FAQ Real Estate Investment Trust Morrison Foerster | 18 on the foreclosed real estate, which can pass through to stockholders. The REIT, however, cannot take advantage of the foreclosure property rules if it has acquired the mortgage with intent to foreclose. Accordingly, these REITs will have to make decisions about which mortgages to purchase. Alternatively, they can acquire the properties in a TRS to avoid foreclosure property issues. What other regulatory compliance obligations may mortgage REITs have? Mortgage REITs are subject to the lending requirements of Fannie Mae and Freddie Mac and general mortgage lending laws and regulations, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, Home Ownership and Equity Protection Act of 1994, Housing and Recovery Act 2008, Truth in Lending Act, Equal Credit Opportunity Act, Fair Housing Act, Real estate Settlement Procedures Act, Home Mortgage Disclosure Act and Fair Debt Collection Practices Act. In addition, mortgage REITs must continually assess the availability of exemptions from the Investment Company Act. See “Are there Investment Company Act considerations in structuring and operating a REIT?” above. Private REITs How are private REITs established? A REIT, like any other company, may issue equity securities without registration under the Securities Act if there is an available exemption from registration, such as Section 4(a)(2) of the Securities Act (often in accordance with Regulation D) or Regulation S or Rule 144A under the Securities Act. Private REITs are commonly used in private equity and other private real estate investment structures and by public REITs in joint ventures in order to allow beneficial tax treatment for investments in real estate by certain types of investors, including non-taxable U.S. investors, such as public pension funds, and foreign investors, including sovereign wealth funds, among others. Are there constraints on private REITs that are not relevant for public REITs? Yes. Private REITs are subject to restrictions on how many stockholders they may have even though they must have at least 100 holders. For example, Section 12(g) of the Exchange Act requires a company to register under the Exchange Act and be subject to its periodic reporting and other obligations if it has at least 2,000 stockholders of record or 500 stockholders who are not accredited investors, and the Investment Company Act requires registration of investment companies that have more than 100 holders who are not qualified purchasers unless another exemption (such as under Section 3(b) or Section 3(c) of the Investment Company Act) is available. Further, while the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act), passed by Congress on December 18, 2015, repealed the preferential dividend rule with respect to REITs that file annual and periodic reports with the SEC under the Exchange Act, the preferential dividend rule continues to apply to private REITs. Therefore, distributions that are not made (i) pro rata, (ii) with no preference to any share of stock as compared with other shares of the same class and (iii) with no preference to one class of stock as compared to another class except to the extent the former is entitled to such preference, will be considered “preferential dividends,” in which case, the entire amount of such dividend would be ineligible for the dividends paid deduction and for consideration in determining if the REIT met the 90% distribution test. In addition, the equity securities of private REITs are not traded on public stock exchanges and generally have less liquidity than those of listed public REITs. However, many private REITs offer their equity holders some form of interim liquidity similar to non-traded REITs. Can a private REIT satisfy the ownership and holder requirements? Yes. In a typical private REIT structure, one or a handful of stockholders may own all the common stock, while a special class of preferred shares may be owned by at least 100 holders in order to satisfy the requirement of having at least 100 stockholders. A private REIT also must satisfy the 5/50 test, but, in most cases, it is not an issue because the holders of shares in the private REIT will be corporations or partnerships with many investors. The 5/50 test is applied by looking through those entities to their
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