Real Estate Investment Trusts

Anna T. Pinedo, Morrison & Foerster Thomas A. Humphreys, Morrison & Foerster Halle Benett, UBS Investment Bank

2009 Morrison & Foerster LLP All Rights Reserved

Why a REIT?

Real Estate Investment Trusts

A REIT is an investment vehicle designed to allow investors to pool capital to invest in real estate assets Publicly traded investment vehicle Pass-through entity for U.S. federal income tax purposes Can be classified into three categories:
Equity REITs Mortgage REITs Hybrid REITs

Real Estate Investment Trusts

Equity REITs
Real REITs that directly own, invest in, or acquire, manage, or develop real property Derive revenue from income generated by rents Include shopping mall, apartment complex, commercial office, hotel and other similar REITs

Real Estate Investment Trusts

Mortgage REITs
Invest indirectly in real property through investments in mortgages, CMBS, RMBS, etc. Generate income from interest earned

Hybrid REITs
A combination of equity and mortgage interests in properties

Real Estate Investment Trusts

Capital Structure
Equity
Common Preferred

Debt
Subordinated Senior

Management
Internal External

Why Invest in REITs

Access
Provides retail investors with an opportunity to participate in real estate investments

Tax advantages Highly liquid Dividend-paying Professionally managed

Mortgage REITs

History of Mortgage REITs

Construction loan REITs formed by several major banks in the 1960s and 1970s
Example: Chase REIT Made loans to developers, other real estate owners When the real estate market went into a downturn, many construction loan REITs went bankrupt in the mid-1970s as the loans soured

History of Mortgage REITs

Next wave of mortgage REITs began cropping up in the 1980s
Examples: Strategic Mortgage Investments, Inc., Countrywide REIT, Capstead Mortgage Corporation Mortgage REITs sold off the 90% senior interests in loans originated by the REIT while retaining a 10% subordinated interest. IRS granted PLRs allowing nonrecognition on the sale of senior interests. PLRs later revoked after reconsideration of technical issues. Mortgage REITs shifted to borrowings through CMOs. CMOs were treated as borrowings rather than sales for US federal income tax purposes. 1986 Act created REMICs, intended to be the sole vehicle for securitizing mortgages. REITs may also securitize mortgages (old-style CMOs), but limitations exist on excess inclusion income
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History of Mortgage REITs

In the 1990s, mortgage REITs boomed. Large REITs, such as American Home Mortgage, Impac, and others, created successful businesses originating and securitizing residential and commercial mortgages. A few REITs suffered in the mid-1990s, including, for example, Mortgage Realty Trust, which filed for bankruptcy in 1995, and Crimi Mae, which filed for bankruptcy in 1998.

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History of Mortgage REITs

During the early 2000s, many mortgage REITs expanded into subprime lending. Beginning in early 2007, such mortgage REITs began to feel the heat. The financial crisis wiped out an entire segment of these REITs. Examples: American Home Mortgage Investment Corp., New Century Financial Corporation, and Peoples Choice Financial Corporation, among others.

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Today
At least 14 mortgage REITs have filed registration statements to raise capital in the last several months General Investment Strategies
Invest in high quality securities Originate mortgage loans Invest in distressed debt

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REIT Market Update

Mortgage Finance
Company Non-Agency REITs Chimera Investment Corp. Redwood Trust Inc. PennyMac Mortgage Investment Invesco Mortgage Capital Inc. MedianNon-Agency REITs CIM RWT PMT IVR 3.49 13.94 18.41 19.94 2,339 1,080 308 199 10.8 (0.2) na na 5.3 1.2 (6.5) na na (2.7) (2.5) (14.2) (2.1) (0.3) (2.3) (11.0) (5.2) (2.5) (2.0) (3.9) 7.8 46.5 73.6 14.6 30.5 6.5 7.6 6.1 6.2 6.3 1.07 1.35 0.92 1.02 1.04 1.07 1.35 0.92 1.02 1.04 9.2 7.2 na 7.2 5.0 5.0 10.0 4.0 5.0 Ticker Share Price ($) Market Cap ($mm) LTM (%) Price Change YTD 3 Month (%) (%) 1 Week (%) Price/EPS 2009E 2010E (x) (x) Price/ Book Tang. (x) Book (x) Dividend Yield (%) Long-Term EPS Growth (%)

