real estate investment trusts and chapter 207, hawaii revised statutes
TRANSCRIPT
REAL ESTATE INVESTMENT TRUSTS
AND
CHAPTER 207 , HAWAII REVISED STATUTES
G e o r g e K. Ikeda A s s o c i a t e R e s e a r c h e r
R e q u e s t No . 8 - 6 7 1 4 O c t o b e r , 1969
L e g i s l a t i v e R e f e r e n c e B u r e a u U n i v e r s i t y of H a w a i i
TABLE OF CONTENTS
Page
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . 1
BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . 3
A Foreign Lender Defined . . . . . . . . . . . . . 3
. . . Cons t ruc t ion and Mortgage A c t i v i t y i n Hawaii 5
REAL ESTATE INVESTMENT TRUSTS . . . . . . . . . . . . . 8
. . . . . Real E s t a t e Investment T r u s t s i n General 8
"Equity" T r u s t s and "Mortgage" T r u s t s . 12
REITs i n Hawaii . . . . . . . . . . . . . 12
. . . . . Taxat ion and Regula t ion under Chapter 207 15
SUMMARY . . . . . . . . . . . . . . . . . . . 1 8
FOOTNOTES . . . . . . . . . . . . . . . . . . . . . . . 19
Appendix
House Reso lu t ion No . 268. F i f t h L e g i s l a t u r e . Regular Ses s ion of 1969 . . . . . . . . . . . . . . . . . . . . 22
INTRODUCTION
House Reso lu t ion 268 of t h e 1969 Regular S e s s i o n of t h e
F i f t h L e g i s l a t u r e ( s ee p. 22) r eques t ed t h e L e g i s l a t i v e Reference
Bureau t o extend i t s s tudy of f o r e i g n l ende r s prepared pursuant
t o House Reso lu t ion 109 o f t h e 1968 Budget Sess ion of t h e Fourth
L e g i s l a t u r e .
The s tudy prepared i n 1968, e n t i t l e d "Foreign Lenders and
1 Mortgage A c t i v i t y i n Hawaii", concen t r a t ed on the impact on
t h e economy of t h e S t a t e a s w e l l a s p o s s i b l e adverse e f f e c t s
upon domestic ( s t a t e - c h a r t e r e d ) l end ing i n s t i t u t i o n s b y t h e
i n c l u s i o n of f o r e i g n (ou t -o f - s t a t e ) f e d e r a l l y c h a r t e r e d sav ings
and l o a n a s s o c i a t i o n s w i th in t h e d e f i n i t i o n o f a " f o r e i g n
l e n d e r " , thereby a l lowing them t o make d i r e c t mortgage loans
i n Hawaii on a tax-exempt b a s i s . None of t h e f i n d i n g s of t h e
s tudy i n d i c a t e d any adverse e f f e c t s would r e s u l t should t h e
f o r e i g n f e d e r a l s a v i n g s a n d l o a n a s s o c i a t i o n s b e al lowed t o make
such mortgage investments i n Hawaii.
On t h e b a s i s of t h e Bureau s tudy , H.B. 40 "Re la t ing t o
Foreign Lenders and Mortgage Lending" was in t roduced i n t h e
1969 Regular Ses s ion and was passed b y the House of Representa-
t i v e s i n a form t h a t included f e d e r a l s av ings and loan a s s o c i a -
t i o n s a s f o r e i g n l ende r s . During t h e s e s s i o n , however, an
i n t e r e s t among some l e g i s l a t o r s i n a l s o i nc lud ing " r e a l e s t a t e
investment t r u s t s " under t h e d e f i n i t i o n of fo re ign l e n d e r s
r e s u l t e d i n t h e amendment of H.B. 40 b y t h e Sena te . The b i l l
(H.B. 40 , S.D. 1) was s e n t back t o t h e House which d i d no t
ag ree t o t h e change and was r e f e r r e d t o t h e conference com-
m i t t e e where it remains. The s t a t u s of t h e b i l l c a r r i e s over
i n t o t h e 1970 Regular Ses s ion .
A t t h a t t ime , s e v e r a l Wouse members were concerned over
t h e l a c k of in format ion r ega rd ing r e a l e s t a t e investment t r u s t s
and sponsored t h e r e s o l u t i o n which r e s u l t e d i n t h e e x t e n s i o n
of t h e Bureau 's s t u d y of f o r e i g n l e n d e r s . This r e p o r t i s
l i m i t e d t o r e a l e s t a t e investment t r u s t s , and it is suggested
t h a t more d e t a i l e d background m a t e r i a l on mortgage a c t i v i t y
i n Hawaii can b e found i n t h e L e g i s l a t i v e Reference Bureau ' s
s tudy r e f e r r e d t o e a r l i e r which t h i s r e p o r t supplements.
