1
This prospectus supplement relates to an effective registration statement under
the Securities Act of 1933, but is not complete and may be changed. This
prospectus is not an offer to sell these securities and it is not soliciting an
offer to buy these securities in any state where the offer or sale is not
permitted.
SUBJECT TO COMPLETION, DATED JULY 24, 2001
PRELIMINARY PROSPECTUS SUPPLEMENT TO PROSPECTUS DATED MARCH 18, 1999
[CAPITAL AUTOMOTIVE REIT LOGO]
3,000,000 Common Shares
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Our common shares are traded on the Nasdaq National Market under the symbol
"CARS." The last reported sale price on July 23, 2001 was $18.00 per share.
The underwriters have an option to purchase a maximum of 450,000 additional
common shares to cover over-allotments of shares.
INVESTING IN OUR COMMON SHARES INVOLVES RISKS. SEE "RISK FACTORS" ON PAGE
S-4.
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS COMPANY
----------- -------------- -----------
Per Share............................................ $ $ $
Total................................................ $ $ $
Delivery of the common shares will be made on or about , 2001.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus supplement or the accompanying prospectus is truthful or complete.
Any representation to the contrary is a criminal offense.
CREDIT SUISSE FIRST BOSTON
CIBC WORLD MARKETS
FRIEDMAN BILLINGS RAMSEY
RAYMOND JAMES
BB&T CAPITAL MARKETS
FERRIS, BAKER WATTS
Incorporated
The date of this prospectus supplement is July , 2001.
2
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3
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TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT
PAGE
----
ABOUT THIS PROSPECTUS SUPPLEMENT..... S-4
RISK FACTORS......................... S-4
SUMMARY.............................. S-5
CAPITAL AUTOMOTIVE REIT.............. S-9
SELECTED FINANCIAL INFORMATION....... S-13
USE OF PROCEEDS...................... S-14
CAPITALIZATION....................... S-14
PRICE RANGE OF COMMON SHARES AND
DISTRIBUTION POLICY................ S-15
PAGE
----
PROPERTIES........................... S-16
FEDERAL INCOME TAX CONSEQUENCES...... S-19
UNDERWRITING......................... S-37
NOTICE TO CANADIAN RESIDENTS......... S-39
LEGAL MATTERS........................ S-40
EXPERTS.............................. S-40
PROSPECTUS
PAGE
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ABOUT THIS PROSPECTUS................ 3
RISK FACTORS......................... 3
THE COMPANY.......................... 6
USE OF PROCEEDS...................... 8
MARKET PRICE OF COMMON SHARES........ 8
RATIO OF EARNINGS TO FIXED CHARGES... 8
DESCRIPTION OF DEBT SECURITIES....... 8
DESCRIPTION OF SHARES OF BENEFICIAL
INTEREST........................... 25
PAGE
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DESCRIPTION OF PARTNERSHIP
AGREEMENT.......................... 36
FEDERAL INCOME TAX CONSEQUENCES...... 38
PLAN OF DISTRIBUTION................. 57
LEGAL MATTERS........................ 58
EXPERTS.............................. 59
WHERE YOU CAN FIND MORE
INFORMATION........................ 59
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YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO
WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL
TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT MAY ONLY BE ACCURATE
ON THE DATES OF THIS DOCUMENT.
S-3
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ABOUT THIS PROSPECTUS SUPPLEMENT
References to "we," "us" or "our" refer to Capital Automotive REIT or, if
the context requires, Capital Automotive L.P., which we refer to as the
"Partnership," and our business and operations conducted through the Partnership
and/or directly or indirectly owned subsidiaries. The term "you" refers to a
prospective investor. We are the sole general partner of the Partnership, and as
of June 30, 2001, owned approximately 71.8% of the units of partnership interest
in the Partnership. Units of the Partnership held by limited partners (other
than us) are redeemable, at the option of the holder, for cash, or we may assume
the redemption obligations of the Partnership and acquire the units in exchange
for our common shares on a one-for-one basis.
In this prospectus supplement, we use the term "dealerships" to refer to
franchised automobile dealerships, motor vehicle service, repair or parts
businesses and related businesses, which are the types of businesses that are
operated on our properties and the term "dealer group" to refer to a group of
related persons and companies who sell us properties. We also use the terms
"dealer group," "tenant," or "operators of dealerships" to refer to the related
persons and companies that lease our properties.
