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Investors study how to form a REIT.

The best incentive for operating a real estate investment trust (REIT) properly is to have a large stake in the company, advised William Newman, president of NAREIT and CEO of New Plan Realty Trust.

"This way you are more interested in the health and welfare of the company than ripping it off," he added.

Nearly 100 owners and investment advisors listened to Newman and other REIT specialists provide tips on forming real estate investment trusts at a workshop held at New York City's Parker Meridian Hotel earlier this month.

The workshop was sponsored by the National Association of Real Estate Investment Trusts (NAREIT), and was designed to answer questions about this form of pooled real estate ownership.

REITs are real estate based and for the most part consist of properties that are grouped together to form one company. The stock interest in this company is sold on the stock exchanges or privately placed and allows people of all income levels to invest in real estate with a minimum and easily traded investment.

REITs are beginning to attract more interest among owners and investors because of the evolution of the public commercial real estate markets, explained NAREIT President Mark O. Decker. Only 5 percent of real estate is securitized and it is a natural evolution, Decker explained. There is a lack of credit available from traditional capital sources and there is a relatively good performance from those REITs already formed. It is investor driven, Decker said, because the investors can value a REIT every day on the stock market. Owners like it, too, because of the ability to raise capital in this fiscally tight environment, he added.

"We're seeing a lot of interest from all of our sessions," Decker said, "which attracted over 700 participants in eight cities."

REITs must pass several specific tests to be eligible for special tax treatment under Securities and Exchange Rules, as well as Internal Revenue Service codes and various and differing State regulations.

"This is a liquid, low-leverage business, explained REIT analyst and portfolio investor, Kenneth D. Campbell. Most investors desire a total return that is relatively comparable to the Standard & Poor's 500 return, he noted, but with a one-point risk premium. This brings the typical expected REIT return to around 12 percent, Campbell said, and consists of approximately 8 percent growth and 4 percent dividend.

New Plan Realty, one of the more established REITs, has a 15 percent total return consisting of 5 percent to 6 percent in dividend and 8 percent to 9 percent in growth.

"No REIT is going to come out of the box and come into this charmed circle," Campbell said.

A. James Donohue, a managing director in Merrill Lynch's Financial Institutions Group, said there may not be many new, good REITs that can be launched. Donohue said the idea of forming a REIT tends to evolve over time and can be discussed with local security branch managers who then direct it to New York. Some property owners bring their ideas to Ken Campbell for advice, Donohue added. "The more an idea is thought out," he said, "the more useful the response will be from an investment banker."

Morris L. Kramer, a partner in Roberts & Holland, which specializes in tax matters, explained that the REIT is a "tax animal" and must be suitable for a REIT from a federal income tax standpoint.

Lawrence S. Kaplan, a CPA and partner in the tax department of Kenneth Leventhal & Company, noted there is no distinction between a REIT and a regular corporation aside from the tax standpoint, but there are very specific "hardcore" record keeping requirements. The rules are designed to prevent control of the company, he said.

"While the rules are not user-friendly," Kaplan explained, "they are not all that devastating once you learn to work with them."

In the past, Kaplan said, REITs would lose their status if they failed one of the tests. Now failure, for the most part, results in the imposition of a penalty tax, he explained. The key reason for this is that Congress looks favorably towards REITs, Kaplan added.

A REIT is expected to distribute 95 percent of its taxable income to its shareholders each year. It also must ensure that 95 percent of its annual gross incomes consists of 75 percent income test items. Failure to satisfy this last income test, he noted however, may result in a REIT losing its REIT status for five years.

While qualified U.S. pension trusts are considered one shareholder, the irony, Kaplan said, is that foreign pension trusts can own 100 per cent as the IRS "looks through" to the many individual pensioners. The problem with tampering with this in Congress, he added, is that once that body is lobbied to allow this break for U.S. pension funds, it might eliminate the benefits granted to foreign pension trusts.

Kramer said there are also asset tests and 75 percent of a REIT's assets must be in real property interests. Income can be generated, by among other things, rental income and for payment for services customarily provided to tenants. No rent, however, can be received based on net profits of a tenant. REITs are also limited as to the ownership of securities and stock in other corporations.

REITs were not designed to become "dealers" in real estate and Kaplan said there can be a 100 percent tax penalty if certain rules are not followed. Properties can be sold if they were held for more than four years under a "safe harbor" rule. While no more than seven properties may be sold in one year, a multiple sale of property to a single purchaser can be considered one sale if pooled.

Decker, president of NAREIT, said successful REITs do not buy properties to sell and churn their portfolios.

Additionally, no more than 30 percent of the gross annual income of a REIT can come from the gain on the sale of property held for less than four years or securities held for less than one year. Kaplan said this last rule has made it difficult for REITs to invest in troubled properties and maintain the REIT status. For this reason, changes are being requested in Congress, particularly because the Resolution Trust Company would like to create some REITs with some of its portfolio.

Decker said the RTC cannot go forward with its plans unless changes are made in the REIT laws.

There are tax and legal obstacles, Decker noted, and some people are not willing to make the sacrifice to turn their properties into a REIT.
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Title Annotation:real estate investment trust
Author:Weiss, Lois
Publication:Real Estate Weekly
Date:Jun 10, 1992
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