Real Estate ETFs and REITs: Time to Hedge the Homestead? Message Board

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Strategies & Market Trends : Real Estate ETFs and REITs: Time to Hedge the Homestead?

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From: Sam Citron	2/20/2009 11:22:02 AM
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REITs Paper Over the Cracks [WSJ 2.7.09] By JOHN JANNARONE online.wsj.com Just when investors in commercial real-estate investment trusts thought they had seen it all, magicians at the Internal Revenue Service have a new trick. It makes dividends disappear and taxes them anyway. REITs such as Simon Property Group and Vornado Realty Trust are getting in on the act. The ruling, introduced in December, lets them for one year skip a longstanding requirement to pay 90% of pretax income to shareholders in cash. Instead, they are keeping the money to shore up balance sheets -- weighed down by large debt loads and souring property investments. That sounds sensible. But investors should beware a sleight of hand. REITs now are allowed to pay as much as 90% of the dividend in stock and just 10% with cash. Dividends paid in shares are the equivalent of a stock split -- worth nothing to investors -- or in this case a forced rights offering because the REIT keeps the cash it would otherwise have paid out. [Shot Property] The snag: Tax is still due on 100% of the dividend. That can mean that investors face a tax bill bigger than their cash payout. Simon is using the rule to its limit, declaring a quarterly dividend of nine cents in cash and 81 cents in stock. Vornado will pay 40% of its dividend in cash, which should at least leave shareholders with enough money to cover their tax liability. Shareholders had good reason to expect dividends to hold up. In return for an exemption from corporate taxes, REITs had to pay 90% of pretax income as a cash dividend -- at least until now. Indeed, Simon could have cut its dividend to about 70 cents and stayed within the threshold. Investors might have found that a better option than being given a tax liability if the shareholding isn't in a tax-exempt account. Retail investors historically have owned about 30% of commercial REITs, according to Barclays Capital. REITs are struggling as their traditional funding sources dry up -- such as unsecured bond financing and the commercial mortgage-backed securities markets. That leaves REITs with every incentive to preserve capital. Simon has $24 billion in net debt, and Vornado has $14 billion, although neither has an imminent problem from big debt maturities. The REIT industry overall has about $100 billion in debt due by the end of 2010, which could pose a challenge if real-estate markets continue slumping. From a valuation perspective, Green Street Advisors reckons Simon's shares trade at a 15% discount to the value of its assets, while Vornado trades at a 6% discount. Those aren't far from the average discount of 10% across the industry. But when it comes to comparing dividend yields, investors should be careful to include only payments that come in hard cash.

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