITs
pension
already flush
are
are
investors
The key
large
with
nonprofit
endowments,
plans,
and
foundations; not small individual shareholders.
The Internal Revenue Code restricts the use of borrowed
by tax-exempt
money
complex
short,
institutions.
by the
restrictions vary
some tax-exempts
real
estate
type of
are prohibited
"debt financed property" as
all
Although detailed
institution, in
from investing
defined by the Code.
investments,
and
especially
in
Virtually
development
Judicious use of leverage is,
projects, are debt financed.
by
and
desirable way
large,
a
even
for
returns,
structure
risk-averse
as
serves
tax-exempt
which
leverage without
the use of
benefit from
institutions can
REIT
The
institutions.
through
a conduit
estate
real
enhance
to
technically investing in debt-financed property.
way:
skill
the
provides
developer
the equity capital and the
The REIT provides
two partners.
are thus
tax-exempt nonprofits,
debt financed property, which is
Such private trusts are set
status under the
for REIT
filing
costly
avoid
insulated from
the
held by the joint venture.
up as corporations that qualify
Internal Revenue Code,
enough, less than 500
intentionally small
incurs debt
The investors in the
and develops the real estate projects.
REIT,
This
expertise.
and
the entity that
the REIT, is
partnership, not
joint
with just
business entity
a separate
venture partnership,
establish a
a developer
REIT and
The private
in the following
the deals are set up
In simple terms
the
procedures with
but kept
shareholders, to
Securities
and
Exchange Commission.
Property Capital Advisors, Inc.
advisory firm that handles
equity
REIT that
permanent
projects
lender,
separate private
Each
of
the
American Stock
Capital Trust has participated
While Property
development
Property Capital Trust, a public
on the
trades
(PCA) of Boston is the
two
its
as
a
joint
advisor
partner
and
also
operates
two
(PCA)
reportedly
92
for years in
venture
REITs, PCA/Sammis and
REITs are
Exchange.
PCA/Tishman Speyer.
capitalized
with
approximately $120
companies
and
available.)
specific
while
The
the
two PCA
institutional
(These
the
provide the
minimal shareholdings
about twenty
minimum
number
of
In some cases
individuals in order
must be sold to
to meet the minimum requirement.
only
necessary working
a REIT is one hundred.
shareholders to form
not
five
holds
each have
required
is
around twenty
PCA/Tishman-Speyer REIT
investors who
are private
information
REIT holds
private REITs
although
capital,
equity.
financial
The PCA/Sammis
properties
three.
million in
Pension plans count as one
single individual shareholder whereas nonprofit corporations
can
count
each
shareholders in
of
their
the REIT.
shareholders
Large pension
can create complications since
as
individual
plan participants
private REITs must also meet
the test that no more than 50% of the shares can be owned by
five or fewer individuals.
According
private
REITs face
which can be
be
some of
President
the familiar
of PCA,
substantial at times, is a
put into
real
even
complications of
Excess cash,
the cumbersome REIT regulations.
adhering to
must
Melzer,
to Robert
problem because it
The
related investments.
estate
four-year minimum holding period inhibits the timely sale of
certain
property.
from
profiting
improvement
Because
certain
REITs
operational
services, the
REIT
are
from
forbidden
income,
must forfeit
like
tenant
some of
the
income to the developer or negotiate additional compensation
through some other acceptible activity.
The
private approach
holds interesting
prospects for
new development
high-risk
REITs, which are perceived
investments and
common market.
developers
substantially discounted
As previously mentioned,
often identify
"bottom"
of
a
conceivable
that
on the
entrepreneurs and
investment opportunities
market
securities-buying public
as particularly
cycle,
when
the
is least likely to
the private
vehicles
at the
mainstream
invest.
could
It is
be used
as
"incubators," designed specifically not
to trade in a major
public
an
market
develop
a
until
track
incubation period
after
record.
they have
Access to
opportunity
capital
would be augmented through
during
to
the
joint venture
partnerships and private placements with institutional money
sources.
funds
After
the
demonstrating success
REIT
could
reasonably
with
"go
institutional
public"
to
tap
additional sources of capital. 2 2
REIT/REMIC Strategies
Another suggested
development framework that may
viable of
choice in the
vehicle.
