Chapter 21 REITs

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What is a Real Estate Investment Trust?
A REIT is a:
• Publicly or privately held company that that owns real estate equity or
real property debt
• Passes most of its earnings and capital gains onto shareholders
• Only retained earnings are taxed, PROVIDED REIT meets
–
–
–
–
–
Ownership requirements
Management requirements
Asset requirements
Income requirements
Distribution requirements
Trade Association: National Association of Real Estate Investment Trusts
(www.nareit.com)
1
REITs
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Performance vs Equities over past 28 years
REIT Requirements
Tax Treatment
Types of REITS
o Equity, Debt, Hybrid
o Sector Specific (Office, Retail, Residential,
Hotel, Self Storage, Diversified, Specialty)
o Market specific (e.g. just NYC office)
o UPREIT, DownREIT
Representation in Market Indices
REIT Valuation
o FFO, Adjusted FFO, CAD
Economies of Scale
REIT Advisors
REIT Growth
2
Month
Dec-05
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
3
Dec-06
(12.4%)
Dec-95
Russell 2000
Dec-94
(14.0%)
Dec-93
Equity REITs
Dec-92
(12.7%)
Dec-91
SNP 500
Dec-90
Dec-89
Dec-88
Dec-87
Dec-86
Dec-85
Dec-84
5,000.00
Dec-83
6,000.00
Dec-82
Dec-81
Dec-80
Dec-79
Dec-78
Index 1978:12 = 100
REITs
Equity REITs, SNP 500, Russell 2000
1978:12-2007:10
7,000.00
4,000.00
3,000.00
2,000.00
1,000.00
0.00
Requirements
Ownership
– 5 or fewer entities may not own 50% or more of the
outstanding shares (the “5/50 Test”)
– No one shareholder owns more than 9.9% (pension funds
excluded)
– REIT shares must be transferable and held by at least 100
persons
– Must be managed by a board of directors or trustees
– Must be incorporated in one of the 50 states or DC as a
taxable entity
4
Requirements
Management
– REIT managers must be passive
• REIT trustees, directors or employees may not actively engage
in managing or operating REIT properties (includes providing
service and collecting rents from tenants).
• Managers may set policy: rental terms, choose tenants, sign
leases, make decisions about properties.
– REITs allowed to own 100% of a Taxable REIT Subsidiary (TRS).
• REIT Modernization Act of 1999 (effective 2001)
• TRS can provide services to REIT tenants and others (previously, this
was not allowed).
• Debt and rental payments from TRS to REIT are limited to ensure that
the TRS actually pays income taxes.
5
Requirements
Assets
– 75% of assets must be real estate, cash, and govt. securities
• other REIT shares are considered real estate assets, but
not more than 20% of its assets can be stocks in taxable
REIT subsidiaries
– not more than 5% of assets can be stock in non-real estate
corporations
– may not have more than 10% of voting securities of any
corporation other than another REIT, Taxable REIT
Subsidiary (TRS) or subsidiary whose assets and income
are owned by the REIT for federal income tax purposes
6
Requirements
Income
– 95% of gross income must be from dividends,
interest, rents, or gains from sale of certain assets
(real estate, cash, or govt securities).
– The 95% rule includes income from dividends and
non-real estate sources (e.g. bank deposit interest)
– Implication: less than 5% of REIT income can come
from service fees
7
Requirements
Income
– No more than 30% of gross income can be derived
from
• sale or disposition of any securities held less
than 6 months
• sale or disposition of real estate held for less
than 4 years, except those involving foreclosures.
• properties held for sale in the normal course of
business (anti-dealer provision)
8
Requirements
Compliance
– Company must make a REIT elective by filing
IRS Form 1120-REIT.
– Company must mail letters to shareholders of
record requesting details of REIT benefits
Source:
http://www.investinreits.com/learn/formingareit.cfm
9
Requirements
Distributions
– must distribute 90% of all taxable income to investors
• mandates fairly low retained earnings policy
• has important implications for financing growth
– Note: prior to 2001, minimum distribution requirement was
95%.