BACKGROUND
A Foreign Lender Defined
Before d i s c u s s i n g r e a l e s t a t e investment t r u s t s , i t would
b e u s e f u l t o review b r i e f l y Chapter 207 of t h e Hawaii Revised
S t a t u t e s , t h e S t a t e ' s f o r e i g n l ende r law. I n g e n e r a l , t h e
t e r m f o r e i g n l ende r r e f e r s t o a bank or o t h e r l end ing i n s t i -
t u t i o n c h a r t e r e d i n ano the r s t a t e which makes l oans i n Hawaii
b u t does no t mainta in a p l a c e of b u s i n e s s i n Hawaii. A f o r e i g n
lender l a w such as Chapter 207 a l lows t h e s e f i n a n c i a l i n s t i -
t u t i o n s t o make loans wi thout be ing s u b j e c t e d t o r e g u l a t i o n
and t a x a t i o n b y t h e S t a t e . I n Hawaii, q u a l i f y i n g f o r e i g n
l ende r s a r e o n l y r equ i r ed t o f i l e wi th t h e Department of
Regulatory Agencies and t h e r e a f t e r a r e pe rmi t t ed t o :
(1) Make loans ;
(2 ) Receive s e c u r i t y for l oans ;
( 3 ) Acquire b y assignment o r o therwise p a r t i a l o r e n t i r e i n t e r e s t s i n loans o r i n s e c u r i t y f o r loans :
(4) S e r v i c e (bu t on ly b y o r through i n d i v i d u a l s who a r e r e s i d e n t s o f , o r co rpo ra t ions doing b u s i n e s s , i n Hawaii) , c o l l e c t , enforce , o r o therwise r e a l i z e upon loans o r upon s e c u r i t y f o r loans o r upon i n t e r e s t s t h e r e i n : and take , ho ld , and d i spose of any p r o p e r t y acqui red (whether b y purchase a t any s a l e pursuant t o f o r e c l o s u r e by s u i t o r fo re - c l o s u r e under power of s a l e , o r b y f o r e c l o s u r e
b y e n t r y , o r b y conveyance i n l i e u of f o r e c l o s u r e ) i n enforcement of t h e r i g h t s of t h e f o r e i g n l e n d e r i n t h e event of d e f a u l t b y any borrower: and
( 5 ) Empower agen t s and s e r v a n t s o r i n connec t ion wi th , and e n t e r i n t o and perform c o n t r a c t s , and do o t h e r a c t s and t h i n g s necessary o r a p p r o p r i a t e f o r o r p re l imina ry o r i n c i d e n t t o , any of t h e foregoing a c t i v i t i e s , b u t not mainta in any o f f i c e i n t h i s S t a t e f o r t h e conduct of any such a c t i v i t i e s . 2
A s t a t e which e n a c t s a f o r e i g n l ende r law g a i n s c e r t a i n
advantages because funds f o r f i nanc ing , o therwise unava i l ab l e
through l o c a l sou rces , a r e provided f o r development and con-
s t r u c t i o n . For Hawaii, which has had a h i s t o r y of a sho r t age
of mortgage funds , t h e p r e s e n t law, passed i n 1961, has
encouraged lending from a r e a s of h igh c a p i t a l c o n c e n t r a t i o n
and f a c i l i t a t e d t h e boom i n c o n s t r u c t i o n a c t i v i t y which has
c o n t r i b u t e d h e a v i l y t o t h e v igo r of t h e s t a t e economy i n t h e
postwar pe r iod .
H.B. 40, S.D. 1, does n o t a f f e c t any o t h e r p a r t of
Chapter 207 and would o n l y add f o r e i g n f e d e r a l savings and
loan a s s o c i a t i o n s and r e a l e s t a t e investment t r u s t s i n t h e
d e f i n i t i o n of fo re ign l ende r s . I f Chapter 207 is amended by
t h e b i l l , s e c t i o n 207- l l (2 ) would read:
(2) "Foreign l ende r " means (A) a member o f t he Federal Reserve System, an " in su red bank" a s def ined i n t h e Federa l Deposi t Insurance Act, an " in su red i n s t i t u t i o n , " a s de f ined i n t h e Federal Savings
and Loan Insurance Corpora t ion Ac t , a f e d e r a l l y c h a r t e r e d sav ings and loan a s s o c i a t i o n , a " r e a l e s t a t e investment t r u s t " a s def ined i n t h e I n t e r n a l Revenue Code,or an insurance company, t h e p r i n c i p a l o f f i c e of which i s i n another s t a t e , whether in- co rpo ra t ed o r unincorporated and whether a c t i n g i n i ts i n d i v i d u a l c a p a c i t y o r i n a f i d u c i a r y c a p a c i t y , (B) t h e t r u s t e e o r t r u s t e e s from time t o t i m e i n o f f i c e o f any employee b e n e f i t p l a n , and (C) any c o r p o r a t i o n a l l of t h e c a p i t a l s t o c k of which (except d i r e c t o r s ' q u a l i f y i n g s h a r e s ) is owned by one o r more f o r e i g n l ende r s of t h e c l a s s e s s p e c i f i e d i n c l a u s e s (A) and (B) of t h i s paragraph, b u t t h e term " fo re ign l ende r " does not inc lude any smal l l oan o r i n d u s t r i a l loan company of t he gene ra l c h a r a c t e r covered b y c h a p t e r s 408 and 409.
Cons t ruc t ion and Mortqase A c t i v i t y i n Hawaii
S ince t h e 1968 Bureau s t u d y on f o r e i g n l e n d e r s was pre -
pared , t h e c o n s t r u c t i o n i n d u s t r y i n Hawaii has advanced t o a
new h igh i n t h e t o t a l va lue of c o n s t r u c t i o n ($463 m i l l i o n )
i n a l l c a t e g o r i e s i nc lud ing r e s i d e n t i a l , commercial, and
3 governmental p r o j e c t s . This is p a r t of a c o n s t r u c t i o n t r end
which has cont inued v i r t u a l l y un in t e r rup ted s i n c e 1955 i n
Hawaii. By mid-year 1969. c o n s t r u c t i o n was s u b s t a n t i a l l y
ahead o f t h e same pe r iod i n 1968, and i n d i c a t i o n s were t h a t
t h e demand would r e s u l t i n ano the r r eco rd i n c o n s t r u c t i o n
volume f o r 1969. 4
To suppor t t h e h igh l e v e l of c o n s t r u c t i o n , f i nanc ing is
necessary and t h e r e l a t i o n s h i p between t h e a v a i l a b i l i t y of
mortgage money and c o n s t r u c t i o n a c t i v i t y is a d i r e c t one.