RISK FACTORS
Our prospectus supplement and the accompanying prospectus, including our
documents incorporated herein by reference, contain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Also, documents
which we subsequently file with the SEC and are incorporated herein by reference
will contain forward-looking statements. When we refer to forward-looking
statements or information, sometimes we use words such as "may," "will,"
"could," "should," "plans," "intends," "expects," "believes," "estimates,"
"anticipates" and "continues." In particular, the risk factors included or
incorporated by reference in this prospectus supplement and accompanying
prospectus describe forward-looking information. The risk factors are not
all-inclusive, particularly with respect to possible future events. Other parts
of, or documents incorporated by reference into, our prospectus supplement and
accompanying prospectus may also include forward-looking information. Many
things can happen that can cause our actual results to be different than those
described. These factors include, but are not limited to:
- risks that our growth will be limited if we cannot obtain additional
capital;
- risks of financing, such as our ability to consummate additional
financings on terms which are acceptable to us and the ability to meet
existing financial covenants;
- risks that acquisitions may not be consummated;
- risks that our tenants will not pay rent or that our operating costs will
be higher than expected;
- risks related to the automotive industry, such as the ability of our
tenants to compete effectively in the automotive retail industry and the
ability of our tenants to perform their lease obligations as a result of
changes in any manufacturer's production, inventory, marketing or other
practices;
- environmental and other risks associated with the acquisition and leasing
of automotive properties; and
- risks related to our status as a real estate investment trust, commonly
referred to as a REIT, for federal income tax purposes, such as the
existence of complex regulations relating to our status as a REIT, the
effect of future changes in REIT requirements as a result of new
legislation and the adverse consequences if we fail to qualify as a REIT.
Given these uncertainties, readers are cautioned not to place undue
reliance on these forward-looking statements or those incorporated into this
prospectus supplement and the accompanying prospectus from our Current Report on
Form 8-K/A filed on January 19, 2001. We also make no promise to update any of
the forward-looking statements, or to publicly release the results if we revise
any of them. You should carefully review the risks and the risk factors
incorporated by reference into this prospectus supplement and the accompanying
prospectus, as well as the other information in this prospectus supplement and
the accompanying prospectus before buying our common shares.
S-4
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SUMMARY
This summary may not contain all of the information that is important to
you. You should carefully read the entire prospectus supplement and the
accompanying prospectus, especially the "Risk Factors" section on page S-4 of
this prospectus supplement and the "Where You Can Find Available Information"
section on page 59 of the accompanying prospectus, as well as the documents
incorporated by reference in this prospectus supplement and in the accompanying
prospectus, before making an investment decision. Unless otherwise expressly
stated or the context otherwise requires, all information in this prospectus
supplement assumes that the underwriters' over-allotment option is not
exercised.
STRATEGY AND GENERAL INFORMATION
We are a self-administered and self-managed real estate company operating
as a REIT for federal income tax purposes. Our primary business strategy is to
purchase real estate (land, buildings and other improvements), which we
simultaneously lease to operators of franchised automobile dealerships and motor
vehicle service, repair, parts or other related businesses under long-term,
triple-net leases. Triple-net leases typically require the tenant to pay all
operating expenses of a property, including, but not limited to, all real estate
taxes, assessments and other government charges, insurance, utilities, repairs
and maintenance. We focus on buying properties from dealer groups that have a
long history of operating multi-site, multi-franchised dealerships, generally
targeting the largest dealer groups in terms of revenues in the largest
metropolitan areas in the U.S. in terms of population.
Industry sources estimate that the real property and improvements
associated with the approximately 22,250 franchised automobile dealerships
throughout the U.S. are worth in excess of $50 billion, of which we estimate
approximately $15 to $18 billion would meet our acquisition criteria. We believe
that we are the only real estate company to focus exclusively on acquiring
dealership properties. At this time, we are not aware of any other entity that
is pursuing, or intends to pursue, our strategy of acquiring dealership
properties and simultaneously leasing the properties to dealer groups on a
long-term, triple-net basis.
Our sale-leaseback acquisition structure allows dealer groups to achieve
liquidity and diversify their investments while maintaining ownership and
control of the operations of the dealership. Dealer groups frequently use the
proceeds received upon the sale of property to us for future growth, including
acquisitions, expansions or funding of other lines of business. Sellers also can
achieve the flexibility to pursue personal goals such as estate and other tax
planning.
As of June 30, 2001, we had invested approximately $1.1 billion in 251
properties located in 27 states, comprising approximately 1,644 acres of land
and containing approximately 9.2 million square feet of buildings and
improvements. Our tenants operate 376 motor vehicle franchises on our
properties, representing 39 brands of motor vehicles. As of June 30, 2001, all
of our properties (excluding one parcel valued at approximately $500,000 and
acquired with another property at no additional cost), were 100% leased under
long-term leases which were performing and in full force and effect.
BUSINESS OBJECTIVE
The objective of our business strategy is to provide long-term,
predictable, stable cash flow in order to maximize shareholder value.
We believe that developments in, and the nature of, the automotive retail
industry help provide us with this steady cash flow because:
- The primary source of profits for many dealerships has shifted from new
motor vehicle sales to used motor vehicle sales, parts and service.
Revenues from used motor vehicle sales, parts and service tend to
increase during economic downturns as consumers generally retain their
vehicles longer or consider the purchase of less expensive used vehicles.
In general, this shift has made the dealership less dependent on new
motor vehicle sales and more stable in all economic environments.
