Financing Focus

Know Your REITs

In today's market not all real estate investment trusts are the same.

T oday's almost-instantaneous access to financial information along with corporate governance improvements have dramatically altered the commercial real estate landscape for investors interested in diversifying through real estate investment trusts. This additional capital has put non-exchange traded REITs on competitive footing with publicly traded REITs for acquisitions in recent years. Publicly traded REITs' initial public offerings have increased slightly, but their overall acquisition appetite has been less than that of non-traded REITs at times.

When working with publicly traded or private REITs, real estate professionals must keep the public or private nature of the entity in mind. For example, if it is raising capital exclusively from suitable individuals, a private REIT may have greater difficulty in fulfilling the equity requirement of a given transaction due to the much smaller pool from which it is sourcing equity. Younger public entities, often with smaller asset bases, focused on acquisitions may have less flexibility in a given transaction as a result of the regulations and restrictions of their public filing schedule. To benefit from working with non-traded REITs, brokers must understand different REIT classifications and structures.

Private vs. Public REITs

The National Association of Real Estate Investment Trusts divides REITs into three classifications: private, publicly traded, and non-exchange traded. Private REITs, which are not registered with the Securities and Exchange Commission, raise equity from individuals, trusts, or other entities that are accredited under federal securities laws. While the laws governing this qualification are quite specific, an accredited investor generally is a sophisticated individual or entity with a net worth that is well above the nation's median income and asset levels. Private REITs generally are subject to less regulation, with the exception of guidelines associated with maintaining REIT status.

Publicly traded and publicly registered non-exchange traded REITs generally raise capital from a much broader investor base, although this does vary from company to company and between exchange-traded and non-exchange-traded stock offerings. While many institutional entities, such as insurance companies or pension plans, certainly meet accredited investor standards, the tax advantages of a REIT structure are not always attractive or necessary. Some institutions are placing capital or making investments through their own tax-preferred structure, and Internal Revenue Service REIT rules can be too restrictive.

Publicly traded and publicly registered non-traded REIT companies must file regular audited financial updates with the SEC. Both existing and potential investors, analysts, the media, and other interested parties can use these detailed and regulated filings to compare and contrast the operations of certain companies and draw conclusions about recent market conditions. However, traditional investment bank analysts limit their actual analysis and research reporting to publicly traded REITs. Private REITs are not required to practice this level of financial transparency.

Traded vs. Non-Traded

By trading on an exchange each day, publicly traded REITs provide investors with the ability to buy or sell their investment in a particular REIT's stock with relative ease. Non-exchange traded REITs lack this market-driven liquidity. Investors in non-traded REITs, whether publicly registered or private, generally rely upon the ability and willingness of the company itself to provide redemption programs for investors.

Investors often seek a balance between liquidity, yield, and volatility. Traded REITs are more directly subject to the volatility of the exchange on which they are listed and broader equity markets in general, while non-traded REITs are separated from the daily volatility of the equity markets and are more closely associated with the underlying value of the real estate in their portfolio. At any given time, traded REITs can have stock prices that are above or below the net asset value of their portfolio. Non-traded REITs, while illiquid, generally are valued by the underlying real estate in their life cycle after their equity offerings have concluded and independent appraisals are conducted.

Public REITs, both traded and non-traded, are governed by state regulations and broadly by North American Securities Administrators Association standards. Although some state suitability requirements may vary, non-traded REITs generally are available to individuals with a net worth of $150,000 or with both a $45,000 annual income and a $45,000 net worth. Traded REITs generally are available to those that meet minimum investment requirements for traded securities, which are exempt from NASAA regulations.

Capital and Exit Strategies

In theory, publicly traded REITs are designed to be infinite life investments with daily liquidity. This outlook may influence the way traded REITs' managers handle portfolio decisions. For example, the management of a traded REIT may be motivated to make decisions to support current yield with less concern for the capital appreciation component of their individual asset investments. On the other hand, non-traded REITs with finite lives generally are able to pursue total return goals that include current yield and capital appreciation.

Publicly traded REIT investors must time their liquidity to match what they believe to be the most advantageous stock price given their individual hold strategy. This is unlike many non-traded REITs where investors have subscribed to a management team's philosophy of executing an exit strategy at the proper time for the entire portfolio.

Traded REITs do not necessarily exit, although recently some have either been sold or merged with other REITs, investment funds, pension funds, or other significant real estate investors. Non-traded REITs typically seek an exit for its investor base by listing the corporation on a stock exchange, selling the portfolio to another significant real estate investor, or selling off the assets in an orderly disposition.

REIT Acquisitions

In sourcing acquisitions for public or private REITs, brokers should know a company's particular acquisition strategy and the speed at which it is willing to move. Publicly traded REITs' regular filings often provide insights into their particular acquisition strategies. Publicly traded and publicly registered non-exchange traded REITs regularly inform the market via filings on their financial condition and their acquisition or corporate positioning goals. Keeping track of a company's dividends and charting historical dividends as they relate to particular leases at particular assets give professionals an advantage. Providing acquisition candidates or working on significant lease transactions that help a REIT's portfolio meet desired dividend rates increases the likelihood of future business with that entity.

M. Jason Mattox

M. Jason Mattox is senior vice president of Behringer Harvard Real Estate Investments in Addison, Texas. Contact him at (214) 655-1600 or jmattox@behringerharvard.com.

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