Chapter 21 - REITS

AFFO

Adjusted Funds from Operations -key REIT metric

Financing of Public REIT - Debt Side

Balance sheet strategy should outline leverage levels •While more leverage generally improve returns, public markets have limits --The financial crisis changed leverage levels in public real estate --Not uncommon to see leverage exceeding 60% for REITs in 2007 --Currently debt levels for Washington REIT is approximately 35% debt is a FUNCTION OF COST AND FLEXIBILITY •Line of credit generally replaces need for construction debt

Biggest benefit of the 3

Biggest benefit - tax deductible liability No corporate income tax for REIT - if there is, it is so minor The trust and its shareholders are singly taxed on distributions compared to a regular corporation which is taxed on its income and the shareholder is taxed on the dividend distribution

Is a transaction accretive to FFO?

Cap rate is inverse of trading multiple As long as the share price is issued where the inverse of the P/FFO multiple is less than the cap rate on an acquisition the transaction should be accretive to FFO/share cap rate = inverse of multiple

CAD

Cash Available for Distribution

REIT Capital Raising

Common equity - the shares bought on the stock exchange Preferred equity - looks and feels like a bond -permanent money -the payout never changes (no maturity, no growth) Corporate debt •Unsecured bonds-- 10 year paper? Most common market is 10 year •Line of credit - coming from syndicate of banks -Banks that join in lending as the line of credit -Feels like checking account you can only spend money on certain things (bank putting restrictions on it)- buildings, development (not just anything, like beer -Never use more than half of it - people want to know you have cushion in case anything happens Unsecured term loans Property level debt - mortgages CMBS pools - cheap money if you can get it but have to think about what is on the other side of the phone (not friendly people) JV Structure*

Formula for FFO write down formula on cheat sheet?

FFO = Net Income + Depreciation + Amortization -/+ Gains and Losses from Sale of Real Estate

FAD

Funds available for distribution

FFO

Funds from Operations -a key REIT metric cash from net operating income

How do REITS grow

Grow income from existing properties--> increasing rents Grow income through acquisitions Grow income through development Grow income by providing service for fees--> only the ones allowed under the rules Grow income through financial engineering-->-manipulating balance sheets and taking advantage of nuisances in the market (pay off debt today? Things like this)

Difference between NOI and FFO

Is not net operating income (not a building to building analysis) You are starting with actual accounting income statement and working your way back up to get to FFO Going from earnings and rising up from there -- adding non cash items from net income -- take away losses on real estate

1991

Kimco Realty first public offering was vertically integrated REIT proving own property management and asset management

Concept of a REIT

Market trying to get at the ability of a small investor (like my mom and dad) to invest in real estate -can invest $1,000 •Can real estate investing be similar to mutual fund investing? -Mutually sharing an ownership of a basket of stocks -like a Fidelity Fund •Can the investment allow the small investor to diversify holdings though one investment? •Would the investment be passive?

NAV Value

Net asset value per share

What is the optimal level of debt?

Optimal level of debt between 25-30% for REITs--> low leverage for Real Estate company

Private REIT

Private REITs are offerings that are exempt from SEC registration and whose shares do not trade on national stock exchanges. could be in private equity firm (Blackstone could have REIT) Accountants, lawyers, and IRS (really tracks you)

REIT

Real Estate Investment Trust

What does AFFO do compared to FFO?

Straight line rent adjustment - positive statement on income statement •No growth in that lease according to the accountants

What do REITS always have to be doing?

They always have to raising capital because they give most of their money away to their investors dividend money

Does a traditional REIT own real estate directly?

Yes

Net Asset Value write down on cheat sheet

approximates the current value of all assets and liabilities on the balance sheet -•only true way to value real estate or other hard assets

AFFO write down formula on cheat sheet?

better approximation of operational cash flow, taking into account leasing commissions, recurring capital items and cash rents AFFO = FFO +/- Straight Line Rent - Recurring Cap Ex - 2nd Generation Leasing Commissions - other recurring charges

1st generation leasing costs

build a building and then lease it up for the first time

Mortgage REITs

derive their revenue from mortgage, much more volatile, much smaller % of REITs do this -Higher dividend yield, the more risk listed as public on the stock market as well •purchasing or originating mortgages and mortgage-backed securities and earning income from the interest on these investments.

2nd generation leasing costs

doing renewals - building is up and operational and you are just leasing it up

What is the incentive for a REIT?

it is a passive investment-->pass through mechanism IT IS SINGLE TAXED •The REIT itself is not taxed on taxable income (pay out 90% of taxable income to dividend (investors)) •One of biggest expense on deduction statement are dividends

Public, non-listed REIT

not listed on the stock exchange •Different in the way they raise money •RAISE MONEY LIKE SUBSCRIPTION COMPANY •Go to brokers •Investment does not seem as volatile •Not riding with the market - non listed, no day to day value that is published -but still registered with SEC (Securities Exchange Commission)

