Developing a Convention Center REIT

If private investors from Cleveland and selected other cities decided to form a REIT to develop and finance privately-owned convention centers, how should they proceed? First, there is considerable real estate, legal and accounting expertise already available in most major cities about forming and operating real estate investment trusts (REITs). Also, a National Association of Real Estate Investment Trusts (NAREIT) exists.

What is a REIT? According to NAREIT, a REIT is a company that owns, and in most cases, operates income-producing real estate such as apartments, shopping centers, offices, hotels and warehouses. Some REITs also engage in financing real estate. The shares of most REITs are freely traded, usually on a major stock exchange.

A company that qualifies as a REIT is permitted to deduct dividends paid to its shareholders from its corporate taxable income. As a result, most REITs remit at least 100 percent of their taxable income to their shareholders and therefore owe no corporate tax. Taxes are paid by shareholders on the dividends received and any capital gains. Most states honor this federal treatment and also do not require REITs to pay state income tax. To qualify as a REIT, a company must distribute at least 90 percent of its taxable income to its shareholders annually. However, like other businesses, but unlike partnerships, a REIT cannot pass any tax losses through to its investors.

How are REITs financed? Historically, income-producing commercial real estate often was financed with high levels of debt. Properties provided tangible security for mortgage financing, and the rental income from those properties was a clear source of revenue to pay the interest expense on the loan. Property markets often were dominated by developers or entrepreneurial businessmen who were attempting to build personal fortunes and who were willing to take on huge risks to do so. Prior to the real estate recession of the early 1990s, it was not uncommon for individual properties to carry mortgages that represented over 90 percent of the properties’ estimated market value or cost of construction. Occasionally, loan-to-value ratios went even higher. The severe real estate recession of the early 1990s forced many real estate lenders, developers and owners to reconsider the appropriate use of debt financing on real estate projects.

Today, properties owned by REITs are financed on a much more conservative basis. On average, REITs are financing their projects with about half debt and half equity, which significantly reduces interest rate exposure and creates a much stronger business operation. Two-thirds of the REITs with senior unsecured debt ratings are investment grade.

Does a convention center REIT exist? I have not found one yet. Private recreational facilities have been financed and operated through REITs however. A limited number of convention centers have been privately financed by other means across the country. Could a convention center REIT be formed that contained 4-5 convention centers. Technically, I see nothing that would prevent that from happening. The key is to make it an attractive investment opportunity so people would want to invest.

Stay tuned as I explore this issue further.

National Association of Real Estate Investment Trusts.