RE I” CLass #8
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Real Estate Investments I
(Business 33450)
Winter Quarter, 2023
Instructor: . Pagliari, Jr.
Key Take-Aways:
• Benefits of the REIT structure.
• REIT definitions and mechanics:
Tax issues,
NAVs, and
FFO, AFFO.
• Accretive v. dilutive investments and issuances.
• Preferences for public v. private real estate.
• Performance of public v. private real estate [a quick overview (a RE II focus)].
REITs represent an interesting combination of
real estate and Booth’s traditional strengths in
accounting, economics and finance. In fact, a
number of REIT CEOs are Booth alums.
Real Estate Investments I
Instructor: . Pagliari, Jr.
Class Notes – Week #8:
An Introduction to
Real Estate Investments Trusts (REITs)
Table of Contents
I. WHAT IS A REIT? ……………………………………………………………………………………………….. 1
II. BROAD OVERVIEW OF THE REIT MARKET …………………………………………………………….. 3
III. A CURSORY COMPARISON OF EQUITY REITS TO THE S&P 500 ……………………………….. 12
IV. BENEFITS OF THE REIT STRUCTURE …………………………………………………………………… 17
V. WHY THE REIT BUZZ? WHY THE REIT COLLAPSE? ……………………………………………… 20
VI. A DIGRESSION: WHAT IS FFO? ……………………………………………………………………………. 31
VII. ANOTHER DIGRESSION ON FFO: CAP RATES V. LEVERAGE …………………………………….. 41
VIII. INITIAL THOUGHTS ON SECURITY DESIGN …………………………………………………………… 47
IX. REITS AND ECONOMIES OF SCALE ……………………………………………………………………… 56
X. GROWTH V. ACCRETIVE PROJECTS? ……………………………………………………………………… 58
XI. PREMIUM/
XII. THE CLIENTELE EFFECT ⇒ SHOULD THE WRAPPER MATTER? ………………………………. 69
XIII. AN APPLICATION: UNDERSTANDING “STREET” RESEARCH ……………………………………. 72
XIV. NCREIF V. NAREIT: SORTING OUT AN APPLES-TO-ORANGES COMPARISON ………….. 82
These notes were partly prepared based on the gracious support of (co-founder of
Advisors and Booth alum); however, any remaining mistakes or omissions are the fault of the Instructor.
I. What Is a REIT?
A. In the 1960s, Congress (along with President L.B. Johnson) enacted REIT legislation that
enabled small investors to access large-scale commercial real estate (ala mutual funds).
B. REITs are portfolios of interests in real properties, mortgage loans and other ancillary assets.
C. Key legislative aspect: REITs avoid (double) taxation1 if meet certain tests (see below).
D. Types of REITs (as defined by NAREIT):
1. Equity REITs – more than 75% of its assets are invested in real property,
2. Mortgage REITs – more than 75% of its assets are invested in mortgage loans, and
3. Hybrid REITs – are neither equity nor mortgage REITs (have faded to oblivion).
E. For purposes of this class, we will focus on equity REITs and, accordingly, often use the terms
“equity REITs” and “REITs” interchangeably.
F. For purposes of this class, we will further focus on equity REITs that are publicly traded –
most of which is on the NYSE. As a technical aside, REITs are a form of ownership – like
corporations, partnerships, etc. – and it is not necessarily the case that they are publicly traded.
G. Simplistic overview of characteristics of certain legal entities:
1 That is, taxation at both the entity/corporate level as well as at the individual/shareholder level.
Type of Legal Entity Taxation Public Private
Limited Partnerships
(Ltd. Pships)
Limited Liability
Companies (LLCs)
Real Estate
Investment Trusts
C-Corps. Yes
Exchange/Trading
Most popular &
our emphasis
Often, B-piece/
mezzanine lenders
(with leverage) – see
last week’s notes
(e.g., BXMT)
Non-traded (or private)
REITs: NTRs (e.g.,
Wells, Inland,
Behringer-Harvard, etc.),
along with NTRs 2.0
(e.g., BREIT) – not our
focus here.
