Are REITs the right choice for you? - real estate investment trusts - Column

In November of 1992, Al Taubman kicked off a boom in real estate investment trust offerings by raising almost $300 million on Wall Street. By August of 1993, less than a year later, almost $5 and a half billion had been raised in the first seven months of '93; $1.8 billion in the first three weeks of August alone. 1993's eight month numbers are the largest offerings in one year since the real estate investment trust came on the scene over 30 years ago.

Among the famous names currently being marketed are JMB Realty ($286 million), General Growth Properties ($363 million in April 1993), and Crown American Realty ($424 million), with dozens of other well-known names rushing to take advantage of this opportunity to raise money on their real estate on Wall Street. Current dividend yields are running from approximately 5 percent on such tried and true REITs as Weingarten Realty of Texas, to slightly over 9 percent on EQK Green Acres (a single regional shopping center on Long Island, New York.)

What Made the Boom?

Several factors are at work: one is arbitrage. If real estate can be bought for cash-on-cash returns of 8, 9 or 10 percent and securities investors will accept dividend yields of less than 7 and a half percent with returns of as little as 5 and 6 percent possible - there is money to be made by putting together packages of real estate that show 10 percent and marketing them as REITs at 7 percent. Also, the recent troubles of bank and insurance company lenders who find themselves locked into foreclosed real estate (REO) has resulted in their walking away from the lending market, leaving a financing vacuum for the REITs. Putting together several hundred million dollars of funds enables real estate-entrepreneurs to buy bargains and to refinance their existing high cost debt.

How You Can Tap This Market?

Do you want to sell your real estate to the public at REIT prices? The first step is to assemble a package of equity real estate. Today's real estate investment trusts typically involve equity ownership; the day of the mortgage real estate trusts has gone. Often, the funds raised are used either to pay off existing, more expensive, debt or to expand an existing real estate portfolio. In some cases, a combination of both: paying off debt on existing properties and using the surplus funds raised to make additional acquisitions. Also and most important to owners, forming a REIT makes their equity portfolio liquid and helps both diversifications of risk and estate planning.

For example, you enhance the liquidity of your real estate. Instead of trying to sell a $10 million shopping center, it is easier to sell shares of marketable securities in thousand dollar units. Shares sold at dividend yields of less than 7 or 8 percent enhance the value of your real estate. As an insider and owner, you have made your ownership more liquid in the public marketplace and priced it at today's low dividend yields.

Bailing Out?

True, Wail Street underwriters are reluctant to sell an issue to the public solely for the purposes of bailing out the insiders. But, the insiders may sell a portion of their holdings now and still retain ownership of the remainder. Some real estate investment trusts have done initial public offerings, in which the insiders sold off a portion of their holdings, followed by secondary offerings in which even more of the insiders' holdings were liquidated at even better prices (assuming that the initial securities have gone up in value).

Keeping Control

Do you lose control? If your underwriter gets broad distribution for your stock, you should wind up with several thousand small shareholders and you may be able to control the real estate trust with as little as 10 or 20 percent of the outstanding shares which would have effective voting control. Public corporations with -thousands of shareholders often have effective voting control with as little as a few percentage points of ownership, since the public stock is so widely dispersed. Control may also be kept by issuing different classes of stock, or by owning the management company and selling only the ownership position to the public.

Finding the "Right" Underwriter

There are more than 1,000 securities underwriting firms. These range in size, from one-man operators to the multi-branch, multi-owner, national organizations like Merrill Lynch or Smith Barney. Some of the small underwriters do as little as one or two deals a year; while the larger ones do multi-billion dollar offerings in good years.

But which underwriter is best for you'?. How do you find him? Does he understand your kind of real estate? As in every field, there are underwriters who will treasure your account and help you find the best market for your shares and there are others to whom your public offering will be a burden.

As attorneys for clients with public offerings, we have always felt that the first step is to analyze your particular portfolio and take it to the specific underwriters who handle your kind of merchandise. That changes from time to time, but matching the underwriter and the offeror is the most important key to a successful public offering. In addition to finding the underwriter who is best for your real estate package, the roles of the attorney and the real estate management are to work together to make a "saleable" package. The underwriter needs to see that your real estate is showing growth, or that it has stood up better than the competition in your local market, during the recent downturn.

Preparing the Information Package

What kind of information do you need for the underwriter? A brief checklist we use for potential underwriting clients:

(a) History. The name of your company, its history (when was it started and by whom). A brief description of your unique features; your position in your market and your acquisition and growth philosophy.

(b) Management. Who are the principals? What do they do? What are their qualifications? Is there a second level of middle management (in case something happens to one of the principals).

