Friday, October 18, 2024
Weekly SSRN Tax Article Review And Roundup: Speck Reviews A Theory Of The REIT By Oh & Verstein
This week, Sloan Speck (Colorado; Google Scholar) reviews a new work by Jason Oh (UCLA) & Andrew Verstein (UCLA; Google Scholar), A Theory of the REIT, 133 Yale L.J. 755 (2024).
In A Theory of the REIT, Jason Oh and Andrew Verstein reconceptualize the connections between corporate law and tax law to illuminate the viability and attractiveness of real estate investment trusts (REITs) as an investment vehicle. Oh and Verstein ask why public equity REITs have burgeoned in size and number over the last three decades, when their “Rube Goldberg governance structure” runs contrary to well-traveled tenets of corporate law (818). More specifically, Oh and Verstein observe that REITs are largely immune to hostile takeovers and generally prohibited from retaining earnings.
These features invert the broad discretion conventionally afforded to corporate managers, as well as outsiders’ ability to hold managers accountable for their decisions. Oh and Verstein argue that REITs’ interlocking tax and governance features, taken together, offer investors a bundled package with its own “cohesive internal logic” (786). This logic not only explains REITs as “the preferred structure for collective real estate investing” (788). The dynamics that make REITs dominant also complicate the narratives and stakes around corporate distributions, managerial duties, and takeover defenses outside of Oh and Verstein’s case study.
Oh and Verstein’s theory of the REIT is elegantly constructed, weaving empirical observations, legal regimes, and economic analysis into a cohesive framework that simultaneously explains and justifies REITs’ role in capital markets. Depreciable real property has a predictable life cycle, which drives a tax wedge between longstanding holders of low-basis real property and potential investors with liquid capital. Bridging these constituencies requires management to balance competing and complex interests, which occurs best when corporate law insulates management from idiosyncratic external threats. REITs’ tax-law restrictions on investments and retained earnings, in turn, dissuade these entrenched managers from unchecked empire-building. Finally, the requirement that REITs distribute their earnings necessitates “special tax treatment” in the form of conduit (or quasi-passthrough) taxation (766). With these pieces linked by function and market effects, REITs’ apparent corporate-law faux pas make sense. Oh and Verstein’s analysis is virtuoso, given the diverse bodies of law that give rise to these enmeshed traits, as well as the transparent fact that lawmakers did not intend these traits to work together.
My sense is that these interdependencies are less tightly connected in practice, which opens a host of research questions that build on Oh and Verstein’s compelling theoretical framework. For example, REITs can, and do, retain significant cash from operations outside of the IRS’s now-permanent safe harbor for cash-stock distributions. Analysts evaluate REITs’ profitability using funds from operations—essentially, net cash flow—rather than net income for accounting or tax purposes. This metric, on a per-share basis, often is double the amount of REITs’ distributions to shareholders. Essentially, the difference reflects retained resources that management can deploy with discretion tempered only by tax law’s (fairly flexible) income and asset limitations for REITs. The source of this difference, of course, is depreciation, which reduces REITs’ taxable income (and required distributions) as a noncash expense. Not every REIT transaction involves low-basis property acquired tax-free. Often financed through amenable capital markets, REITs’ cash purchases create some leakiness in Oh and Verstein’s model (as do alternative financing techniques such as joint ventures). Further research is warranted into how REITs mix taxable and tax-free transactions to manage their distribution requirements and avoid the tax-law restrictions on retained earnings.
A second tension relates to Oh and Verstein’s treatment of contractual solutions to REIT investors’ tax-derived heterogeneity. Most prominently, these solutions involve tax protection agreements (TPAs) that obligate REITs to indemnify property contributors for adverse tax consequences over a specified time period, essentially aligning the joint tax costs of a property disposition with that disposition’s economic returns. Oh and Verstein find “only four TPAs currently in effect” in 2024, as well as a clear downward trend in the use of TPAs over time (802–03). But most mainstream practitioner commentary treats TPAs as common and customary parts of REIT deals. Indeed, Oh and Verstein observe that TPAs have generated only one reported court decision (805), which might imply that these agreements, if they exist, are meeting the needs of property contributors. If Oh and Verstein are correct about TPAs’ (in)frequency, then this fact would (or should) seriously unsettle practitioner understandings of the REIT market—and this aspect of Oh and Verstein’s article is worthy of a longer and more extensive exegesis.
