Investor service rating agencies cite the passage of the REIT Modernization Act (RMA) as a credit plus for REITs. While RMA legislation reduces the REIT minimum distribution requirement to 90 percent from 95 percent, offering REITs more flexibility, it is the Act's creation of Taxable REIT Subsidiaries (TRS) that these credit watchers applaud.

"When the news hit the wire last fall we saw it was a credit positive for the sector," said Lisa Sarajian, managing director, Standard & Poors, New York, NY. "The reduction of the payout requirements gives companies more internally generated cash flow that they can retain. Although the differential is modest, many companies, depending on how they manage their growth, could find that reduction materially assists them in reducing external financing. The second most notable provision is TRS. This clearly is going to make it easier and more transparent for companies to engage in related ancillary business opportunities. We thought both were positives. "

In its January 2000 report, "REIT Modernization Act (RMA); A Benefit for the REIT Industry" Moody's Investors Service notes the Act will "facilitate REITs' ability to generate and diversify revenue." Tenant services like concierge and telecommunications are some of the area's where REITs may expand, according to the report. Although Moody's expects these services to produce modest revenues compared to rental payments, the rating agency said, "more importantly, they will put REITs on a more equal footing with non-REIT property owners . . ."

"Moody's sees the most important piece of the RMA being the Taxable REIT Subsidiary rules," said John J. Kriz, managing director of real estate finance at Moody's, New York, NY. "The rules will create significant flexibility for REITs to become diversified, full-service property businesses which we believe is important given the trends in the industry."

However, Kriz cautions REITs as they move into TRSs. "Expanding into businesses in which they may be less experienced may be a challenge for some firms." And the way those subsidiaries are financed may come into play. If done on a leveraged basis it could have a negative effect on bondholders, he said. However, if done on a conservative financial basis and successfully executed it would be a plus for REITs as they solidify their property base.

While Mark Berry, assistant vice president, Duff & Phelps Credit Rating Co. concurs that the "direct ownership of TRSs will greatly enhance the financial transparency of related entities" he too cautions REITs moving into new ventures. "Unless these new business lines serve essential tenant needs and penetrate deeply into the existing customer base, incremental revenue sources could negatively impact quality of cash flow, as earnings become more reliant on activities considered by Duff & Phelps to be more variable than rental income due to real estate cycles (merchant building), higher operating expenses or capex requirements, or short-term service contracts."

As noted by Fitch IBCA Inc., as REITs become more creative in partnering with nontraditional real estate ventures in order to maximize the profit potential at the TRS (Internet companies, e-commerce, etc.), there exists the possibility of straining management resources for the traditional core real estate business, notwithstanding the potential for adding leverage at the TRS level.