Mortgages ou t s t and ing i n Hawaii t o t a l e d approximately $1.38
b i l l i o n i n 1968. Of t h i s amount about two-thi rds of t h e
ho ld ings w e r e he ld b y Hawaii-based f i n a n c i a l i n s t i t u t i o n s
whi le about one- th i rd , o r $460 m i l l i o n of t h e mortgages ou t -
5 s t a n d i n g , was made up of mainland investments . This i n d i c a t e s
t h e degree t o which Hawaii is dependent upon mainland mortgage
money. The mainland s h a r e is even more s i g n i f i c a n t s i n c e t h e
$460 m i l l i o n does no t i nc lude t h e p a r t i c i p a t i o n f inanc ing and
o u t r i g h t mortgage purchases o f mainland-based i n s t i t u t i o n s
which a r e included i n t h e amount he ld b y t h e Hawaii-based
f i n a n c i a l i n s t i t u t i o n s .
The compet i t ion f o r mortgage money is more a c u t e whenever
a t i g h t money market p r e v a i l s . There is, a t p r e s e n t , cause
f o r concern. A t t h e t i m e of t h e p r e p a r a t i o n of t h i s r e p o r t ,
t h e prime i n t e r e s t r a t e ( t h e r a t e charged b y banks t o t h e i r
b e s t c l i e n t s i n bus ines s borrowing) had been r a i s e d t o an un-
precedented 8-1/2 p e r c e n t which tends t o have a r e s t r a i n i n g
e f f e c t on t h e mortgage market by c u t t i n g o f f a f low of funds.
T h i s i s because much of t he money a v a i l a b l e f o r mortgages
comes from sav ings . With h igh i n t e r e s t r a t e s , s a v e r s f i n d
t h a t t h e i r money can e a r n more i n bonds and o t h e r high y i e l d -
i ng investments and thus , t h e flow of sav ings slows down t o
i n s t i t u t i o n s l i k e sav ings and loan a s s o c i a t i o n s which a r e a
major source of r e s i d e n t i a l c o n s t r u c t i o n . Insurance companies,
which a r e ano the r source of mortgage money, a l s o f i n d l e s s ms~:ey
t o i n v e s t i n mortgages s i n c e p o l i c y ho lde r s may borrow on
t h e i r l i f e i n su rance a t lower i n t e r e s t r a t e s than any o the r
source .
I n a t i g h t money market, c o n s t r u c t i o n a c t i v i t y u s u a l l y s u f f e r s
a slump. Hawaii, which con t inues t o b e dependent upon mainland
investments t o f i nance i t s c o n s t r u c t i o n , w i l l v e ry l i k e l y f e e l
t h e impact , a l though i t i s s t i l l u n c e r t a i n whether t hese e f f e c t s
w i l l be major ones. I f t h e o b j e c t i v e of t h e l e g i s l a t o r s is t o
a t t r a c t a s much mortgage money a s p o s s i b l e t o ensure t h a t con-
s t r u c t i o n w i l l con t inue a t i t s p r e s e n t l e v e l , then t h e i n c l u s i o n
of more f o r e i g n l e n d e r s may be a d e s i r a b l e p o l i c y . The d e c i s i o n ,
however, r e q u i r e s c a r e f u l cons ide ra t ion a n d t h e d i f f i c u l t y w i t h
r e a l e s t a t e investment t r u s t s l ies i n t h e f a c t t h a t t h e i r
a c t i v i t i e s i n t h e S t a t e have been of a l i m i t e d n a t u r e t o d a t e .
REAL ESTATE INVESTMENT TRUSTS
Rea l E s t a t e Investment T rus t s i n General
Real e s t a t e investment t r u s t s ( h e r e a f t e r r e f e r r e d t o a s
REITS) a r e unincorporated t r u s t s o r a s s o c i a t i o n s , managed b y
one o r more t r u s t e e s . They a r e s i m i l a r t o s t o c k investment
companies (commonly c a l l e d "mutual funds") i n t h a t they enable
i n v e s t o r s t o pool t h e i r i n d i v i d u a l funds t o t a k e advantage of
investment o p p o r t u n i t i e s and t h e p r o b a b i l i t y o f h ighe r r e t u r n s
wh i l e a t the same time enjoying c e n t r a l i z e d , exper ienced, and
sound f i n a n c i a l management t o ensu re t h e s a f e t y of t h e s e i nves t -
ments. The pr imary d i f f e r e n c e between the REITs and t h e s t o c k
investment companies is t h a t t h e REITS i n v e s t i n r e a l e s t a t e
and r e a l e s t a t e mortgages whi le t h e s t o c k companies i n v e s t i n
s t o c k and s e c u r i t i e s . 6
REITs a c t u a l l y d a t e back t o mid-nineteenth cen tu ry Boston
where an o r g a n i z a t i o n f i r s t o f f e r e d sha re s t o t h e pub l i c ,
promising a s t eady income t o i n v e s t o r s . S i m i l a r o rgan iza t ions
were begun i n o t h e r c i t i e s which provided the needed c a p i t a l
t o develop t h e s e l o c a l i t i e s . I n 1936, however, a f e d e r a l
c o u r t d e c i s i o n r u l e d t h a t t h e REITs were co rpo ra t ions s u b j e c t
t o t h e co rpo ra t e income t a x . S ince t h e t a x on t h e t r u s t s
diminished p r o f i t s t o i n v e s t o r s by imposing a double t a x a t i o n
on them once they r ece ived d iv idends , t h e REITs no longer
proved a t t r a c t i v e and many were l i q u i d a t e d . 7
The c u r r e n t i n t e r e s t i n REITs, however, goes back on ly
t o 1960 when Congress passed Pub l i c Law 86-779 which added
s e c t i o n s 856, 857, and 858 t o t h e I n t e r n a l Revenue Code.
