REAL ESTATE INVESTMENT TRUSTS (REIT)
A limited-liability single tax entity created by Congress in 1960
as a vehicle for pooling funds to make real estate investments.
REITs typically hold equity real estate (Equity REITs),
mortgages and mortgage backed securities (Mortgage REITs),
or both (Hybrid REITs).
Dividends paid by REITs are deductible from its taxable
income, so REITs usually pay no Federal income tax. They are
therefore single tax entities because the tax liability falls only
on the dividends paid to the shareholders.
Restrictions on REIT organization and income dispersal:
It must pay out at least 95% of its ordinary taxable
income as dividends.
It must be organized as a corporation or business trust.
It must be managed by a board of directors or trustees.
It must have fully transferable shares.
It must have a minimum of 100 shareholders.
No more than 50% of the shares can be held by five or
fewer individuals during the last half of each taxable
year. (Five-or-fewer rule)
At least 75% of the total assets must be invested in real
At least 75% of gross income must be derived from rents
or mortgage interests.
No more than 30% of gross income can be derived from
the sale of properties held less than four years, securities
held less than six months or other prohibited
Organizational Structure and Control:
REIT activities are supervised by either a board of directors or
trustees. Day-to-day management of the REIT may be handled
either internally (a self-administered) REIT or contracted to an
Umbrella Partnership REIT (UPREIT):
REIT that owns shares in an operating partnership, which in turns controls
real estate investments. REIT serves as the general partner of and has an
interest in the operating partnership that owns, operates, manages, and
controls each of the real estate assets. This structure is currently used
because it avoids the ownership concentration restrictions of the REIT tax
Down-REIT Partnership Structure
Operating Partnerships created for the sole purpose of acquiring properties
from potential sellers seeking to defer taxes on their capital gains. This
structure facilitates the acquisition of partnerships or properties by the
exchange of limited partnership units (i.e. allows sellers to convert
ownership interests into partnership shares, not a taxable event)
Reduces mismatch between the interests of the REIT and the
interest of the limited partners because their position is usually not
as large as those found in UPREITs.
May be lock-out provisions form property sales or debt repayment
which reduces the REITs ability to fully manage its assets
A structure that involves both a real estate investment trust and an operating
company or C Corporation. Under this structure, the shares of common
stock of both the REIT and the operating company are cojoined and traded
under one ticker symbol. REIT shareholders own equal shares of the real
estate investment trust and the C Corporation and receive tax benefits of the
REIT as well as additional earnings generated by the operating company.
A structure in which the shares of the REIT and the operating companies are
traded separately under different ticker symbols. The REIT shareholders are
not equal shareholders in the “paper-clip” C Corporation, however, investors
may choose to purchase stock in either the REIT or the “paper-clip” to
mitigate potential investment risks associated with this structure.
REIT can conduct operating businesses and still preserve
their special tax status.
REIT can participate in more aggressive investments to
achieve higher yields.
Difficulties for management operating two companies with
potential conflicts of interest.
More difficult to accurately depict cash flows and leverage
of the REIT, because there are no consolidated reporting
Funds from Operations (FFO)
Original definition (1991): Supplemental measure of a REITs profitability,
provides additional information for net income under generally accepted
accounting principles (GAAP). Defined as:
“Funds from Operations means net income (computed in accordance
with generally accepted accounting principles), excluding gains (or
losses) from debt restructuring and sales of property, plus depreciation
and amortization, and after adjustments for unconsolidated
partnerships and joint ventures.”
Importance of FFO
There is an important difference between REIT earnings per share and
FFO per share:
Example Assumed 10 Outstanding
Shares of REIT Stock
REIT REIT Cash
Rent $100 $100
- Operating 40 40
Net operating 60 60
- Deprec. 40 -
Net Income 20 -
Cash Flow - 60
EPS $2 -
FFO per - $6
Problems with FFO:
1) the addback of non-real estate-related amortization to net income
and the manipulation of interest rates.
FFO is computed by adding amortization back to NOI, the
intent was to exclude the amortization of nonrecurring or
intangible costs, but it has been used more broadly. Many
REITs, have taken deferred financing costs (usually prepaid
interest) capitalized this as an asset and amortized over the life
of the loan.
2) accounting for the real depreciation of real estate
FFO is computed by adding back depreciation to NOI.
However, because there is a certain amount of real depreciation,
which requires capital expenditures to protect the current and
future cash flows from the real estate assets, adding all the
depreciation exaggerates the FFO
NAREIT’s proposals to redefine FFO reporting requirements:
1. REITs accounting for unconsolidated joint ventures should be
extended from partnerships to include unconsolidated corporations.