10
Tax Treatment
• Accelerated depreciation is allowed for determining
taxable income
• 40 year asset life required for calculating income
available for distribution to investors
• Shareholders dividends may exceed REITs taxable
income (because of depreciation, amortization)
• REIT distributions
– Dividends taxed as ordinary income
– Return of capital reduces shareholder’s tax basis
11
Tax Treatment
REIT Management has Considerable Flexibility
•
•
•
•
Tax treatment of leasing commissions
Tax treatment of financing fees
Tax treatment of tenant improvements
Straight-line graduated lease payments
That influence analysts’ performance evaluation.
12
REITs
Number of Publicly Traded REITs
250
Total
Equity
Mortgage
Hybrid
200
150
100
50
Year
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
0
13
Year
20
04
20
01
19
98
19
95
19
92
19
89
19
86
19
83
19
80
19
77
19
74
19
71
Billion $$$
REITs
REIT Market Cap
350
300
250
200
150
100
50
0
14
REITs
REIT Percent Market Cap by Type
100.0%
90.0%
Equity
Mortgage
Hybrid
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
1971
1976
1981
1986
1991
1996
2001
Year
15
REITs
Historical Offerings of Securities (As of 10/31/2006)
Year
1998
1999
2000
2001
2002
2003
2004
2005
2006
Total
Number
474
205
114
127
187
228
266
259
165
IPO
17
2
0
0
3
8
29
11
5
Secondary Equity
Common
Preferred
216
81
29
71
11
31
58
21
85
25
82
64
79
61
71
36
56
34
Secondary Debt
Unsecured Secured
145
15
69
34
70
2
44
4
71
3
68
6
97
0
105
36
67
3
16
REITs
Equity REIT Sectors ( % Market Cap)
Health Care
5.2%
Self Storage
3.9%
Specialty
4.3%
Industrial/Office
26.7%
Lodging/Resorts
7.3%
Diversified
7.6%
Residential
18.7%
Retail
26.3%
17
Equity REITs
REIT
Symbol
Sector
Apartments
Equity Residential
NYSE: EQR
Apartment Investment & Management Co. NYSE: AIV
UDR, Inc.
NYSE: UDR
Diversified
Vornado Realty Trust
NYSE: VNO
Duke Realty Corp.
NYSE: DRE
Health Care
Health Care REIT, Inc.
NYSE: HCN
Nationwide Health Properties Inc.
NYSE: NHP
Hotel
Starwood Hotels & Resorts Worldwide Inc. NYSE: HOT
Hospitality Properties Trust
NYSE: HPT
Industrial
Prologis
NYSE: PLD
AMB Property Corp
NYSE: AMB
First Industrial Realty Trust
NYSE: FR
Office
Boston Properties Inc
NYSE: BXP
SL Green Realty
NYSE: SLG
Mack-Cali Realty Corp.
NYSE: CLI
Retail
Simon Property Group
NYSE: SPG
General Growth Properties, Inc.
NYSE: GGP
Taubman Centers, Inc.
NYSE: TCO
Price
(12/3/2007)
Market Cap
(billions)
D/E
Beta
P/E
$37.22
$38.82
$22.00
$10.09
$3.71
$2.95
1.85
3.62
3.48
1.70
1.41
1.48
8.82
65.57
23.53
$88.49
$26.59
$13.54
$3.87
2.03
1.57
1.18
0.99
26.52
17.35
$44.36
$31.42
$3.62
$2.92
1.15
0.96
1.57
1.46
36.51
10.81
$53.44
$36.35
$10.64
$3.40
1.22
1.09
0.69
1.01
19.29
11.13
$64.93
$60.70
$36.81
$16.72
$6.01
$1.64
1.29
1.23
2.04
1.50
1.10
0.97
13.57
20.75
14.87
$97.41
$101.67
$35.04
$11.62
$6.02
$2.38
1.24
1.41
1.22
1.32
1.18
1.42
9.18
10.47
14.43
$97.24
$47.05
$54.10
$21.69
$11.47
$2.85
4.57
15.95
1.56
1.45
1.13
41.12
38.47
65.50
18
Debt REITs
REIT
Sector
Symbol
Price
(12/3/2007)
Market Cap
(billions)
D/E
Beta
P/E
Commercial
Annaly Mortgage
NLY
$17.10
$6.870
9.93
0.70
14.77
Capstead Mortgage Corp.
