Bill Could Force Changes in Paired-Share REITs


New legislation seeking to rein in the powers of so-called paired-share REITs will clip their wings but not ground them, according to analysts.

The nation’s four paired-share real estate investment trusts were dealt a major blow last week when the leaders of the House and Senate tax-writing committees introduced a bill that would eliminate further use of their special tax status.

The move caps months of lobbying, primarily by hoteliers such as Hilton Hotels Corp. and Marriott International Inc., who sought to eliminate the tax breaks of rivals including Starwood Hotels & Resorts Trust and Patriot American Hospitality, claiming that the REITs’ paired-share status gave them a competitive advantage in accumulating large real estate portfolios.


“We don’t mind competition, but we want to ensure that we are playing on a level playing field,” said Hilton Senior Vice President Marc Grossman.

The legislation would have no impact on the remaining 200-plus REITs across the country. And, says one Treasury Department official, it does not portend closer scrutiny of the REIT industry as a whole.

“We think the REIT industry in general is operating on a very sound basis and is performing a valuable service for investors,” said Donald C. Lubick, the Treasury Department’s assistant secretary for tax policy.

REIT analysts like Ralph Block of Bay Isle Financial and author of “The Essential REIT” says the issue has been overblown.

“It just means that hotel companies that operate as REITs are no longer going to be able to manage their hotels in-house,” Block said.

The paired-share debate began brewing last year, when Starwood aggressively bid up the selling price of casino and hotel powerhouse ITT Corp., a bid it ultimately won for $10 billion. The heat was turned up even further in late January, when the Clinton administration announced its intention to close the tax loophole used by these four firms, a move that would add an estimated $139 million to federal coffers over 10 years.

Analysts and administration officials say the endorsement by high-ranking Senate and House Republicans almost ensures its adoption.

If the measure is passed, says Jon Fosheim of REIT research firm Green Street Advisors in Newport Beach, each REIT will likely spin off its operating company as a separate entity with the same management team, and become what is commonly referred to as a “paper-clipped” REIT.

Even so, they will still have a slight advantage over ordinary companies in making deals, he said. REITs are tax-exempt as long as they distribute 95% of their gross income to shareholders.

“It doesn’t mean you’ve got a level playing field. Net, they still pay less taxes,” Fosheim said.

Paired-share REITs consist of two companies, one a tax-exempt firm that owns property, and a second taxable operating company. Both trade as one stock. The taxable company pays most of its income as rent to the REIT, therefore avoiding corporate income tax.

Critics say these firms have manipulated their paired-share status, sheltering income that should be taxed, allowing them to pay higher prices for acquisitions.

Leases negotiated by the hotel operating entity and the ownership entity are not conducted at arms length, opponents say, and it is to their advantage to pay inflated lease rates because it allows them to shelter more income.

The newly introduced bill would not completely reverse the paired-share status of these four firms, which were grandfathered when Congress originally banned their structure in 1984.

But it will prevent them from operating their own assets in any new acquisitions. In addition to Starwood and Patriot American, two other actively traded firms share this status: Meditrust Corp. and First Union Real Estate. None of them are based in California.

The stock prices of these four REITs have taken a big hit since President Clinton first announced plans to rein in their powers. Since January, Starwood has dropped 12% to a low of $50.13 before rebounding to $53.56 at the close of business Monday. Patriot American likewise dropped 13% to $24.75 earlier in the month, before recovering to $26.81 Monday.

Block says the drop has made these two stocks a good value for investors.

“Both companies hope to do a higher percentage of growth in 1998 and 1999 than in previous years when they were basically acquisition machines,” he said. And, he says, neither are trading at a premium compared to the rest of the REIT pack.

Instead, bearing the brunt of this pending legislation are First Union and Meditrust, which have failed to fully utilize their unique structure in making acquisitions. First Union, which had traded at $15.44 in January, has dropped to $11.88 a share. Meditrust also has declined, closing at $30.33 on Monday after trading as high as $34.75 in January.