1 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin CHAPTER 5 PRIMARY FORMS OF REAL ESTATE OWNERSHIP Sole Proprietorships C Corporations S Corporations General Partnerships Limited Partnerships Real Estate Investment Trusts Limited Liability Companies

2 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Sole Proprietorship Primary Advantages: –taxable income and losses ‘‘flow through” to individual's tax return –simple and inexpensive to set up Primary Disadvantages: –investor’s personal assets generally at risk –investor must actively manage property to obtain full tax shelter benefits –ability to finance acquisitions may be limited

3 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin C Corporation Primary Advantages: –limited liability to shareholders –opportunity to raise additional funds –shareholder interests easily transferred Primary Disadvantages: –income is subject to double taxation –tax losses do not pass through to shareholders

4 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin S Corporation Primary Advantages: –taxable income and losses may “flow through” to stockholder’s individual tax return –limited liability to shareholder –shareholder interests easily transferred Primary Disadvantages: –S corporation losses subject to at risk limitations –must not have more than 75 shareholders

5 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin General Partnership Primary Advantages: –taxable income and losses “flow through” to partner’s individual tax return Primary Disadvantages: –tax losses are subject to passive loss restrictions –each partner is jointly and severally liable –partnership interest are difficult to transfer

6 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Limited Partnership Primary Advantages: –taxable income and losses “flow through” to partners individual tax returns –allows limited partners to limited their liability Primary Disadvantages: –tax losses are subject to passive loss restrictions –ownership interests are difficult to transfer

7 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Real Estate Investment Trusts (REITs) Primary Advantages: –REITs are not subject to double taxation –limited liability to shareholders –REITs allow investors liquidity and diversification Primary Disadvantages: –income is portfolio income –tax losses do not pass through to the shareholders –REITs must meet substantial operating restrictions

8 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin A Closer Look at Limited Partnership Syndication A real estate syndicate is a business organized to perform real estate activities (i.e., development, investment, lending, etc.). History Role Regulation

9 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin A Closer Look at Real Estate Investment Trusts (REIT) A (REIT) is a corporate form of ownership engaged in real estate investment, but with no taxation at the corporate level. Basic operations –REITs invest primarily in real property and mortgages.

10 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin REIT Ownership Restrictions Must have 100 or more shareholders. Cannot have less than six shareholders with > 50% of the REITs shares. > 90% of income must be paid in dividends. > 75% of assets must be real estate, cash, or securities. > 75% of income must come from real estate assets.

11 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin REIT Types REITs can be classified by their assets –Equity REITs, Mortgage REITs, and Hybrid REITs pre-1990: “diversification plays” post-1990: “management plays”

12 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin REIT Valuation Discounted Cash Flow used by REITs to evaluate properties Net Asset Value (NAV) v. Total Stock Market Capitalization Price/Income ratio Funds from Operations (FFO)

13 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin REAL ESTATE CAPITAL Public Real Estate: –Real estate held by public corporations –Public REITs Private Real Estate: –Individuals, Partnerships, Private REITs, Limited partnerships, S corporations, or Limited liability companies –Pension funds, Commingled funds, Joint ventures, and other institutional investors

14 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin REAL ESTATE CAPITAL Public Real Estate: –Commercial real estate equity: $1.72 trillion –Commercial mortgage debt: $0.25 tillion –Residential mortgage debt: $2.38 trillion Private Real Estate: –Commercial real estate equity: $1.79 trillion –Commercial mortgage debt: $1.03 trillion –Residential real estate equity: $4.80 trillion –Residential mortgage debt: $1.96 trillion

15 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin HISTORICAL RETURN PERFORMANCE