What is a Real Estate Investment Trust?

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What is a Real Estate Investment Trust? A REIT is a:• Publicly or privately held company that that owns real estate equity or real property debt • Passes most of its earnings and capital gains onto shareholders • Only retained earnings are taxed, PROVIDED REIT meets – Ownership requirements– Management requirements– Asset requirements– Income requirements– Distribution requirements Trade Association: National Association of Real Estate Investment Trusts (www.nareit.com) 1

REITs • Performance vs Equities over past 28 years • REIT Requirements • Tax Treatment • Types of REITS o Equity, Debt, Hybrid o Sector Specific (Office, Retail, Residential, Hotel, Self Storage, Diversified, Specialty) o Market specific (e.g. just NYC office) o UPREIT, DownREIT • Representation in Market Indices • REIT Valuation o FFO, Adjusted FFO, CAD • Economies of Scale • REIT Advisors • REIT Growth 2

REITs Equity REITs, SNP 500, Russell 2000 1978:12-2007:10 7,000.00 6,000.00 SNP 500 (12.7%) Equity REITs (14.0%) 5,000.00 00 1 Russell 2000 (12.4%) =2 4,000.00 :1879 1 3,000.00 xedIn 2,000.00 1,000.00 0.00 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 c-7 c-7 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-8 c-9 c-9 c-9 c-9 c-9 c-9 c-9 c-9 c-9 c-9 c-0 c-0 c-0 c-0 c-0 c-0 c-0 e e e D D D 3 D Month

Requirements Ownership – 5 or fewer entities may not own 50% or more of the outstanding shares (the “5/50 Test”) – No one shareholder owns more than 9.9% (pension funds excluded) – REIT shares must be transferable and held by at least 100 persons – Must be managed by a board of directors or trustees– Must be incorporated in one of the 50 states or DC as a taxable entity 4

Requirements Management – REIT managers must be passive • REIT trustees, directors or employees may not actively engage in managing or operating REIT properties (includes providing service and collecting rents from tenants). • Managers may set policy: rental terms, choose tenants, sign leases, make decisions about properties. – REITs allowed to own 100% of a Taxable REIT Subsidiary (TRS). • REIT Modernization Act of 1999 (effective 2001)• TRS can provide services to REIT tenants and others (previously, this was not allowed). • Debt and rental payments from TRS to REIT are limited to ensure that the TRS actually pays income taxes. 5

Requirements Assets – 75% of assets must be real estate, cash, and govt. securities • other REIT shares are considered real estate assets, but not more than 20% of its assets can be stocks in taxable REIT subsidiaries – not more than 5% of assets can be stock in non-real estate corporations – may not have more than 10% of voting securities of any corporation other than another REIT, Taxable REIT Subsidiary (TRS) or subsidiary whose assets and income are owned by the REIT for federal income tax purposes 6

Requirements Income – 95% of gross income must be from dividends, interest, rents, or gains from sale of certain assets (real estate, cash, or govt securities). – The 95% rule includes income from dividends and non-real estate sources (e.g. bank deposit interest) – Implication: less than 5% of REIT income can come from service fees 7

Requirements Income – No more than 30% of gross income can be derived from • sale or disposition of any securities held less than 6 months • sale or disposition of real estate held for less than 4 years, except those involving foreclosures. • properties held for sale in the normal course of business (anti-dealer provision) 8

Requirements Compliance – Company must make a REIT elective by filing IRS Form 1120-REIT. – Company must mail letters to shareholders of record requesting details of REIT benefits Source: http://www.investinreits.com/learn/formingareit.cfm 9

Requirements Distributions – must distribute 90% of all taxable income to investors • mandates fairly low retained earnings policy• has important implications for financing growth – Note: prior to 2001, minimum distribution requirement was 95%. 10

Tax Treatment • Accelerated depreciation is allowed for determining taxable income • 40 year asset life required for calculating income available for distribution to investors • Shareholders dividends may exceed REITs taxable income (because of depreciation, amortization) • REIT distributions – Dividends taxed as ordinary income– Return of capital reduces shareholder’s tax basis 11

