Equity REITs FIN 460

Real estate company/trust Listed or private Tax exemption Created to allow retail investors access to commercial real estate Real estate financing vehicle 1 WHAT IS A REIT?

Asset requirement: At least 75% in real estate assets Income requirement: At least 75% of gross income from real estate Distribution requirement: 90% of taxable income Held by minimum 100 persons No more than 50% held by 5% or fewer 2 REIT REQUIREMENTS

TYPES OF REITS 3 Equity REIT Mortgage REIT Hybrid REIT

1986 Tax Act Internal management Property management Operating companies REIT Modernization Act (1999) Taxable REIT subsidiaries (TRS) 4 THE NEW REITS

Organizational structure Avoid capital gains tax Operating partnerships (OP) units in REIT DownREIT 5 UPREIT

Specialized versus diversified Property types Investment criteria Not-a-Problem-for-REITs.aspx Not-a-Problem-for-REITs.aspx 6 REIT INVESTMENTS

Problems of reporting earnings as measure of cash flow REIT’s free cash flow? FFO as performance measure FFO=NI-Capital gain/loss+Depreciation FFO can be affected by, e.g. TI & free rents, leasing commissions, straight-line rents, other income 7 OPERATING PERFORMANCE

AFFO as alternative AFFO = FFO-Recurring capital expenses- Amortization of TI-Amortization of leasing commissions-Adjustments for rent straight- lining Not commonly reported; calculations differ 8 OPERATING PERFORMANCE

Growing income from existing properties Growing income from acquisitions Growing income from development Growing income from services Financial engineering 9 REITS AND GROWTH

Wave of IPOs in early 90s Mortgage debt and equity Transition from mortgage debt to unsecured publicly traded debt Bond ratings Credit lines DJV 10 REIT CAPITAL STRUCTURE

REITs and capital structure theory – Trade-off theory – Pecking order theory – Market timing – Different types of capital for different uses – Pre-issuance capital structure affects issuance choices 11 REIT CAPITAL STRUCTURE

12 for-REITs.aspx REIT IPO

Advantages – Arbitrage – Access to capital – Stock options as management incentive – Liquidity – Dominance of preferred equity – Timing of REIT IPO – Overvalued? 13 GOING PUBLIC

Wave of going privates Reasons for going private? 14 GOING PRIVATE

Mortgage debt Unsecured debt Credit lines 15 REITS AND DEBT

Acquisition joint ventures Development joint ventures Dispositional joint ventures 16 REITS AND JV

Behaved like bonds in the past Behave like real estate and stock Cointegrated with direct real estate index (NCREIF) REITs in S&P 500 behave more like stock (increased correlation) 17 ARE REIT REAL ESTATE OR STOCKS OR BONDS?

Direct versus indirect real estate investment Access to investment grade property Liquidity Professional management Tax-exemption (similar to direct investor) High dividend yield 18 REITS AS AN INVESTMENT

Correlations of REITs with other asset Diversification – Property type – Geographically – Economic base Value versus bond proxy REITs versus blue chip REIT REIT returns lead direct real estate returns 19 REITS AS AN INVESTMENT

Individual investors – Baby boomers Institutional investors REITs have grown in market cap Joined S&P500, 400 and 600 All property types available Increased liquidity Professionalism Alternative to direct investment 20 REIT INVESTORS

Which REIT sectors performed best in the last years? Momentum-Will-Continue.aspx Momentum-Will-Continue.aspx REIT performance compared to other assets Overview of REIT performance by sector 21 PERFORMANCE OF DIFFERENT TYPES OF REITS

Factors – Management – Access to capital and effective deployment – Balance sheet strength – Sector/geographical focus and expertise – Insider stock ownership – Dividend payout ratio – Absence of conflicts of interest 22 VALUING A REIT

Industry level – High interest rate – Property markets, e.g. overbuilding – Capital market access – Legislation 23 ISSUES AFFECTING REITS

Individual level – Local recessions – Changing consumer and business preferences – Credibility ( Plans-Coming-in-Place-for-REITs.aspx) Plans-Coming-in-Place-for-REITs.aspx – Balance sheet – Small market cap 24 ISSUES AFFECTING REITS

Transparency? Dividend discount (growth) model FFO multiple NAV 25 VALUING A REIT

Agency problems and governance Market sentiment Spill over effects Herding 26 BEHAVIORAL ISSUES AND REITS

Improves-Bottom-Line.aspx Improves-Bottom-Line.aspx Sustainability M&A Internationalization Ready-to-Expand-in-Scope.aspx Ready-to-Expand-in-Scope.aspx More sectors 27 REIT TRENDS

Invests-in-Affordable-Housing- Communities.aspx Invests-in-Affordable-Housing- Communities.aspx Mercy Corps REIT, Lent, Portland Single family REIT 28 REIT TRENDS