Agency REITs
Annaly Capital Management MFA Financial Inc. Hatteras Financial Corp. Capstead Mortgage Corp. Anworth Mortgage Asset Corp. American Capital Agency Corp. Cypress Sharpridge Investments New York Mortgage Trust Inc. MedianAgency REITs Overall Median Overall Mean Note: Market Data as of October 30, 2009 NLY MFA HTS CMO ANH AGNC CYS NYMT 16.91 7.42 28.10 13.16 7.13 26.00 13.35 6.08 9,347 1,651 1,017 909 742 502 242 57 21.1 37.4 32.0 34.3 28.9 44.4 na 211.8 34.3 32.0 46.7 6.6 26.0 5.6 22.2 10.9 21.7 na 176.4 21.7 10.9 29.3 0.4 0.3 (0.8) (1.5) (5.4) 14.1 0.8 3.1 0.3 (0.6) (0.7) (3.1) (3.5) 1.5 (0.4) (7.6) (9.5) (1.0) (21.3) (3.3) (3.3) (5.5) 6.2 6.9 5.8 5.7 5.8 4.3 5.8 5.7 5.8 6.0 15.7 5.8 5.9 5.6 5.5 5.5 5.5 5.3 4.5 5.5 5.7 5.8 1.02 1.06 1.08 1.07 0.97 1.17 0.98 1.24 1.07 1.06 1.08 1.03 1.06 1.08 1.07 0.97 1.17 0.98 1.24 1.07 1.07 1.08 14.2 11.9 15.7 17.6 18.0 23.1 15.1 15.4 14.2 12.0 5.0 3.0 5.0 4.5 1.0 5.0 na na 4.8 5.0 4.8

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REIT Market Update

Mortgage Finance
Company Ticker Share Price ($) Market Cap ($mm) LTM (%) Price Change YTD 3 Month (%) (%) 1 Week (%) Price/EPS 2009E 2010E (x) (x) Price/ Book Tang. (x) Book (x) Dividend Yield (%) Long-Term EPS Growth (%) Commercial Mortgage REITs 2009 IPOs Starwood Prop Trust Inc. Colony Financial Inc. CreXus Investment Corp. Apollo Comm Real Estate Fin Median 2009 IPOs Commercial Mortgage REITs Pre 2009 IPOs NorthStar Realty Finance Corp. iStar Financial Inc. Gramercy Capital Corp. Newcastle Investment Corp. Anthracite Capital Inc. NRF SFI GKK NCT AHR 3.53 2.09 3.14 1.92 0.72 241 208 157 102 57 (35.7) 81.7 110.7 (52.6) (79.2) (9.7) (6.3) 145.3 128.6 (67.7) (1.4) (14.0) 118.1 195.4 24.1 (1.4) (22.3) 12.1 (16.5) (13.3) 4.9 nm nm na 4.1 nm nm nm na nm 0.19 0.14 0.21 nm 0.16 na 0.15 0.57 nm 0.16 11.3 na na na na STWD CLNY CXS ARI 20.13 19.45 14.18 17.91 979 285 253 188 na na na na na na na na na na na na (0.9) (2.0) (1.0) (2.3) (1.50) nm na na na 9.9 na na na nm na nm nm na na na na na nm na na 10.0 na na na 10.00

Arbor Realty Trust Inc.