Tax Treatment REIT Management has Considerable Flexibility • Tax treatment of leasing commissions• Tax treatment of financing fees• Tax treatment of tenant improvements• Straight-line graduated lease payments That influence analysts’ performance evaluation. 12

REITs Number of Publicly Traded REITs 250 Total 200 EquityMortgage 150 Hybrid 100 50 0 1 3 5 7 9 1 3 5 7 9 1 3 5 7 9 1 3 5 7 7 7 8 8 8 9 9 9 0 0 0 9 9 9 0 0 0 1 1 1 2 2 2 Year 13

REITs REIT Market Cap 350 300 250 $$ $ 200 n 150 illio B 100 50 0 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 Year 14

REITs REIT Percent Market Cap by Type 100.0% 90.0%80.0% Equity 70.0% Mortgage 60.0% Hybrid 50.0%40.0%30.0%20.0%10.0% 0.0% 1971 1976 1981 1986 1991 1996 2001 Year 15

REITs Historical Offerings of Securities (As of 10/31/2006) Total Year Number IPO Secondary Equity Secondary Debt Common Preferred Unsecured Secured 1998 474 17 216 81 145 15 1999 205 2 29 71 69 34 2000 114 0 11 31 70 2 2001 127 0 58 21 44 4 2002 187 3 85 25 71 3 2003 228 8 82 64 68 6 2004 266 29 79 61 97 0 2005 259 11 71 36 105 36 2006 165 5 56 34 67 3 16

REITs Equity REIT Sectors ( % Market Cap) Self Storage Specialty Health Care 3.9% 4.3% 5.2% Industrial/Office 26.7% Lodging/Resorts 7.3% Diversified 7.6% Retail 26.3% Residential 18.7% 17

Equity REITs Price Market Cap Sector REIT Symbol (12/3/2007) (billions) D/E Beta P/E Apartments Equity Residential NYSE: EQR $37.22 $10.09 1.85 1.70 8.82 Apartment Investment & Management Co. NYSE: AIV $38.82 $3.71 3.62 1.41 65.57 UDR, Inc. NYSE: UDR $22.00 $2.95 3.48 1.48 23.53 Diversified Vornado Realty Trust NYSE: VNO $88.49 $13.54 2.03 1.18 26.52 Duke Realty Corp. NYSE: DRE $26.59 $3.87 1.57 0.99 17.35 Health Care Health Care REIT, Inc. NYSE: HCN $44.36 $3.62 1.15 1.57 36.51 Nationwide Health Properties Inc. NYSE: NHP $31.42 $2.92 0.96 1.46 10.81 Hotel Starwood Hotels & Resorts Worldwide Inc.NYSE: HOT $53.44 $10.64 1.22 0.69 19.29 Hospitality Properties Trust NYSE: HPT $36.35 $3.40 1.09 1.01 11.13 Industrial Prologis NYSE: PLD $64.93 $16.72 1.29 1.50 13.57 AMB Property Corp NYSE: AMB $60.70 $6.01 1.23 1.10 20.75 First Industrial Realty Trust NYSE: FR $36.81 $1.64 2.04 0.97 14.87 Office Boston Properties Inc NYSE: BXP $97.41 $11.62 1.24 1.32 9.18 SL Green Realty NYSE: SLG $101.67 $6.02 1.41 1.18 10.47 Mack-Cali Realty Corp. NYSE: CLI $35.04 $2.38 1.22 1.42 14.43 Retail Simon Property Group NYSE: SPG $97.24 $21.69 4.57 1.56 41.12 General Growth Properties, Inc. NYSE: GGP $47.05 $11.47 15.95 1.45 38.47 Taubman Centers, Inc. NYSE: TCO $54.10 $2.85 1.13 65.50 18