Finally, Oh and Verstein’s model emphasizes the role of REITs’ tax subsidy in making markets that accommodate small investors in real estate. I am curious, however, as to whether reductions in this subsidy would meaningfully undo the careful balance that Oh and Verstein adduce. As Brad Borden argues, REITs’ overall tax revenue cost is contingent, concentrated, and likely fairly small. From a rate perspective, REIT investments are not terribly different from interests in well-managed, high-quality real estate partnerships, which often prize consistent distributions. (The biggest difference probably arises in how the soon-to-sunset pass-through deduction applies.) What the REIT industry offers is discipline, expertise, and assurances of quality with respect to assets under management—all features that flow from the corporate and tax restrictions to which REITs are subject. To the extent that REITs’ appeal stems from this bundling rather than mere tax savings, Oh and Verstein implicate a more sustained analysis into the coproduction of corporate regulation through tax and nontax instruments.
Overall, A Theory of the REIT advances an insightful and counterintuitive reconstruction of the corporate law “story” for REITs. Oh and Verstein masterfully integrate tax considerations with corporate law and the business landscape, and the authors allude to their theory’s implications for corporate governance more generally. Scholars of tax, business, and securities law, as well as policymakers, should view Oh and Verstein’s excellent article as required reading.
Here’s the rest of this week’s SSRN Tax Roundup:
- Reuven S. Avi-Yonah (Michigan) & JJ Wang (Michigan), Tax Delegation Post-Loper Bright, U Mich. Pub. L. Res. Paper (Oct. 16, 2024)
- John Manuel Barrios (Yale Sch. Mgmt.), John Gallemore (UNC, Kenan-Flagler Bus. Sch.) & Yongzhao (Vincent) Lin (Wash. U. Olin Bus. Sch.), Spillovers from Regulatory Fragmentation: Evidence from Corporate Tax Burdens (Oct. 14, 2024)
- Karen C. Burke (Florida), SALT Substitutes and Other Workarounds, 76 Tax Law. 605 (2024)
- Wei Cui (UBC), False Idols in the Early History of International Taxation (Oct. 14, 2024)
- Min Dai (H.K. Polytechnic U.), Yaoting Lei (Nanchang U., Sch. Econ. & Mgmt.), Hong Liu (Wash. U., Olin Bus. Sch.) & Chen Yang (CUHK, Dept. Sys. Eng’g & Eng’g Mgmt.), Optimal Tax-Timing with Transaction Costs (Oct. 15, 2024)
- Isabell Euler (Ludwig-Maximilians-U. München), Simon Harst (Ludwig-Maximilians-U. München, Deborah Schanz (Ludwig-Maximilians-U. München), Caren Sureth-Sloane (Paderborn U.) & Johannes Voget (U. Mannheim), Tax Complexity and Foreign Direct Investment, TRR 266 Acct. Transparency Working Paper Ser. No. 160 (Oct. 2024)
- Afnan Murad (U. Karachi, Bus. Sch.) & Danish Ahmed Siddiqui (U. Karachi, Bus. Sch.), How Tax Complacency, Knowledge, and Penalty Affects Tax Compliance in the Informal Sector of Pakistan: The Mediatory Role of Tax Attitude, Volunteer, and Taxpayer Trust, Complemented by Tax Morale, and Tax Patriotism (Oct. 18, 2024)
- Henry Ordower (St. Louis), Tax As Hybrid Law: Borrowing and Convergences, 11 J. Int’l & Comp. L. 259 (2024)
- Alice Pirlot (Geneva Grad. Inst.), Climate Clubs: An International Tax Law Perspective, 52 INTERTAX 1 (2024)
- Alex Raskolnikov (Columbia), Taxes and Tournaments, __ Mich. St. L. Rev. __ (forthcoming)
- Richard C. Sansing Dartmouth, Tuck Sch. Bus.) & Carolyn Levine (Delaware, Accounting & MIS), Optimal Tax Avoidance and Corporate Social Responsibility with Heterogeneous Consumers and Investors (Sept. 10, 2024)
- Adam B. Thimmesch (Nebraska), A Future for the State Corporate Income Tax, __ Tax Law. __ (forthcoming 2024)
- Alex Zhang (Emory), The Origins of U.S. Territorial Taxation and the Insular Cases, 134 Yale L.J. Forum (forthcoming 2024)
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