Pub l i c Law 86-779 exempted t h e REITs from t h e c o r p o r a t e t a x
i n t h e same manner " r e g u l a t e d investment companies' w e r e
exempted e a r l i e r .
I n the ca ses of b o t h t h e REITs and " r egu la t ed investment
companies", where 90 p e r c e n t o r more o f o rd ina ry income i s
d i s t r i b u t e d t o sha reho lde r s , t h e f e d e r a l government t axes on ly
t h e u n d i s t r i b u t e d income, whi le t h e d i s t r i b u t e d ea rn ings of t h e
company a r e taxed t o t h e sha reho lde r s a s o rd ina ry income. Any
amount which t h e t r u s t r e t a i n s i s s u b j e c t t o t h e r e g u l a r
c o r p o r a t e income t a x . I n t h e ca se of t h e REITs, however,
a d d i t i o n a l q u a l i f i c a t i o n s a r e app l i ed .
A s s p e c i f i e d i n t h e I n t e r n a l Revenue Code, a r e a l e s t a t e
investment t r u s t must:
(1) Be organized under s t a t e law a s an unincorporated t r u s t o r a s s o c i a t i o n managed by one o r more t r u s t e e s ;
( 2 ) Have t r a n s f e r a b l e s h a r e s o r c e r t i f i c a t e s of b e n e f i c i a l i n t e r e s t ;
( 3 ) Be a type of o rgan iza t ion which would be taxed a s an ord inary domestic co rpo ra t ion i n t h e absence o f the p rov i s ions of t h e s e Sec t ions .
The b e n e f i c i a l ownership of q u a l i f y i n g REITs must b e he ld
b y 100 o r more persons . No f i v e o r Zewer i n d i v i d u a l s may
d i r e c t l y o r i n d i r e c t l y own more than 50 pe r c e n t of t he
t r u s t . The REIT may n o t hold any p r o p e r t y p r i m a r i l y f o r
s a l e t o customers i n t h e ord inary cou r se of t r a d e o r bus ines s
T h i s p rov i s ion , t o g e t h e r w i th c e r t a i n o t h e r p rov i s ions r e s t r i c t -
i n g t r u s t s from p rov id ing s e r v i c e s t o t e n a n t s except through
an independent c o n t r a c t o r , a r e designed t o make s u r e t h a t t he
t r u s t ope ra t e s a s a condu i t s t r i c t l y f o r investment income.
Income requirements a r e d iv ided i n t o t h e t h r e e fol lowing
c a t e g o r i e s , a l l t h r e e o f which must b e met b y a t r u s t i n
o r d e r t o q u a l i f y :
(1) Ninety p e r c e n t o r more of a t r u s t ' s g r o s s income must b e ob ta ined from d iv idends , i n t e r e s t , r e n t s from r e a l p rope r ty , g a i n s from t h e s a l e of s e c u r i t i e s and real p r o p e r t y and abatements and refunds of t a x e s on r e a l p rope r ty .
( 2 ) The second income t e s t r e q u i r e s t h a t a t l e a s t 75 pe r c e n t of a r e a l e s t a t e investment t r u s t ' s income must b e income from r e a l p r o p e r t y , which is de f ined t o i nc lude r e n t s from r e a l p roper ty , g a i n from t h e s a l e of r e a l p rope r ty , mortgage i n t e r e s t , d iv idends and o t h e r d i s t r i b u t i o n s from o t h e r r e a l e s t a t e t r u s t s q u a l i f y i n g under t h e I n t e r n a l Revenue Code and abatements and refunds of t axes on r e a l p roper ty .
Thus, 75 pe r c e n t of t h e t r u s t income must be der ived from
r e a l p rope r ty , ano the r 15 p e r c e n t must be de r ived from e i t h e r
r e a l p r o p e r t y o r from sou rces from which a r egu la t ed inves t -
ment company may d e r i v e 90 pe r c e n t of i t s income, and t h e
remaining 10 pe r c e n t is n o t l i m i t e d a s t o source .
-10-
( 3 ) Under t h e t h i r d t e s t , no t more t h a n 30 p e r c e n t of t h e t r u s t ' s g ros s income may b e ob ta ined from s a l e s o f s e c u r i t i e s he ld f o r l e s s than s i x months o r from s a l e s of r e a l p r o p e r t y he ld f o r l e s s than f o u r y e a r s from invo lun ta ry convers ions .
