Month: October 2015

Making a property investment is a major commitment for most and can run into hundreds of thousands of dollars worth of commitment if not more. In response to that a few years back some clever finance folks came up with what is known as a Real Estate Investment Trust or REIT.

A REIT is conceptually very similar to a mutual fund. You are busy and don’t necessarily have the expertise or knowledge to make good investment decisions. And the amount of money you have is not sufficient to get the best possible deals. So you hand over your money to a fund manager who pools monies from a number of small investors just like you and then invests in a bunch of properties.

The idea behind investing in a bunch of properties is that you get diversification and get access to the growth and cash flow of a number of premium properties, which you would have never been able to get access to yourself. And most REITs are also trade-able. Just like Equities or Bonds you can sell the units you hold to some other investor who is willing to buy giving you ample liquidity.

So you have an expert property manager, diversification and liquidity. This thing is the best thing since sliced bread, correct?

Wrong.

While conceptually REITs make a lot of sense their performance leaves a lot to be desired. Let’s take a look at the benchmark REIT index in Australia.

In the last ten years investors have lost 3.5%. While yes there has been the GFC of 2008 in the interim, equities suffered a similar drop and have since recovered spectacularly.

So the theory has to be property market suffered a terrible crash in 2008 and has been limping since ever since and the expert property manager is not at fault.

Wrong again.

Australian property did not suffer a major crash in 2008 and have since performed well. If the so-called expert fund managers were worth the ungodly amount of fees they charge they should have at least mirrored the markets performance. Yet they have saddled their portfolios with white elephants. And remember whether your investment gains or looses they will still charge their fees. They always win!

People should be in control of their investment decisions. Most folks have a good amount of local knowledge. They know which property development is going to be a dud and which is going to be a winner. An innate knowledge of a myriad of local factors,which the fund managers sitting in their air-conditioned high-rise offices will never know or will care to know. And unlike equities, property is not volatile. You do not need to sit starting at a monitor worrying whether your asset prices are going up or down. A manager has limited role to play in making your selection.

A crowdfunding real estate platform allows you to pick and choose the specific and multiple properties you want to invest in and still invest only in small amounts. In this way, you don’t have to pay a fund manager unnecessary fees and be saddled with white elephants.

A crowdfunding real estate platform removes the middle men and empowers investors by giving them choice and saving management fees. This is why investing in opportunities listed on crowdfunding real estate platform is fundamentally superior to a REIT.

What’s happening to capital in America today is beginning to resemble the bible’s Exodus. Corporations are fleeing in droves, incorporating in other industrialized nations to avoid evil Pharaoh, Uncle Sam. Called, tax-inversions, companies who have operations and a significant portion of their earnings generated abroad, side-step the double taxation that would otherwise take place by re-incorporating in a country with a lower corporate tax rate. With the U.S. corporate tax rate currently at 35% (the highest of all the industrialized nations) and with “tax-credits” unable to offset taxes levied by host countries, it is hard to cast patriotic shame on a business that completes this maneuver. The situation is worrisome for Congress. The US treasury stands to lose billions in possible corporate tax revenue. Look for Congress to pass a bill this year to curb the flood of tax-inversions.

Tax-inversions have taken the lion’s share of media coverage. Fewer people (who work in D.C.) are aware of the tax saving move other corporations are taking to avoid Uncle Sam’s whip: REIT conversions. Real Estate Investment Trusts are not new. Since the 60’s, Congress and the IRS have been relatively easy on REIT entity formation. Indeed, nowadays non-traditional assets, such as timber, data centers, prisons, billboards, and others, are qualifying for REIT status.

Even with the recent spike in REIT conversions, the treasury’s loss of tax revenue will only be a blip compared to other tax avoidance ploys like inversions. REITs were a middle-class spurred creation, allowing more investors access and participation in real estate deals. Despite revenue loss, our government gains by not having to subsidize urban improvement projects.