Capital Trust Inc. JER Investors Trust Inc. Realty Finance Corporation Median Pre 2009 IPOs Note:

ABR
CT JRT CRTYZ

2.00
1.96 0.55 na

51
43 3 na

(42.4)
(71.9) (98.1) na (62.2)

(32.2)
(45.6) (94.1) Na (38.9)

10.5
23.3 48.6 na 36.4

(18.0)
(18.3) (3.5) na (15.9)

nm
nm na na 4.1

nm
nm na na

0.19
0.13 0.16 na 0.16

0.19
0.13 0.16 na 0.16

na

na
na na na

Market Data as of October 30, 2009

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Historical Valuations
Price to NTM EarningsLast 10 Years
30.0

Dividend YieldLast 10 Years

20.0 18.0

25.0 16.0 20.0 14.0 12.0 15.0 10 yr Avg: 9.2x 13.5%

(% )

(x)

10.0 8.0 6.0

10 yr Avg: 10.2%

10.0

5.0

6.0x

4.0 2.0

0.0 1999

2001

2003

2005

2007

2009

0.0 1999

2001

2003

2005

2007

2009

REIT Median
Source: FactSet Note: 1 Median includes Annaly Capital, Anworth Mortgage, Capstead Mortgage, MFA Financial and Redwood Trust

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Historical Valuations
Price to BookLast 10 Years
2.00 1.80 1.60 1.40 1.20 10 yr Avg: 1.10x 1.02x

(x)

1.00 0.80 0.60 0.40 0.20 0.00 1999

2000

2002

2003

2004

2005

2006

2007

2008

2009

REIT Median
Source: FactSet Note: 1 Median includes Annaly Capital, Anworth Mortgage, Capstead Mortgage, MFA Financial and Redwood Trust

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REIT Registrations
REITs Currently in Registration
Initial Filing Date Current Filing Date Issuer Deal Value ($mm) Manager Asset Class Focus Incentive Fee?

8/28/09 8/28/09 7/29/09

8/28/09

Marathon Real Estate Mortgage Trust

300 500 500

Marathon Asset Management Brookfield Transwestern

Residential Commercial Whole Mortgage Loans & Subordinated Debt

Yes Yes Yes

10/21/09 Brookfield Realty Capital Corp. 9/2/09 Transwestern Realty Finance Inc

7/27/09
7/17/09 7/14/09 7/13/09 7/08/09 6/12/09 5/21/09 8/15/08 6/04/08 4/25/08 2/29/08 2/12/08 5/11/07

10/30/09 Bayview Mortgage Capital LLC

9/29/09 Ladder Capital Realty Finance Inc

500
400 200 300 500 500 250 250 200 200 250 250 200

Bayview Asset Management (Blackstone)

Ladder Capital Finance Holdings (UBS DRCM, TowerBrook and GI Partners) Ellington Management Group Angelo Gordon & Co. (GE Capital) AllianceBernstein Legg Mason Waterfall Asset Management (M.D. Sass Macquarie) CW Financial Services na Highland Financial Holdings Group FII Holdings MFA Mortgage Investments Marathon Asset Management

Diversified
Commercial Diversified Diversified PPIP Diversified PPIP Diversified PPIP Residential Non-Agency MBS Commercial Commercial Residential Agency MBS Diversified Residential Non-Agency MBS Commercial

Yes
No Yes Yes Yes Yes No Yes Na No Yes No No

10/08/09 Ellington Financial LLC 7/13/09 9/18/09 10/6/09 7/29/09 11/7/08 6/04/08 9/22/09 5/30/08 5/15/09 6/28/07 AG Financial InvestmenTrust Inc t Foursquare Capital Corp Western Asset Mortgage Capital Sutherland Asset Management Corp CWCapital Realty Trust Inc Petra Real Estate Opportunity Trust Madison Square Capital Inc Point Asset Management Inc MFResidential Investments Inc Marathon Real Estate Finance Inc

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Recent REIT IPOs

IPO Date 9/23/09

Issuer Apollo Commercial Real Estate Finance Colony Financial Inc

Manager Apollo Global Management

Completed IPO Size ($mm) 200

Gross Proceeds ($mm) 1 210

Asset Class Focus Commercial Loans

Incentive Fee? No

9/23/09

Colony Capital

250

293

Commercial Loans

Yes

9/16/09

CreXus Investment Corp.