There a r e c e r t a i n investment requirements:
(1) The f i r s t r e q u i r e s t h a t 75 pe r c e n t of t h e value of t h e t r u s t a s s e t s be i n r e a l e s t a t e a s s e t s , cash and cash i tems, and government s e c u r i t i e s . Th i s t e s t i s designed t o a s su re t h a t most of t h e t r u s t ' s a s s e t s w i l l b e i n r e a l e s t a t e .
(2 ) Not more than 25 pe r c e n t of t he va lue of t h e t r u s t a s s e t s may b e inves t ed i n s e c u r i t i e s of o t h e r companies (except o t h e r REITs which q u a l i f y a s " r e a l e s t a t e a s s e t s " ) .
( 3 ) Not more than 5 p e r c e n t of t h e value of t h e t r u s t a s s e t s may b e inves t ed i n any one i s s u e r , nor i n more than 10 p e r c e n t o f t he vo t ing s e c u r i t i e s of such i s s u e r . *
The 1960 t a x b e n e f i t l e g i s l a t i o n se rved a s an impetus f o r
t h e es tab l i shment and development of REITs. While REITs which
s o l d s h a r e s on ly w i th in a s i n g l e s t a t e were exempt from f i l i n g
w i t h t h e S e c u r i t i e s and Exchange Commission, a l l REITs s e l l i n g
sha re s o u t s i d e a s i n g l e s t a t e f e l l under f e d e r a l r e g u l a t i o n .
A s of June 30, 1968, r e g i s t r a t i o n s ta tements o f 61 REITs
were e f f e c t i v e under t h e SEC r u l e s and t h e g r o s s a s s e t s of
t h e s e REITs w e r e more than $1 b i l l i o n . 9
"Equity" T r u s t s and "Mortqaqe" T r u s t s
REITs a r e organized i n two d i f f e r e n t forms. Most m I T s
a r e "equ i ty" t r u s t s which i n v e s t p r i m a r i l y i n income producing
p r o p e r t y such a s commercial (shopping c e n t e r s , o f f i c e b u i l d i n g s ,
h o t e l s , e t c . ) , and i n d u s t r i a l r e a l e s t a t e . The i r main source
of income is from r e n t s . The o t h e r form of REITs i s t h e
"mortgage" t r u s t which i n v e s t s p r i m a r i l y i n l oans secured b y
mortgages on r e a l e s t a t e . These mortgages c o n s i s t o f bo th
long-term mortgages ( m a t u r i t i e s of more than t e n y e a r s ) and
shor t - term mortgages (one t o two yea r s ) f o r c o n s t r u c t i o n o r
o the r i n t e r i m f inanc ing . The income of mortgage t r u s t s is
p r i m a r i l y from i n t e r e s t earned and d i scoun t s rece ived du r ing
t h e p e r i o d of amor t i za t ion of t h e loans . LO
REITs i n Hawaii
The impact of t h e REITs i n Hawaii has s t i l l been minimal
i n t h e c o n s t r u c t i o n i n d u s t r y and has been l i m i t e d t o a few
mortgage t r u s t s involved p r i m a r i l y i n t h e c o n s t r u c t i o n of
I I condominium apar tments and h o t e l s . Although t h e REIT i n v e s t -
ments i n Hawaii have been f o r c o n s t r u c t i o n , REITs i n o t h e r
a r e a s a l s o make a v a r i e t y of investments e i t h e r a lone o r i n
p a r t i c i p a t i o n (by purchasing a p a r t i a l i n t e r e s t i n a mortgage
l o a n t h a t was acqui red by ano the r l ende r i n t h e l o c a l e ) wi th
o t h e r i n s t i t u t i o n a l i n v e s t o r s . Most REIT investments i nc lude
t h e fol lowing:
-12-
(1) F i r s t mortgage c o n s t r u c t i o n loans , which f i n a n c e t h e c o n s t r u c t i o n of r e s i d e n t i a l , commercial o r i n d u s t r i a l b u i l d i n g s .
(2 ) FHA insured , VA guaranteed, and convent ional f i r s t mortgage l o a n s , which f inance t h e purchase o r :he r e f i n a n c i n g of completed r e s i d e n t i a l and income p r o p e r t i e s .
( 3 ) Warehousing l o a n s , which a r e loans u s u a l l y made t o mortgage bankers o r f i n a n c i a l i n s t i t u t i o n s on a shor t - te rm b a s i s and secured b y t h e pledge of f i r s t mortgage loans .
( 4 ) Standby commitments t o make long-term f i r s t mortgage loans . The REIT charges a f e e f o r i s s u i n g t h e le t ter o f commitment a g a i n s t which a borrower may ob ta in a c o n s t r u c t i o n o r i n t e r i m loan .
(5 ) Long-term f i r s t mortgage loans on p r o p e r t y i n Canada in su red b y an agency of t h e Canadian Government.
( 6 ) Ownership of income-producing r e a l p rope r ty , and unimproved r e a l p rope r ty f o r f u t u r e development.
(7 ) S e c u r i t i e s o r o the r e q u i t y i n t e r e s t s i n r e a l p r o p e r t y p r o j e c t s .
(8) S e c u r i t i e s of o t h e r co rpo ra t ions .
(9) Municipal, s t a t e and f e d e r a l o b l i g a t i o n s , and those o f t h e i r i n s t r u m e n t a l i t i e s , a s we l l a s bank time d e p o s i t s , commercial paper and banke r s ' acceptances .
