NEW YORK— Early returns are in on the REIT Modernization Act, and the consensus is the RMA has set the stage for a transformation in the way lodging REITs conduct their operations. In fact, many are looking for Congress to let the other shoe drop and allow them to take an active hand in the management of their hotel assets. But according to John Arabia, senior lodging analyst for Green Street Advisors, top-level lodging REIT executives would do well to be careful for what they wish; they just might get it, and that could ultimately upset the entire regulatory apple cart. “The attitude and tone many lodging REIT executives have adopted— one beseeching the nation’s lawmakers to let them actively manage their own assets— scares me,” Arabia said. As he explained, such a scenario would come perilously close to mirroring the paired-share REIT structure. Arabia noted that, prior to being overhauled by the government, the paired-share structure offered exceptional tax-efficiency in that REITs enjoyed a huge advantage over C-Corps. because they paid little in corporate taxes; granted wide-ranging operating flexibility making it possible for REITs to enter into multiple business lines; and, most importantly, allowed REITs to benefit from both the aforementioned advantages with the same shareholder base and without raising conflicts of interest. “It’s important for lodging REIT executives understand that they reap the tax benefits they do primarily because the Internal Revenue Service recognizes their passive real-estate-ownership position,” Arabia said. “But clearly, hotels are an active, operating business, so the lease structure was born… even though, by all accounts, it’s complex, confusing and unwieldy.” However, with this month’s implementation of the RMA, Arabia maintained that “lodging REITs have at long last been put on equal footing with the rest of the REIT world. Now, lodging trusts are passive owners who can finally realize bottom-line collection of revenues [and no longer be unduly concerned with ‘leakage’ to their lessees].” In essence, the Newport Beach, CA-based analyst was fearful of a return to something of a paired-share structure because it could invite government reintervention, all in the name of “leveling the playing and investing field.” Additionally, Arabia felt there would be widespread concern over “insiders” controlling third-party management companies— a situation that could be “rife with interest conflicts” and potentially harmful to shareholders. “As I see it,” he said, “the biggest conflict would be if a company ‘insider’ is sitting on both sides of this new corporate set-up. It’s not unrealistic that such a scenario could ultimately earn much more revenue [for the REIT]than anticipated. “For instance,” Arabia warned, “we might ultimately see shareholders flogged by less-than-ethical, insider-owned management teams. As such, might the price paid for recapturing leases [in some cases]end up proving to be a more profitable transaction than it should have been?” But that’s exactly what could happen, he said, if ownership/management “should allow insiders to control both sides of the transaction.” While Arabia likens the RMA to something of a two-edged sword, NAREIT Senior VP/General Counsel Tony Edwards offered a more benign view of the new operational guidelines. “[The RMA] may not be a cure-all for what ails [lodging]REITs, but it can indeed be a positive factor and a most effective tool if used correctly. And that means,” the Washington, DC-based official said, “it needs to be wielded along with— and not in place of— sound management principles.” Edwards’ opinion was basically seconded by David Richter, research analyst, Salomon Smith Barney, New York, who agreed that “the RMA is [generally]a good thing for the REIT industry, and its implementation would prove to be a net positive, especially for those [little operating companies]who hold leases and manage real estate.” However, steppi