S-5
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- The recent consolidation of the ownership of dealerships has allowed us
to target larger dealer groups which typically offer a greater diversity
of brands of motor vehicles, thus minimizing the potential adverse impact
of changes in consumer preferences or manufacturer-specific issues.
- Franchise agreements, under which dealerships operate, often limit the
ability of the dealership to move its location, which makes long-term
leases attractive and increases the likelihood that our tenants will
renew their leases.
To achieve this objective of long-term, predictable, stable cash flow, we
are:
- diversifying both geographically and by brand of motor vehicles offered
by franchised automobile dealerships operated by our tenants in order to
minimize the potential adverse impact of economic downturns in certain
markets, changes in consumer preferences or manufacturer-specific issues;
- utilizing credit underwriting and monitoring standards for prospective
and existing tenants that focus on credit history, liquidity, tangible
net worth, historical profitability and rent and other cash flow coverage
ratios, and, in connection with our real estate analysis, stressing
market valuation, location, market characteristics, retail dynamics, age
and condition of improvements and environmental condition;
- acquiring only properties that are zoned for dealership operations, and
simultaneously with our purchase, leasing the properties to dealer groups
on a long-term, triple-net basis;
- requiring cross-guarantees (or guarantees by a parent) of all leases
within a dealer group; and
- minimizing interest rate risk by generally matching the term of our
leases with that of our debt as well as the types of leases with the
types of debt (fixed or variable) in order to maintain an investment
spread over the lease term.
RECENT DEVELOPMENTS
PROPERTIES SUBJECT TO ACQUISITION AGREEMENT. On July 20, 2001, we entered
into an agreement with a seller to purchase nine automotive retail properties
located in seven states for approximately $102.4 million. We expect to pay for
the properties with approximately $51.5 million in long-term debt and
approximately $50.9 million from the net proceeds of this offering. These
properties are expected to have initial lease terms of 15 years, with multiple
renewal options exercisable at the option of the tenant. The pending
acquisition, which is expected to close during the third quarter of 2001, is
subject to our completion of due diligence and to customary closing conditions.
We believe that this acquisition will be accretive to our FFO and AFFO on a
diluted basis in 2002. An explanation of FFO and AFFO is set forth below under
"-- Funds from Operations and Adjusted Funds from Operations Increases."
RECENT PROPERTY ACQUISITIONS. During the second quarter of 2001, we
completed a total of approximately $32.5 million of acquisitions in six separate
transactions. The acquisitions included three dealership properties, two of
which are operated by an existing tenant, and facility improvements and two
construction fundings with existing tenants. We paid for the acquisitions with
approximately $31.8 million drawn on our short-term credit facilities and units
of the Partnership valued at approximately $0.7 million at the time of
acquisition. These acquisitions added approximately 181,000 square feet of
buildings and improvements on approximately 24 acres of land in five states
(California, New Jersey, Oregon, Texas and Virginia). These properties have
initial lease terms ranging from 10 to 20 years, with a weighted average initial
lease term of 12.1 years. The leases, in general, have renewal options
exercisable at the option of the tenant ranging from a total of 20 to 40 years.
S-6
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RENTAL REVENUE INCREASES. Our rental revenue for the three months ended
June 30, 2001 increased 13% to $28.4 million, as compared to $25.0 million for
the same quarter in 2000. Our rental revenue for the 12 months ended June 30,
2001 increased 16% to $108.7 million, as compared to $93.9 million for the 12
months ended June 30, 2000. The increases were primarily attributable to the
growth of our real estate portfolio and the timing of our property acquisitions,
from which we generate our rental income.
FUNDS FROM OPERATIONS AND ADJUSTED FUNDS FROM OPERATIONS INCREASES. Our
FFO for the three months ended June 30, 2001 increased 14% to $15.1 million, as
compared to $13.2 million for the same quarter in 2000. Our FFO for the 12
months ended June 30, 2001 increased 13% to $56.8 million, as compared to $50.5
million for the 12 months ended June 30, 2000. AFFO, which is FFO excluding
straight-lined rents, for the three months ended June 30, 2001 increased 12% to
$14.2 million, as compared to $12.7 million for the same quarter in 2000. AFFO
for the 12 months ended June 30, 2001 increased 11% to $53.9 million, as
compared to $48.5 million for the 12 months ended June 30, 2000.
