Legislation May Not Rein In Stapled REITs

<B> Legislation May Not Rein In Stapled REITs</B>

By Maria P. Vallejo

Paired-share real estate investment trust companies are expected to survive past next year, much to the dismay of some industry experts who have lobbied against their existence.

The White House's recent proposal to restrict the expansion of paired-share REITs may have been made in vain, analysts said. While most analysts understand the reasoning behind some hoteliers and industry observers rallying against the structure's existence, they believe Congress undoubtedly will pass over the proposal or only partially restrict the unique REIT's expansion.

"We don't expect the proposal will go through," said Brad Hatfield, analyst at New York-based Deutsche Morgan Grenfell. "A lot of paired-share REITs and REIT proponents, in general, will put up a big battle."

These are unhappy words to some paired-share REIT opponents who lobbied Congress to investigate the validity of the grandfathered structures. Citing unprecedented accumulated mass in the past two years and supposedly superior financial clout, these lobbyists finally caught the attention of Capitol Hill. They maintained the entities gained unfair tax and structural advantages during hotel company bidding wars that resulted in their recent noted success.

"It's absolutely clear that they have a tax advantage over their competitors, which are operating businesses," said Hilton Hotels Corp. CEO Stephen Bollenbach, one of the loudest critics of the unique trust structure. "I don't know how you could conclude that it's not unfair."

Unfortunately for paired-share REIT opponents, Bass PLC's acquisition of Inter-Continental last week may have proven their theory wrong. Bass PLC outbid paired-share REIT Patriot American Hospitality (see story, page 1). "It's definitely not hindering other companies from acquiring assets because many times Starwood and Patriot have gone up against other companies and have actually lost an acquisition," Hatfield said.

Analysts said the tax advantage and possible tax circumvention theory would be difficult to prove, given that paired-share REITs are required to distribute 95 percent of their net income in dividends to shareholders. These shareholders then pay taxes out of their pockets. This theory arguably works against lobbyists because individual income tax rates sometimes exceed corporate tax rates, resulting in higher collected governmental taxes.

Starwood Hotels & Resorts, the most prominent of the so-called stapled REITs, seemed to be the primary target of recent congressional and industry debate. Last week's merger completion, which bolstered the Phoenix-based REIT into the position of the largest hotel company worldwide only solidified some industry leaders' contention that the structure provided unfair advantages in expansion. Starwood outbid Hilton Hotels Corp. for possession of ITT Corp. with a $10.2 billion offer after Hilton attempted a 10-month-long hostile takeover of the company (<I>BTN</I>, Feb. 23).

Unwavering about the validity of his company, Starwood CEO Barry Sternlicht defended his treasured paired-share entity by relating its structure to paper clip REITs. In fact, should the legislation pass, Sternlicht said he plans to convert Starwood into a paper clip REIT to continue its growth.

"It has no advantage over a C-corporation. A paper clip REIT can mirror everything I do," Sternlicht said.

Stapled or paired-share REITs consist of a C-corporation and a REIT, which passes its taxes to its shareholders. The two are traded together under the same stock symbol. A paper clip REIT also consists of a REIT and C-corporation working together, but they are not traded as a single unit. The paper clip structure, while similar to the paired-share REIT, does not eliminate conflicts of interests for the shareholders. In paper clip REITs, shareholders do not have a claim on the income earned by the management companies. Therefore owners and operators are not necessarily working towards a common goal.

Proposed legislation may kick up short-term REIT activity, since it would not be retroactive and would not go into effect until Jan. 1, 1999.

"There may be a rushed need to acquire as much as you can while this limited potential window exists," said Steven Bloom, senior REIT analyst for New York-based Morgan Stanley, Dean Witter.