CMO
$12.26
$0.379
13.78
1.37
na
Capital Trust
CT
$30.96
$0.542
5.20
0.98
7.63
Allied Capital
ALD
$24.07
$3.720
0.63
0.18
23.12
Thornburg Mortgage Asset
TMA
$10.43
$1.360
15.68
0.63
na
Anworth MTG Asset CP
ANH
$7.18
$0.329
9.96
0.86
na
Redwood Trust, Inc.
RWT
$30.40
$0.853
73.87
1.35
184.2
RAIT Financial Trust
RAS
$8.74
$0.533
11.45
2.31
na
Newcastle Investment Corp
NCT
$12.84
$0.678
9.24
2.01
10.66
Residential
Both
19
Umbrella Partnership REIT
UPREIT
• REIT formed by consolidating limited-partnerships
• Partnership interests known as Operating Partnership
(OP) units
• REIT owns property indirectly through OP
• Partnerships allocated REIT shares based on appraised
value of partnership property
• Property owners can swap RE investments for OP units
using IRS tax deferred exchange rule 731
• REIT issues shares to the public and purchases
properties owned by the OP
• First UPREIT created by Taubman in 1992
20
Taubman UPREIT
UPREITS such as Taubman Centers, Inc. are structured to
contain two distinct parts: A publicly traded corporation
and a real estate partnership. The publicly traded
corporation, TCO, owns units in the TRG real estate
partnership. It is this partnership that actually houses the
UPREIT's assets, primarily shopping malls. Investors can
purchase common stock in the corporation, while investors
with direct ownership in the real estate partnership hold
preferred shares in the TCO corporation. Each share
represents the same fractional ownership of the underlying
assets, and has the same voting power.
Source: http://www.AndersonEconomicGroup.com
21
22
DownREIT
• Like an UPREIT, a DownREIT acquires
property on a tax deferred basis by issuing
partnership units
• DownREIT can own multiple partnerships
– Can form partnerships with each acquisition
– More flexible than an UPREIT
• DownREIT can own assets at both the REIT and
OP levels
23
REITs in Market Indexes
S&P 500 Index
REIT
Ticker
Entered
AIMCO
AIV
3/13/2003
Archstone-Smith
ASN
12/17/2004
Boston Properties
BXP
3/31/2006
Equity Residential
EQR
11/1/2001
Kimco Realty Corporation
KIM
4/3/2006
Plum Creek Timber, Inc.
PCL
1/16/2002
ProLogis
PLD
7/16/2003
Public Storage, Inc.
PSA
8/18/2005
Simon Property Group
SPG
6/25/2002
Vornado Realty Trust
VNO
8/11/2005
As of October 2, 2006; www.nareit.com
24
REITs in Market Indexes
S&P 400 Mid Cap Index
REIT
Ticker
Entered
AMB Property Corporation
AMB
1/27/2003
Developers Diversified Realty Corp.
DDR
9/30/2004
Highwoods Properties, Inc.
HIW
10/7/2003
Hospitality Properties Trust
HPT
10/1/2001
Liberty Property Trust
LRY
12/11/2002
The Macerich Company
MAC
Mack-Cali Realty Corporation
CLI
3/19/2003
New Plan
NXL
10/1/2001
Rayonier
RYN
pre-REIT
Regency Centers
REG
4/25/2005
United Dominion Realty Trust
UDR
1/27/2003
Weingarten Realty Investors
WRI
11/10/2004
As of October 2, 2006; www.nareit.com
7/1/2005
25
REITs in Market Indexes
S&P 600 Small Cap Index
REIT
Ticker
Entered
Acadia Realty Trust
AKR
5/25/2005
Colonial Properties Trust
CLP
10/1/2001
EastGroup Properties, Inc.
EGP
5/27/2005
Entertainment Properties Trust
EPR
6/3/2004
Essex Property Trust
ESS
4/24/2002
Inland Real Estate Corporation
IRC
10/2/2006
Kilroy Realty Corporation
KRC
10/1/2001
Lexington Corporate Properties Trust
LXP
9/4/2003
LTC Properties, Inc.
