law also greatly expanded what and how much a REIT can engage in, such as offering concierge services to apartment tenants, investing in “merchant” property development, and engaging in other real estate–related businesses. The TRS can also form joint ventures (JVs) with other parties to provide additional services.
However, certain limitations do apply. For example, no more than 25% of a REIT's gross assets can consist of TRS securities. Originally, it was 20%, though that changed with the REIT Investment Diversification and Empowerment Act of 2007 (RIDEA). Loan and rental transactions between a REIT and its TRS are also limited. And any transactions that aren't conducted on an arm's‐length basis incur substantial excise taxes. Plus, income from the TRS is subject to taxes at regular corporate income rates.
Another area the RMA affected was restrictions on hotel and lodging REITs concerning the leasing of properties to a “captive” or controlled subsidiary. They're now allowed to do so, provided that each TRS‐held property is operated by an outside manager or independent contractor. This way, they can capture more of the economic benefits of ownership for their shareholders. And Nareit suggests there are several other benefits involved in the legislation. These include better quality control over the services offered, since they can now be delivered directly by the REIT's controlled subsidiary. Plus, the sector now has an opening to earn substantial nonrental revenues as well.
As for RIDEA, almost all of its provisions were incorporated into the Housing and Economic Recovery Act of 2008 signed by President Bush. It provides REITs with more certainty and flexibility relating to the purchase and sale of assets … the size of the TRS relative to a REIT's total assets … and overseas investments and foreign currencies. It also expands the flexibility that hotel and lodging REITs enjoy in leasing properties to a TRS to their healthcare associates as well.
These laws have opened up a new range of tools for the sector to utilize. However, any tool can be used wisely or carelessly toward a positive outcome or a pointless one. So far, the value of the TRS asset in particular is still subject to debate. Many early ventures – especially with respect to technology and internet investments in the late 1990s – have been failures.
Prior to the Great Recession, TRS activities performed well such as developing new properties, leasing them up, and selling them. However, complexity risks did evolve when REITs with “conglomerate‐like” platforms invested in areas outside of their areas of expertise.
Another important change that came out of the 1998–1999 bear market was capital recycling. Since REITs had less of an ability to raise equity capital to fuel purchases and acquisitions, they turned to making that kind of money through sales instead. In so doing, they changed an entire mindset. In the past, selling properties was seen as a sign of failure: of something going very, very wrong. Yet it's become much more commonplace in the last two decades, and that's a very big deal. This allows management teams to create value for themselves and shareholders in a whole new way, giving REITs much more control over their ups and downs (see Figure 3.1).
Source: Nareit.
The 21st Century (So Far)
Every bear market leads to a bull market eventually, and every bull market leads to a bear market. Moreover, one sector suffering will often lead to another's rise and vice versa. So it's not surprising that the highly speculative dot‐com bubble bursting would send despondent investors back into safer stocks like REITs. That renewed interest in value investing brought REITs to levels they had never experienced before … right up until the next bubble burst. And that one was directly tied to housing.
The MSCI U.S. REIT Index reached a closing high of 1233.66 on February 7, 2007. Yet 25 months later, it bottomed out at 287.87. It took REITs the next two years to recover most of what they'd lost.
Sometimes stocks and sectors suffer from their own foolishness. Other times, they're the victims of outside sources beyond their control. And, in this case, it was much more the latter. A volatile cocktail of government policies, a lack of banking integrity (or intelligence), and public enthusiasm – among other factors – sent property prices skyrocketing. And when the housing market proved to be less than perfect, those bank bets came crashing down, leading to the collapse of Bear Stearns and Lehman Brothers, Merrill Lynch selling itself to Bank of America, Wachovia selling itself to Wells Fargo, and AIG almost collapsing under its own weight.
While national leaders and legislators decided to bail big banks and car companies out, REITs weren't anywhere as lucky. They were left to deal with the fallout on their own, including vacancy rates as high as 17.5% in certain subsectors. They also had to handle overall debt leverage levels that shouldn't have been unmanageable but were anyway due to the circumstances.
Like most property owners, REITs have always used debt to finance their purchases. Heading into the 2007 downturn, leverage ratios of about 45% were consistent with recent norms. With that said, ratios of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) had risen. Combine that with the perfect storm that erupted, and you have intense problems indeed.
Fortunately, most REITs rose to the occasion. While most did have to cut their dividends – 35 in 2008, 56 in 2009, and another seven in 2010 – they worked hard to reduce their debt leverage by raising equity, selling some properties, forming joint ventures for others (a trend that developed specifically to handle the depressed conditions), and preserving cash however else they reasonably could. As a result, they were able to rebound sharply in 2009 and 2010. In fact, by the end of that second year, they were much healthier than their private real estate counterparts.
The sector went on to grow for much of the next decade, including by adding new subsectors such as prisons, farms, and gaming – all of which we'll discuss in greater depth in subsequent chapters. New REITs went public, some of which through C‐corp spinoffs where already publicly traded companies turned their real estate into separate businesses altogether.
On that last note, President Obama did sign an omnibus appropriations bill on December 18, 2015, which contains significant changes to U.S. taxation of REITs. It limits the use of the spinoff transaction in two ways according to the Proskauer Law Firm:
“First, the Act disallows tax‐free treatment in a spinoff if either the distributing corporation or controlled corporation is a REIT. Second, the Act prohibits a taxable corporation that is a party to a tax‐free spinoff from making a REIT election for a ten‐year period beginning on the date of the distribution.”
The Act does not, however, impact the ability of a REIT to spin off another REIT, such as the spinoff of DDR Corporation into Retail Value Trust or Spirit Realty into Spirit MTA REIT.
There was also merger and acquisition (M&A) activity during this time, such as Prologis Inc. taking over DCT Industrial for $8.5 billion in 2018, Omega Healthcare purchasing MedEquities Realty for $600 million in 2019, Healthcare Trust of America acquiring Duke Realty's medical office building portfolio for $2.75 billion in 2017, and Mid‐America Apartment buying up Post Properties for $3.9 billion. Then there was the “mega‐mall” marriage between Simon Properties and Taubman Centers that was first agreed on in February 2020. Due to the shutdowns that soon followed, the deal was later closed at $2.6 billion and involved Simon acquiring an 80% stake in Taubman Realty Group, the operating partnership through which Taubman Centers conducts its operations.
2016 in particular was a big year considering how
