Large Insider Stakes Are Quite Common…

We've reviewed the insider holdings of the 100 largest equity REITs by market capitalization. Using operating partnership (OP) units as an indicator of founder holdings, we calculated these share equivalents as a percentage of total shares and share equivalents, then grouped the REITs by these percentages. (See Exhibit.)

REITs generally restrict outsider holdings to less than 10 precent of the common shares outstanding, so we focused our attention on REITs where 10 percent or more of the common shares and share equivalents consist of OP units. Then we went to the SEC filings to determine how many of the OP units are held by the founders and their families.

…the death of a founder can be a non-event for REIT investors, at least from a trading point of view.

The filing data confirmed our belief that, by and large, the founding fathers still hold the bulk of the OP units. Even where a company has been acquired, payment is often made with the acquirer's OP units. An example is Simon Property Group's acquisition of DeBartolo Realty Corporation, as a result of which the DeBartolo family holds a roughly 11 percent stake in Simon in the form of OP units.

This methodology excludes those REITs where the founders hold their stakes in common stock, rather than OP units. A significant example is Public Storage, in which B. Wayne Hughes owns about 30 percent of the shares outstanding. Nevertheless, we think that it provides an indication of what problems, if any, lie ahead for the REIT investor, since founders who own common stock face similar potential tax liability problems should sale of the shares be forced.

…But Are Generally Not An Immediate Problem

In general, company founders have consistently maintained, from the beginning of the IPO process through the present, that they have no plans to liquidate their holdings. Apart from issues of pride of ownership and management, they would face prohibitive tax liability if they did so.

The potential tax liability is incurred upon the death of the stock/unitholder, but such an event appears distant, in most cases. Most of the founders range in age from the 50s to the early 70s. At the high end of the range, the Internal Revenue Service life expectancy tables suggest a ten to fifteen year remaining life span for a 70-year-old. Moreover, the holdings are generally distributed among family members, many of whom are considerably younger and have much longer expected life spans.

Experience to Date Is Scant but Positive

In recent years there have been three patriarch deaths—Edward DeBartolo of DeBartolo Realty Corporation in 1994, Martin Bucksbaum of General Growth Properties in 1995, and Frank Pasquerilla of Crown American Realty Trust in 1999. At the time of passing, the family ownership stakes in each company amounted to approximately 34 percent, 35 percent, and 35 percent, respectively.

In none of these cases was there a forced conversion of OP units into shares to settle a tax liability, notes veteran REIT investor Ken Campbell. Whether these founders had gifted out their units before they had substantial value, or had purchased enough insurance to cover any potential liability, the techniques used to avoid a forced conversion were successful.

REIT Industry Overhang Apparently a Non-Issue

The good news is that the industry appears to be accumulating experience that demonstrates that the death of a founder can be a non-event for REIT investors, at least from a trading point of view. More good news is that management transitions have also been non-events.

Whether this will continue to be the case is unclear. Estate planning means different things to different people, and all lawyers are not equally able. There may be some surprises as the mantle passes to a new generation, but experience to date suggests that they could be infrequent. Investors can probably be confident that most founders have capably planned the settlement of their estates.