Manage REIT investor expectations and build trust in 2024


The 2023 real estate market wasn't ideal, to say the least.


Jim Wittmer

“The real estate industry, including REITs, have experienced the lowest capital raised since 2013.”

Jim Wittmer

National Managing Partner, Tax Growth

“The real estate industry, including REITs, have experienced the lowest capital raised since 2013,” said Grant Thornton LLP Tax Growth Managing Partner Jim Wittmer.


In particular, REITs are more sensitive to capital flow, he said. That’s because REITs are required to distribute 90% of their taxable income in order to maintain their tax status as a REIT. In addition, REITs typically pay annual dividends to their shareholders.


Due to current market conditions, REITs may be forced to reevaluate their cash flow positions. If cash flows ever become scarce, REITs may consider suspending dividend payments. There may also be differences depending on whether the REIT is publicly traded or privately held. Publicly traded REITs may simply look to maintain minimum distributions, while private REITs may experience additional challenges in the form of redemption requests from investors. Cash will be needed to handle these requests.


Between fewer transactions and high interest rates in the last year and a half, some REITs have struggled to acquire new assets and, in turn, generate current deductions to lower their taxable income. Private REITs were sometimes forced to sell assets, often at sizable gains, to satisfy their cash needs to redeem certain investors who were looking to redeploy their investment portfolios. Without new portfolio investments being acquired, there wasn’t a simple way to generate deductions to offset gains from the sale of assets.


These gains have had a domino effect on the taxable income of private REITs and the taxability of the distributions paid to their investors. Higher gains mean higher taxable income for the REIT, resulting in a lower return on capital dividends being paid to shareholders. Because of this, investors end up paying more tax on these distributions.


“Many REIT investors likely had much different expectations regarding the taxability of their distributions when they first invested, that is, until the market conditions slowed,” Wittmer said. “And not meeting the expectations of investors can have negative impacts to REITs’ future capital raises.”       


Something else is at stake too: REITs’ reputation and their ability to manage the expectations of the investor population.


“This can also present a philosophical question to the REIT,” Wittmer said.  “Specifically, does one adopt tax planning strategies to satisfy the expectations of the redeeming investors today at the expense of the investors who decide to keep their investment in the REIT for the long-term?”  After all, there is only a certain amount of basis available in the REIT assets, until market conditions improve and new assets are acquired. Accelerating asset basis recovery today means that less will be available in the future.


“This is more than a temporary issue,” Wittmer added. “It appears the market conditions will continue in the foreseeable future.”


Until the market returns to more favorable conditions, REITs can employ a number of tax planning strategies to help generate deductions, manage the return of capital percentage expectations and build trust with their investors.




Strategies to help generate tax deductions


To help generate deductions for investors, REITs can employ a few tax planning strategies and other business planning methods. No matter what route they take, it’s important for REITs to manage expectations around deductions because “it’s also not ideal to generate too much of a deduction,” Wittmer said. “Creating a deficit does not benefit current shareholders if there is no accumulated earnings and profits to reduce.”


While this issue primarily affects private REITs, publicly traded REITs may benefit from strategies to generate deductions as well.


“While publicly traded REITs are still impacted by the external market conditions, investors can simply exchange their shares on the open market. They don’t need to dispose of an asset to generate cash when an investor wants to liquidate,” Wittmer said. “However, publicly traded REITs may still want to explore ways to generate tax deductions as a mechanism to preserve cash.”


To start, an annual evaluation of current-year spend on existing investments could help REITs identify items that may be eligible to be treated as a “repair” for federal income tax purposes. HVAC, plumbing and electrical expenditures, and some roofing costs may qualify as items that could be treated as current-year expenses. The actual tax treatment of expense versus capitalization is dependent upon the actual facts being applied against the relevant tax authority.


“Often, these items may be capitalized and depreciated for financial statement purposes, but following the current tax regulations, one may be able to generate current-year tax deductions,” Wittmer said.


Evaluating REIT assets that have been acquired in prior tax years can also provide an opportunity to generate current-year deductions. Because REITs own many assets with significant acquisition costs, utilizing cost segregation techniques on existing assets in the portfolio can generate significant tax deductions that help manage the taxability of the distributions and preserve cash. 


Cost segregation involves evaluating the underlying assets and breaking them down into various components using existing tax authority to generate current-year deductions without the need to amend prior-year tax returns by the REIT itself or at the investor level.  

“This is accomplished via an accounting method change, a common tax planning strategy,” Wittmer said. “Many accounting method changes can be filed with the filing of the REIT return itself, well after the calendar year-end.”


REITs should also keep in mind the timeline they are working with. Form 1099s are due to individual investors at the end of January.


“It will be prudent to keep that timeline in mind so the taxability of the distributions can be appropriately reported. Since the market conditions have not changed, there will be more opportunities in 2024,” Wittmer explained. And that’s where employing the right tax strategies at the right time can come into play.





At the end of the day, it’s more than numbers


Headshot of Jim Wittmer

“Market conditions fluctuate. They aren’t set in stone. The tax strategies you employ shouldn’t be, either.”

Jim Wittmer

National Managing Partner, Tax Growth

When a REIT experiences low capital raises, it can present challenges — but navigating those challenges can help them prepare for the future. 


Transactions will eventually pick up and market conditions will improve, Wittmer advised. As REITs partake in tax planning, they should be sure to understand the existing market conditions and their needs to manage investor expectations. 


“While the market conditions are temporary, REITs will need to be mindful of their long-term strategy,” Wittmer said. “How you handle unfavorable conditions can impact your brand perception and help mitigate future risk.”






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