FIDAC (Annaly)

200

268

Commercial Loans

No

8/11/09

Starwood Property Trust Inc

Starwood Capital Group

810

952

Commercial Loans

Yes

7/29/09

PennyMac Mortgage Investment Trust Invesco Mortgage Capital Inc.

PNMAC Capital Management (BlackRock, Highfields) Invesco Ltd. (NYSE: IVZ)

320

335

ResidentialDistressed Loans

Yes

6/25/09

170

206

DiversifiedPPIP

No

6/11/09

Cypress Sharpridge

Cypress Sharpridge Advisors LLC

100

115

Residential Agency MBS

No

Source: Company Filings Note: 1 Gross proceeds including over-allotment option and private placement

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Tax Requirements

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Taxation of REITs
Requirements: Section 856(a)
Centralized management Transferable shares C Corporation for tax purposes Not a financial institution or insurance company Widely held (5 or fewer test, 100 shareholder requirement) Income and assets tests Distribution requirements

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Income Test
At least 75% of a REITs gross income must be:
Rents from real property; Interest on obligations secured by mortgages on real property or on interests in real property; Gain from the sale or other disposition of real property (including interests in real property and interests in mortgages on real property) which is not dealer property; Dividends or other distributions on, and gain (other than gain from prohibited transactions) from the sale or other disposition of, shares in other REITs;

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Income Test
Abatements and refunds of taxes on real property; Income and gain derived from foreclosure property; Commitment fees; Gain from the sale or other disposition of a real estate asset which is not a prohibited transaction; and Qualified temporary investment income.

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Income Test
At least 95% of the REITs gross income must be derived from:
Items that meet the 75% income test; Other dividends; Other interest; and Gain from the sale or other disposition of stock or securities that are not dealer property.

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Asset Test
At least 75% of the value of the REITs total assets is represented by real estate assets, cash and cash items (including receivables), and Government securities (base securities).
25% asset test. Not more than 25% of the value of the REITs total assets is represented by securities (other than base securities). 25% asset test. Not more than 25% of the value of the REITs total assets is represented by securities of one or more TRSs. 5%/10% asset tests: except for TRSs and base securities,
Not more than 5% of the value of the REITs total assets is represented by securities of any one issuer, The REIT does not hold securities possessing more than 10% of the total voting power of the outstanding securities of any one issuer, and The REIT does not hold securities having a value of more than 10% of the total value of the outstanding securities of any one issuer.

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Distribution Requirements
The REIT provisions do not apply to an entity for a taxable year unless the deduction for dividends paid during the taxable year equals or exceeds: (i) the sum of (a) 90% of the real estate investment trust taxable income for the taxable year (determined without regard to the deduction for dividends paid and by excluding any net capital gain); and (b) 90% of the excess of the net income from foreclosure property over the tax imposed on such income by Code Section 857(b)(4)(A) minus (ii) any excess noncash income.

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Prohibited Transactions Tax

A REIT is subject to a 100% tax on net income derived from prohibited transactions. Prohibited transaction means a sale or other disposition of dealer property. Dealer property is: stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

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Taxable REIT Subsidiary

A REIT may enter into otherwise prohibited activities through a TRS. The TRS itself is taxable as a corporation. For purposes of the asset tests, 25% of a REITs assets can be held in TRSs. With respect to the income tests, the Code allows the TRS to perform noncustomary services which would otherwise not qualify as good income.

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Foreclosure Property
Income and gain from foreclosure property is good income for both income tests even if it would not otherwise qualify as good income. Thus, the income cannot disqualify the REIT. However, the price for this protection is that the REIT is subject to tax at regular corporate rates on income from foreclosure property that does not otherwise qualify as good income under the 75% income test. Foreclosure property means any real property (including interests in real property), and any personal property incident to such real property, acquired by a REIT as the result of such REIT having bid in such property at foreclosure, or having otherwise reduced such property to ownership or possession by agreement or process of law, after there was default (or default was imminent) on a lease of such property or on an indebtedness which such property secured. Foreclosure property does not include property acquired by the REIT as a result of indebtedness arising from the sale or other disposition of dealer property not originally acquired as foreclosure property.