Debt REITs Price Market Cap Sector REIT Symbol (12/3/2007) (billions) D/E Beta P/E Commercial Annaly Mortgage NLY $17.10 $6.870 9.93 0.70 14.77 Capstead Mortgage Corp. CMO $12.26 $0.379 13.78 1.37 na Capital Trust CT $30.96 $0.542 5.20 0.98 7.63 Allied Capital ALD $24.07 $3.720 0.63 0.18 23.12 Residential Thornburg Mortgage Asset TMA $10.43 $1.360 15.68 0.63 na Anworth MTG Asset CP ANH $7.18 $0.329 9.96 0.86 na Both Redwood Trust, Inc. RWT $30.40 $0.853 73.87 1.35 184.2 RAIT Financial Trust RAS $8.74 $0.533 11.45 2.31 na Newcastle Investment Corp NCT $12.84 $0.678 9.24 2.01 10.66 19

Umbrella Partnership REIT UPREIT • REIT formed by consolidating limited-partnerships• Partnership interests known as Operating Partnership (OP) units • REIT owns property indirectly through OP• Partnerships allocated REIT shares based on appraised value of partnership property • Property owners can swap RE investments for OP units using IRS tax deferred exchange rule 731 • REIT issues shares to the public and purchases properties owned by the OP • First UPREIT created by Taubman in 1992 20

Taubman UPREIT UPREITS such as Taubman Centers, Inc. are structured to contain two distinct parts: A publicly traded corporation and a real estate partnership. The publicly traded corporation, TCO, owns units in the TRG real estate partnership. It is this partnership that actually houses the UPREIT’s assets, primarily shopping malls. Investors can purchase common stock in the corporation, while investors with direct ownership in the real estate partnership hold preferred shares in the TCO corporation. Each share represents the same fractional ownership of the underlying assets, and has the same voting power. Source: http://www.AndersonEconomicGroup.com 21

DownREIT • Like an UPREIT, a DownREIT acquires property on a tax deferred basis by issuing partnership units • DownREIT can own multiple partnerships – Can form partnerships with each acquisition– More flexible than an UPREIT • DownREIT can own assets at both the REIT and OP levels 23

REITs in Market Indexes S&P 500 Index REIT Ticker Entered AIMCO AIV 3/13/2003 Archstone-Smith ASN 12/17/2004 Boston Properties BXP 3/31/2006 Equity Residential EQR 11/1/2001 Kimco Realty Corporation KIM 4/3/2006 Plum Creek Timber, Inc. PCL 1/16/2002 ProLogis PLD 7/16/2003 Public Storage, Inc. PSA 8/18/2005 Simon Property Group SPG 6/25/2002 Vornado Realty Trust VNO 8/11/2005 As of October 2, 2006; www.nareit.com 24

REITs in Market Indexes S&P 400 Mid Cap Index REIT Ticker Entered AMB Property Corporation AMB 1/27/2003 Developers Diversified Realty Corp. DDR 9/30/2004 Highwoods Properties, Inc. HIW 10/7/2003 Hospitality Properties Trust HPT 10/1/2001 Liberty Property Trust LRY 12/11/2002 The Macerich Company MAC 7/1/2005 Mack-Cali Realty Corporation CLI 3/19/2003 New Plan NXL 10/1/2001 Rayonier RYN pre-REIT Regency Centers REG 4/25/2005 United Dominion Realty Trust UDR 1/27/2003 Weingarten Realty Investors WRI 11/10/2004 As of October 2, 2006; www.nareit.com 25

