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MONTHLY NEWSLETTER:  APRIL 2010 ISSUE

THE RE-EMERGENCE OF REITS
BY BRENT VAN ALFEN
PROVIDENCE FINANCIAL CO., LLC



The Re-emergence of what? No it is not a virus that we thought was finally eradicated by modern science!

REIT is a common acronym for Real Estate Investment Trust. This is a tax designation for a company that invests in real estate and is required to distribute 90% of its income, which may be taxable if held by the REIT, into the hands of the REIT investors. Taxes to be paid on these pass-through profits are then the responsibility of the REIT investors. The REIT structure was designed to provide a similar structure for investment in real estate as mutual funds provide for investment in stocks. This vehicle has brought considerable capital to the real estate markets. REITS may be publicly traded or privately held and they can look for equity investments or mortgage investments.

During the recent meltdown in the financial and real estate markets, REITS in general were hit pretty hard in their liquidity and share prices. Stock prices for many dropped as much as 70% to 80%. While I have not looked into the matter enough to be sure, I suspect there were some mortalities in the industry during that time, but many of them have recovered.

I don’t claim to be an expert on REITS in general; but I have encountered a few in the charter school world as they look for safe, profitable investments for their funds. Virtually all of the REITS with which I have had discussions are looking for equity investments or ownership of the facilities as opposed to granting a mortgage loan to their school clients. After becoming the owner, they want to enter into a long-term lease with the school tenant with the usual triple net, annual escalator, etc. features normally found in long-term commercial leases. This means that the school/lessee is responsible for all upkeep, repair, etc. costs associated with ownership but without the ownership. The lease escalators are generally aggressive, being based on a fixed percentage, the consumer price index, or a real estate value index of some sort. They often require a new appraisal periodically, and the lease is then based on the higher of the then current lease level or the appraised amount. Another cost that the school/lessee is usually responsible for is property taxes. In many states, if the property is owned by a for-profit company, even though the only tenant is a not-for-profit, property tax is due every year. Of course, the cost is passed through to the school tenant. In short, this is one of the most expensive ways for a charter school to occupy a building; they do not build any equity, and they will never own it. Even if a school pays too much for financing the purchase of its facility, at least the payments stay level so that in a few years there is a benefit as opposed to a lease, which never levels the lease payments.

REITS often like to associate themselves with education management companies (“EMO”). This association provides financial benefits to the EMO and the REIT. The perception that a school will be a better risk if managed by an EMO is attractive to the REITs; but as yet, I have not found a benefit for the school to lease its facility from a REIT. There are many of these REIT/EMO partnerships that remind me of a couple of vultures feeding off of an emaciated carcass. I cannot count how many schools have called me about how to get out of a bloated EMO contract and/or similarly bloated lease contract.

While there are superb Education Management Companies with fair prices that I heartily recommend, there are others I would never recommend, because they are neither good at what they do nor are their fees reasonable. I have yet to discover a REIT that offers fair value to a charter school when compared to financing a purchase of their facility. A simple lease-versus-buy analysis will answer that question for a school that wants to evaluate those options. If you would like help evaluating this, give me a call. There is no charge or obligation

For information contact Brent Van Alfen, Providence Financial Co., LLC
Phone: 801-299-8555 Email: brent@providencefinancialco.com






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