The
real
(REMIC)
was created
become
the
1990s is a
estate
form
mortgage-backed securities.
is a complex arrangement, but
legislation to overcome some
by development REITs.
It also
To
investment
Tax Reform
conduit
Act of
1986 to
real
estate
Combining a REIT with
a REMIC
of
trading
it fully exploits the current
of the start-up problems faced
provides the REIT a means to
additional capital through access
market.
combination REIT/REMIC
mortgage
under the
standard
be a
illustrate, Weirick's
94
to the secondary mortgage
hypothetical
example 2 3
outlined below weaves together several parameters that might
characterize
1990s;
a
downtown,
publicly funded
renovation
a
long-term
of
an old
build-to-suit
tenant,
development
and
warehouse
finish out
a
projects of
building
requirement
public/private
the
near
for
a
partnership
arrangement with the city to encourage further redevelopment
of the warehouse area.
Assume that the owner of
potential
tenant
the property has identified a
interested
in occupying
the
warehouse,
provided it could be redeveloped to a high quality standard.
property owner, together with several
The first step is the
investors, forms
other private
the
initial
investment
an S corporation
capital.
This
set-up
to supply
lets
the
investors capture losses and any rehabilitation tax credits.
The S
corporation, the
The tenant
development agreement.
guaranteed
by the
financing
can
city (if
be
from
Meanwhile,
into a
signs a lease, partially
that additional
required), so
obtained
proceeds.
Development
city enter
tenant, and the
local
the
institutions.
and
city
the
S
corporation work together with master planning architects to
design a development scheme for the surrounding area.
Sometime
after the
demonstrates acceptable
formation of a REIT.
to buy the
to engage
first
property
cash flow,
the city
and
initiates the
The REIT sells shares to raise capital
warehouse from the Subchapter
in further development
REIT is set up
is completed
of the area.
so that it can also be
owner can transfer property at
S corporation and
a REMIC.
The city's
A property
fair market value to a REMIC
95
in
gains
capital
to
subject
S
the
Thus,
swap.
upon the
in the
for an interest
swap its warehouse
corporation can
being
payments without
of future
a stream
return for
The
REMIC to realize an income flow rather than a lump sum.
income to the owner would be principal and interest payments
based on fair
market value of the property and
classified as
portfolio income
shares
on
based
secondary market.
Sale of REMIC
to
financing
be
securities
mortgage
the
in
offerings
with
customized
allows
mortgage
the
interests
investor
of
a pool of mortgages.
(securities) backed by
A REMIC
for tax purposes.
classes
multiple
issue
can
it would be
will free up
Mortgaging of the property
the investor capital to pursue additional projects.
the REIT has
Now that
been established, the
city can
use it to undertake infrastructure improvements in the area.
be developed, in a variety
New renovation projects can also
of
One
ways.
seller, obtain
the next
for the
way is
a long-term
old warehouse.
as independent contractor to be
Lease payments
adjusted (lower) during the
development period to
expenditure.
Through REMIC status,
allow for constructions
the
structured so
lease could be
the legal developer of its own new facility.
could be
a
and purchase
tenant commitment
The
that the tenant could serve
to identify
city's REIT
can
REIT
securities,
convert
assets
its
providing even
more
into
efficient
mortgage-backed
access to
the
capital markets.
This suggested
strategy
that would
public use of
require
the REIT is
thorough
96
an untested
research and
legal
review
is
It
implemented.
be
actually
it could
before
included, however, to demonstrate that creative thinking may
lead to new and innovative uses of the REIT vehicle.