(c) Rental Income. Its volume and its nature (do you have lots of small tenants or a few big ones ?) If you have large tenants, tell us something about their credit rating. Are we selling an almost guaranteed income stream of rents from AAA tenants or is our market strength based on lots of little tenants, none of whom can hurt us if they fold? How do our rents compare with competitors?

(d) Expenses. A five-year income and expense history is most important to demonstrate trends. If our expenses are lower than our competitors or less than industry averages, there should be an explanation.

(e) Financing. What is the present status of our mortgage indebtedness? Are rates fixed or floating? Do we want to retinanee our debt if our offering is successful, or should we keep existing financing and use the new funds to expand by buying real estate whose value we can increase?

(f) Accounting. Have we five years of certified audited financial statements (or can we get them if needed, and how long will it take)? It is best to start planning for this audit immediately, if you-are not already certified, because it will take time to prepare.

(g) References. Banking and lending history are needed (your track record and reputation with lenders is important). If there has been trouble, it should be explained. Very few real estate borrowers have experienced an 100 percent record these past five years.

(h) Projections. With five years of history behind us, can we project the next year or two? Footnotes will be needed to explain assumptions and changes in our pattern.

(i) Purpose of the Financing. What are you going to do with the money? Show the amounts and the intended use of all funds raised.

The Pros and Cons of "Going Public"

Have you considered the advantages and disadvantages of being public? A public offering increases your net worth and the value of your insider stock. It gives you working capital and improves your credit; offers the opportunity of additional acquisitions and estate tax liquidity. Going public gives you marketable securities to use as incentives to top management and key employees; it offers risk-spreading diversification of insider holdings.

The disadvantages are: Giving up such executive perks as the company yacht, lump sum entertainment expenses, etc. Tighter accounting control on income and expenses. Public airing of confidential information such as insider dealings; large contracts; special financings, etc. Representation on your Board by public or banker personnel can help give you another viewpoint, but it does slow down decision making. The need for stockholders meetings and. the stockholders' rights to information and arms-length dealings can also trouble you'; especially if you are not used to it. Dealing with the public, the trade press and the "short sellers' all give rise to problems, take up executive time and cost money. Selecting the Underwriter Which underwriter? Does he do deals of your size? What type and industry does he handle. What is his track record and history?

Will he be around to help you in the aftermarket and offer future financial guidance? What will the underwriter cost in commissions, other expenses, stock options and warrants; and to whom does the underwriter distribute (geographically - by investor type, etc.).

Dealing with the Underwriter

Making an effective presentation; getting the "best" price for your issue (bearing in mind the future performance of your stock). Sometimes bargain pricing of the first issue gives a boost to future offerings by causing an immediate post-offering price rise. Over pricing the initial offering can make it sink like a lead balloon.

Timing

Should you go to the market now or wait until your earnings go up?

Form of Underwriting

What kind of an underwriting should you get? Best efforts, all-or-none, or a firm commitment? Do you know what goes into a SEC registration and are you prepared to put the information together and disclose it to the world?

What Must YOU Do?

Over 20 years ago I wrote a book of hundreds of pages on "Going Public," which was first published by Prentice-Hall in 1974. While bull and bear markets have come and gone in those years, the basic technique of putting together a package that is saleable first to the underwriter ,and then to the public remains the same. Deciding on whether going public is for you and for your company and making the changes in your package to meet securities market criteria have remained the same, though the multiples change from year to year.

The major task is putting together your information, in form needed by the securities underwriters, and in deciding whether the benefits of raising money from Wall Street offsets the detriments that exist and remain unchanged. For large issues, Wall Street offers the ability of raising large wholesale sums of money cheaply. But small companies with small issues often find the paperwork and expense ratio is high. Only by analyzing your own situation, and consulting with knowledgeable accountants, lawyers and underwriters can you see if the fit is good for you, or whether other financing will work better. Keep in mind that expanding your real estate base in the 90's, without some kind of public financing, is going to be hard, since conventional lenders are presently reluctant to lend because of their past mistakes and the soft market. The REIT offers growth at low cost to those who use it.

(David S. Berman is a New York attorney, senior counsel to the firm of Fink Weinberger p.c.; he is the author of three-volumes on public offerings and has lectured on the subject to audiences consisting of accountants, lawyers, brokers, underwriters and mortgage bankers, as well as at New York University's Real Estate Institute, where he was on the faculty for a number of years. Mr. Berman is a member of the Mortgage Bankers Association of New York, of various professional real estate and building trade associations and has lectured on the subject of real estate finance to numerous professional groups across the country.)

COPYRIGHT 1993 Hagedorn Publication
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