A return of capital lowers the investors cost basis in an asset. Reits could raise capital at a cost lower than the return they could get from investing that capital in. Reit capital structure and firm value american economic association. Introduction compare and contrast worldwide real estate investment trust reit regimes 3 pwc has a global team of real estate tax and legal professionals who have conceived this booklet to keep you up to speed and allow you to compare the various regimes. Master limited partnerships and real estate investment trusts. So in this example reit a has a higher cost of capital than b, even though a can borrow at a lower rate. Three essays on equity reits cost of capital iskandar aditya arifin, ph. Tax reform is a windfall for reit investors the new tax law benefits reit investors more than it does the real estate investment trusts themselves. Opportunities and challenges facing the us reit industry. The combination of these corporate and shareholderlevel advantages typically provides reits with a lower cost of capital than other corporations.
A companys cost of capital is the cost of its longterm sources of funds. A companys cost of capital is often referred to as its hurdle rate when used to evaluate a commitment of capital to an investment or project, as it is the minimum rate of return the company can earn on existing assets and still meet the expectations of its capital providers. Macroeconomic uncertainties part of financial forecasts microeconomic change predictability of disruptive business models cost of capital the challenges of low interest rates, populism, and new technologies guest. The future role of reits in real estate finance by anthony downs. Nine years on from the beginning of the global financial crises, the opportunities and challenges facing the us real estate investment trust reit industry and the us real estate market in general are accentuated by the relatively mature state of this real estate cycle.
One quick way to determine a reits nominal equity capital cost is to estimate the reits expected per share ffo for the next 12. This paper outlines the growth and development of the equity reit market. Reits will likely face a higher cost of capital in 2014, along with the likelihood of higher interest rates, according to paul adornato, managing director with bmo capital markets. Note, this same argument applies whether or not either or both investors are reits. Put the expertise and resources of our reit team to work for you. Unsecured reit debt and its role in reit capital structure by joshua p. Market capitalization weighted indicies designed by wachovia to measure the performance of the u. Weighted average cost of capital the commercial group. Based on this motto, we focus on the following subjects. The cost of capital is the companys cost of using funds provided by creditors and shareholders. A lower credit rating increases a reits cost of debt capital, potentially reducing its available growth opportunities. Reit capital raising buoyed by low interest rates 7182017 by sarah borchersenketo reits raised more capital in the first half of the year than they did in the same period of 2016, as companies continue to take advantage of low interest rates, according to analysts.
A focus on corporate flexibility and wealth creation. Pdf on the capital structure of real estate investment trusts reits. They document that a higher level of environmental performance in a reits portfolio is associated with a lower cost of equity capital. Understanding balance sheet risk in reits seeking alpha. When interest rates are low, the reits cost of capital is low, romano says. Issues in estimating the cost of capital for equity reits citeseerx.
Cost of capital is the required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. Today, average leverage among reits is near an alltime low of 32%, compared with 63% in 2008 ex. Small and midcap reit relative total returns exhibit significantly higher variation by comparison. Reit balance sheets are generally stronger than ever. Further findings imply that reits with increased trading volume and stock prices pay lower fees, suggesting these characteristics lower.
Longterm capital gains from carried interests held less than three years will be treated as shortterm capital gains i. Old reits and new reits zelllurie real estate center. A real estate investment trust reit is a company that owns, operates, or finances incomeproducing properties. A reit must maintain a cost of capital thats lower than the cash yield on the new properties it buys in order for affo per share and its dividend to grow sustainably over time. A short lesson on reit taxation intelligent income by. Once delevered, these new reits have become low capital cost operators, fueling. Weighted average cost of capital for an apartment reit discussion of results weighted average cost of capital calculations based on historical data. The smaller companies dont systematically underperform, its just that their performance tends to be more volatile. Compare and contrast worldwide real estate investment. Paragon is an upscale retail mall managed by sph reit. Reits present an interesting case study for examining the cost of equity capital. Despite the disruption in the equity markets and the rising interest rates, the strength of the stalwart reits bestinclass capital structure positions the company to.
