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					REAL ESTATE INVESTMENT TRUSTS (REIT)

    Definition:

          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:

          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
                  estate assets.

                 At least 75% of gross income must be derived from rents
                  or mortgage interests.



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                  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
                   transactions.

      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
             external advisor.


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
laws.

 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

“Paired-Share” REIT
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


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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.


“Paper-clip” REIT
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.

      Advantages:
            REIT can conduct operating businesses and still preserve
             their special tax status.

              REIT can participate in more aggressive investments to
               achieve higher yields.

      Disadvantages:
            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
              requirements.




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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
                             income        Flow
                            statement
              Rent            $100         $100
              - Operating       40           40
                Expenses
              Net operating      60              60
              Income
              - Deprec.          40               -
              Net Income         20               -
              Cash Flow           -              60
              EPS                $2               -
              FFO per             -              $6
              share

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



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             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
       appliance expenditures.
    4. REITs disclose the noncash effect of straight-lining of rents.

                            Equity REITs
             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
                                            before depreciation.
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”



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Occupancy Numbers                       Leased space or occupied space.



CASE: GENERAL GROWTH PROPERTIES REIT: Are active
portfolio management strategies possible under current ownership and
distribution rules?

Historical context for the IPO
      Savings and Loan failures and weakness in the commercial
       banking industry.
      Curtailment of all forms of commercial real estate lending.
      Severe overbuilding in many real estate sectors - high vacancy
       rates.
      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,
       Simon, Urban)

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
corporation (REIT)

      Refinance mortgage debt during “credit crisis” of early 1990’s
       (See Pro Forma)
      Estate Planning for General Partners (Martin and Matthew
       Bucksbaum)
      Need for greater access to capital markets to achieve growth
       objectives (10% per annum)
                  Make new acquisitions


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                  New development
                  Expansions and redevelopment of existing properties
                  Dynamic management of tenant mix and leasing
                   structure

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:
                              Bucksbaum brothers,
                              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,
       Inc.)
                 55% owned by employees and 45% owned by
                   Bucksbaums

What do you see as the potential positives and negatives of this
structure? For REIT shareholders? For LP’s?




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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-
      gain”.

             “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
        Insurance Co.)
       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
      Table)
   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
          existing properties.



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Financial Performance:
      Distributed approx. 84% of FFO

                        High                 Low              Dividends
1993
    Q2                 $26.00               $23                  .31
    Q3                  24.75              $22.13                .37
    Q4                  23.50              $19.25
1994
    Q1                 $21.50              $19.63                .39
    Q2                 $22.00              $19.25                .39
    Q3                 $22.63              $19.50                .39
    Q4                 $22.63              $19.25                .41
1995
    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




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Capital Requirements going forward into 1995
      More significant growth opportunities through portfolio
       acquisition.
      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,
       expansion, development)

      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




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       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
               $87,772,500
                   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
portfolio)

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.



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          Portfolio has not had recent capital improvements . The two
           malls under construction will require about $250 million.

  Debt
         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
         unreasonable.

  Equity
         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).

  Financing
         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
   Three Scenarios:

      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
       prices
      Aggressive: assumes an initial capitalization rate of 8.75% on
       $1.2 billion purchase, interest on assumed debt of 8%, asset


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  management fees of 50 basis points, $.16 increase in share
  prices
 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
  prices




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DOCUMENT INFO
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posted:8/7/2008
language:English
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Description: This is an example of general growth properties. This document is useful for conducting general growth properties.
Mary Jean Menintigar Mary Jean Menintigar
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