Chapter 21:

Real Estate Investment Trusts

(REITs)
McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Real Estate Investment Trusts

Creation of the Internal Revenue Code
Pass-through entity: No corporate taxes
Asset requirements
75% test

Income requirements
Distribution requirements
90% rule

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Real Estate Investment Trusts

Ownership requirements
100 person minimum

Pre-1986: Management Activity Restriction

1986 Tax Reform Act relaxed the
restriction and led to vertically integrated
operating companies
1991 Kimco Realty Offering
Taubman Realty Offering
Umbrella Partnership REIT (UPREIT)
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Real Estate Investment Trusts

Tax treatment
Accelerated depreciation
40-Year asset life
REIT dividends
Taxed as ordinary income

1999 Real Estate Modernization Act

Usual and customary provision of services.
This was especially beneficial to REITs that
owned hotels.
Taxable REIT subsidiaries
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Exhibit 21-1

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Real Estate Investment Trusts

Equity trusts
Specializations
Property type
Trust duration

Investment appeal
Diversified portfolio
Liquidity

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Real Estate Investment Trusts

Equity trusts
Investment appeal
Mutual funds
Exchange traded funds
International REITs
Closed-end funds

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Real Estate Investment Trusts

Equity trusts
Caveats
Purchase of original property not arms length
Conflicts of interest

Safeguards
Appraisals
Sarbanes-Oxley

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Real Estate Investment Trusts

Private REITs
Targeted to institutional investors
Syndicated to investors
Incubator REITs

Mortgage REITs
Mortgage REITs have come back into favor
again. The last time Mortgage REITs were
popular was in the 1970s.

Hybrid REITs
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Real Estate Investment Trusts

Funds from Operations (FFO)
REIT equivalent to earnings per share
Depreciation impact

Adjusted Funds from Operations (AFFO)

Funds Available for Distribution/Cash
Available for Distribution (FAD/CAD)
FAD/CAD is the amount of actual cash that is
left over.
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Real Estate Investment Trusts

Expansion & Growth
Little Free Cash Flow
Income distribution rules

Secondary Stock Offering

Dilution vs. accretion

Debt Financing

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Real Estate Investment Trusts

Growing income
Existing properties
Rental income
Redevelopment

Acquisitions
Purchase properties with cash at positive spreads.
Swap shares for property interests.

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Real Estate Investment Trusts

Growing income
Development
Provision of services
Property management, brokerage, development,
etc.

Financial engineering
Improve financing terms and lower capital costs.

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Real Estate Investment Trusts

Additional issues
Tenant improvements & free rent
Leasing commissions & costs
Straight-line rents
Income from managing other properties
Types of mortgage debt
Ground leases

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Real Estate Investment Trusts

Additional issues
Lease renewal options
Occupancy numbers: occupied vs. leased
space
Retail REITs: Sales per square foot
Costs of being a public company
Sarbanes-Oxley

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Real Estate Investment Trusts

Mortgage REITs
Does not own real property. Does own
mortgage paper.

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