Professional Documents
Culture Documents
What is it?
Securitized real estate investment Ownership form created by IRS code
20:2
Requirements
Assets
75% of assets must be real estate, cash, and govt. securities
other REIT shares are considered real estate assets
not more than 5% of assets can be from 1 issuer if not covered under above test may not have more than 10% of voting securities of 1 issuer if not covered under 1st test
20:3
Requirements
Income
95% of gross income must be from dividends, interest, rents, or gains from sale of certain assets (real estate, cash, or govt securities). 75% of gross income must be derived from rents, interest on mortgages, gains from sale of certain assets, or income from other REITs
20:4
Requirements
Income
No more than 30% of gross income can be derived from
sale or disposition of securities held less than 6 months sale or disposition of real estate held for less than 4 years, except those involving foreclosures. properties held for sale in the normal course of business (anti-dealer provision)
20:5
Requirements
REIT Modernization Act of 1999 (effective 2001)
REITs allowed to own 100% of a Taxable REIT Subsidiary (TRS). TRS can provide services to REIT tenants and others (previously, this was not allowed). Debt and rental payments from TRS to REIT are limited to ensure that the TRS actually pays income taxes.
20:6
Requirements
Distribution
must distribute 90% of all taxable income to investors
mandates fairly low retained earnings policy has important implications for firm size
20:7
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.
20:8
Requirements
Anti-concentration rule
5 or fewer entities may not own 50% or more of the outstanding shares Exceptions:
look-through provision for US pension funds UPREIT structure (umbrella partnership)
20:9
Tax Treatment
Accelerated depreciation is allowed for determining taxable income 40 year asset life required for calculating income available for distribution to investors
20:10
REIT Types
Equity Mortgage Hybrid
20:11
Equity REITs
Blank Check
does not disclose investments to shareholders prior to acquisition.
Specified Trusts
purchase a specific property (Rockerfeller Center Properties)
Mixed Trusts
invests in both blank check and specific properties
20:12
Equity REITs
Leveraged v. Unleveraged Finite-life v. Nonfinite-life
finite-life is self-liquidating
20:13
Equity REITs
Closed-End v. Open-End
closed-end protect shareholders from future dilution
Exchange Trusts
tax-free exchange of property for shares in the REIT
20:14
Equity REITs
Developmental-Joint Venture
funds construction costs lower cost of capital for developer
20:15
Mortgage REITs
Invests in mortgages
earn the spread between costs of funds and mortgage loan rates
20:16
UPREIT
REIT formed by consolidating limitedpartnerships partnerships allocated REIT shares based on appraised value of partnership property
20:17
Taubman UPREIT
20:18
REIT Benefits
invest in a diversified RE portfolio managed by professionals higher liquidity
20:19
REIT Disadvantages
possible conflicts of interests between sponsor and REIT shareholders
20:20
$160,000
$140,000
$120,000 140 $100,000 120 100 80 60 $40,000 40 $20,000 20 0 Market Cap Equity REITs
$80,000
$60,000
$0
19 71 19 72 19 73 19 74 19 75 19 76 19 77 19 78 19 79 19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00
20:22
20:23
Structural Changes
End of High LTV Nonrecourse Financing
By early 1990s, commercial banks and insurance companies had reduced exposure to real estate
Regulatory pressure on banks Regulatory pressure and changing business conditions on insurance companies
20:24
Structural Changes
With high LTV nonrecourse loans, real estate owners had no need to raise equity
made them abnormal compared to other capital intensive businesses in the US
20:25
Structural Changes
Debt Rollover Timing
Industry refinanced with 5-7 year miniperms following bond market rally of 1986
20:26
Structural Changes
End of high LTV financing and debt rollovers created a capital squeeze in 1992 that forced many real estate owners to consider raising equity in the public markets for the first time UPREITs created
allowed original owners to maintain effective control of assets
20:27
REIT Liquidity
Research finds that equity REITs have the same liquidity as firms in other industries, holding constant firm size and exchange listing
liquidity measured as the bid-ask spread
20:29
REIT Liquidity
Bid-Ask does not decrease during down real estate markets relative to that for all stocks
very different from liquidity conditions in private markets must remember that bid-ask is for a marginal change in ownership, transactions in the private market typically involve whole properties or portfolios of properties (control issues arise)
20:30
REIT Growth
REITs have limited ability to grow through retained earnings (little free cash flow) Most expand through additional stock offerings (follow-on offerings)
20:31
EPS v. FFO
earnings per share (EPS) is a fictional accounting number
REIT must distribute at least 95% of EPS
20:32
20:34
Reported FFO?
