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Remember REIT’s? A Lot of Bankers Would Rather Not

By D Magazine |

Ask your banker if he’s lent much money to real estate investment trusts. If he just stares, chances are he has. If he smiles, takes on a sagacious look and raises his finger to speak, he probably hasn’t.

While big New York and Chicago banks bemoan the day they lent a dime to REIT’s, Dallas’ largest banks are being cheered for the tiny volume of loans they have out to REIT’s, investment vehicles currently rated with New York City bonds and W. T. Grant loans as the most regretted financial creatures of the decade. And while REIT’s all over the country are wallowing in their own unre-paid loans, a couple of Dallas trusts are doing reasonably well.

Created by Congress in 1961, REIT legislation gave the little guy a chance to make money in real estate by joining thousands of other small investors in buying shares in an REIT, which in turn invested the shareholders’ money in real estate. The advantage is simply this: the REIT’s earnings are tax-free so long as 90 per cent of the profits are distributed to shareholders. While an ordinary corporation pays the 48 per cent corporate income tax and then pays dividends, the REIT skips the tax and passes the untaxed profits along to investors.

Some big banks started their own REIT’s, to which they lent money and also collected fees for “advising.” Take Chase Manhattan, for instance. Chase’s REIT is considered one of the most imperiled in the nation, with $987 million in assets, including $27 million of the bank’s own money. Last fiscal year the REIT lost $166.5 million.



Republic of Texas chief financial officer W. C. Hat-field says, “We seriously considered starting an REIT but determined that it would be a conflict of interest. If the loans were good loans, then our bank’s real estate department should make them. If they were bad loans, then we shouldn’t make them at all, even through an REIT.”

Only 1.8 per cent of Republic’s loan portfolio is in REIT loans, Hatfield says, adding that so far no loan has been foreclosed, although a few are not current on interest payments. “We were aware of the old banking maxim that you can’t borrow short and lend long without get-ing into trouble,” Hatfield says. “So we just stayed out of the REIT business.” (In addition to equity capital, REIT’s lend money which they borrow from banks through short-term loans. If the interest rate an REIT pays on its short-term bank loans exceeds the interest rate the REIT earns on money it lends out for two or three years, the REIT suffers.)

First International’s plan-ning and investment officer, Leonard Huber, says much the same as Hatfield, but adds one other reason for his bank’s avoiding its own REIT. “There’s a practice called reciprocal lending,” Huber says. “If a bank lends money to your REIT, you might be expected to lend money to its REIT. We didn’t want any part of that.”

In its fall report, New York investment house Drexel Burnham & Co. praised Republic and First International for staying away from the seven largest “troubled” REIT’s. Drexel Burnham said “It seems obvious that some banks made a conscious and very prudent decision not to get involved with the largest REIT’s. The champions in this category seem to be Republic of Texas and First International.” The report goes on to point out that Republic has no loans out to the seven largest “troubled” REIT’s and that first International only has a half million lent to them. By contrast, Chase Manhattan has $294 million out, while First National Bank of Chicago has $221 million loaned to the seven REIT’s.

Among Dallas’ three largest REIT’s, the picture ranges from good to gloomy. Perhaps the strongest local REIT at the moment is Henry S. Miller Realty Trust. Miller’s trust is an “equity”, trust, which invests in completed buildings (instead of engaging in lending activities, as do most REIT’s). About 70 per cent of Miller’s money is invested in such properties, including Hillside Shopping Village, Kiest-Polk Shopping Center and Golden Triangle Shopping Center. Most of Miller’s shopping centers, office buildings and warehouses are fully leased, which accounts for the low proportion of bad properties in Miller’s portfolio. Only 10.5 per cent of Miller’s assets are not producing income, compared with the REIT industry average of 48 per cent.

Realty Trust Newsletter rates Miller’s $32 million portfolio as “average in market risk and investor appeal,” one of the higher ratings given by editor Kenneth Campbell, who makes his living watching REIT’s for Audit Investment Research. Another plus for Miller – the trust is paying a quarterly dividend, something only 40 out of 130 REIT’s are currently able to do.

Among the nation’s ten largest “mortgage” REIT’s, Dallas’ Lomas & Nettleton Mortgage Investors is one of the healthiest. Says John Sexton, executive vice president of the REIT’s parent, Lomas & Nettleton Financial Corporation: “One of our biggest advantages is experience. When L&N Financial Corporation went public in the early ’60’s, it got into lots of bad real estate loans. Working out of bad loans is damned fine experience. After you’ve fought your way out of bad loans, you understand what goes into making good ones.”

L&N Mortgage Investors has employed two conservative policies which have paid off since the real estate collapse. First, the parent company, which originates the loans, puts its money where its mouth is, funding 20 per cent of all of its subsidiary REIT loans. Second, the REIT goes light on bank borrowing. While the average REIT has $3.20 debt for every $1 equity, L&N Mortgage Investors is lightly leveraged with only $1.80 debt for every $1 equity. The results are clear. Lomas & Nettleton has only 14 per cent of its assets failing to draw income. That compares with 62 per cent for the average “mortgage” REIT.

Still times aren’t the best for L&N Mortgage Investors, whose stock has fallen from a high of near 50 to today’s 13. Its $295 million portfolio is rated by Drexel Burnham as one of the 12 healthiest among the big 50. Realty Trust Review’s Campbell says “Lomas & Nettle-ton has some damned fine people who have done an excellent job considering they’re working in a depressed real estate market.” Despite that, Campbell rates L&N “below average in investor appeal with a high risk of dividend fluctuations.” The trust is still paying a regular dividend.

Easily Dallas’ most troubled REIT is Justice Mortgage Investors, sponsored by Glenn Justice Mortgage Company. No less than 81 per cent of Justice’s $81 million loan portfolio is not earning interest. The integrity of this figure is probably guaranteed by Justice’s bank credit agreement which states that any loan 60 days overdue must be qualified as non-interest bearing. Says a Justice officer, “We think it’s better to classify a note past due than it is to bring it current by renegotiating it with the stroke of a pen.”

Justice is taking some hard knocks these days. Drexel Burnham places Justice in its worst category and Campbell rates Justice as “not recommended – an extreme risk.” Justice’s stock has plummeted from the high 20’s to a recent quote of 1 5/8. Its 1979 bonds, face value $1,000, sold recently for $180. Perhaps one of Justice’s problems is that it went public in early 1972, at the height of the boom, and quickly leveraged itself heavily, hoping to maximize its take of the boom’s profits. Justice is stretched thin with $3.20 in debt for every dollar in equity.

Times are likely to remain precarious for REIT’s -signs of a major upturn inthe depressed building market simply aren’t apparent.The Dallas REIT’s aren’tmaking new loan commitments and many monthswill pass before they arelikely to do so. The REITstrategy: dig in and hold onto what you’ve got.

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