REITs in Market Indexes S&P 600 Small Cap Index REIT Ticker Entered Acadia Realty Trust AKR 5/25/2005 Colonial Properties Trust CLP 10/1/2001 EastGroup Properties, Inc. EGP 5/27/2005 Entertainment Properties Trust EPR 6/3/2004 Essex Property Trust ESS 4/24/2002 Inland Real Estate Corporation IRC 10/2/2006 Kilroy Realty Corporation KRC 10/1/2001 Lexington Corporate Properties Trust LXP 9/4/2003 LTC Properties, Inc. LTC 2/14/2006 Mid-America Apartment Communities, Inc. MAA 8/22/2006 New Century Financial Corporation NEW pre-REIT Parkway Properties PKY 10/29/2004 PS Business Parks, Inc. PSB 7/27/2006 Senior Housing Propeties Trust SNH 8/22/2006 Sovran Self Storage SSS 7/8/2004 As of October 2, 2006; www.nareit.com 26

REIT Valuation EPS v. FFO • Earnings per share (EPS) is an accounting number – REIT must distribute at least 90% of EPS • Funds from operations (FFO) is REIT cash flow (no depreciation/amortization) • FFO means net income (computed in accordance with GAAP), excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization of assets uniquely significant to the real estate industry, and after adjustments for unconsolidated entities in which the REIT holds an interest. Adjustments for these entities are to be calculated to reflect FFO on the same basis. • Moreover, NAREIT believes that items classified by GAAP as extraordinary or unusual are not meant to either increase or decrease reported FFO. 27

REIT Valuation How to Calculate FFO Revenues – Operating expenses– Depreciation & amortization– Interest expense– General & Administrative expense = NET INCOME (GAAP) Net Income – Profit from real estate sales+ Depreciation & amortization = FFO 28

REIT Valuation How to Calculate FFO Ten shares outstanding REIT REIT Income Cash Statement Flow Rent $ 100 $ 100 – Operating Expenses 40 40 Net Operating Income 60 60 – Depreciation/amortization 40 Net Income 20 Cash Flow 60 EPS $ 2 FFO Per Share $ 6 Example from Brueggeman and Fisher, page 631. 29

REIT Valuation Key Parts (D&A) • Legitimate add-backs • real property depreciation• amortization of capitalized leasing expenses• amortization of tenant allowances and improvements • Add-backs not allowed • amortization of deferred financing costs• depreciation of computer software• depreciation of company office improvements 30

REIT Valuation Adjusted FFO FFO minus: – Recurring capital expenditures (e.g. painting, carpets, etc.)– Amortization of tenant improvements– Amortization of leasing commissions– Adjustment for rent straight-lining = Adjusted FFO (AFFO) 31

REIT Valuation Impact on FFO • Depending upon management’s strategy with respect to capitalizing or expensing items, calculated FFO and percentage of payout of net income can vary widely • Kimco Realty (KIM) expenses everything they can — reduces measured NOI — increases amount they can retain (65% payout ratio – lowest in industry) • Large group of about 10 has payout ratios over 95% — capitalize aggressively — raises FFO — reduces what they can retain 32

Financial Analysis REIT Financial Ratios Earnings per Share, EPS = Net income/shares outstanding Funds from Operations, FFO = Net Income plus Depreciation & Amortization Return of Capital, ROC = Dividends minus Earnings Cash Retention, CR = FFO minus Dividends Book Value, BV = Assets minus Liabilities 33

Financial Analysis Example: Midwestern Property Trust Summary Properties: 5 million square feet Original Cost: $300 million Depreciated Cost: $170 million Mortgage Debt: $ 80 million Annual Interest Rate: 8% Term: 10 years Number of Common Shares: 5 million 34

Financial Analysis Example: Midwestern Property Trust Operating Statement Net Revenue $ 70,000,000 less Operating Expenses 30,000,000 Deprecation and amortization 15,000,000 General and administrative 4,000,000 Management expenses 1,000,000 Income from Operations $ 20,000,000 less interest expense 6,400,000 Net income (loss) $13,600,000 Net income (loss) per share $ 2.72 35

Financial Analysis Example: Midwestern Property Trust Balance Sheet: Assets Cash $ 500,000 Rents Receivable 1,500,000 Properties @ cost 300,000,000 less accumulated depreciation 130,000,000 Properties-net 170,000,000 Net Assets $ 172,000,000 36

