Now cash-constrained, REITs face “potential existential crisis”

The coronavirus has battered revenues, hobbling trusts that must pay out 90% of taxable income to maintain their status

The financial challenges caused by the coronavirus is causing some REITs to change paying out their regular cash dividends (Credit: iStock)
The financial challenges caused by the coronavirus is causing some REITs to change paying out their regular cash dividends (Credit: iStock)

UPDATE, March 26, 11:05 a.m.: Covid-19 has been battering real estate investment trusts, some of which have had to shut down hotel, mall and other properties to prevent the spread of the virus. The closures have strained the cash flow of those companies, which are required to pay out the vast majority of their taxable income to maintain their REIT designation.

The financial challenges caused by the new coronavirus is causing some REITs to change — or delay — paying out their regular cash dividends to help make sure they have enough money on hand. And a major industry group has stepped up to ask Washington for help.

“It is a potential existential crisis for REITs,” said Joseph Gulant, chair of the business department at Blank Rome.

Companies that are classified as REITs, which own, operate or finance real property, pay out 90 percent of their taxable income to investors, income that REITs don’t pay taxes on.

As taxable income slows because of Covid-19, the burden of making those dividends may cause some public REITs in particular to slash payments or up the amount of stock they are allowed to pay out in lieu of cash. Others have opted to delay or suspend payments for the time being.

For instance, Park Hotel & Resorts said it was pushing its first-quarter dividend to April, though dividend payments could be suspended until the end of the year. City Office REIT said Wednesday that because of Covid-19 uncertainty, it was issuing a dividend of 15 cents per share for the quarter, down from nearly 24 cents last quarter. And mall owner Macerich said because of the uncertainties surrounding the coronavirus and the need to remain financially flexible, 80 percent — the highest allowable amount — of the firm’s dividend would be paid out in stock, with the rest in cash.

“It is phantom income,” Gulant said of REITs opting to pay out greater proportions of dividends with stock. “There’s nothing [investors] can really do about it but groan.”

Nareit, an organization that advocates for the REIT industry, this month sent a letter to the Treasury Department asking the agency re-issue guidance allowed during the financial crisis. The letter, obtained by The Real Deal, calls for allowing REITs to increase the maximum stock component to 90 percent, given how Covid-19 has “significantly impacted all REITs, but most severely in the lodging, retail, and healthcare sectors.”

“We believe that Congress, the Treasury and other agencies recognize the important economic role REITs play and will take appropriate action to address the industry’s needs in this crisis,” Nareit said in a statement to TRD.

Public REITs have long been considered safe investments because they have built-in, steady revenue streams — usually property rents for equity REITs or debt service payments for finance REITs.

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But markets, including REITs, have been hit hard over the past month. Fears that the coronavirus will slow the global economy has led to market turmoil and prompted the White House and the Senate to reach an agreement on the largest stimulus deal in history to contain the economic fallout from the virus.

Paying out more stock than usual to shareholders should alleviate much of the cash-flow burden REITs may be facing now, said Barry Herzog, partner and chair of the tax practice at Kramer Levin Naftalis & Frankel.

But for shareholders that still have to pick up the tax on those dividends, getting paid in stock means less cash on hand. “You may have unhappy shareholders in that respect, and that’s a non-tax consideration a REIT will have to grapple with,” Herzog said.

Other REITs might not even have any taxable income for the year. “If you don’t have taxable income you’re technically not required to distribute anything,” said Eric Green of Berkowitz Pollack Brant Advisors + CPAs, based in Boca Raton, Fla.

With public REITs, “there are certain expectations that their shareholders have … and some of them still distribute some dividends,” he added. “But with the market being affected negatively, and most REITs stocks are affected negatively as well, they may need to cut their dividends.”

But while REITs may already be cutting dividends and paying out more in stock than investors may like, experts said it would be unlikely for REITs to all together ditch their designation — a process called “de-REITing” — in an effort to keep cash on hand to run operations. De-REITing was a move that some experts had floated in 2017, when the federal tax change cut the corporate tax rate to 21 percent.

The devastation the coronavirus has caused to the economy has made complying with all of the requirements increasingly difficult for REITs, said Michelle Jewett, a partner at Stroock & Stroock & Lavan who focuses on tax law.

If a REIT can’t hit certain requirements to maintain their status, it could automatically lose its status or pre-emptively terminate that status, said Herzog of Kramer Levin. But if a company were to convert to a regular corporation, it would not only be taxed at a higher rate — in exchange for dropping the distribution requirement — it also would be prohibited from trying to become a REIT again for five years.

“It’s a big decision to terminate your status, because you can’t really turn back,” he said.

Correction: A previous version of this article misspelled the last name of Michelle Jewett, a partner at Stroock & Stroock & Lavan.