FFO is defined under the revised definition adopted in October 1999 by the
National Association of Real Estate Investment Trusts (NAREIT) as net income
(loss) before minority interest (computed in accordance with GAAP) excluding
gains (or losses) from sales of property, plus depreciation and amortization of
assets unique to the real estate industry, and after adjustments for
unconsolidated partnerships and joint ventures. NAREIT developed FFO as a
relative measure of performance and liquidity of an equity REIT in order to
recognize that income-producing real estate historically has not depreciated on
the basis determined under GAAP. FFO does not represent cash flows from
operating activities in accordance with GAAP (which, unlike FFO, generally
reflect all cash effects of transactions and other events in the determination
of net income) and should not be considered an alternative to net income as an
indication of our performance or to cash flow as a measure of liquidity or
ability to make distributions. We consider FFO a meaningful, additional measure
of operating performance primarily because it excludes the assumption that the
value of the real estate assets diminishes predictably over time, and because
industry analysts have accepted it as a performance measure. Comparison of our
presentation of FFO, using the NAREIT definition, to similarly titled measures
for other REITs may not necessarily be meaningful due to possible differences in
the application of the NAREIT definition used by other REITs.
QUARTERLY DIVIDEND INCREASES. On July 17, 2001, we announced our 14th
consecutive increase in the quarterly dividend on our common shares. The amount
of the quarterly dividend for the quarter ended June 30, 2001 was increased to
$0.387 per share from $0.386 per share for an annualized rate of $1.548 per
share. The dividend is payable on August 21, 2001 to shareholders of record on
August 10, 2001. You will be entitled to receive the dividend for the second
quarter 2001 as long as you are a holder of record on the record date for the
dividend.
RECENT FINANCING COMMITMENT. On June 6, 2001, we received a commitment for
$150.0 million of secured financing from Toyota Financial Services. The
commitment provides for a 12-year term with interest at a spread over the
one-month LIBOR rate, which may be swapped to a fixed rate. We anticipate
drawing upon this commitment to fund a portion of the purchase price of the
properties described under "-- Properties Subject to Acquisition Agreement"
above, as well as future acquisitions, and to repay amounts outstanding under
our short-term credit facilities. Borrowings under the commitment are subject to
customary conditions precedent and lender's satisfaction with the loan
documentation.
S-7
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THE OFFERING
Securities offered................. 3,000,000 common shares, plus up to an
additional 450,000 common shares to cover
the underwriters' over-allotment option.
Shares and units to be outstanding
after this offering................ 33,160,683(1)
Use of proceeds.................... We will use the net proceeds from the
offering, including any net proceeds
received upon exercise of the underwriters'
over-allotment option, to fund a portion of
the purchase price of the properties
described under "-- Recent
Developments -- Properties Subject to
Acquisition Agreement" above.
Risk factors....................... See the "Risk Factors" section on page S-4
and other information contained herein for
a discussion of factors you should
carefully consider before deciding to
invest in our common shares.
Nasdaq National Market symbol...... "CARS"
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(1) Based on the number of common shares and units of the Partnership
outstanding as of July 23, 2001. Excludes common shares issuable upon (i)
the exercise of outstanding warrants and (ii) the exercise of outstanding
options under our stock incentive plan.
S-8
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CAPITAL AUTOMOTIVE REIT
GENERAL
Capital Automotive REIT is a self-administered and self-managed real estate
company operating as a REIT for federal income tax purposes. We own interests in
real estate and conduct our operations, directly or indirectly, through the
Partnership. We are the sole general partner of the Partnership and, as of June
30, 2001, owned an approximately 71.8% interest in the Partnership.
As of June 30, 2001, we had invested approximately $1.1 billion in 251
properties located in 27 states, comprising approximately 1,644 acres of land
and containing approximately 9.2 million square feet of buildings and
improvements. Our tenants operate 376 motor vehicle franchises on our
properties, representing 39 brands of motor vehicles.
Our principal executive offices are located at 1420 Spring Hill Road, Suite
525, McLean, Virginia 22102 and our telephone number is (703) 288-3075. Our Web
site address is www.capitalautomotive.com. The information contained on our Web
site is not a part of this prospectus supplement or the accompanying prospectus.
THE AUTOMOTIVE RETAIL INDUSTRY
The automotive retail industry is the largest component of retail sales in
the U.S., with sales (including sales of new and used vehicles, parts and
service, and finance and insurance) during 2000 of over $1 trillion. The
industry is highly fragmented with approximately 22,250 franchised automobile
dealerships. In recent years, ownership of these franchises has begun to
consolidate with the emergence of large private and publicly-traded dealer
groups, which we target as potential tenants. In fact, the five largest
publicly-owned dealer groups in terms of new vehicle sales, AutoNation, Inc.
(NYSE: AN), Sonic Automotive, Inc. (NYSE: SAH), UnitedAuto Group, Inc. (NYSE:
UAG), Group 1 Automotive, Inc. (NYSE: GPI) and Lithia Motors, Inc. (NYSE: LAD),
are included among our tenants.