2. REITs provide a reconciliation of the addbacks to GAAP net
income to arrive at FFO.
3. REITs provide further disclosure of capital expenditures on an
aggregate basis with detail on tenant improvements and allowances
for retail, office and industrial properties and capitalized carpet and
4. REITs disclose the noncash effect of straight-lining of rents.
Issues in Accounting and Financial Disclosure
Issue Usual Interpretation
Tenant Improvements and Free Tenant improvements paid by landlord are
Rents: Effects on FFO often capitalized and then depreciated - thus
cash flow for tenant improvements are not
included in FFO because FFO earnings are
Use of Straight Line Rents Leases with step-ups are often reported as the
mean rent over the holding period.
Lease Guarantees Usually involves the REIT sponsor
guaranteeing the rental income on space that
is currently vacant.
Terms of Mortgage Debt and Are there participating mortgages, is the debt
Obligations floating or fixed?
Existence of Ground Leases Rights of reversion may belong to
landowner, may be subordinated or indexed.
Lease Renewal Options How much exists and at what terms.
Percentage Leases No standard of measurement “mall store
sales” “Large space users”
Occupancy Numbers Leased space or occupied space.
CASE: GENERAL GROWTH PROPERTIES REIT: Are active
portfolio management strategies possible under current ownership and
Historical context for the IPO
Savings and Loan failures and weakness in the commercial
Curtailment of all forms of commercial real estate lending.
Severe overbuilding in many real estate sectors - high vacancy
High quality regional malls experienced fairly stable cash flows
and maintained their value during late 1980’s and early 1990’s.
Many IPO’s in late 1992 - 1993 were enclosed-mall shopping
center companies (eg. Taubman, Macerich, Crown, DeBartolo,
Portfolio strategy for the original Bucksbaum partnership
Develop and manage enclosed-mall shopping centers
Anchor malls with high volume merchandisers (See Table)
Carefully manage tenant base and lease structure of malls
Management objectives in move from partnership to public
Refinance mortgage debt during “credit crisis” of early 1990’s
(See Pro Forma)
Estate Planning for General Partners (Martin and Matthew
Need for greater access to capital markets to achieve growth
objectives (10% per annum)
Make new acquisitions
Expansions and redevelopment of existing properties
Dynamic management of tenant mix and leasing
Original REIT Structure
Self administered Real Estate Investment Trust
UPREIT Structure (See Chart)
59.6% General Partnership interest in Operating
Partnership held by REIT shareholders
40.4% Limited Partnership interest in Operating
Partnership held by:
members of their families
trusts for the benefit of their families
Total ownership interest held by Bucksbaums
5.8% of common shares in REIT (See Chart)
39.7% LP interest
Aggregate if exchange of partnership units for shares
of common stock - (.058*60.3%)+39.7% 43.2%
External management company (General Growth Management,
55% owned by employees and 45% owned by
What do you see as the potential positives and negatives of this
structure? For REIT shareholders? For LP’s?
Purpose of UPREIT:
Designed to facilitate a public offering for a privately held portfolio
without triggering a tax liability for the sponsors based on “built-in-
“Built-in-gain” is the difference between fair market value
and the current tax basis - usually equal to total capital
invested less accumulated tax depreciation.
When would the tax liability come due for the LP’s?
Outcome of IPO (April, 1993)
Sold 18,975,000 shares of common stock
Received $383 M in net proceeds (Share price $22)
21 enclosed regional malls (18 from original Bucksbaum portfolio
and 3 from the IBM retirement fund managed by Equitable Life
13.2 M square feet of GLA
Average occupancy rate = 87%
Sale per square foot (GLA) = $180
GGP Strategy after the IPO
1. In less than one year later acquired 40% interest in $1 B. Centermark
portfolio ( 19 enclosed malls from Prudential Insurance Co. - See
2. In less than 18 months, began development of two new regional malls:
West Valley Mall - Tracy, CA
500,000 sq. ft
Anchored by Target, Gottschalks, JC Penny.
Opened last year
Eagle Ridge Mall - Winter Haven, FL
700,000 sq. ft
Anchored by Sears, JC Penny and Dillard
Opened last year
Funded by 100% debt (line of credit and construction loans)
3. Within 24 months, $15 M spent on renovations and expansions of
Distributed approx. 84% of FFO
High Low Dividends
Q2 $26.00 $23 .31
Q3 24.75 $22.13 .37
Q4 23.50 $19.25
Q1 $21.50 $19.63 .39
Q2 $22.00 $19.25 .39
Q3 $22.63 $19.50 .39
Q4 $22.63 $19.25 .41
Q1 $22.63 $20.38 .41
Q2 $21.75 $19.38
FFO per share was $1.58 in 1993 and increased by 16% to $1.83
in 1994, most of the growth from the Centermark portfolio
Based on conservative capitalization rate, the $182 million initial
investment in Centermark increased by $100 M. and including
distributions of cash flow, the IRR on deal over 40%.