In our real estate context, we refer to these as “REOCs” (real estate operating
companies); they are not part of the U.S. Tax Code. [Recall: the “opco” (e.g., Marriott)
v. “propco” (e.g., Host) discussion of week #1.] However, we use this designation to
distinguish those publicly traded real estate companies which are not REITs.
H. In order to avoid double-taxation, REITs must meet a number of ownership, asset and income
1. be a corporation, business trust or similar association,
2. be managed by a board of directors or trustees,
3. have shares that are fully transferable,
4. have no more than 50% of the shares held by five or fewer individuals during the last
half of each taxable year (the “five-or-fewer” rule),3
5. invest at least 75% of total assets in real estate assets,
6. derive at least 75% of gross income from rents (from real property) or interest on
mortgages (on real property),4 and
7. pay dividends of at least 90% (used to be 95%) of their taxable income.
a. This is the most significant requirement of avoiding double taxation.
b. It suggests that, in order to grow in excess of “organic growth” (i.e., cash
flow and appreciation), REITs must continually access the (debt and/or
equity) capital markets (which include the private joint-venture business (e.g.,
SITE Centers (née DDR), Kimco, PLD (see §V), etc.)).
c. Note: Regular or “C” corporations do not have to abide by this restriction
and they tend to find retained earnings to be their favorite source of new
2 A review of all the legal requirements for REIT status is beyond the scope of this discussion. For further
discussion, see: . King, “REITs as Legal Entities,” and . Brandon, “Federal Taxation of Real
Estate Investment Trusts,” both in R. Garrigan and J. Parsons, eds., Real Estate Investment Trusts:
Structure, Analysis and Strategy, McGraw-Hill, 1997.
3 Prior to the Omnibus Budget and Reconciliation Act of 1993 (OBRA), domestic pension funds were (but no
longer) effectively restricted from REIT investing since they were treated as single individuals for purposes of
the five-or-fewer rule.
4 The REIT Modernization Act (RMA) of 1999 loosened the restraints against “bad” income (i.e., the existing
legislation requires passive/portfolio-like income and, therefore, operating income from hotels, senior living,
condominium development, etc. represents “bad” income).
5 See Myers and Majluf, “Corporate Financing and Investment Decisions When Firms Have Information that
Investors Do Not,” Journal of Financial Economics, 1984; in particular, consider the “pecking order
hypothesis” which asserts that firms view internal financing as their first preference (then issuance of new debt
and finally raising new equity).
This may not be quite as harsh
as you might first imagine:
taxable income < cash flow ∆ ≈ f(depreciation) https://www.sitecenters.com/ https://www.kimcorealty.com/about-us https://www.prologis.com/ https://www.amazon.com/Real-Estate-Investment-Trusts-Structure/dp/0786300027 https://www.amazon.com/Real-Estate-Investment-Trusts-Structure/dp/0786300027 https://www.sciencedirect.com/science/article/abs/pii/0304405X84900230 https://www.sciencedirect.com/science/article/abs/pii/0304405X84900230 II. Broad Overview of the REIT Market A. As shown below, the vast majority (i.e., more than 90%) of today’s REITs are equity-oriented 6 For completeness: There is also the CRSP/Ziman Real Estate database. For reasons unclear to your Instructor, it has gotten little traction in the practitioner world. $1,000,000 $10,000,000 Equity, Mortgage & Hybrid REITs for the Period 1972-2022 Aggregate REIT market capitalization of approximately $1.4 trillion, as of year-end 2022. Boom in "go- private deals (to be subsequently discussed). Beginning of the boom in REIT (OBRA 1993). http://www.crsp.org/products/research-products/crspziman-real-estate-database B. The risk/return performance for selected REIT property types (for which the data series covers all years, beginning from 1994 (e.g., the single-family rental sector began in 2015)): Sources: NAREIT, “Annual Index Values & Returns,” and Instructor’s calculations. Industrial Diversified Lodging/ Resorts Self Storage Shopping Centers Regional Malls Free Standing