Industry data indicate that well-managed dealership operations have been
profitable in all economic environments. In the past, new motor vehicle sales
represented a large portion of a typical dealership's profits. Industry sources
have estimated, however, that, over the past decade, only approximately 15% of a
typical dealership group's profits were derived from new motor vehicle sales
while approximately 85% of a typical dealer's profits were generated by used
motor vehicle sales, parts and service -- areas that historically have performed
well in all economic environments. During economic downturns, consumers
generally retain their vehicles longer or consider the purchase of less
expensive used vehicles -- both choices requiring more frequent service and
replacement parts. We believe that increasing vehicle complexity, longer
manufacturer warranties and the availability of extended new and used car
warranties will also ensure that parts and service departments will continue to
be primary dealership profit centers. Franchised automobile dealerships sell
approximately 40% of all used vehicles. Manufacturers' certified used car
programs and high-quality trade-ins allow dealerships to maintain this important
revenue source. The shift in a dealership's primary source of profit from new
motor vehicles sales to used motor vehicle sales, parts and service improves the
stability of our tenant's operating cash flow and its ability to make lease
payments in all economic environments.
The diversity of the brands of motor vehicles offered by large dealer
groups is important to the stability of their cash flow. Because consumer
preferences may not always align with manufacturers' products, these large
dealer groups discovered that brand diversity is necessary to sustain
profitability over long periods of time. Brand diversification by these large
dealer groups makes them more resistant to changes in consumer preferences and
other manufacturer-related issues.
Franchised automobile dealerships operate under franchise agreements with
automobile manufacturers. These agreements generally grant the dealership an
exclusive market area for a particular brand of motor vehicle. Because of these
agreements, dealer groups are often limited in their ability to move their
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dealership locations. Accordingly, long-term leases are attractive to dealer
groups and the likelihood that our tenants will renew their leases is increased.
BUSINESS AND ACQUISITION STRATEGY
Our primary business strategy is to purchase real estate (land, buildings
and other improvements), which we simultaneously lease to operators of
franchised automobile dealerships and motor vehicle service, repair, parts or
other related businesses under long-term, triple-net leases. Triple-net leases
typically require the tenant to pay all operating expenses of a property,
including, but not limited to, all real estate taxes, assessments and other
government charges, insurance, utilities, repairs and maintenance. We focus on
buying properties from dealer groups that have a long history of operating
multi-site, multi-franchised dealerships, generally targeting the largest dealer
groups in terms of revenue in the largest metropolitan areas in the U.S. in
terms of population. We believe that we are the only real estate company
exclusively pursuing this strategy. The objective of our strategy is to provide
long-term, predictable, stable cash flow for our shareholders.
We fund the purchase of properties with cash from operations, proceeds from
debt or equity financings, the assumption of existing debt, newly issued units
of the Partnership, or a combination of the foregoing. We generally lease our
properties to established, creditworthy tenants, for a period of 10 to 20 years.
The tenant usually has the option to renew the lease on the same terms and
conditions for one or more additional periods of five to 10 years each.
When we evaluate prospective tenants and potential properties for purchase,
we consider such factors as:
- the management, operating experience and reputation of the dealer group;
- the dealer group's credit history, liquidity, tangible net worth,
historical profitability and rent and other cash flow coverage ratios;
- the geographic area in which the property is located;
- the market value of the land, buildings and other improvements, the
potential for alternative uses and the likelihood that the properties
will retain value, or potentially, appreciate in value;
- the construction quality, condition and design of the dealership
buildings and other improvements located on the property;
- the environmental condition of the real estate;
- the brands of motor vehicles offered by the franchised automobile
dealerships operated by the dealer group; and
- competitive conditions in the vicinity of the property.
For our existing tenants, we have a program that can fund significant
facility improvements and expansions for properties in our portfolio. Under this
program, the cost of the improvements is added to the existing lease, which is
reset to the original term when the funding is completed. In certain
circumstances, we will also provide commitments to purchase newly constructed
dealerships or fund new construction.
We believe that because of the unique requirements of dealerships, these
properties are a discrete sector of the national retail real estate industry.
Based on industry sources, we estimate that the real property and improvements
associated with franchised automobile dealerships are worth in excess of $50
billion, of which we estimate approximately $15 to $18 billion would meet our
acquisition criteria. We believe that these properties present attractive
acquisition opportunities because they generally have zoning which permits
dealership operations as well as a wide range of alternative uses and locations
with frontage on and visibility from major thoroughfares. In the event that a
property becomes unsuitable for dealership use, the property could typically be
redeveloped for other commercial uses.
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DEBT STRATEGY
We have adopted a policy to limit debt to approximately 65% of our assets
(calculated as total assets plus accumulated depreciation). As of June 30, 2001,
our debt was approximately 56.5% of our assets. This policy may be changed by
our Board of Trustees at any time without shareholder approval. In addition, to
minimize interest rate risk, we generally match the term of our long-term leases
with that of our debt as well as the type of leases with the type of debt (fixed
or variable) in order to maintain an investment spread over the lease term. We
describe this process as "match-funding." Our previous intent was to
substantially match-fund at least 85% of our total outstanding debt with
long-term leases. Due to the current divergence between interest rates for fixed
and floating rate debt, we have elected to reduce our match-funding guideline to
at least 70%. This reduction provides us with additional flexibility. We may
further change the guideline at any time without shareholder approval. As of
June 30, 2001, approximately 83% of our debt outstanding was substantially
match-funded and non-recourse to us. As of June 30, 2001, our long-term debt had
a weighted average remaining term of 10.9 years, and our leases had a weighted
average remaining lease term of 11.4 years.