Although t h e REITs do i n v e s t i n FHA insu red , VA guaranteed
and convent ional long-term f i r s t mortgage loans on completed
b u i l d i n g s , t h e s e have not been t h e type of commitments they
have made i n Hawaii because more a t t r a c t i v e investment
o p p o r t u n i t i e s e x i s t he re . The emphasis i s on c o n s t r u c t i o n of
commercial b u i l d i n g s and condominiums, and t h i s is important
t o no te s i n c e r e s i d e n t i a l housing, o t h e r than mul t i -un i t
p r o j e c t s , w i l l probably n o t a t t r a c t funds from t h e REITs.
Short - term c o n s t r u c t i o n loans have a g r e a t e r a t t r a c t i o n ,
d e s p i t e t h e i r h igh r i s k , because t h e y a l low a h i g h e r i n t e r e s t
r a t e and provide t h e REITs w i t h d i v e r s i t y i n t h e i r investments .
I n i n t e r i m f inanc ing of t h i s s o r t , t h e REITs f u r n i s h t h e con-
s t r u c t i o n funds f o r a p r o j e c t while some o t h e r f i n a x i a l i n s t i -
t u t i o n such a s an insurance company, sav ings bank, sav ings and
l o a n a s s o c i a t i o n , o r commercial bank provides a commitment
f o r a f i r s t mortgage loan o r t h e permanent mortgage. General ly ,
t h e c o n s t r u c t i o n loans a r e r e p a i d by t h e borrower o u t of proceeds
of t h e long-term f i r s t mortgage. Making more funds a v a i l a b l e
f o r shor t - term c o n s t r u c t i o n f inanc ing may b e d e s i r a b l e i n
Hawaii s i n c e most Hawaii mortgage bankers , w i th t h e excep t ion
of commercial banks, o r d i n a r i l y do n o t do i n t e r i m c o n s t r u c t i o n
f inanc ing . Commercial banks, however, l i k e t h e Bank of Hawaii
and t h e F i r s t Hawaiian Bank, have not taken any p o s i t i o n
a g a i n s t t h e REITs f o r t h e reason t h a t banks have supported a
p o l i c y of encouraging t h e i n f l u x of new investment c a p i t a l
i n t o t h e S t a t e . Moreover, i n t he c a s e of commercial banks on
t h e Mainland, many have reduced t h e i r c o n s t r u c t i o n l end ing
because of t i g h t money cond i t i ons l e a v i n g t h e investment f i e l d
i n l and development and c o n s t r u c t i o n loans t o t h e REITs.
Another r e a s o n why t h e R E I T s have n o t been viewed a s a
t h r e a t t o l o c a l l ende r s is t h a t t h e REITS have worked f o r t h e
most p a r t through mortgage correspondents o r through p a r t i c i p a -
t i o n w i t h commercial banks o r o t h e r f i n a n c i a l i n s t i t u t i o n s bo th
h e r e i n Hawaii and throughout t h e country . I n p a r t i c i p a t i o n ,
l o c a l l e n d e r s o r i g i n a t e and s e l l l oans from t h e i r own p o r t f o l i o ,
s eek ing i n v e s t o r s on t h e Mainland who w i l l e i t h e r purchase t h e
mortgage loans o u t r i g h t o r a p a r t i a l i n t e r e s t i n t h e mortgage.
Local l e n d e r s r e t a i n t h e s e r v i c i n g of t h e mortgage and t h e f e e s
f o r t h e s e r v i c i n g vary wi th t h e s i z e o f t h e loan and a r e nego-
t i a t e d between t h e l o c a l l ende r and t h e fo re ign l ende r . Thus,
t h e a t t i t u d e of l o c a l l e n d e r s would t end t o be coope ra t ive
r a t h e r than compe t i t i ve , a l though t h i s a t t i t u d e may w e l l change
i f t h e REITs b e g i n t o make d i r e c t loans t o b u i l d e r s and developers ,
by-passing t h e l o c a l l e n d e r a s t h e middleman, which t h e REITs
might do under Chapter 207.
Taxat ion and Requlat ion under Chapter 207
The t a x exemption provided i n s e c t i o n 207-12 may w e l l be
regarded a s t h e c o r e of t h e fo re ign l ende r law and i s a major
f e a t u r e i n a t t r a c t i n g investment. REITs, l i k e o t h e r ou t -of - s ta te
i n v e s t o r s , a r e looking f o r investments which w i l l produce h igh
n e t y i e l d s , and t a x b e n e f i t s i n c r e a s e t hose y i e l d s . I n t h e
c a s e o f p a r t i c i p a t i o n loans , t h e income de r ived from t h e
s h a r e of t h e l o c a l l ende r on t h e loan i s t a x a b l e b y t h e S t a t e
b o t h a s p a r t of t he 4 p e r c e n t g e n e r a l e x c i s e t a x and the n e t
income t ax . On the o t h e r hand, t h e income o f t h e fo re ign
l e n d e r de r ived through i t s s h a r e i n t h e p a r t i c i p a t i o n o r d i r e c t
purchase is t a x exempt. I n a d i r e c t loan , no t a x revenue
w o d d accrue t o t h e S t a t e .