LTC
2/14/2006
Mid-America Apartment Communities, Inc.
MAA
8/22/2006
New Century Financial Corporation
NEW
pre-REIT
Parkway Properties
PKY
10/29/2004
PS Business Parks, Inc.
PSB
7/27/2006
Senior Housing Propeties Trust
SNH
8/22/2006
Sovran Self Storage
SSS
7/8/2004
As of October 2, 2006; www.nareit.com
26
REIT Valuation
EPS v. FFO
• Earnings per share (EPS) is an accounting number
– REIT must distribute at least 90% of EPS
• Funds from operations (FFO) is REIT cash flow (no
depreciation/amortization)
• FFO means net income (computed in accordance with
GAAP), excluding gains (or losses) from debt restructuring
and sales of property, plus depreciation and amortization of
assets uniquely significant to the real estate industry, and
after adjustments for unconsolidated entities in which the
REIT holds an interest. Adjustments for these entities are
to be calculated to reflect FFO on the same basis.
• Moreover, NAREIT believes that items classified by GAAP
as extraordinary or unusual are not meant to either increase
or decrease reported FFO.
27
REIT Valuation
How to Calculate FFO
Revenues
– Operating expenses
– Depreciation & amortization
– Interest expense
– General & Administrative expense
= NET INCOME (GAAP)
Net Income
– Profit from real estate sales
+ Depreciation & amortization
= FFO
28
REIT Valuation
How to Calculate FFO
Ten shares outstanding
Rent
- Operating Expenses
Net Operating Income
- Depreciation/amortization
Net Income
Cash Flow
EPS
FFO Per Share
REIT
Income
Statement
REIT
Cash
Flow
$ 100
40
60
40
20
$ 100
40
60
60
$ 2
Example from Brueggeman and Fisher, page 631.
$ 6
29
REIT Valuation
Adjusted FFO
FFO minus:
–
–
–
–
Recurring capital expenditures (e.g. painting, carpets, etc.)
Amortization of tenant improvements
Amortization of leasing commissions
Adjustment for rent straight-lining
= Adjusted FFO (AFFO)
31
REIT Valuation
Impact on FFO
• Depending upon management’s strategy with
respect to capitalizing or expensing items,
calculated FFO and percentage of payout of net
income can vary widely
• Kimco Realty (KIM) expenses everything they can -reduces measured NOI -- increases amount they can
retain (65% payout ratio - lowest in industry)
• Large group of about 10 has payout ratios over 95% -capitalize aggressively -- raises FFO -- reduces what
they can retain
32
Financial Analysis
REIT Financial Ratios
Earnings per Share, EPS
= Net income/shares outstanding
Funds from Operations, FFO = Net Income plus Depreciation
& Amortization
Return of Capital, ROC
= Dividends minus Earnings
Cash Retention, CR
= FFO minus Dividends
Book Value, BV
= Assets minus Liabilities
33
Financial Analysis
Example: Midwestern Property Trust
Summary
Properties:
Original Cost:
Depreciated Cost:
Mortgage Debt:
Annual Interest Rate:
Term:
Number of Common Shares:
5 million square feet
$300 million
$170 million
$ 80 million
8%
10 years
5 million
34
Financial Analysis
Example: Midwestern Property Trust
Operating Statement
Net Revenue
less Operating Expenses
Deprecation and amortization
General and administrative
Management expenses
Income from Operations
less interest expense
Net income (loss)
Net income (loss) per share
$ 70,000,000
30,000,000
15,000,000
4,000,000
1,000,000
$ 20,000,000
6,400,000
$13,600,000
$ 2.72
35
Financial Analysis
Example: Midwestern Property Trust
Balance Sheet: Assets
Cash
Rents Receivable
Properties @ cost
less accumulated depreciation
Properties-net
Net Assets
$
500,000
1,500,000
300,000,000
130,000,000
170,000,000
$ 172,000,000
36
Financial Analysis
Example: Midwestern Property Trust
Balance Sheet: Liabilities
Short term
Mortgage debt
Total debt
Shareholders’ equity
Total Liabilities and equity
$
2,000,000
80,000,000
82,000,000
90,000,000
$ 172,000,000
37
Financial Analysis
