From "How Forest City Decided to Become a REIT": tax savings ended, business refined, upside from institutional investors

There are a couple of intriguing quotes in How Forest City Decided to Become a REIT, a 2/3/16 National Real Estate Investor interview with David LaRue, CEO of Forest City Enterprises, now Forest City Realty Trust (which now prefers to be called Forest City).

Forest City, he said, sought "a sustainable capital structure that translated into reducing our leverage and increasing the cash flow from the business," meaning less debt and more revenue. But they didn't join the rush to REITs initially.

LaRue restated the rationale:

From a tax standpoint, we were tax efficient. We weren’t paying substantial taxes because of our depreciation and interest expense. Our taxable income was very much managed, and we could continue to grow the business and execute on the strategies we had at that time. So it was a question from investors, and as Chuck Ratner used to tell investors when he was CEO, when it’s the right time for Forest City to do this, based upon value and based upon the market, we would do it.

Another reason was they had to divest assets, including a basketball team and arena, that wouldn't qualify under the REIT structure. As LaRue put it, "a REIT has to generate a majority of its income from real estate rent and qualified income sources and real estate related income."

The REIT bonus

Forest City was one of only a handful of real estate companies operating as C Corporations, and is now among 198 REITs traded on the NYSE. Said LaRue:

I think as you look at investors and analysts, Forest City Realty Trust as a REIT is a business they understand. They know we have to distribute and pay a dividend based on taxable income. That is a benefit to shareholders. So we have common structure that is familiar. There are requirements to operate. A certain percent of your income and your assets must be qualified assets. So what it does is allow us to continue to have the market believe that we are remaining focused in our core businesses, which are in those qualified real estate businesses.

That should draw more investors, including institutional ones, especially since REITs must distribute a larger percentage of earnings in dividends, and Forest City has resumed a dividend it suspended in 2008. And that should drive a higher stock price. (So far, it's gone down and then back up this year.) One analyst recently upgraded the stock from "Sell" to "Hold."

Harvesting losses

As I wrote 1/13/15, the previous August, on a conference call with investment analysts, Forest City Enterprises was asked about REIT plans.

"It's a process and an issue we continue to look at," LaRue said. "We still have substantial NOLs [net operating losses] that allow us as a C Corp to continue to be very tax-efficient... As we go through repositioning, and go through non-core asset sales, it gives us some additional flexibility."

In the future, LaRue said last August, "lower levered portfolio and less development on our pro-rata share... bringing in strategic partners, will point to us becoming a taxpaying entity," which means they will have used those NOLs. "We haven't picked a date, but we're heading there [toward a REIT] over that time period."

In other words, losses--including paper losses calculated through depreciation--were very helpful.