Will TRS spell success for REITs?

While virtually no real estate professional disputes that the REIT Modernization Act is a victory for the industry, the degree to which taxable REIT subsidiaries will transform the sector over the next several years is open to debate.

Five titans in the REIT world gathered at the Waldorf+Astoria on June 5 to address the timely topic during the 2000 NAREIT Institutional Investor Forum. The program, titled "Unlocking the Potential of Taxable REIT Subsidiaries (TRS)," attracted hundreds of conference attendees who came to hear how REITs may evolve in the years ahead now that the REIT Modernization Act has won government approval.

Seizing the day "If you execute, it is a wonderful vehicle because you have the best of both worlds," said Milton Cooper, chairman and CEO of Kimco Realty Corp. "You have a REIT parent, and you have a subsidiary that can have retained earnings and be an asset. I see it as a wonderful, positive step for the industry."

Kimco owns and operates 404 neighborhood and community shopping centers and two regional malls. Cooper said TRS has leveled the playing field for REITs with private real estate companies, as well as the rest of corporate America.

Sam Zell, the outspoken chairman of both Equity Office Properties Trust and Equity Residential Properties Trust, believes TRS complements one of the greatest assets of REITs - their enormous operating leverage. "We have a series of real estate companies today in size, scale and sophistication that never existed before," said Zell. "When it's all said and done, the Street will recognize consistent, predictable streams of income. We as publicly-held companies have an enormous incentive to seek out, identify and implement businesses that will create repetitive streams of income for us."

The ability to maximize creativity is one great advantage of TRS, emphasized Zell. He pointed out that Equity Residential interfaces with 1 million people each year who typically range in age from 25 to 39 and who have no children. "When you touch those 1 million people with those kinds of characteristics, how can you take advantage of that? I fully believe there are lots of ways."

Zell said his company recently purchased a furniture rental company. Why? "If you've got 250,000 apartments, owning a furniture rental company has real synergistic and significant benefits, and significant profitability," he said. "We couldn't have done it without TRS."

A less enthusiastic view Since the act's passage late last year, much has been written about the REIT industry's ability to provide new services, generate new income and pay new taxes through the creation of TRS.

However, Edward Linde, president and CEO of Boston Properties, argued that the availability of TRS is not a transforming event. Linde anticipates that ancillary services will account for only 5% or 10% of Boston Properties' income. "I really don't think it's going to dramatically enhance our ability to earn money," he said. "The current management of Boston Properties has no particular expertise in offering services that we know nothing about."

Linde said he prefers to channel his energies into what's best for his company and investors alike. "I have never wanted to be in the cleaning business. I never wanted to be in the construction business. I never wanted to be in a lot of businesses only because I think they're lousy businesses," he said. "It doesn't seem to me to make any sense to be in those businesses just because we have a law that allows us to be in them."

Steven Roth, chairman and CEO of Vornado Realty Trust, said the big question is whether REIT management teams will venture only into related businesses where they have the in-house capacity to manage those businesses, or whether they will "go off and do some crazy stuff, like zinc manufacturing in Africa." Added Roth, "My guess is that it is going to be the former, and that the market is going to murder anybody that does anything too adventurous."

Cooper suggests that anyone who considers investing in a business should first analyze the management team, which naturally has a stake in the company. "The idea that we are going to be morons and take our stake and speculate is absurd," said Cooper.

Quest for a silver bullet The search for the perfect application has proven to be elusive for Linde. "I guess so far we've had a failure of imagination because we have not been able to come up with any magic bullets," he lamented.

Boston Properties is active on several fronts, including telecommunication services, concierge services and elevator displayscreens. "Those are all nice, and I'm very able to try to profit from it as much as possible," said Linde, "but where is the dynamite application?"

Linde recounted a story involving a friend who plays a major role in the office supply business. Linde explained to his friend that Boston Properties controls 36 million sq. ft. of office space occupied by tenants who buy stationery in their normal course of business. Linde posed the question of whether it would be possible for Boston Properties to facilitate interaction between his friend's company and those tenants in order for both companies to profit.

Linde told him the two companies could team up to offer discounts on office supplies, but his friend didn't like the idea. "I tend to agree with him because I don't think there is some lock that we have. I don't think there is some way that we can translate this position of being their landlord," said Linde. "In fact, I hate to admit this of course, most tenants have a certain suspicion about their landlords. That's why I'm sorry to be as pessimistic as I am about what the opportunities are."

John Bucksbaum, CEO of General Growth Properties, the second largest shopping center REIT in the country, agreed with Linde's analysis regarding applications. "You need to have the killer application. If you're selling broadband, it's not whether you have broadband available because everyone is going to have it available," explained Bucksbaum. "I think the emphasis on the application part of all of this, whatever the business is, is going to be critical as to whether or not it's successful."

A final thought Recognizing that the commercial real estate industry has been transformed over the past eight years to the point where it now exhibits oligopoly tendencies, Zell has come to the conclusion that the old ways of doing business are inevitably going to change. "Most important of all, we're going to change the people," said Zell, "because we are going to end up adding people who have the expertise in these arenas that the real estate industry has never had before.'

* John Bucksbaum CEO, General Growth Properties, Chicago

* Milton Cooper chairman and CEO, Kimco Realty Corp., New Hyde Park, N.Y.

* Edward Linde president and CEO, Boston Properties Inc., Boston

* Steven Roth chairman and CEO, Vornado Realty Trust, New York

* Sam Zell chairman of Equity Office Properties Trust and Equity Residential Properties Trust, Chicago

* Moderated by David Shulman general partner, Lehman Brothers, New York

The REIT Modernization Act, which was signed into law by President Clinton on Dec. 17, 1999, will take effect in January 2001. The legislation will allow REITs to own up to 100% of the stock of a taxable REIT subsidiary that can provide ancillary services, such as telecommunications, to REIT tenants. Currently, a REIT is required to use independent contractors to provide non-customary services to tenants. In effect, the legislation will create new and diverse streams of income for REIT shareholders, say NAREIT officials. In addition, the Act will lower the required dividend payout for REITs from 95% to 90% of taxable income, leading to a greater level of retained capital for the REIT sector. For more details of the Act, please log on to www.nareit.org.

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