Although it has never been e s t a b l i s h e d whether t h e p r a c t i c e s
o f p a r t i c i p a t i o n o r o u t r i g h t purchase of l oans b y ou t -o f - s t a t e
l e n d e r s o t h e r than f o r e i g n l ende r s a s de f ined b y law a r e i n
c o n f l i c t w i t h Chapter 207, many (such a s t h e f o r e i g n f e d e r a l
sav ings and loan a s s o c i a t i o n s ) have been us ing t h e s e methods
i n t h e p a s t wi thout be ing chal lenged. A s was po in ted o u t i n
t h e 1968 s t u d y , however, d i r e c t loans by a l e n d e r which did no t
q u a l i f y under Chapter 207 would appear t o b e a v i o l a t i o n of
t h e law. A s t h e s i t u a t i o n a c t u a l l y e x i s t s , however, t h e making
o f d i r e c t loans i s no t a common p r a c t i c e e i t h e r of REITs o r
most q u a l i f y i n g f o r e i g n l ende r s w i th investments i n Hawaii.
There i s some reason f o r doubt, moreover, t h a t REITs w i l l
o r i g i n a t e t h e i r own loans i n Hawaii. On t h e Mainland, t h e
REITs appear t o work mainly through correspondents who have
an i n t i m a t e knowledge of t h e l o c a l market and cond i t i ons .
The p a t t e r n f o r most f o r e i g n l ende r s o p e r a t i n g i n Hawaii has
been one of working wi th l o c a l mortgage bankers , and t h i s
should n o t d i f f e r t o any g r e a t degree w i t h t h e REITs. I f t h e
REITs do make d i r e c t l oans , t h e p r o j e c t s a r e thoroughly
i n v e s t i g a t e d and c a r e f u l a t t e n t i o n is g iven t o each s t e p of
t h e p r o j e c t . Through t h e s e methods, t h e REITs have avoided
a "get- r ich-quick" image, and t h e p & l i c a s shareholders seem
t o be adequa te ly p r o t e c t e d b y f e d e r a l t a x laws; t h e r u l e s of
t h e S e c u r i t i e s and Exchange Commission, s t a t e s e c u r i t i e s com-
mission, o r b o t h , which r e q u i r e a f u l l d i s c l o s u r e of t h e f a c t o r s
t o b e made known t o i n v e s t o r s . While no d e f i n i t i v e judgment
can be made, t h e REITs, a s a whole, have not been ins t ruments
of abuse s i n c e t h e i r reappearance a f t e r 1960. 12
The REITs have on ly begun t o e n t e r t h e Hawaii cons t ruc-
t i o n p i c t u r e , and i t i s s t i l l d i f f i c u l t t o measure t h e i r t o t a l
impact because t h e i r a c t i v i t i e s have been l i m i t e d t o cons t ruc-
t i o n f i nanc ing of a few h o t e l and condominium p r o j e c t s . There
a r e m c o n c r e t e f i g u r e s of t h e amount of t h e i r investments t o
d a t e a l though one e s t ima te was $15 t o $20 m i l l i o n . The REITs
and t h e i r investment p a t t e r n s a r e dependent on a number of
f a c t o r s , n o t t h e l e a s t of which i s t h e a c t i v i t y on t h e s t o c k
market because of t h e n a t u r e of i t s o rgan iza t ion and i t s
s h a r e o f f e r i n g s . I n t h e q u e s t f o r h igh y i e l d investments ,
t h e RELTs have looked t o Hawaii which i s undergoing a cons t ruc-
t i o n boom, and t h e S t a t e can probably expect more investments ,
b u t no t much o t h e r t han shor t - term c o n s t r u c t i o n loans . No one
can deny t h a t t h e p o t e n t i a l does e x i s t f o r the REITs t o become
a major f a c t o r i n mortgage f inanc ing i n Hawaii, b u t t h e impact
i s no t r e a l l y measurable a s pt.
I n t h e f a c e of con t inu ing demands f o r mortgage funds
and t h e h igh l e v e l of cons t ruc t ion i n Hawaii, t h e r e does not
seem t o b e any reason why t h e REITs should n o t be included i n
t h e d e f i n i t i o n of fo re ign l ende r s , a long wi th t h e f e d e r a l l y
c h a r t e r e d sav ings and loan a s s o c i a t i o n s which were t h e s u b j e c t
o f t h e e a r l i e r s tudy.
FOOTNOTES
L e g i s l a t i v e Reference Bureau, Un ive r s i t y of Hawaii, Request No. B-4863, November, 1968 (Mifieographed).
Hawaii Rev. S t a t . , Sec. 207-13 (1967) .
Cons t ruc t ion i n Hawaii 1969, Bank of Hawaii (Honolulu: 1969) , p . 2.
"Review of Business and Economic Cond i t i ons , " Bank of Hawaii, June , 1969.
Cons t ruc t ion i n Hawaii 1969, p. 5
C a l i f o r n i a , D iv i s ion of Real E s t a t e , Reference Book, 1968 e d i t i o n (Sacramento: 1968) , p. 222.
Don G. Campbell, The Handbook of Real E s t a t e Investment ( ~ n d i a n a p o l i s and New York: Bobbs-Merrill Company, Inc . , 1968) , pp. 118-22.
Nat iona l Assoc i a t i on o f Real E s t a t e Investment Funds, Handbook of Merrber T r u s t s (n.p. 1968) , pp. 4-6.
William A . Kelley, Jr., "Real E s t a t e Investment T r u s t s A f t e r Seven Years, " Business Lawyer, 23 ( Ju ly , 1968) , p. 1002.