Financial Analysis Example: Midwestern Property Trust Balance Sheet: Liabilities Short term $ 2,000,000 Mortgage debt 80,000,000 Total debt 82,000,000 Shareholders’ equity 90,000,000 Total Liabilities and equity $ 172,000,000 37

Financial Analysis Example: Midwestern Property Trust Profit Summary $ Amount Per Share Earnings $ 13,600,000 $ 2.72 NOI $ 35,000,000 $ 7.00 FFO $ 28,600,000 $ 5.72 38

Financial Analysis Example: Midwestern Property Trust Other Financial Data and Ratios Market price per share of common stock (given) $ 75.00 Dividend per share (given) $ 4.00 Recovery of Capital per share $ 4.00 – $ 2.72 = $ 1.28 Cash retention per share $ 5.72 – $ 4.00 = $ 1.72 Earnings yield $2.72/$75.00 = 3.62% FFO yield $5.72/$75.00 = 7.62% Dividend yield $4.00/$75.00 = 5.33% Current earnings multiple $75.00/$2.72 = 27.6x Current FFO multiple $75.00/$5.72 = 13.1x Net assets per share $172M/5M = $ 34.00 Equity or book value per share $90M/5M = $ 18.00 39

Economies of Scale Minimum Efficient Firm Size • Typical REIT IPO from 1993 – $100,000,000 firm with 50/50 debt-equity ratio, yielding 8% on equity – implies roughly $4,000,000 in income– even with relatively low payout ratio of 75% of earnings, can retain only $1,000,000 40

Economies of Scale What will $1,000,000 buy? – for an apartment REIT, a good-sized garden apt. complex costs $20-$25 million, retaining the added $1,000,000 adds little flexibility with respect to acquiring properties for portfolio. – from broad capital market perspective, this firm probably should increase payout ratio (this is what happened in reality) • shareholders received high dividend yield, firm had to repeatedly go to the capital markets to fund acquisitions 41

Economies of Scale $10 billion REIT – same 50/50 debt-equity ratio and 8% yield on equity for a $10 billion REIT – implied income of about $400,000,000 – if firm chooses not to aggressively expense, it will have a relatively high payout ratio • if that ratio is 95%, implies the firm can retain $20,000,000 • that’s a good-sized garden apt complex, 1/5th of a large regional mall, or a couple of decent- sized warehouses or industrial sites. 42

Economies of Scale $10 billion REIT – if firm chooses to aggressively expense items to reduce accounting earnings and lower its required payout under the REIT tax law, the situation is markedly different – assume its payout ratio falls to 75%: • ratio implies retention of $100,000,000• which will buy a portfolio of any property type except regional malls and downtown office buildings 43

REIT Advisors • Prior to 1986, REITs – Passive investment vehicles– Day to day business decisions (property management and investment decisions) conducted by 3rd party external advisors – Advisors frequently had conflicts of interest • Were property owners trying to sell the REIT property• Were advisors to other (competing) REITs • 1986 Tax Reform Act – A REIT “may directly select, hire and compensate those independent contractors who will provide customary services that may be provided by a REIT in connection with the rental of property, rather than hiring an independent contractor to hire other independent contractors.” – Allowed REITs to be self-advised/self-managed. 44

REIT Advisors Number (and %) of REITs by Type of Advisor Advisor Style 1996 1998 2000 External 100 87 25 (35%) (30%) (9%) Internal 186 194 244 (65%) (70%) (91%) Total 286 281 269 Source: Real Estate Investment Trusts, by Chan Erickson and Wang, Oxford, 2003, p.58 45

REIT Growth 1. Grow income from existing properties – Raise rents – Reduce vacancy – Increase Operating Efficiency 2. Acquisitions – Purchase properties @ positive spreads between property yields and WACC – Swap shares in REITs to take advantage of tax provisions 3. New construction 4. Financial Engineering – Manipulate Funds from Operations – Leverage – Change payout ratio Most REITs finance expansion with additional stock offerings 46