Real estate investment trusts have introduced a whole new vocabulary to the industry, beginning with the acronym REIT, pronounced "reet." Although the federal legislation authorizing REITs is nearly 40 years old, many of these terms have only recently come into common use because of the rapid growth of REITs in the last several years.
Following is a glossary of some of the most common REIT terms, based on information provided by the National Assn. of Real Estate Investment Trusts, or NAREIT, and by partner Paul D. Prescott of Arthur Andersen Real Estate Services Group in Los Angeles. More information is available from NAREIT at its Internet site at http://www.nareit.com.
REIT: A real estate investment trust, authorized by legislation signed into law by President Eisenhower in 1960, is a corporation or business trust that owns and operates real estate under a set of rules that provides tax advantages for the operating company while providing dividend income for its investors. To qualify as a REIT, a corporation or trust must distribute at least 95% of its taxable income as dividends to its shareholders and must meet a number of other criteria.
REITs generally do not pay corporate income tax to the Internal Revenue Service, and most states do not require REITs to pay state income tax. A REIT can be either privately owned or publicly held, but the term REIT has come to be almost synonymous with a publicly traded entity. Some REITs invest in a variety of property types such as office and industrial buildings and shopping centers, and others specialize in one property type. Some REITs confine themselves to a specific geographic market or region, and others operate nationwide.
FFO: This is an acronym for funds from operations, a measurement of cash flow. Because of the unique structure of REITs and their reliance on real estate as the source of their income, financial analysts generally consider FFO to be a more accurate measure of a REIT's performance than net income.
UPREIT: This is an acronym for umbrella partnership REIT. It combines a number of existing partnerships or business entities into a new REIT. Typically, the partners in the existing business entities or partnerships become members of a new partnership called the "operating partnership." In an UPREIT, the REIT typically does not own its property directly, but instead owns an interest as the general partner and majority owner of the new operating partnership, whose members initially receive partnership units as their payment for contributing their properties to the deal.
By contrast, in a DOWNREIT the REIT typically owns some of its property directly and some in partnerships.
The UPREIT has emerged as the REIT structure of choice because it offers a number of tax advantages to the partners who form it and to owners who later sell their properties to the UPREIT.
"In general, the UPREIT is perceived as less of a tax risk for those who sell their properties to a REIT, because it is generally easier to execute a tax-deferred transaction through the UPREIT structure," Prescott said.
Equity REIT: An equity REIT owns real estate and derives its revenue primarily from rent.
Mortgage REIT: A mortgage REIT lends money to real estate owners and derives its revenue primarily from interest earned on mortgage loans.
Hybrid REIT: Hybrid REITs combine the characteristics of equity REITs and mortgage REITs.
Paired-share REIT: Also known as a "stapled REIT," a paired-share REIT combines the shares of a REIT with the shares of an operating company engaged in a specific business, so that an investor buying a share of one automatically receives a share of the other. This arrangement provides tax advantages to both, because the REIT does not have to pay taxes on its rental income, and the operating company gets a tax deduction for the rent it pays to the REIT.
An example of a paired-share REIT is Starwood Hotels & Resorts Trust, which combines the shares of the Starwood hotel chain with the shares of a REIT that owns the real estate on which Starwood operates its hotels. Congress prohibited the formation of new paired-share REITs in 1984, but a handful of existing paired-share companies were permitted to continue operating. A proposed IRS restructuring and reform act contains a provision that would further limit the activities of existing paired-share REITs.
Paper-clipped REITs: Generally, these are vehicles used to obtain tax advantages similar to those enjoyed by paired-share REITs. A paper-clipped REIT signs a deal to provide the real estate for an operating business; in return, the business agrees to lease its facilities from the REIT or to at least give the REIT the right of first refusal to provide space for the business.