From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘REITs

REIT Development Pipeline

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On June 28, Fitch Rating Services issued a report on the REIT development pipeline that has generated a bit of discussion in the real estate community.  Fitch’s emphasis was on the lack of development — with some noteworthy exceptions — and how this has “not a meaningful” implication for REIT credit risk.  However, the topic is important from a fundamental perspective, and deserves a bit more discussion.

Historically, REITs weren’t in the development business.  REITs are a tax vehicle, and to maintain that status, they’re supposed to collect rents and pay 95% of those rents out to shareholders (well, that’s a gross oversimplification, but let’s go with it).  As such, REITs enjoy preferential tax status, and have usually enjoyed excellent leverage.  REITs have some significant limitations on the proportion of profits which are supposed to come from business enterprises, capital gains, and such, and can lose their preferential tax status if these other items exceed a certain threshold.

During hot and heavy times (let’s say, pre-2007), REITs are hit with a triple-whammy.  First, they depreciate existing properties, and need that depreciation to shelter income (and thus exceed the 95% threshold, which they usually do and which investors expect).  Second, they were loathe to sell fully depreciated properties in order to buy new ones, because the huge capital gains from sales would impact the preferential tax status.  Finally, developers were demanding large premiums — income producing buildings were selling for amazing multiples which barely made sense (that’s called a “bubble”, folks).

The good news for a REIT was that if they developed their own properties, the development profits could be kept in-house, and there would be no fatal tax recognitions.  Depreciation expenses stayed high, and they could thus pay-out higher and higher funds from operations to shareholders.  It was a win-win.  The only downside, of course, was that development activities were considered risky, and so the credit rating agencies kept a close eye on these practices.  However, REITs were typically less leveraged than other ownership vehicles, to the riskiness was usually minimal.

A tthe peak, in 2007, the REIT universe had an aggregate investment of 7.6% of undepreciated assets in the development pipeline, or a total of $34 Billion.  By March 31, 2012 (the cut-off for data in the Fitch report) that had collapsed to 2.7%., and indeed over a third of that is in the fundamentally sound apartment market.

Fitch summarizes the market as “fairly muted”, and says that “By and large, companies have not ramped up development pipelines,” according to Steven Marks, managing director at Fitch in a follow-up interview to Globe Street.  “It is really growth via acquisitions and organic cash flows from existing portfolios.”

The report also noted that over the past 10 years, REIT development activities have had a high correlation with U.S. GDP changes.  Thus, improvements in U.S. GDP would signal development opportunities for REITs, but continued stagnation in the U.S. GDP suggests that REITs will continue to remain quiet on the development front.

Written by johnkilpatrick

July 16, 2012 at 8:10 am

October 10 — Update #2

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Since my last post, I also had the privilege of attending (and speaking) at the semi-annual meeting of the Real Estate Counseling Group of America (RECGA). RECGA is a small but highly influential group, founded in the 1970’s by the great real estate valuation leader, Dr. Bill Kinnard, and over the years has counted in its membership many of the presidents of the Appraisal Institute and other leading groups, editors of several of the top real estate journals, noted professors and highly influential authors in the field.

The Fall meeting was held in Washington, DC, and the core of the meeting was Friday’s educational session. Max Ramsland opened up with a presentation demonstrating the impact of the number of anchor tenants on the appropriate cap rate of shopping centers. Carl Shultz, a member of the Appraisal Standards Board, followed with a discussion of impending changes to the Uniform Standards of Professional Appraisal Practice (USPAP). These changes are currently discussed in an Exposure Draft, which he invited RECGA members to revieww and submit comments about, and will be incorporated (with appropriate changes) in the 2012 edition of USPAP. Both Mr. Ramsland and Mr. Shultz are also RECGA members.

Two non-members followed with somewhat related presentations on eminent domain. Scott Bullock from the Institute for Justice was one of the attorneys who argued the famed Kelo case before the U.S. Supreme Court, and he discussed the status of eminent domain law since that landmark case. With a somewhat different perspective, we heard from Andrew Goldfrank, a U.S. Justice Department attorney who heads up all Federal takings litigation.

The afternoon session kicked off with David Lenhoff, a RECGA member and former editor of the Appraisal Journal, who discussed the complex issues surrounding hotel valuation. I followed with a brief synopsis on the Gulf Oil Spill, focusing on the current status of the claims and litigation processes. Reeves Lukens, a RECGA member, and his son, Tripp Lukens, discussed the state of pharmaceutical properties in the U.S. Joe Magdziarz, who is the incoming president of the Appraisal Institute (AI) discussed the current issues facing that organization, with a particularly emphasis on the recent controversies between AI and the Appraisal Foundation (AF). Notably, the founding Chair of AF, Jeff Fisher, is a RECGA member and was able to provide some historic commentary. RECGA members Jeff Fisher and Ron Donahue brought the day to a conclusions with discussions about the state of the securitized real estate market, including REITs.

For more information about RECGA, visit the web site,

Written by johnkilpatrick

October 10, 2010 at 11:24 am

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