Two of t h e REITs con tac t ed i n t h e course of t h e r e p o r t who have inves t ed i n Hawaii were Con t inen ta l Mortgage I n v e s t o r s and F i r s t Mortgage I n v e s t o r s which a r e bo th Boston-based b u t n a t i o n a l i n scope. Con t inen ta l Mortgage I n v e s t o r s has more than 12,000 shareholders and has made loans i n 40 s t a t e s over t h e l a s t 7 years t o t a l i n g some $500 m i l l i o n . F i r s t Mortgage I n v e s t o r s r epo r t ed over 180 mortgage correspondents i n 43 s t a t e s and Puer to Rico and r e p o r t e d approximately 5,800 shareholders i n 1968. Con t inen ta l Mortgage I n v e s t o r s i s l i s t e d on t h e New York S tock Exchange wh i l e F i r s t Mortgage I n v e s t o r s ' s h a r e s a r e t r aded over t h e counte r .
1 2 . Ke l l ey , p. 1011. A number of REITs organized i n C a l i f o r n i a appear t o be i n t e r e s t e d i n investments i n Hawaii and i f t h e y do not se l i t h e i r sha re s a c r o s s s t a t e bo rde r s , a r e r e g i s t e r e d w i t h and r egu la t ed b y t h e C a l i f o r n i a Corpora- t ions Commissioner .
13. U n t i l t he June-July (1969) s t o c k market slump, s tock i n F i r s t Mortgage I n v e s t o r s moved up i n p r i c e b y nea r ly 30 p e r c e n t and Con t inen ta l Mortgage Inves to r s by 25 pe r c e n t from t h e beginning of t h e yea r .
ACKNOWLEDGMENTS
The fo l lowing i n d i v i d u a l s were h e l p f u l i n t h e p r e p a r a t i o n of t h i s r e p o r t and we a r e g r a t e f u l f o r t h e i r coopera t ion .
M r . Char les Wade, F i r s t Hawaiian Bank M r . H. Howard Stephenson, Bank of Hawaii M r . P e t e r Smith, AMFAC F i n a n c i a l Corporat ion
Correspondence was a l s o conducted with s e v e r a l persons a s s o c i a t e d wi th REITs and we a p p r e c i a t e t h e in format ion they provided us .
M r . Hal Mendon, F i r s t F i d e l i t y Company (Beverly H i l l s , C a l i f o r n i a )
Mr. Durand A . Holladay, Mortgage Consu l t an t s (Investment Advisor t o C o n t i n e n t a l Mortgage I n v e s t o r s ) (Coral Gables , F l o r i d a )
M r . Surnner H. Shafmaster , F i r s t Mortgage Advisory Corporat ion ( Investment Advisor t o F i r s t Mortgage I n v e s t o r s ) (Miami Beach, F l o r i d a )
Appendix
(To be made one and eight copies) FIFTH Wj%&M LEGISLATURE, 1-
STATE OF HAWAII
-
14. NO. 268
REQUESTING THE LEGISLATIVE REFERENCE BUREAU TO EXTEND ITS STUDY RELATING TO FOREIGN LENDERS.
WHEREAS, pursuant t o House Reso lu t ion No. 109, adopted a t t h e Fourth ~ e g i s l a t u r e , Budget Sess ion of 1968, t h e L e g i s l a t i v e Reference Bureau conducted and d u l y submit ted a s t u d y o n t h e p r o v i s i o n s of House B i l l No. 185, in t roduced i n t h e s a i d Budget Ses s ion of 1968, which proposed t o amend S e c t i o n 98L-8(b), Revised Laws of Hawaii 1955, t o inc lude f e d e r a l l y c h a r t e r e d sav ings and loan a s s o c i a t i o n s w i th in t h e meaning of the term " f o r e i g n l e n d e r " , enab l ing such a s soc i a - t i o n s t o f i l e s t a t emen t s w i t h t h e Department of Regulatory Agencies and t h e r e a f t e r make mortgage loans i n Hawaii; and
WHEREAS, it i s now d e s i r o u s t o extend t h a t s tudy t o cover t h e impact on t h e mortgage bus ines s i n Hawaii b y a proposed i n c l u s i o n of a r e a l e s t a t e investment t r u s t a s de f ined i n t h e I n t e r n a l Revenue Code w i t h i n t h e meaning of t h e term " fo re ign l e n d e r " ; now, t h e r e f o r e ,
BE I T RESOLVED b y the House of Represen ta t ives of t h e F i f t h L e g i s l a t u r e o f t h e S t a t e of Hawaii, Regular Ses s ion of 1969, t h a t i t r e q u e s t t h e L e g i s l a t i v e Reference Bureau t o ex tend i t s s tudy on t h e p rov i s ions of House B i l l No. 185 wi th regard t o a proposed i n c l u s i o n of r e a l e s t a t e investment t r u s t a s de f ined i n t h e I n t e r n a l Revenue Code wi th in t h e meaning of t h e term " fo re ign l ende r " and with regard t o t he economic impact of such i n c l u s i o n on t h e morcgage bus ines s i n Hawaii; and
BE IT FURTHER RESOLVED t h a t t h e L e g i s l a t i v e Reference Bureau submit t h e r e p o r t of i ts f ind ings and recommendations t o t h e House of Represen ta t ives t h i r t y days p r i o r t o t h e convening of t h e 1970 Regular Sess ion: and
2 Page-
I BE I T FURTHER RESOLVED t h a t a duly c e r t i f i e d copy gf t h i s R e s o l u t i o n be t r a n s m i t t e d t o t h e L e g i s l a t i v e R e f e r e n c e Bureau.
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