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NEW YORK CITY-The election of REIT status by companies under Section 856 of the IRS code is "generally a modest credit negative," according to Fitch Ratings in a new report. Therefore, REITs are typically rated one or two notches lower than similar entities that have not elected REIT status, says Fitch in "Credit Implications of Electing REIT Status."

REITs must pay at least 90% of their taxable income in the form of dividends to shareholders, Fitch comments. As a result of this requirement, REITs' ability to retain capital is more restrained, and their necessity to regularly access the capital markets for growth capital is more difficult, when compared to that of comparable companies that have not elected REIT status.

"While electing REIT status is typically a credit negative, revoking REIT status may not necessarily be a credit positive, since the revocation of REIT status is usually triggered by a company's inability to operate under REIT parameters," notes Steven Marks, managing director and REIT group head at Fitch. However, other considerations may offset the economic constraints of the REIT structure.

"For example, a company may elect REIT status partly in order to meet investor demand for yield-oriented stocks," Marks says in the report. Under the IRS code, at least 75% of a REIT's total investment assets must be in real property, mortgages or other interests in real estate, and a REIT must gain at least 75% of gross income from rents or mortgage interest.

The report also focuses on the broader issue of the compatibility of the REIT structure to the business models of certain real estate companies. For example, in recent months, the credit quality of loans held for investment of certain mortgage lenders, including subprime residential mortgage lenders, has deteriorated.

Fitch notes that in this environment, the risks associated with some real estate businesses do not agree with the capital retention limitations of REITs. "In general, electing REIT status may not be financially feasible for some real estate companies," notes Christopher Wolfe, managing director in Fitch's finance and leasing companies group, in the report. "However, the REIT structure may suit the business models of many real estate companies, despite the limitations it places on financial flexibility."

Instant Insights /

Fitch Sees Problems in Electing REIT Status

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