Realty Income Trust

"As a result of this new opportunity to make leveraged deals we now started a trend, which many other REITs later followed, of buying land under office buildings and other real estate properties and net leasing the land back to the owner with the ground lease being subordinated to the first mortgage. We always put in a pro- vision that the first mortgage could never be refinanced for an amount greater than the original nor the maturity date extended, with the result that our ground leases would ultimately be superior to any new financing. One of the most successful of this type of operation was at the Center Plaza development in Boston, directly opposite all the new government buildings. This was in the Redevelopment Agency area where old buildings had been torn down and developers were being given options to acquire land and build new structures on these sites. The Leventhal brothers in Boston had received such options but did not have sufficient capital to pay cash for the land as the options expired. Our REIT, Realty Income Trust, agreed to put up the cash on three separate occasions as they developed the property and to subordinate the ground lease to their first mort- gage lenders on the buildings. Our net lease required a 10 percent return to us on the land investment plus an override based on their gross rents in excess of a specific amount in each of the three loca- tions. This was typical of the sort of deal that we were making in our REIT before the deluge of financing that occurred in this field in 1969 to 1971. When money got tight and the banks were having difficulty in providing mortgage financing for real estate developments at that time, they became aware of the advantages of setting up REITs that they managed through advisory companies raising capital from the general public through the sale of common stock and subordinated debentures. The law was so drawn that the advisor was permitted a fee of 1V2 percent not only on all of the investments made by the REITs but also on all the commitments outstanding for which the money had not yet been put out. The result of this outrageous fee structure was that everybody and his brother set up REITs all over the country. Through the sale of securities to the public plus huge borrowings from banks with high leverage up to 4 to 1 permitted, some $20 billion of new capital was injected into the real estate market within a three-year period. The greed of the advisors was so great and the capital available for investment so enormous that absolutely everyone who"

"managed REITs made some fantastic mistakes by forcing capital out to unqualified borrowers at unprofitable spreads. Result—one of the worst financial debacles in the history of this country oc- curred in the last ten years because of these excesses. The banks thought that by having huge advisory fees and using OPM (other people's money) they could earn more for the stock- holders of the banks than they could earn if the banks made the loans directly to the developers. Because of this huge surplus of capital, the risks taken by REITs were unwarranted and the com- petition to put funds out was so great that the spread between the cost of money and the return received produced no profit to the lenders. In addition, most of the leverage was created through open lines of credit to the REITs at floating rates. On the other hand, the REITS were making largely long-term fixed rate commitments to their customers with this short-term money. When prime rates went to 12 percent in 1974, the roof fell in. Practically every REIT in the country was in serious trouble and many of them will never recover. Since practically all of the leading banks in the country lent money to the REITs, aggregating even today many billions of dol- lars, the situation finally reached the stage where the banks could not foreclose their mortgages. They have had to be satisfied with work-out situations at low-interest rates requiring many years in the future to resolve. I'm glad to say that one of the very few REITs that has come through this situation intact is Realty Income Trust, which has never missed an interest payment to its banks or to its debenture holders and is currently paying dividends at the rate of Si.40 per share. It is, I believe, the only REIT in the country that is currently paying such a high return through dividends on its total equity capital—approximately 9 percent. The two young managers of Realty Income Trust, Ron Kutrieb and Rob Freeman, have done an outstanding job in an industry that has been nothing but disaster for practically every other REIT ever formed."