As of June 30, 2001, we had total debt outstanding of $626.8 million. Of
this debt, approximately $564.7 million (consisting of $476.3 million of fixed
rate and $88.4 million of variable rate debt) was mortgage debt secured by
approximately 210 of our properties. In addition, we had $62.1 million
outstanding on our revolving credit facilities. Our earliest significant debt
maturity is not until 2011.
BUSINESS OBJECTIVE
To achieve our objective of long-term, predictable cash flow to maximize
shareholder value, we are:
- diversifying geographically and acquiring properties located
predominately in major metropolitan areas in order to minimize the
potential adverse impact of economic downturns in certain markets;
- diversifying by brand of motor vehicles offered by franchises operated by
our tenants to minimize the potential adverse impact of changes in
consumer preferences or manufacturer-specific issues (for example, work
stoppages causing delays in availability of specific models);
- "partnering" with those dealer groups leading the consolidation that is
occurring in the automobile retail industry;
- leveraging the contacts and experience of our management to build and
maintain long-term relationships with dealer groups;
- acquiring only properties that are zoned for dealership operations, and
simultaneously with our purchase, leasing the properties to dealer groups
on a long-term, triple-net basis, thereby minimizing brokerage,
re-leasing and similar costs and, due to the historical and long-term
operation of dealerships at property locations, increasing the likelihood
that our tenants will renew their leases;
- requiring cross-guarantees (or guarantees by a parent) of all leases
within a dealer group;
- requiring our tenants to submit financial and other information,
generally quarterly, to ensure compliance with financial covenants, such
as minimum tangible net worth and rental cash flow coverage ratios;
- minimizing interest rate risk by substantially match-funding our
long-term leases with debt; and
- utilizing a variety of financing sources, such as the issuance of units
of the Partnership, or other equity securities or debt securities, or a
combination thereof.
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We believe that our business and acquisition strategy provides dealer
groups with an opportunity to:
- achieve liquidity, while maintaining ownership and control of the
operations of the dealerships;
- diversify their investments;
- obtain funds to expand the operations of the dealer groups;
- facilitate family and/or estate planning; and
- benefit from an attractive tax deferred real estate solution (for
example, our "UPREIT" structure allows us to acquire properties in
exchange for units of the Partnership, thereby giving the sellers the
benefit of being able to defer some or all of the taxable gain they
otherwise would have incurred on the sale of their properties, a
structure which enhances our ability to consummate transactions).
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SELECTED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The following information is unaudited and was derived from our
consolidated financial statements. The information is only a summary and does
not provide all of the information contained in our consolidated financial
statements, including the related notes, Management's Discussion and Analysis of
Financial Condition and Results of Operations, and Quantitative and Qualitative
Disclosures about Market Risk, which are part of our Annual Report on Form 10-K
for the year ended December 31, 2000. You should read our financial statements
and other information filed with the SEC. Information as of and for the six
months ended June 30, 2001 does not purport to be indicative of our financial
condition or results of operations to be expected as of and for the year ending
December 31, 2001.
FOR THE PERIOD FROM
FOR THE SIX MONTHS OCTOBER 20, 1997
ENDED JUNE 30, FOR THE YEARS ENDED DECEMBER 31, (DATE OF INCEPTION)
--------------------- -------------------------------- TO DECEMBER 31,
2001 2000 2000 1999 1998 1997
---------- -------- ---------- -------- -------- -------------------
OPERATING DATA:
Total revenues................. $ 56,481 $ 50,440 $ 103,151 $ 75,873 $ 34,931 --
Depreciation and amortization
expense...................... $ 10,155 $ 8,654 $ 17,725 $ 15,347 $ 6,304 $ 1
General and administrative
expense...................... $ 3,445 $ 3,324 $ 6,592 $ 6,781 $ 5,487 $ 649
Interest expense............... $ 23,495 $ 20,632 $ 42,694 $ 24,541 $ 2,254 --
Minority interest(1)........... $ (5,449) $ (5,092) $ (10,328) $ (7,473) $ (4,395) --
Net income (loss).............. $ 13,937 $ 12,738 $ 25,812 $ 21,731 $ 16,491 $ (650)
Diluted earnings per share..... $ 0.63 $ 0.61 $ 1.22 $ 1.01 $ 0.79 --
OTHER DATA:
FFO(2)......................... $ 29,506 $ 26,124 $ 53,455 $ 44,205 $ 27,047 $ (650)
AFFO(2)........................ $ 27,869 $ 25,095 $ 51,096 $ 43,243 $ 27,047 --
Weighted average number of
common shares and units
outstanding - diluted
(000's)...................... 30,673 29,361 29,476 28,796 26,228 --
Cash dividends declared per
common share................. $ 0.773 $ 0.7375 $ 1.50 $ 1.38 $ 0.876 --
Properties owned at end of
period....................... 251 231 244 230 120 --
JUNE 30, DECEMBER 31,
--------------------- ----------------------------------------------------
2001 2000 2000 1999 1998 1997
---------- -------- ---------- -------- -------- -----------------
BALANCE SHEET DATA:
Real estate before accumulated
depreciation.................. $1,089,384 $951,745 $1,037,870 $935,525 $511,132 --
Total assets.................... 1,060,277 943,221 1,021,589 942,559 583,211 $1,011
Mortgage loans.................. 564,707 508,631 571,519 501,510 161,997 --
Borrowings under credit
facilities.................... 62,140 9,500 14,200 -- -- 1,000
Total other liabilities......... 12,235 12,037 30,109 26,066 18,659 661
Minority interest............... 118,687 118,249 115,728 115,384 93,898 --
Total stockholders' equity
(deficit)..................... 302,508 294,804 290,033 299,599 308,657 (650)
---------------
(1) Minority interest represents income attributable to the units of the
Partnership owned by limited partners (other than us) of the Partnership.
