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FNCE 333 Lecture 16

FNCE 333 Lecture 16. Real Estate Investment Trusts Professor C. F. Sirmans. Readings -- REITs. Brueggeman and Fisher, Chapter 21 REIT Readings NAREIT www.nareit.org REIT Watch, Feb 2008 REIT Chartbook, Jan 2008 REITCafe.com. Overview. What are REITs? REIT Industry

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FNCE 333 Lecture 16

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  1. FNCE 333Lecture 16 Real Estate Investment Trusts Professor C. F. Sirmans

  2. Readings -- REITs • Brueggeman and Fisher, Chapter 21 • REIT Readings • NAREIT www.nareit.org REIT Watch, Feb 2008 REIT Chartbook, Jan 2008 • REITCafe.com

  3. Overview • What are REITs? • REIT Industry • REIT Performance

  4. Overview • What are REITs? • Basic definitions • History • Choosing to be a REIT • REIT structure • Recent changes

  5. What is a REIT? A REIT is a corporation or business trust that combines the capital of many investors to acquire (or provide financing) for all types of income producing real estate

  6. Types of REITs • Equity REITs – Owns equity interests in income producing real estate. • Mortgage REITs – Originates or acquires loans to real estate investors/developers. • Hybrid REITs – Both owns commercial real estate and holds mortgages.

  7. Advantages of REITs • Professionally managed- corporate governance issues • Liquidity – shares are traded on major exchanges • Tax advantages – no corporate income taxes are paid by REITs if it meets requirements • Diversification – REITs own variety real estate portfolios • Current Income – Dividend yields

  8. Created by Congress • Law passed in 1960 • Designed to facilitate public ownership of real estate “…small investors can secure advantages normally available only to those with large resources.” - Committee Report, 1960 • Four “generations” since 1960 • Grew dramatically in the 1990s • Intended to serve “small” investors

  9. What are REITs? • Publicly traded operating companies that own and manage commercial real estate • Chartered as a corporation or business trust • 2/3 as corporations • 1/3 as business trusts • Corporations and business trusts operate under the same rules for federal tax, regulatory and financial reporting purposes.

  10. What are REITs? • Companies operate like other publicly traded corporations • Full time management teams • Traditional corporate governance • SEC financial reporting • Business plans designed to maximize shareholder value • REITS are not taxed at corporate level • Operating as a REIT is a voluntary election under the Internal Revenue Code

  11. The REIT Choice • What Must a Firm Do? • Stock must be widely held • At least 75 percent of assets must be real property • At least 75 percent of revenue must come from real estate • At least 90 (95% prior to 2001) percent of taxable income must be distributed annually to shareholders • What does the Firm Get? • Taxes are paid at the shareholder level. No taxes at corporate level.

  12. What Qualifies a REIT? There are four requirements….. • Organizational Structure • Assets Tests • Income Tests • Distribution Requirement

  13. REIT Organizational Structure Requirements: • Be a corporation, business trust or similar association. • Be managed by a board of directors or trustees • Have shares that are transferable. • Have a minimum of 100 shareholders. • Have no more than 50% of the shares held by a five or fewer individuals during the the last half of each taxable year. Source: NAREIT, Laws Affecting REITs, 2001

  14. REIT Assets Tests • The REIT must invest at least 75 percent of total assets in real estate assets, cash, cash items and government securities (real estate assets include land and improvement, mortgages, shares in other REITs and interest in partnerships that have real estate assets); • The REIT may not own more than 10 percent of the voting securities or value of any one issuer (other than another REIT, a “qualified REIT subsidiary,” (“QRS”) i.e., a corporation that is owned 100 percent by the REIT, or a “taxable REIT subsidiary” (“TRS”). • No more than 5 percent of the REIT’s total assets may be invested in the securities of any one company (other than another REIT, a QRS, or a TRS); • No more than 20 percent of the REIT’s total assets may be represented by securities in one or more TRSs. Source: NAREIT, Laws Affecting REITs, 2001

  15. REIT Income Tests • The REIT must derive at least 75 percent of gross income from rents from real property, interest on obligations secured by mortgages on real property, gains from the sale of real property (other than those considered “dealer property”), dividends or gains from investments in other REITs, abatements and refunds of property taxes and mortgage or purchase commitment fees; • The REIT must derive at least 95 percent of gross income from sources qualifying under the 75 percent plus gains from dividends, interest and sales of securities. Source: NAREIT, Laws Affecting REITs, 2001

  16. Distribution Requirement • The REIT must distribute at least 90 percent of (95% prior to 2001) its REIT taxable income. Source: NAREIT, Laws Affecting REITs, 2001

  17. Overview • REIT Industry • REITs before the 1990s • REITs in the 1990s • REIT Industry in 2007

  18. REITs Before the 1990s • History of market capitalization • End of 1971 = $1.5 billion • End of 1980 = $2.3 billion • End of 1989 = $11.6 billion • Compound annual growth = 19.2 percent • Largest REIT at the end of 1980’s about $700 million • Leading U.S. real estate companies were privately owned • Factors limiting growth • REITs could own but not manage properties • Limited partnerships could pass through operating losses • Changing role of debt/equity financing

  19. REIT Industry In the 1990s • Factors promoting growth • Property management restrictions eliminated • Limited partnerships curtailed • Capital markets demand more equity to replace debt • UPREIT structure introduced in 1992 • Many leading U.S. real estate companies now are publicly traded

  20. REIT Industry in 2007 • 178 Companies in the NAREIT Composite Index • Total equity capitalization of $465 billion • Represents 10-15 percent of U.S. institutional-quality real estate

  21. REIT Industry in 2008 • Invested in all major property types and geographic regions of U.S. • REITs own and manage about 40,000 individual properties across the U.S. • Increasing liquidity in securities due to growth of industry and consolidation • Moderate financial leverage earns investment grade status • 50 REITs are rated investment grade by Standard & Poor’s • 2/3 of REITs by equity capitalization are investment grade • REIT Modernization Act of 1999 – effective 2001

  22. Overview • REIT Performance • Operating Characteristics • Factors affecting performances • Performance characteristics

  23. Factors Affecting Performance • REITs are real estate stocks • REITs have distinct investment performance characteristics • REIT returns are influenced by: • Real estate fundamentals • Equity market valuations • Real estate market supply and demand determine occupancy and rental growth • Equity market assesses risk and prices cash flow

  24. Operating Characteristics • Financial leverage and debt coverage • Payout ratios • Trading Volume

  25. Performance Characteristics • Historically return composed of relatively high dividend yields and moderate, long-term price appreciation • Dividend yields historically average 7.0 – 7.5 percent – recent years 4.0 - 6.0 percent • Low correlation with other stocks and bonds

  26. Global REITs In the last 5-8 years, the REIT structure has been developed in countries around the world. Global REIT Readings For a country-by-country comparison, see E&Y Global REIT reading

  27. Global REIT Market

  28. Global REIT Diversification • For an example of the use of global REITs for diversification, see the Pramerica reading

  29. Summary Successful public real estate industry? • Stabilize real estate market? • Flexibility essential • Role of regulators

  30. Summary • A Public real estate industry can succeed • both debt (CMBS) and equity (REIT) • REITs were a success story of the 1990s • in the footsteps of the residential MBS markets • Public real estate securities contribute to a healthy real estate market • create liquidity and stability • provide investment diversification opportunities • spread risks and rewards of real estate investment • create a more transparent, accountable and efficient real estate industry • Flexibility and adaptability are essential • legislators and regulators • industry participants

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