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				“Putting Property To Work” Real Estate Investment trusts offer Retailers an opportunity to put the value of Their locations to work in their businesses The Journal of Petroleum Marketing By Phil H. Shook Once the province primarily of apartments and office buildings, the traditional Real Estate Investment Trust (REIT) is now being viewed as an attractive way for some petroleum marketing and convenience store companies to enhance asset values and expand through acquisitions. Created by 1969 legislation, REITs are corporations or trusts that pool the capital of at least 100 shareholders to buy or finance income producing properties. For companies that qualify, REITs offer a number of advantages over the traditional corporate structure. They are virtually exempt from corporate taxes as long as at least 95 percent of net earnings are paid to shareholders in the form of dividends. REITs have become attractive for investors because dividend yields are often higher than those of stocks, due to the requirement that REITs pay out 95 percent of net earnings to shareholders. By comparison, corporations typically distribute less than 50 percent of their net earnings, according to the National Association of Real Estate Investment Trusts (NAREIT). In addition, traditional REITs have been able to use their shares as currency to make acquisitions on favorable terms, according to Stephen Ryan, investment adviser for the Baltimore-based investment firm Legg Mason. For petroleum marketers and c-store operators - many of whom often quip that their valuable corner locations place them in the real estate business to begin with - REITs can create tax advantages and provide an opportunity to improve cash flow. "REITs can offer their shares on a tax-deferred basis in exchange for real property while providing the sellers liquidity as well as an attractive dividend, typically in the 7- to 10-percent range," Ryan says. "A seller of convenience stores or fuel marketing assets can exchange their property for shares in a REIT without paying capital gains, receive a nice dividend and provide liquidity for themselves and their families." In a step toward the establishment of a REIT, Fort Worth, Texas-based FFP Partners L.P., operator of 400 c-stores, truckstops and self-service gasoline outlets, recently spun off its marketing operations from its real estate holdings. According to Steve Hawkins, FFP?s chief financial officer, a REIT could enhance shareholder value, offer new avenues of growth for the company and provide a source of capital for smaller petroleum operators looking for money to expand their businesses. "One of the main reasons you become a REIT in this day and age is that it is easier to raise funds," Legg Mason's Ryan says. "Wall Street can go out and raise funds because investors like the fact that 95 percent of all cash flow of funds from operations has to be passed back through to shareholders." By taking the initial step of spinning off its petroleum operations from its real-estate assets, Hawkins says FFP is following the lead of Jericho, N.Y.-based Getty Petroleum Corp., which spun off its petroleum marketing business to stockholders last March. "We saw that we had two very different types of businesses - one was our real estate business, with its ownership of properties, and the other was the [petroleum] marketing business," explains John J. Fitteron, chief financial officer of Getty Realty Corp. Getty, one of the nation's largest independent gasoline marketers, realized a significant increase in the value of its equity securities on a combined basis when it split its marketing and real estate holdings into separate New York Stock Exchange traded companies. Getty Realty, trading at $21.75 per share as of this writing, has a market capitalization of approximately $217 million and reports about $100 million in annual revenue, while Getty Petroleum, trading at $5.50 per share, has a market capitalization of $75 million with close to $900 million in sales. "Wall Street seems more interested in the predictable and higher cash flows from Getty Realty than investing in the volatile earnings derived from gasoline margins at Getty Petroleum," Ryan says. The idea of companies that own gas stations and c-store properties entering the REIT market reflects current trends in the real estate market, Ryan claims. He says the REIT market is beginning to attract investor interest in areas outside of its traditional markets of apartments, office buildings, retail centers and health care. The REIT industry currently is looking at portfolios made up of airport, parking lot and prison properties. According to Fitteron, Getty is one of the first petroleum marketing companies to place its real estate assets nto a separate public company, and he noted that most companies in the retail sector lease their properties rather than own them outright. "Most of the department stores and retail establishments prefer not to tie up their capital in real estate, but use it for inventory and for marketing expenditures." Fitteron says Getty Realty will operate as a specialty real estate company focusing on acquiring gasoline stations and c-stores. "We feel it is a natural fit for us because our people on the real estate side have also spent most of their careers dealing with properties in the petroleum and c-store industries," fitteron says. "They really understand the petroleum business and the properties, so it makes sense for us to focus on that side of the business as opposed to trying to understand strip shopping centers, which have their own dynamics." Getty Realty's goal, Fitteron says, is to buy or build properties and lease them back to operators. "It could improve their balance sheet dramatically and, at the same time, free up capital that they could put into revenue-generating types of improvements," he says. As a result of the spinoff, Getty Petroleum, now a major lessee of Getty Realty, is debt-free and doesn't have any money