Final Notecountry is likely to taper
Further development of this
in
attentive asset
existing
The
can be capably handled
legislation in
new
frontiers
these activities
Favorable
through the REIT vehicle.
recent years has strengthened
in
exploiting
the rules
&
the REIT, and
being
still
are
Securitization, which has provided investors with
explored.
a comfortably
continue
Acquisition
representative
demonstrated that
REITs have
Development
of underutilized
management and renovation
structures.
on
be placed
emphasis will
More
to come.
the years
to
transactions.
the overall
REIT vehicle
a
play
major
role
Although it represents
real estate
seems to
market.
The use
of
continue
through
the
estate
real
efficient
more
many
in
will
market,
real
estate
a very small facet of
industry, development
through the
choice in
the current
be a logical
development
REITs for
1990s
and
the
is likely
evolution
techniques will surely improve the process over time.
97
of
to
new
REFERENCES
CHAPTER ONE:
1 Cameron
S. Blake, "The Real Estate Investment Trust:
Performance Over the Business Cycle," Thesis, Massachusetts
Institute of Technology 1988, p. 31; Interview with Mr.
Arthur Viner, Chairman, ICM Property Investors.
2 Interview with Mr. William King; Partner, Goodwin,
Proctor and Hoar; Boston, Massachusetts, June 18, 1990.
3 Section
856(d)(2)(C), U.S. Internal Revenue Code, 1986.
4 Benito M. Lopez, Jr. and Thomas R. Smith Jr., "Real
Estate Investment Trusts: A Brief History," REITs 1986 (New
York: Practising Law Institute, 1986), pp. 13-19.
5 REIT
Fact Book: The REIT Concept (Washington: The
National Association of Real Estate Investment Trusts, 1989)
p. 13.
6 Theodore
S. Lynn, Harry F. Goldberg and Robert H.
Steinfeld, Real Estate Investment Trusts, (Paramus, NJ:
Prentice Hall Information Services) See Appendix B,
"Legislative History - REIT Provisions."
7 Stephen
P. Jarchow, Real Estate Investment Trusts (New
York: Wiley & Sons), p.140 and 240.
8Stan Ross, "Real Estate's Equity Players,"
Institutional Investor, September 1988, pp. 26-28.
CHAPTER TWO:
9 Interview
with Ms. M. J. Morrow, Vice President Finance, Federal Realty Investment Trust; Bethesda,
Maryland, June 4, 1990.
1 0 Real
Estate Investment Trusts: The Low-Risk,
High-Yield, Asset-Growth Opportunity (New York: New York
Institute of Finance, 1988) p. 47.
1 1 Steve
Bergsman, "Increased Assets Help Keep REIT
Dynamics Healthy," National Real Estate Investor, October
1988, p. 144.
1 2 Anne
E. Mengden and David Hartzell, "Real Estate
Investment Trusts - Are They Stocks or Real Estate?" Salomon
Brothers Bond Market Research, Real Estate, August 27, 1986,
p. 1
1 3 See
Jarchow, p. 136-138 for a more extensive discussion
of anti-takeover provisions.
1 4 Lynne
B. Sagalyn, "RE Securities: Risk and Return Over
the Business Cycle," Working Paper, MIT Center for Real
Estate Development, June 1989, p. 10.
1 5 Jarchow,
p. 59.
1 6 Harlan
S. Byrne, "Extraordinary REIT: That's Chicago
Dock & Canal on More Grounds Than One," Barron's, November
3, 1986, pp. 16 & 18.
CHAPTER THREE:
1 7 REIT
Facts, p. 3.
18Sagalyn, p. 5.
19Telephone interview with Mr. John Foshiem, GreenStreet
Advisors; Los Angeles, California, July 2, 1990.
2 0 ICM Property
Investors, 1989 Annual Report, p. 5.
CHAPTER FOUR:
2 1 REIT
Line, (NAREIT) May, 1990, pp. 2-3.
2 2 This
use was suggested by Mr. William King, of Goodwin,
Proctor and Hoar.
2 3 William N. Weirick, "REIT/REMIC Strategies to Replace
Public Syndications in Public/Private Development," Real
Estate Review, Spring 1989, pp. 71-75.
99