Example: Midwestern Property Trust
Profit Summary
$ Amount
Per Share
Earnings
$ 13,600,000
$ 2.72
NOI
$ 35,000,000
$ 7.00
FFO
$ 28,600,000
$ 5.72
38
Financial Analysis
Example: Midwestern Property Trust
Other Financial Data and Ratios
Market price per share of common stock (given)
Dividend per share (given)
Recovery of Capital per share
$ 4.00 - $ 2.72 =
Cash retention per share
$ 5.72 - $ 4.00 =
Earnings yield
FFO yield
Dividend yield
$2.72/$75.00 =
$5.72/$75.00 =
$4.00/$75.00 =
Current earnings multiple
Current FFO multiple
Net assets per share
Equity or book value per share
$75.00/$2.72
$75.00/$5.72
$172M/5M
$90M/5M
=
=
=
=
$ 75.00
$ 4.00
$ 1.28
$ 1.72
3.62%
7.62%
5.33%
27.6x
13.1x
$ 34.00
$ 18.00
39
Economies of Scale
Minimum Efficient Firm Size
• Typical REIT IPO from 1993
– $100,000,000 firm with 50/50 debt-equity ratio,
yielding 8% on equity
– implies roughly $4,000,000 in income
– even with relatively low payout ratio of 75% of
earnings, can retain only $1,000,000
40
Economies of Scale
What will $1,000,000 buy?
– for an apartment REIT, a good-sized garden apt. complex
costs $20-$25 million, retaining the added $1,000,000 adds
little flexibility with respect to acquiring properties for
portfolio.
– from broad capital market perspective, this firm probably
should increase payout ratio (this is what happened in
reality)
• shareholders received high dividend yield, firm had to
repeatedly go to the capital markets to fund acquisitions
41
Economies of Scale
$10 billion REIT
– same 50/50 debt-equity ratio and 8% yield on
equity for a $10 billion REIT
– implied income of about $400,000,000
– if firm chooses not to aggressively expense, it
will have a relatively high payout ratio
• if that ratio is 95%, implies the firm can retain
$20,000,000
• that’s a good-sized garden apt complex, 1/5th
of a large regional mall, or a couple of decentsized warehouses or industrial sites.
42
Economies of Scale
$10 billion REIT
– if firm chooses to aggressively expense items to
reduce accounting earnings and lower its required
payout under the REIT tax law, the situation is
markedly different
– assume its payout ratio falls to 75%:
• ratio implies retention of $100,000,000
• which will buy a portfolio of any property type
except regional malls and downtown office
buildings
43
REIT Advisors
• Prior to 1986, REITs
– Passive investment vehicles
– Day to day business decisions (property management and
investment decisions) conducted by 3rd party external advisors
– Advisors frequently had conflicts of interest
• Were property owners trying to sell the REIT property
• Were advisors to other (competing) REITs
• 1986 Tax Reform Act
– A REIT “may directly select, hire and compensate those
independent contractors who will provide customary services that
may be provided by a REIT in connection with the rental of
property, rather than hiring an independent contractor to hire other
independent contractors.”
– Allowed REITs to be self-advised/self-managed.
44
REIT Advisors
Number (and %) of REITs by Type of Advisor
Advisor Style
1996
1998
2000
External
100
(35%)
87
(30%)
25
(9%)
Internal
186
(65%)
194
(70%)
244
(91%)
Total
286
281
269
Source: Real Estate Investment Trusts, by Chan Erickson and
Wang, Oxford, 2003, p.58
45
REIT Growth
1.
Grow income from existing properties
–
Raise rents
–
Reduce vacancy
–
Increase Operating Efficiency
2.
Acquisitions
–
Purchase properties @ positive spreads between property yields and
WACC
–
Swap shares in REITs to take advantage of tax provisions
3.
4.
New construction
Financial Engineering
–
Manipulate Funds from Operations
–
Leverage
–
Change payout ratio
Most REITs finance expansion with additional stock offerings
46
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