Squeaky Clean Institutional Real Estate Companies

The barrage of corporate scandals over the last several years has sapped confidence in our proud securities markets. Driven to inflate results (and executives' fat stock option packages) large firms like Enron and WorldCom used dubious accounting methods, questionable foreign tax havens, and bogus underwriting from Wall Street's largest investment banks to bilk thousands of naive investors. But according to a new article from Knowledge @ Wharton, Real Estate Investment Trusts have been model corporate citizens:

Unlike the boom of the 1980s, whose aftermath revealed a host of shady deals between real estate developers and unscrupulous S&L executives, publicly traded REITs have largely been untouched by the most recent scandals.

So how did they do it? The article gives three reasons:

One is the necessity to create cleaner companies after the 1989-92 recession that played havoc with the real estate industry. "There is no question that real estate had a horrendous reputation in the public markets," [Sam Zell, Equity Group Investments of Chicago] said of the pre-1990s era. "But come 1992, the shoe was on the other foot. We were desperate. We had to raise money or our industry was gone."

Zell noted the second reason is that "the nature of our business doesn't lend itself to quite the same amount of Mickey Mouse" as in many other companies. It is hard for REITs to cook their books when they pay out 90% or more of their cash flow as dividends. (REITs are exempt from federal tax so long as they distribute at least 90% of taxable income to investors each year.) The third reason is the level of ownership by management. "No segment of the S&P 500 has a higher concentration of ownership by management than the REITs do," said Zell.

Looks like the rest of Corporate America could learn something from the big REITs. Though not practical for all firms higher dividend payouts keep companies honest by discouraging them from using the tax line as a profit center. Guess Bush and friends knew what they were doing with the dividend tax cuts -- better to have the owners watching the money than the managers.