(2) FFO and AFFO are described under "Summary -- Recent Developments -- Funds
from Operations and Adjusted Funds from Operations Increases."
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USE OF PROCEEDS
The net proceeds from the sale of common shares in this offering, after
deducting the discounts and commissions to the underwriters and other estimated
expenses of this offering payable by us, are estimated to be approximately $50.9
million (approximately $58.6 million if the underwriters' over-allotment option
is exercised in full), assuming a public offering price of $18.00 per share (the
last reported sale price on the Nasdaq National Market on July 23, 2001). We
intend to use all of the net proceeds to fund a portion of the purchase price of
the properties described under "Summary -- Recent Developments -- Properties
Subject to Acquisition Agreement."
Pending their application, we may use the net proceeds to temporarily
reduce amounts outstanding under our short-term credit facilities or may invest
the net proceeds in short-term, income-producing investments.
CAPITALIZATION
The following table sets forth our unaudited historical capitalization as
of June 30, 2001 and as adjusted to show, as if these transactions had occurred
on June 30, 2001, the effects of (i) the acquisition of the properties subject
to an acquisition agreement and related financings as more fully described under
"Summary -- Recent Developments -- Properties Subject to Acquisition Agreement,"
and (ii) this offering and the application of the estimated net proceeds as
described under "Use of Proceeds."
AS OF JUNE 30, 2001
------------------------
HISTORICAL AS ADJUSTED
---------- -----------
(DOLLARS IN THOUSANDS)
DEBT:
Mortgage debt............................................... $ 564,707 $ 616,200
Borrowings under credit facilities.......................... 62,140 62,140
---------- ----------
Total debt........................................ 626,847 678,340
MINORITY INTEREST........................................... 118,687 120,993
SHAREHOLDERS' EQUITY:
Common Shares, par value $.01 per share, 100 million
shares authorized, 21,661,583 shares issued and
outstanding historical; 24,661,583 shares issued and
outstanding as adjusted................................ 217 247
Preferred Shares, par value $.01 per share, 20 million
shares authorized, no shares issued or outstanding
historical; no shares issued or outstanding as
adjusted............................................... -- --
Additional paid-in capital................................ 314,755 363,314
Accumulated deficit....................................... (12,464) (12,464)
---------- ----------
Total shareholders' equity........................ 302,508 351,097
---------- ----------
Total capitalization.............................. $1,048,042 $1,150,430
========== ==========
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PRICE RANGE OF COMMON SHARES AND DISTRIBUTION POLICY
Our common shares have traded on the Nasdaq National Market under the
symbol "CARS" since February 13, 1998 (the date of our initial public offering).
Listed below are the high and low sales prices of our common shares as reported
on the Nasdaq National Market and the distributions declared for each of the
periods indicated.
PRICE PER SHARE
------------------ DISTRIBUTIONS
HIGH LOW DECLARED PER SHARE
-------- ------- ------------------
2001
Third quarter (through July 23)........................ $18.4800 $16.990 $ --
Second quarter......................................... 18.9500 15.360 0.3870(1)
First quarter.......................................... 16.1875 12.875 0.3860
2000
Fourth quarter......................................... $14.5625 $12.375 $0.3850
Third quarter.......................................... 15.6250 12.000 0.3775
Second quarter......................................... 16.0625 11.500 0.3725
First quarter.......................................... 13.0625 10.625 0.3650
1999
Fourth quarter......................................... $14.0000 $11.625 $0.3600
Third quarter.......................................... 13.7500 12.000 0.3500
Second quarter......................................... 13.7500 11.375 0.3400
First quarter.......................................... 15.1875 11.250 0.3300
---------------
(1) The Board of Trustees has declared a dividend of $0.387 per share payable on
August 21, 2001 to shareholders of record on August 10, 2001. You will be
entitled to receive this dividend as long as you are a holder of record on
the record date for the dividend.
