Capital Source Abandons REIT status

by REIT Wrecks on November 4, 2008

For the sake of good order, I need to post the fact that Capital Source has decided to revoke its REIT status after writing about CSE’s chameleon-like transformation into a bank, among other things, in the postMortgage REITs & Custer’s Last Stand. Morphing into a bank allows CSE to take advantage of inexpensive, stable deposits as a funding source, but with the revocation of REIT status as of 2009, CSE is no longer required to meet the IRS requirements with respect to distribution of its income to shareholders (see REIT Definition) . Accordingly, an investment in CSE is now simply an investment in a regional bank, not a REIT.

The Chevy Chase-based company, which earlier this year bought 22 bank branches from Fremont General Corp., will keep its REIT status for the rest of 2008, but will not be a REIT in 2009.

CapitalSource said in a statement that while REIT status has tax advantages, it is “imprudent and perhaps impossible” to maintain a large portfolio of residential investment assets in 2009 due to the uncertain credit markets and weak economic environment.

The company plans to sell its residential mortgage-related investments early next year.

“Entering 2009, CapitalSource will look similar to the way it did prior to becoming a REIT in 2006 with three important exceptions: the company will have achieved its strategy of becoming a bank, leverage will be lower and it will be the owner of a healthcare net lease business,” said chairman and chief executive John K. Delaney in a statement.

CapitalSource said it will keep paying dividends in the fourth quarter and in 2009.

CapitalSource Inc. has suffered amid a weakening economic environment in recent months. The company in August reported a 29 percent profit decline Tuesday as its commercial loan portfolio shrunk.

In September it slashed its quarterly cash dividend by 92 percent.

Earlier this month the company said it would delay an initial public offering for a minority interest in its health care real estate investment trust, CapitalSource Healthcare REIT, because of the volatile market.

However, this IPO could still occur at some point, the company said.

“The decision to revoke our REIT election for 2009 does not preclude any transaction in 2009 with respect to our healthcare net lease business, including an IPO of the business as a separate publicly traded healthcare REIT,” said Thomas A. Fink, CapitalSource CFO, in a statement.

The fact that Capital Source, a relatively healthy REIT, has decided to revoke its REIT status is significant. The REIT model is still broken, and investors continue to punish companies that invest in real estate-related assets, particularly mortgages. Capital Source is gambling that abandoning its connection to the beleaguered business model will cause investors to value the business in a way that is more closely aligned to instrinsic value. REIT investors should remember, however, that CSE’s business has not changed. Capital Source has done nothing but abandon a stigma that unduly punished its valuation.

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Disclosures: None at the time of publication
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