President Clinton's proposed $1.73 trillion balanced budget may have created some heat in the halls of Congress, but the real estate industry is quietly boiling over the potential loss of some of its tax benefits.
Under a proposal by the president last week to generate more tax revenue, publicly traded real estate investment trusts would undergo their most significant structural changes in more than a decade.
Many industry analysts and executives fear that the proposed changes could represent only the beginning of a series of setbacks for the successful REIT industry, which has grown from a fledgling handful of companies with less than $10 billion in 1990 to more than 200 companies valued at $150 billion today. REITS have become such a popular investment that mutual funds have been created to invest exclusively in them.
"Is this the elephant's nose under the tent? I don't think anyone knows yet, but I don't think it's good for the industry," said Robert A. Frank, director of research at Legg Mason Wood Walker Inc. and one of the nation's foremost REIT experts.
"It would slow down the growth of the industry by virtue of the fact that fewer new REITs would be formed, it would make existing REITs more valuable and enhance potential conflicts between real estate owners and their operating contractors," Frank said. "I don't think they're well thought out."
In all, the REIT industry estimates the changes would generate less than $400 million in new tax revenue over five years. REITs would still enjoy significant tax advantages, however, in that they would continue to be exempt from the corporate income tax in exchange for distributing 95 percent of their earnings to shareholders.
Although REITs have been the subject of legislation in years past -- the 1986 Tax Act brought numerous changes, for instance -- much of the current brouhaha stems from the recent fight over ITT Corp.
There, Hilton Hotels Corp. lost a bitter $10 billion bidding war with Starwood Lodging Corp. for the right to buy ITT, a loss Hilton blames on Starwood's so-called paired share or stapled ,, structure that helps it avoid taxes. Even with the stapled structure, though, Starwood is expected to pay as much as $150 million in taxes this year as a result of the ITT acquisition, since ITT's operations will continue to be taxable.
Some analysts, in fact, have already taken to calling the Clinton proposal to eliminate stapled REIT advantages "Bollenbach's Revenge," so named for the head of Hilton, who lobbied both Congress and the administration to change the rules in the wake of the ITT deal.
"I don't think it's right that we have to compete against companies that get a tax break that we don't," Stephen Bollenbach, once chief financial officer of the former Marriott Corp. and now Hilton's president and chief executive, said last week. "We shouldn't have a market economy where a chosen few get advantages -- it's not good economics, it's not good politics, it's not good business."
Unlike most trusts, paired share REITs can own both property and their corresponding operating businesses. A paired share REIT, for example, could both own a hotel as a real estate investment and control the company that runs it.
Under the Clinton proposal, existing stapled trusts would be prohibited from creating or running new operating entities. In addition to Starwood, existing publicly traded paired share REITS are Patriot American Hospitality Inc., Meditrust and First Union Real Estate Investments Inc.
In addition, Clinton's proposals would hamper the formation of new REITs by certain corporations; prevent REITs from owning or creating certain subsidiaries; and limit the amount of REIT stock any single person or company could control. The proposals, if enacted, would take effect in the government's 1999 fiscal year.
To counter the potential assault, the four stapled REITs whose wings would be clipped have hired top guns. Most notably, Starwood retained former U.S. Senate majority leader and presidential candidate Bob Dole to pitch its case on Capitol Hill.
The changes could have a local impact as well, if Rouse Co. is successful in acquiring a closely held, New York-based stapled trust known as Corporate Property Investors Inc.
If the anticipated $4 billion deal goes through and the Bollenbach-inspired changes take effect, Rouse would be prevented from using CPI's paired share structure to create or operate non-real estate businesses.
Rouse has declined to comment on any aspect of the CPI deal -- or whether such a transaction is in the works -- but sources say that the Columbia-based company is more interested in CPI's signature shopping malls than in the stapled trust format.
For its part, the National Association of Real Estate Investment Trusts Inc., the industry's Washington-based trade group, is taking a cautious stance toward the proposed changes.