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The wave of the future
Real estate investors should be aware that many non-traditional commercial property holding companies are utilizing recent IRS rulings, and are taking advantage of raising cash through conversion of their holdings into Real Estate Investment Trusts (REITs). By doing so, these companies not only take full advantage of capital market leverage, but they also save on taxes as well. REITs are not subject to federal income tax, because they must distribute at least 90 percent of their taxable earnings to shareholders as dividends. With these devlopments, there is now much greater choice afforded real estate investors among the list of REIT vehicles available for investment.
The non-traditional REIT conversion trend
REIT conversions are being created across a number of industries. Chief among them include prisons, data centers, cell towers and outdoor advertising billboards. This increase in REITs affords much more diversity for the property investor to consider, much more than traditional REITs that invest mostly in retail shopping centers and office buildings, for example. Of course, real estate investors win when they are provided with an ever-increasing array of investment vehicles to invest in.
REITs are required to invest at least 75 percent of their assets in real estate, and need to earn at least 75 percent of their gross income from rents, or from interest on mortgages. They sell shares of stock in their companies to raise equity for further development purchases, since most of their earnings are required to be given back to shareholders in the form of dividends.
Federal tax exemption
Companies that specialize in non-traditional commercial real estate have been jumping on the bandwagon this year, converting to REIT status, then being publicly traded, in order to take advantage of the federal tax exemption. It also provides these firms with the ability for greater growth by accessing more capital quickly. In addition, by taking advantage of this federal tax loophole, these newly converted REITs garner a major bump in valuation overall, simply because of the cost savings of no federal taxes.
With existing bank money market rates hovering in the three quarters of one percent range, property investors are constantly looking for much greater returns in a stable environment. With REIT returns running in the three and a half percent range this year on average, they are increasingly becoming an investment vehicle of choice for many real estate investors.
Close to an all-time high
It’s interesting to note that REITs now rank third amongst purchasers of real estate in the United States over the first half of this year, with acquisitions of $12.2 billion, according to research compiled by Real Capital Analytics Inc. This data shows that REITs rank just behind private buyers (at $40 billion) and institutional investors (at about $30 billion). In addition, REITs in the United States should come close to an all-time high for raising capital by the end of this year. Right now, they are running about 22 percent higher from last year, having raised over $41 billion through the first three quarters of the year.
Conversion risk versus reward
All this flurry of REIT conversions for existing, non-traditional commercial real estate companies does not come without costs and risks, of course. The conversion process is quite time consuming and expensive, utilizing a great deal of a company’s resources and capital in the short run. Also, once converted, REITs are subject to the vagaries of any new changes in U.S. tax laws that could adversely affect them down the road. But for now, this wave of conversion activity remains strong. And the great upshot is that real estate investors are offered a much greater choice of REIT vehicles in which to invest.
photos courtesy of debtamerica.com, aaii.com, bestmutualfund.org, myplaniq.com