Net Income minus:
Profit from real estate sales
plus:
Real Estate Depreciation
= FFO
20:35
Analyst FFO?
FFO minus:
Recurring capital expenditures Amortization of tenant improvements Amortization of leasing commissions Adjustment for rent straight-lining
20:36
20:37
20:39
20:41
Impact on FFO
Tenant Improvements (TI)
landlord allowance to cover costs of reconfiguring space for tenant TI are capitalized and depreciated - cash flow from TI not included in FFO Implication:
Mgt can use TIs to raise occupancy and rent revenue
20:44
Impact on FFO
Leasing Commissions
usually paid in cash when lease is signed cost is capitalized over life of lease, may not show up in FFO 2 issues:
leasing costs are an operating cost commissions are occasionally paid over lease term
20:45
Impact on FFO
Straight-line Rents (REITS with long term leases)
count average rental rates over lease life in FFO
over states revenue in early years and under state in later years
20:46
Impact on FFO
Lease guarantees
REIT sponsor guarantees income on currently vacant space using master lease (WHY?)
may be for limited period - short term solution to long term problem should have recourse to sponsor sponsor may be charging the REIT guarantee fees
20:47
Impact on FFO
3rd Party Income
income from managing other properties highly variable
20:48
Impact on FFO
Ground Leases
encumber the land underneath buildings (long term) REITs may own buildings subject to a ground lease or REITs may own the ground lease (spread investing)
20:49
Impact on FFO
Depending upon managements 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
20:50
20:53
FFO Growth
FFO Growth = Internal Growth + External Growth
20:54
FFO Growth
Internal Growth
Rental Increases % Rent, Rent Bumps, etc. Tenant Upgrades Property Refurbishments Sale & Reinvestment
20:55
FFO Growth
External Growth
Acquisitions
Accretive = yield on investment is below cost of capital
Example: REIT raise $100m from stock and bond at 10% WACC -- acquire property with a 12% yield == 2% increase in FFO
20:57
20:58
20:60
20:62
20:65
20:66
If you can retain this amount, you do not have to go to Wall Street to fund every portfolio purchase
increases flexibility so that you can quickly take advantage of targets of opportunity and avoid investment banker fees
20:67
suggests that consolidation in the public markets will continue in the next few years
20:68
20:69
mergers difficult because acquired firm inevitably has to be willing to hold the paper of acquiring firms
requires common vision to make it work in the absence of aggressive board intervention
20:70
20:71
REIT Research
Q:
Are REITs real estate or stocks?
important implications for portfolio diversification do REITs provide a real estate index A: REIT returns lag real estate cap rates REIT returns and unsecured real estate returns share a common component that reflects real estate fundamentals REIT returns are noisy.
20:72
REIT Research
Corporate Finance Issues
Dividend policy Capital structure
20:73
REIT Research
Risk and diversification REIT returns highly correlated with stocks (corr = .65 .8) real estate returns have low correlation with stocks (corr=.1 - .3) REIT betas < 1 Real estate portfolio allocation optimal allocation 10% to 19% real estate historic real estate allocation = 3%-5% (pension funds)
20:74
REIT Research
REITs and Inflation Hedging
depend on the time period under study
1970s - REITs are negatively correlated with inflation 1980s - REITs are positively correlated with inflation
20:75