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Captive REITs
A B Assets

Taxpayer
Income

REIT Subsidiary

Rental Payments

Dividends

Dividends Taxpayer

REIT

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Captive REITs
One use of Captive REITs has historically been to reduce or eliminate state taxes. The REIT is not taxed if the state models its tax law after federal law because of the dividends paid deduction. The taxpayer also attempts to receive a second deduction in the same or another jurisdiction. States have been attacking these structures.

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Corporate and Securities Law Issues

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Formation
An existing company may reorganize itself in order to qualify as a REIT
Reorganization will depend upon the original structure Objective will be to have the company hold qualifying assets and transfer assets that yield non-qualifying income

A REIT may be organized as a business trust or as a corporation

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Formation

A new entity may be formed that qualifies as a REIT Most REITs are organized in Delaware or Maryland Marylands REIT law is the most well formed The entitys organizational documents will need to contain special provisions regarding ownership limits and transfers

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Maryland law
Maryland has a statute that applies specifically to REITs organized as trusts. In Delaware, a REIT is required to at all times have at least one trustee which, in the case of a natural person, shall be a person who is a resident of this state or which, in all other cases, has its principal place of business in this state. There is no such requirement in Maryland. Maryland limits the liability of trustees and officers for monetary damages in suits by or on behalf of the REIT or by its shareholders. Maryland REIT Law permits a trust REIT to indemnify and advance expenses to its trustees and officers to the same expansive extent permitted for directors and officers of Maryland corporations.

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Maryland law (contd)

Maryland permits trustees, without shareholder approval, to amend the declaration of trust to cause a trust REIT to continue to qualify as a REIT under the Internal Revenue Code. The Maryland Business Combination Act (which includes a five-year moratorium on transactions with an interested stockholder, and supermajority vote requirements for business combinations thereafter) applies to a Maryland REIT, unless it opts out of the statute. The Maryland Control Share Acquisition Act also includes REITs and is believed to have the lowest trigger (10%) of any state control share acquisition statute.

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Organizational issues

Historically, REITs have been structured in any of the following ways: as UPREITs (umbrella partnership) as Down REITs as paired-share REITs as stapled REITs as paper clip REITs

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UPREIT (Equity)
Public Shareholders

Newly Formed REIT

IPO Cash General Partner Limited Partners (former private real estate partnership interest holders)

OP Units (1:1 conversion to REIT shares)

Operating Partnership (L.P.)

Historic Properties

New Properties

Taxable REIT Subsidiary

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UPREIT (Mortgage)
Public Shareholders

REIT
General Partner OP Units (1:1 conversion to REIT shares)

Structure Permits Future Acquisition of Mortgage Portfolios on a Tax Free Basis (But Would Defer Losses to LPs if Loss Loans)

Limited Partners

Operating Partnership (L.P.)

Mortgages

TRS

(REO/Far Gone Mortgages)

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DOWNREIT
Existing REIT Existing Properties

Contribution Limited Partners

Existing and Contributed Properties

Mortgages

TRS

(REO/Far Gone Mortgages)

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The Paired-Share REIT Structure

Paired Shares Trade as Unit

REIT

Lessee Operator

Rents

Fee Simple Ownership in Property (e.g., Racetrack)

Lease Operating Income

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External versus internal management

External management structure usually resembles a private equity style arrangement
manager receives a flat fee and an incentive fee most incentive fees for external managers are structured with a high water mark

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SEC Filings
In order to file with the SEC for an initial public offering, a REIT will prepare and file a registration statement on Form S-11 The S-11 requirements differ from those for Form S-1 In addition, REIT issuers also must consult SEC Industry Guide 5

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40 Act Exemption
A REIT may qualify for an exemption under section 3(C)(5)(C) of the Investment Company Act of 1940 (the 40 Act):
Available for entities primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate; Generally applies if at least 55% of the REITs assets are comprised of qualifying assets and at least 80% of its assets are comprised of qualifying assets and real estate-related assets. For these purposes, qualifying assets generally include mortgage loans and other assets which are the functional equivalent of mortgage loans.

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