The second way comes from the impact of low interest rates on reit balance sheets. A reits leverage ratio, usually defined as debtebitda or sometimes debtadjusted ebitda, is very important because this is a major factor that credit rating agencies use to determine how risky a reits debt is. Lowest contractual payment obligations store is landlord of choice because. Reit management, however, claims that unsecured debt provides a lower cost of capital and greater operational flexibility. Cost of equity capital i mportant as the concept is, there seems to be no general consensus on how to calculate a reits cost of equity capital. Reit stands for real estate investment trust, and a reit is a particular type of investment vehicle thats designed to allow multiple investors to put their money together into a common pool for. Reit capital raising buoyed by low interest rates nareit. By having reit status, a company avoids corporate income tax. Leverage and value in apartment reits university of michigan. An analysis of the capital structure of commercial real estate investment trusts finds that the strongest reits overall tend to employ lower leverage and longer debt maturity, maintain larger proportions of fixed. This means that you only pay tax on the return of capital portion of a reit distribution when you sell the security. When a reits equity price is trading above the value of the reits real estate, it can issue shares to raise capital in the secondary market and acquire properties. Thats because generally the cost of equity is higher than the cost of debt, which means that debt is a cheaper way to leverage equity capital and lower the overall cost of capital.
This is because a return of capital reduces your cost basis. The biggest surprise in the reit sector during 20, according. You have to consider the cost of your equity as well as the cost of. And the cost of each source reflects the risk of the assets the company invests in. Learn all about real estate investment trust taxation, which accounts to own reits in, the impact of tax reform, and more. Risk premiums betas current riskfree rates waccs could be higher after taking into consideration. Whats more, apples theoretical cost of equity capital in 1998 was lower than the 8. The navbased pricing model 3 executive summary overview our navbased pricing model has been a driver of our stock recomendations for over twenty years it has played an instrumental role in our successful recommendation track record the compartmentalized nature of the model forces discipline to consider all relevant valuation issues the basics nav is the starting point. Unsecured reit debt and its role in reit capital structure. Stor february 2017 corporate presentation store capital.
Master limited partnerships and real estate investment. The last component capital gains is just as it sounds. This occurs when the company sells one of its real estate assets and realizes a profit. As you grow bigger, the cost of borrowing money in the form of interest and issuing equity in the form of distributions is usually reduced. Reits facing higher cost of capital in 2014, analyst says. The return of capital portion of a reit distribution can be thought of as a deferred tax. Wachovia hybrid and preferred securities whppsm indicies. Weighted average cost of capital for an apartment reit. The liquidity crisis led to a dramatic reduction in value of existing properties, and provided an opportunity for the reit industry to expand. Another portion of reit dividends may consist of capital gains. For one, the requirements and limitations of the reit structure make the industry unique with respect to other equities.
Cost of capital includes the cost of debt and the cost of equity. We believe the cost and extended time to build new office properties is an additional risk for. We offer a full suite of corporate and investment banking products and services for both public and private real estate owners. To qualify as a reit with the irs, a real estate company must agree to pay out at least 90 % of its taxable profit in dividends and fulfill additional but less important requirements. Minimum rate of return earned on new investment, as not to dilute. Cornell university school of hotel administration the. In this study we discuss the issue of the cost of public capital raised by real estate investment trusts reits and the cost of. Topic introduction to real estate investment trust. Due to internal revenue service irs regulatory changes that have been phased in since 2011, td ameritrade is now required as are all brokerdealers to report adjusted cost basis, gross proceeds, and the holding.
The smaller reits had higher highs and lower lows than their larger peers, owens says. Companies that manage, operate and own a real estate portfolio consisting of income. After the final distribution has been made, if all your cost basis has not been paid back, at this point you can claim a capital loss for the remainder. A conversion of upreit units to reit shares is generally a taxable event that will result in shortterm capital gain to the holder if done prior to the threeyear holding mark. Weighted average cost of capital for an apartment reit introduction using a standard corporate finance approach, the weighted average cost of capital wacc is calculated in four steps. Further evidence on the capital structure of reits old dominion. We also provide some comparisons of these sample statistics between those reits that have at least 50% of their asset. Payments received are first recorded as return of capital and then any payments in excess of your adjusted cost basis are capital gains. Tax reform is a windfall for reit investors real estate.