Earings on a REIT (accretion)

the goal is all about growing EARNINGS PER SHARE

Basic REIT Rules of 1961 - Asset Requirements

•At least 75% of the value of a REIT's assets must consist of real estate assets, cash and government securities -- 75% of income should come from real estate activity •Not more than 5% of the value of the assets may consist of the securities of any one issuer if the securities are not includable under the 75% test --Can own stocks of other things but CANNOT be a bigger owner - only up to 5% •A REIT may not hold more than 10% of the outstanding voting securities of any one issuer if those securities are not includable under the 75% test •Not more than 25% of its assets can consist of stocks in taxable REIT subsidiaries

Basic REIT Rules - Income Requirements

•At least 95% of the entity's gross income must be derived from dividends, interest, rents or gains from the sale of certain assets --interest income, dividends income, interest from sale and stocks// securities •Those are the things that are added to get to 95% •At least 75% of gross income must be derived from rents, interest on obligations secured by mortgages, gains from the sale of certain assets, or income attributable to investments in other REITs

Investment Benefits of a REIT

•Competitive, Long-Term Performance: REITs have provided long-term total returns similar to those of other stocks. •Substantial, Stable Dividend Yields: REITs' dividend yields historically have produced a steady stream of income through a variety of market conditions. •Liquidity: Shares of publicly listed REITs are readily traded on the major stock exchanges. Transparency •Portfolio Diversification: REITs offer access to the real estate market typically with low correlation with -REITs specialize in all different things - so investing in 1000 of properties •Try to choose one apartment, one industrial, one retail, one long term care// senior housing

What happens to dividends when inflation goes up?

•Dividend increases as inflation happens (why? - rents go up better than expenses go up)- generating more cash flows

Financing of Public REIT - Equity Side

•Focus on public shareholder returns drives decision making process •Choice between raising public equity or private equity -Inserting private equity can improve returns to public shareholder -Conflict between private equity investors and public shareholders

non customary in a REIT = not ALLOWED

•Maid Service •Valet Parking •Child Care Centers •Personal Training •Food Service Operations or Catering •Car Wash/Detailing •Shuttle Bus Service

Public REIT Balance Sheet Management

•Outlining balance sheet strategy provide road map for decision making •Articulating strategy to investors and using it as a measuring stick is important in gaining investor trust •Measuring Debt - Equity mix against strategy helps guide decisions •Knowing your cost of capital is critical in investment analysis --need to know if FFO per share will go up or down --need to know if FFO will go up or down if you have a 6 cap building If NAV will go down, need to say no Balance leverage, maximize return -- have to deal with rating agencies to get review Challenge underwriting assumptions all the time to determine if it was a good investment--> cap rates, rents, psf price, the building, the market --have to assure acquisitions exceed cost of capital

What could price/ FFO be used for?

•Price/FFO is a common stock valuation tool used by the REIT industry by comparing multiples of one REIT versus a peer group and versus historical averages

Other rules of REITS

•REITs cannot •Sell more than 7 properties, or •Have sold properties with an aggregate adjusted basis in excess of 10 percent of the aggregate basis of all the REIT's assets as of the beginning of the taxable year •Cannot sell more than 7 properties in a taxable year •Cannot sell proprieties 10 %

Safe Harbor Rules

•REITs must own properties for at least two years prior to sale - have to be income producing properties for 2 years •Cost of any capital improvements to the property during the two year period cannot exceed 30 percent of the sales price •Distributions to shareholders must equal or exceed the sum of 90% of REIT taxable income

What do equity REITS own and operate?

•Residential buildings •Office buildings •Retail •Industrial •Manufactured housing -Biggest % of what REITS due -Derive revenue from RENT

What can AFFO do?

•Similar to the FFO multiple, the Price/AFFO is a common stock valuation tool used by the REIT industry by comparing multiples of one REIT versus a peer group and versus historical averages

Stock and Ownership Requirements

•The REIT must be taxable as a corporation -and registered as one too •The REIT must be managed by a board of directors or trustees - managers are investors •Shares in a REIT must be fully transferable •Shares in a REIT must be held by a minimum of 100 persons

Equity REIT

•The majority of REITs are publicly traded equity REITs. Equity REITs own or operate income-producing real estate. The market and Nareit often refer to equity REITs simply as REITs.

How does the UPREIT structure improve existing structures?

•UPREIT structure, created in 1992, allows owners/developers the ability to transfer their properties to the REIT form of ownership in a tax free exchange •This rule change allowed for a massive wave of growth in the REIT industry from $9 billion in 1991 to $134 billion in 2000.

UPREIT structure

•Umbrella partnership REIT (UPREIT) is a REIT that owns a controlling interest in a limited partnership that owns the real estate

What are the benefits of a REIT?

•Under the rules in any taxable year, the REIT may be treated as a conduit with respect to income distributed to beneficiaries of the trust •Dividends become a tax deductible expense •Dividend income to the shareholder is taxable income

customary services in a REIT = what is ALLOWABLE

•Utilities •Laundry •Security Services •Trash Service •Sprinkler/Fire Safety •Common Area Cleaning •Application Fees

Raising Equity private v. public

•the process of raising additional public equity in a secondary offering is relatively easy and fast process •Private equity raise is a complicated negotiating process that is shorter than an IPO but much more complicated than a secondary offering •Private equity investors can interject a new method of reporting in addition to what is done for public reporting