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The REIT as a Strategic Real Estate Tool

The REIT as a Strategic Real Estate Tool
by Steven M. Friedman

Real estate investment trusts (REITs) are becoming a strategic business and planning tool for a corporation’s real estate. When properly structured, a company can transfer its real estate free of current taxation to a REIT as part of an initial public offering (IPO) of the REIT. As a result, the transfer can get the real estate off a company’s books, eliminate the related debt, and instead let it own marketable securities. Several recent offerings demonstrate the advantages—tax and otherwise—that REITs have brought to diverse company types.

Automotive REIT
Substantial portions of the net wealth of Capital Automotive REIT’s founders were illiquid and tied up in their investments in land and improvements used in operating their dealerships. Thus, the founders formed a REIT to help them accomplish several objectives:

  • create liquidity through the REIT’s IPO;
  • diversify their investments;
  • maintain a property focus, in this case, specializing in the sale-leaseback of multilocation, multifranchised auto dealerships;
  • achieve growth by acquiring additional dealerships, which could be acquired in a tax-efficient manner using an umbrella partnership REIT (UPREIT) structure to defer the selling dealer’s tax liability; and
  • use triple net leases to minimize re-leasing risk and related costs.

The founders used an UPREIT structure, starting with 36 properties, including 54 franchisees of 24 automobile brands. The REIT’s setup boasted several attractions for investors:

  • It appeared to be a stable cash-flow vehicle with a fairly clear growth strategy.
  • The REIT’s consolidation strategy could be perceived as a plus, due to the fragmented nature of the auto dealership business.
  • The founders’ connections in the industry likely assure growth opportunities. Similarly, the REIT’s board of directors includes a former General Motors Corp. executive.

The REIT successfully completed its IPO on February 13, 1998, selling 20 million shares at $15 per share, for total equity of $300 million.

Going forward, investors might be concerned about the REIT’s ability to grow internally. Pursuant to the company’s sample lease agreements, lease escalations will be based solely on consumer price index adjustments. Interestingly, there will be no percentage rental payments, as one might expect, so that the REIT could share in the success of the dealers’ operations.

Prison REIT
The well-known prison REIT, CCA Prison Trust, was created because Corrections Corp. of America, the largest private operator of correctional facilities in the United States, was growing at a phenomenal rate. The company’s niche is to contract with governmental authorities to privatize the housing of prisoners, saving the local governmental authority significant dollars.

However, in this case, the company was so successful that its financial results arguably began to suffer because of the substantial real estate on its books. The solution? The company spun off all of its real estate, including a pipeline of nine construction projects, into the IPO of a REIT, CCA Prison Trust, that would lease back the facilities to Corrections Corp. The leaseback provides CCA Prison Trust with an 11 percent yield. So far, the REIT has more than $500 million in assets. And, given the shortage of detention space, the REIT believes vacancy will not be an issue.

Entertainment REIT
Taking a page from the CCA playbook, AMC Theaters spun off a number of its megaplex theaters to Entertainment Properties Trust in an IPO that raised more than $250 million. However, unlike Corrections Corp., there is the potential for oversupply of megaplex theaters. Industry observers are concerned about reuse possibilities if the theaters fail to perform. Because of this possible surplus and other issues, the REIT’s share price has been erratic, especially compared to its peer group.

Corporate Real Estate REIT
TriNet Corporate Realty Trust, Inc., purchases and leases back corporate real estate—more than 100 properties, almost all of which are triple-net leased. TriNet’s niche is meeting the balance sheet and property needs of its corporate customer base. A natural evolution of its business now finds TriNet in the build-to-suit market. TriNet focuses on two areas: high-quality corporate tenants and the key strategic real estate assets of those corporations. From a financial perspective, sale-leasebacks don’t get the real estate off the corporate seller’s books. But areas with increasing suburban space demand and the growing maturity of corporate employment base could provide the beginning of a niche market for companies like TriNet.

Lessons
Each of these REIT offerings separates ownership of the real estate from the businesses that use it. At their core, the success of each of these strategies depends on the fundamentals that drive the real estate: financial viability, downside risk management, and potential releasing and/or reuse. And in each case, creative tax planning has helped each REIT and its sponsor achieve these corporate results in a tax-efficient manner.

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Steven M. Friedman is the director of tax in the Washington, D.C., office of the E&Y Kenneth Leventhal Real Estate Group. You can reach him at (202) 327-7257.

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