Lodging REITs

Originated in 1960 legislation, the real-estate-investment trust (REIT) burst onto the lodging industry in the early 1990s as a means for aggregating capital for aggressive purchases of undervalued hotels. REITs are restricted by Internal Revenue Code (IRC) from actually operating the real estate they own, and the IRC requires them to pay out 95 percent of income. Thus, a REIT must lease its property to managers and, as a result, may experience “revenue leakage,” or the loss of some revenue to the manager. However, an unusual REIT structure, known as the paired-share REIT, allowed certain firms not only to purchase hotels but to stanch some of the cash-flow leakage by controlling an associated operating firm. The REITs' strength, which is their ability to draw tax-favored investments, is also potentially their weakness when capital markets tighten. Publicly traded REITs are expected to continue their growth (to augment earnings), and acquisition is a favored strategy for that growth. A strategy of acquisitions, however, requires continual capital inflows. The future direction of REITs is clouded by the current roiling of financial markets.