With new tax laws, REITs get new interest

When the President signed the 1986 Tax Reform Act as ``Reagan, Ronald,'' a lot of people in the real estate business thought he had reversed more than his name. He had turned around years of real estate development based in large measure on tax breaks, not necessarily on economics. Now, real estate experts said, income would be the name of the game, and a major player would be the real estate investment trust, or REIT.

Well, so far in Year One ATR - after tax reform - that hasn't quite happened. In 1985, 59 new REITs were brought to market. In 1986, there were 58 offers. In the first two months of this year, there have been just six new REITs, an annual rate of 36, although a somewhat faster pace is expected later in the year.

Why the slowdown for an established investment that already met the standards of tax reform?

``A lot of people introduced new ones last year to get it done before the tax laws changed,'' says L.Howard Nichol of Advest Inc., a Hartford, Conn., brokerage ``Also, the stock market has given investors more capital appreciation than income-oriented investments.

``I don't expect '87 to be a boom year for REITs in terms of offerings or returns on investment,'' Mr. Nichol continues. Many potential underwriters are waiting to see how tax reform affects the overall real estate market before assembling new trusts, he says.

REITs have been around since 1960, when they were authorized by Congress as a way for individuals to invest in real estate. They are somewhat similar to mutual funds, in that they are professionally managed pools, or trusts, of assets. A REIT's holdings can include shopping centers, office complexes, apartment buildings, and warehouses. They generate income either from owning real estate or collecting interest from mortgage loans used to develop new properties. REITs are sold on the major stock exchanges, with share prices listed in the daily stock market tables. Shares can bought or sold through discount or commission brokers.

A special provision of the US Tax Code requires REITs to keep at least 75 percent of their assets in real estate, cash, and/or government securities. In return, they pay no federal income taxes as long as 95 percent of their net annual earnings are passed along to shareholders.

Those distributions are taxed as ordinary income to those shareholders. All capital gains - including REITs, stocks, and direct real estate investments - are now taxed at this same rate.

Even before Tax Reform, things were looking brighter for REITs. The business had come out of a horrible period in the mid-1970s when many REITs that made mortgage loans went belly-up as interest rates fluctuated wildly. Some ``mortgage REITs'' were holding single-digit construction loans when borrowing costs were in double digits. Many sank into bankruptcy, taking investors' money down with them.

Since then, REITs have made a remarkable recovery. Now instead of the more vulnerable mortgage REIT, most are ``equity REITs,'' which buy and hold property and pay investors out of the rent and the proceeds from sales. A third variety, ``hybrid REIT,'' is a combination of equity and mortgage REITs and produces income from mortgage lending and property ownership.

REIT assets climbed from $7.5 billion in 1983 to $18 billion in '86. Total return last year amounted to 18.78 percent, slightly above the 18.6 percent gain for Standard & Poor's 500 index, but short of the 27.2 percent gain for the Dow Jones industrial average.

REITs are not without their risks, however.

``I find getting information about what REITs are holding in their portfolios can be very difficult,'' says J. Randall Hedlund, a financial planner in Overland Park, Kan. Because a REIT portfolio can can contain offices, malls, and so many other types of real estate and because it can own property anywhere in the country, it takes a knowledgable investor to know what kinds of property and what locations are most rewarding.

Or you can find a REIT with a good record of high yields and total return. Three equity REITs Nichol likes are Mortgage & Realty Trust (on the New York Stock Exchange), Federal Realty Investment (NYSE), and Mortgage Growth Investors (American Stock Exchange). Mortgage & Realty Trust, for example, had a total return of 38.8 percent last year, compared with the industry average of 18.78 percent.

While most mortgage REITs are now structured to make them less vulnerable to big interest-rate fluctuations, equity REITs could benefit from higher inflation because the property they own would get more valuable.

Despite reservations, Mr. Hedlund thinks a well-managed REIT is fine for some people. In the last year, he has recommended them perhaps a half-dozen times, usually to older clients, and only as one of many different types of investments in an overall portfolio. ``I would recommend them to people who are over 60 years of age who need real estate in their portfolios for tax purposes,'' he says. ``They can provide a good source of income.''

You've read  of  free articles. Subscribe to continue.
QR Code to With new tax laws, REITs get new interest
Read this article in
QR Code to Subscription page
Start your subscription today