tied up in long term assets. "It has its money invested in working-capital-type items and it uses its excess cash flow to make enhancements to its facilities, thereby further improving its profitability," Fitteron says. Prior to the spinoff of its petroleum marketing business, Getty Petroleum was a wholesaler and retailer of petroleum products at 1,560 Getty and other branded outlets in 12 Northeastern and Mid-Atlantic states. For the fiscal year ended Jan. 31, 1997, Getty owned approximately 1,100 service station and c-store properties and 10 terminal facilities. Although properties formerly owned by Getty Petroleum make up a major part of Getty Realty's portfolio, Fitteron says that picture will change over the next five years as the real estate company grows on its own, acquiring and leaswing properties to other petroleum operators. Fitteron says there is no immediate plan for Getty Realty to seek status as a REIT, but it may be an option available to the company. While a much smaller company, FFP Partners is setting up a partnership that will hold real estate assets and generate income from leasing revenues. "We will be a publicly traded real estate partnership and we intend to operate that partnership much as though it were a REIT," Hawkins says. Hawkins says the partnership's ultimate goal is to set up a REIT and to take advantage of the tax benefits. While there is a complex set of steps required for a corporate or partnership to qualify as a REIT, the tax implications can make it worth the effort. Most states also honor the federal treatment of REITs and do not require them to pay state income tax. This means that nearly all of a REIT's income can be distributed to shareholders without double taxation. And, unlike a partnership, a REIT cannot pass its tax losses onto its investors. In addition to favorable tax implications, the REIT structure will mean convenience and simplicity for stockholders, Hawkins believes. As a partnership, FFP Partners provides its shareholders with a K1 tax-reporting form at the end of the year. The form is somewhat more complicated than a 1099 form. "As a REIT, while we are subjected to some additional burdens, those burdens are placed on the company, not on the stockholders from a tax reporting standpoint," Hawkins says. "And [shareholders] will receive a 1099 just like they would get from a bank." Hawkins also notes that the investment community favors investing through REITs not through a corporation that owns real estate investment income. Opportunity for Financing REITs also offer petroleum marketers an alternative financing avenue, Hawkins says. "Our real estate entity will be small to begin with and we would be interested in dealing with someone with smaller capital needs as opposed to some large financial institution that is generally not interested in talking to someone unless they want to borrow $25 to $30 million." Hawkins believes FFP Partners will be successful in establishing itself as a REIT, but that road can be long and difficult. In filings with the Securities and Exchange Commission, the company has stated that "because of the complexities related to qualifying as a REIT under federal tax law and regulations, the company may not be able to obtain that status in the near term." In the SEC filing, FFP Partners stated that one of the primary criteria for any restructuring is that it be accomplished in a manner that minimizes the federal income tax effect to the company and its unit holders. FFP Partners currently owns and operates more than 300 c-stores, truckstops and self service gasoline stations in 13 states. The company, whose shares are traded on the American Stock Exchange, also operates a fuel terminal and is a wholesale distributor of motor fuel. In November 1997, FFP Partners entered into an agreement with E-Z Serve Corp. to buy 104 c-stores. If FFP Partners becomes a REIT, it will become one of about 300 operating in the United States today, according to NAREIT. More than 80 percent of these REITs currently trade on the national stock exchanges, including 147 on the New York Stock Exchange, 42 on the American Stock Exchange and 12 on the NASDAQ National Market System. The REIT industry benefited from tax reform initiatives enacted in the 1980s. These initiatives eliminated the incentive of tax sheltered real estate vehicles and promoted a return to the fundamentals of capital formation and investment in real estate for income and appreciation. A tax change in 1986 allowed REITs to manage their properties directly and a 1993 change removed a significant barrier to pension plan investment in REITs. REITs operate under strict rules and the government scrutinizes them as closely as any other traded security for the protection of investors. Investors have access to REIT disclosures through SEC filings. From an investor standpoint, buying into REITs is relatively easy. Share prices vary widely and fluctuate much like stock prices. An investor can purchase shares directly or through mutual funds that specialize in REITs for a minimum investment of $1,000 to $3,000. A Checkered Past But the history of REITs is not without problems. Some REITs posted particularly poor performances in the 1970s, when they got into trouble for highly speculative construction loans. Conflicts of interest between issurers and investors also are a source of criticism of REITs. In some instances, principals have been known to borrow from the REIT to develop property they personally own. Also, some REIT management teams are paid on the basis of total assets rather than on cash flow, which encourages the management to expand the REIT without regard to the quality of its acquisitions. Many REIT operators and analysts argue, however, that the new trusts will not repeat the tainted record of the poorly manged REITs of the 1970s. the modern real estate trust, they say, is not heavily leveraged and public companies now are required to release reams of financial data, which act to restrain overaggressive impulses. February 1998