Why would a corporation (C-corp) want to restructure into a REIT or spin-off part of itself (its real estate assets, traditional or otherwise) into a REIT entity? There are many benefits. By electing REIT status, companies can essentially hand off an eventual tax burden, in the form of appreciation of its RE assets, to the newly structured and independent REIT. For tax purposes, the transaction from parent to offshoot is either a sale or a transfer. If it is not something known as a “deemed sale election,” a transfer in other words, the REIT becomes responsible for the net built-in gain in the converted property. If the parent company declares the transaction a deemed sale, they pay the tax man for any appreciation (there could be a loss in value of the subject properties as well, i.e., depreciation) from the original cost basis. For most people, trying to understand the tax code and the regulations that come with REIT election is as painful as learning Latin at the dentist’s office. But if one is a glutton for punishment, consider starting out with the Thomson Reuters’ Legal Solutions Real Estate Investment Trusts Handbook, 2013-14 edition.

Incentives to Spin-Off Assets into a REIT: Valuation

So far, companies can shield themselves from the taxes in capital gains from their RE assets by passing these off to the newly formed REIT entity. From an equities standpoint, the parent company, if publicly traded, stands to benefit with investors bidding up their common shares from the news release. Companies can unlock intrinsic value (instantly increasing their market cap) with a REIT announcement, and keep it for the short term if they can follow through with the spin-off. The REIT entity in turn commands an enterprise valuation of its own once the IRS gives its blessing. It can be indeed attractive for a management team to consider a stock that fetches a higher price in the open market with both the operating and REIT entity combined. People are familiar with the tax benefit REITs enjoy. REITs can deduct 100% of their profits (by issuing a dividend to shareholders) on their specific tax returns. They can keep up to 10%.

Surely, electing REIT status is financial alchemy at its best. But it is not for every C-Corp. There are REIT “tests” that must be passed yearly. For example, can the ensuing REIT entity prove it has at least 100 different shareholders? Can it show that no more than 5 individuals own more than 50% of the value of the common shares? Will the REIT generate at-least 75% of its gross income from real estate related activity (collecting rents or interest from mortgage notes, e.g.)? There are other operational, organizational, and compliance limitations that have to be resolved by a board of directors. In general, REIT structure is not an appropriate choice for a closely held family business.

How Can a C-Corp Become a REIT?

To qualify for REIT status a company first has to make a REIT election with the IRS. They must file an income tax return using Form 1120-REIT at the end of the REIT’s first year (or part-year), on or after March 15th. The corporation must not necessarily meet the 100 Shareholder or 5/50 Test if it seeks to qualify that same year, but it will upon the start of its second taxable year. Also be prepared to send plenty of letters to shareholders of record, telling them details of share ownership. C-corporation management teams do right by their shareholders when they consult with law, accounting, and investment banking firms that specialize in REITs.

Want to know more about REITs and investing in commercial property? Visit http://www.commoncoremoney.blogspot.com. Subscribe and I’ll send you my eBook: Common Core Money: Financial Literacy for Educators & Other Professionals.

Have you always wanted to invest in real estate but don’t know where to start? Here are some of the different areas of the industry that you can invest in:

Areas That You Can Invest In

Residential: these are properties such as townhouses, apartment buildings and vacation houses. Here a person or a family will pay you in order to live in your property. The length of time that an individual lives in your house depends on your rental or lease agreement.

Commercial: commercial real estate consists mainly of office buildings. When you construct office buildings you can rent them to companies and small business owners. Again the length of time that the business owners use your property depends on your agreement.

Industrial: this one consists of car washes, storage units and any other special type of real estate where customers use your facility on a temporary basis.

Retail: it consists of trip malls, shopping malls and any other retail storefronts. When you construct a mall, you can rent it to a person interested in running it or you can run it yourself.

Mixed-use: this is where you combine any of the above categories into one project. For example, you can construct a storied building with offices, malls and residential areas.

Real estate investment trusts (REITs): this is where you invest in real estate trusts. When the mortgages generate profits, you get a share of it.

Tips on How to Be Successful In The Industry

For you to be successful in the real estate business you need to do a number of things:

Involve an attorney: regardless of the area of the industry that you are interested in always involve an attorney. A good attorney will help you in finding the right construction company. The attorney will also help you in writing professional rental contracts.

Neighborhood: the area where you invest in greatly determines the amount of money that you will make from your investment. To be on the safe side always go for a neighborhood that is growing or has the potential of growing.

Run the numbers: many investors assume that when they construct a building they will have a tenant, which is usually wrong. Before you invest in a building you should run the numbers and find out if you will be able to pay the mortgage if the property sits empty. If you find that you can’t be able to repay the mortgage in the event that the property doesn’t have a tenant for a month or two, chances are that you are stretching yourself too thin.

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