Retail Apartments Manufactured Homes 0% 5% 10% 15% 20% 25% 30% 35% Standard Deviation of Annual Return Risk/Return Performance of Selected REIT Property Types for the Period 1994 − 2022 of Selected REIT Property Types for the Period 1994 − 2022 Surprising σMtg ? [Maybe less so, after considering last week’s discussion of levered loans?] https://www.reit.com/data-research/reit-indexes/annual-index-values-returns C. However, the equity REIT sector has undergone an interesting transformation with respect to acceptable property types: Source: NAREIT D. The equity REIT sector has become increasingly devoted (≈ 60%) to non-core property types (unfortunately, the same depth of property-level performance data does not generally exist for these non-core property types). Consider this estimation:7 7 Provided by Booth alum, (‘14), Head of European Research & Strategy – La Management. Of the total non-core equity, ≈ 40% consists of infrastructure (primarily, cell towers), data centers, health care & self-storage. E. Consider the changing property-type allocation of the U.S. public-sector REIT market: Source: “Visualizing the Real Estate Investment Universe,” Visual Capitalist, August 24, 2022. F. Reminder of the REITs’ performance during the COVID pandemic: The exhibit below measures the change in both enterprise and equity values, as measured by price changes8 in the public REIT market, for selected (core and non-core) property types – since the pandemic’s pricing effects took hold in mid-February of 2020 – through early November of 8 Because the underlying assets of the REITs are essentially unchanged over this period of time (and when there are comparatively few private-market transactions), these public-market valuation changes may represent better “comps” than a small sample of private-market transactions (which often differ in terms of location, lease length, tenant credit-quality, construction quality/design, etc.) used to infer valuation changes for the entire population of assets. 9 Shortly thereafter, Pfizer announced favorable (but preliminary) results with regard to a potential COVID vaccine; the announcement helped reverse some of the earlier stock market losses (e.g., see Grant (2020)). Less than two weeks later, Moderna announced similarly favorable results – resulting in a further rebound of stock prices (e.g., see McCabe, et al. (2020)). https://advisor.visualcapitalist.com/visualizing-the-real-estate-investment-universe/ https://www.pfizer.com/ https://www.modernatx.com/ Changes in Enterprise and Asset Values, for Publicly Traded REITs, by Property Type, for the Period February 21, 2020 through November 4, 2020 Source: Advisors, “REITs Amid a Pandemic,” November 4, 2020. From the onset of the pandemic, more than a 20% “hair cut” in asset valuations had been realized for most of the core property types. However, the so-called “digital” real estate (e.g., cell towers, data centers), which comprises approximately 30% of the NAREIT index, had been among the best-performing sectors. If you extend the picture to include cold storage, self-storage and industrial, you then confront the whole notion that, at least during the pandemic, property returns went up in sectors accommodating the fewest people: returns ↑ = f(# people) ↓ It would seems to upend how successful property investments have been traditionally considered; it inverts the gauzy notions about the “built environment,” “walkability,” etc. – the sorts of things that developers, architects, engineers, etc. passionately describe. G. It wasn’t until the early/mid 1990s that REITs – and equity REITS in particular – became a substantial part of the real estate investment landscape. Up until 1995, private-market transactions – as proxied by the NCREIF index – dominated institutional real estate investing. Thereafter, public-market investing – as proxied by the NAREIT index – has outpaced its private-market counterpart. Note: This comparison is unfair to NCREIF (≈ core properties) because ≈ 60% of NAREIT is non- core; on the other hand, this comparison is unfair to NAREIT because of the different focus (assets v. equity) of NCREIF and NAREIT: Assets = GAV ← NCREIF = Equity = NAV ← NAREIT NAREIT – Equity NAREIT Equities v. NCREIF Market Share and Combined Capitalization for the Period 1978 through 2022 Aggregate NAREIT + NCREIF market capitalization of approximately $2.3 trillion, as of year-end 2022. Note: REITs were generally levered 40-50% (now closer to 30%). NCREIF (core funds) generally levered 25%. H. A view of the changing, and generally declining, aggregate leverage ratio of the publicly traded (equity) REITs: Source: NAREIT, T-Tracker Data Series, Third Quarter, 2022 and Instructor’s calculations. As seen above, there has been a long downward trend in the aggregate leverage ratio, particularly when measured by the market value of the firms’ assets.10 (The occasional spikes in the leverage ratio – when computed using the market value of assets – is generally attributable to falling asset values, during market downturns.) This stands in contrast to the private real estate funds, which generally show no such decline in their leverage ratios. 10 Additionally, REITs have generally have increased the weighted-average maturity of their (fixed-rate) debt, thereby somewhat insulating them from a rising-interest-rate environment. For example, see: Gibson, et al., “Lesson Learned: Listed REITs’ More Prudent Approach to Leverage,” Investors, July 5, y = -0.2122x + 49.057 R² = 0.6157 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Leverage Ratios for NAREIT Equities: Debt to Total Assets Debt/Book Assets Debt/Market Assets Linear (Debt/Market Assets) Source: S&P Capital IQ Pro, NAREIT T-Tracker(R) | Third Quarter, 2022 https://www.reit.com/data-research/reit-market-data/nareit-t-tracker-quarterly-operating-performance-series https://www.janushenderson.com/en-us/investor/article/lessons-learned-listed-reits-more-prudent-approach-to-leverage/ I. As aside: The preponderance of balance-sheet debt11 is now unsecured. As noted in last week’s discussion about leverage: secured debt is evidenced by a mortgage lien against a specific property (or portfolio of properties), while unsecured debt is an entity-level obligation (making such loans “cross-collateralized” obligations): Source: NAREIT, T-Tracker Data Series, Third Quarter, 2022 and Instructor’s calculations. 11 Instructor’s note: The term “balance-sheet debt” is used to highlight the concern that not all of the debt found in unconsolidated joint ventures (often shown as “minority interests) is appropriately rolled up into such calculations. This caveat is particularly apropos for those REITs with significant development pipelines – some of which is down in joint ventures in which the REIT supplies a fraction of the project’s equity capital. This is a longstanding issue for (certain) REITs (as well as many private real estate funds). 2000 2001 2003 2004 2006 2007 2009 2010 2012 2013 2015 2016 2018 2019 2021 2022 NAREIT: Unsecured and Secured Debt Unsecured Debt Secured Debt Percent Unsecured Source: S&P Capital IQ Pro, NAREIT T-Tracker(R)| Third Quarter, 2022 https://www.reit.com/data-research/reit-market-data/nareit-t-tracker-quarterly-operating-performance-series J. While much of this REIT growth was fueled by the tremendous surge of initial public offerings in 1993 and 1994, more recent growth12 has been fueled by the secondary (or, add-on) offerings of existing firms, as shown below: III. A Cursory Comparison of Equity REITs to the S&P 500 A. Simply by way of introduction and comparison, consider the annual performance of the equity REIT market to the S&P 500 since 1972 (the year in which the NAREIT Index was introduced):13 12 Approximately 75% of the total (common) equity offerings have taken place in the last 15 years. 13 Some would argue, particularly because of the small capitalization of the equity REIT market in their early years, that a more apt comparison of equity REIT performance is to that of the small-cap segment of the stock market (e.g., the Russell 1000). In addition to controlling for size, should also control for risk (single- v. multi- factor models) – see the next three pages. Summary of (Common) Equity Offerings for the Period 1982 through 2022 Initial Offerings Secondary Offerings The explosion of REIT 程序代写 CS代考 加微信: powcoder QQ: 1823890830 Email: powcoder@163.com