Look at Strategy from the Balance Sheet
After IPO, debt was 35% of total market capitalization and $50 M
was in the bank
Made total of $235 M of new investments ($182 M Centermark,
$38 M new development and $15 M on new expansions.
Floating rate debt exposure increase $90 M to approx. $300 M.
(Protected only by out-of-the-money LIBOR caps )
Cash position - $0; $15 M unused portion of their line of credit
Capital Requirements going forward into 1995
More significant growth opportunities through portfolio
Develop two additional malls with preleasing commitments.
Additional expansion and redevelopment within the portfolio
Believed returns on these opportunities greater than 15%
Market Perceptions of the REIT 1995
GGP had delivered nearly all IPO growth promises (Acquisition,
Little stock price appreciation - with an initial annual dividend of
$1.48 per share and initial price of $22 gave dividend yield of
6.75% where most recent IPO’s produced 150 - 200 bp. more.
Debt now 52% of total market capitalization (most REITs
covenanted to 55% debt level)
Over $300 M in commercial-bank floating rate debt, interest rate
risk exposure too high.
GGP was not self-managed.
Management Alternatives for “Going Forward” Strategy
Obtain additional debt
conventional secured financing with 60 - 70% LTVs
adverse affects on stock prices
Hybrid debt/Equity Instrument
Perpetual and/or convertible preferred stock placed privately
with institutional investors
Needed to yield 8.25% on the common stock plus capital
gains terms were very unattractive
Issue new common stock
Dividend yield of 8.25% and all-in floating rate debt of 8%
Underwriting fees of 5.3% and expenses of $650,000 - only
94% of the gross proceeds received by GGP
4,500,000 shares at $20.75/share - net proceeds of
If used to reduce floating rate debt interest payment
($7,802,000), dividend on 4,500,000 at $1.64/share
would be $7,380,000 or $422,000 savings.
Total shares and operating partnership units would
increase from 37.5 M to 42.5 M (13% increase)
Which strategy would you recommend? Why?
Newest Venture: Homart Transaction (Sear’s retail real estate
This is the largest U.S. Real Estate transaction ($1.85 billion dollars) ever.
It is a joint venture between GGP, Goldman Sachs, Whitehall Real Estate
Fund and Westfield.
Real Estate Portfolio (retail anchored by Sears stores)
The vacancy rate is 18%, which is the below average for
regional malls. Sales per square foot is $240, which is the
average for GGP properties.
GGP will have 26 additional completed regional malls, 2
malls under construction, 5 community shopping centers,
five community shopping centers under construction
(approx. 25 million square feet total). Also, 190 acres of
undeveloped land surrounding the existing malls.
Portfolio has not had recent capital improvements . The two
malls under construction will require about $250 million.
GGP will assume $720 million in debt. Most of this is to be
refinanced, currently insurance companies are offering 120 to
130 over Treasuries, so an assumed 8% all-in interest rate not
Cash contribution to sale is $480 million. GGP’s 20% share is
$96 million and the remaining $384 million will be raised
privately. GGP’s total investment is thus $240 million ($144
million assumed debt and $96 million draw from credit lines).
Anticipate $650 million in proceeds from sale of community
shopping center business and the Natick Mall in Massachusetts
(this is the most high end mall in the portfolio)
Intuition behind the deal
Good old-fashioned leverage effect from use of debt and the
joint venture structure. A $96 million investment will allow
GGP to control a $1.2 billion portfolio. $650 million will be
generated from the sale of the community mall business and
the sale (for $501 million) of the Natick Mall.
Will attempt to decrease the current vacancy rate.
Will aggressively use kiosk and temporary tenants.
Salomon Analysis of Outcomes
Most likely: assumes an initial capitalization rate of 8.5% on
$1.2 billion purchase, interest on assumed debt of 8.5%, asset
management fees of 30 basis points, $.09 increase in share
Aggressive: assumes an initial capitalization rate of 8.75% on
$1.2 billion purchase, interest on assumed debt of 8%, asset
management fees of 50 basis points, $.16 increase in share
Conservative: assumes an initial capitalization rate of 8% on
the $1.2 billion purchase, interest on assumed debt of 8%, asset
management fees of 25 basis points, $.04 increase in share