On July 23, 2001, the last reported sale price on the Nasdaq National
Market was $18.00 per share. As of June 30, 2001, there were approximately 250
holders of record of our common shares. We believe the total number of our
beneficial shareholders to be approximately 4,000 because certain common shares
are held of record by depositories, brokers and other nominees.
We intend to continue to pay regular quarterly distributions to holders of
our common shares. Future distributions, however, will be at the discretion of
our Board of Trustees and will depend on our actual FFO, financial condition,
capital requirements, the annual distribution requirements under the REIT
provisions of the Code and such other factors as our Board of Trustees deems
relevant.
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PROPERTIES
GENERAL
As of June 30, 2001, we owned 251 properties, representing 376 motor
vehicle franchises, with a total investment of approximately $1.1 billion. These
properties total approximately 9.2 million square feet of buildings and
improvements on approximately 1,644 acres of land in 27 states. Our interest in
each of the properties includes the land, buildings and improvements, related
easements and rights and most fixtures. We do not own or lease any significant
amount of personal property, furniture or equipment at any property. As of June
30, 2001, all of our properties (excluding one parcel valued at approximately
$500,000 and acquired with another property at no additional cost), were 100%
leased under long-term leases which were performing and in full force and
effect.
Our properties generally consist of the land or a leasehold interest in
land and one or more retail showrooms, office space, adjacent service and repair
facilities, parts and accessories departments, and in many cases, acreage set
aside for used car sales, body shops, parking for inventory, vehicles awaiting
service and future development. Land sizes for our properties typically range
from one acre to 20 acres. The properties generally are zoned for a variety of
commercial uses and typically have frontage on major transportation arteries
with high traffic patterns, high visibility, signage and ease of ingress and
egress.
TENANT AND BRAND DIVERSIFICATION
As of June 30, 2001, our properties were leased to 46 different dealer
groups. Our tenants operate 376 motor vehicle franchises on these properties,
representing 39 brands of motor vehicles, consisting of Acura, Audi, BMW, Buick,
Cadillac, Chevrolet, Chrysler, Daewoo, Dodge, Dodge Trucks, Ford, Freightliner,
GMC, GMC Truck, Honda, Hyundai, Infiniti, Isuzu, Jaguar, Jeep, Kia, Land Rover,
Lexus, Lincoln-Mercury, Mazda, Mercedes-Benz, Mitsubishi, Nissan, Oldsmobile,
Plymouth, Pontiac, Porsche, Saab, Saturn, Subaru, Suzuki, Toyota, Volkswagen and
Volvo. No single brand of motor vehicle had an "allocated value" of 10% or more
of our total real estate investments as of June 30, 2001. We allocate value to
our franchises by dividing the amount we paid for a particular property by the
number of franchises located on that property.
Properties operated as franchised automobile dealerships (including related
motor vehicle service, repair, parts and body shops on the same parcel of land)
represented approximately 90% of our total real estate investments as of June
30, 2001. In addition to these properties, we own additional properties,
including raw land and properties on which our tenants operate motor vehicle
service, repair, parts or other related businesses, the majority of which are
operated by dealer groups. Only one tenant accounted for 8% or more of our total
annualized rental revenue as of June 30, 2001. Sonic Automotive, Inc. (NYSE:
SAH) and its affiliates, the tenant of 68 of our properties, accounted for 26%
of our total annualized rental revenue as of June 30, 2001.
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GEOGRAPHIC DIVERSIFICATION
We invest in properties throughout the United States. As of June 30, 2001,
we owned properties in 27 states, with approximately 70% of our total real
estate investments in the top 50 metropolitan areas in terms of population and
approximately 97% of our total real estate investments in metropolitan areas,
according to the most recent data (April 2000) published by the U.S. Census
Bureau on metropolitan statistical areas (MSAs) and primary metropolitan
statistical areas (PMSAs). The following table specifies the metropolitan areas
in which we own properties representing at least 1% of our total real estate
investments as of June 30, 2001.
NUMBER OF TOTAL REAL PERCENTAGE OF TOTAL
METROPOLITAN AREA(1) PROPERTIES ESTATE INVESTMENT REAL ESTATE INVESTMENT
-------------------- ---------- ----------------- ----------------------
Washington, DC-MD-VA-WV.......................... 25 $ 146,768,227 13.47%
Houston, TX...................................... 23 146,158,077 13.42
Dallas, TX....................................... 10 60,644,040 5.57
Charlotte-Gastonia-Rock Hill, NC-SC.............. 12 59,630,515 5.47
St. Louis, MO-IL................................. 9 41,876,263 3.84
Atlanta, GA...................................... 5 33,589,647 3.08
Fort Wayne, IN................................... 9 30,472,089 2.80
Columbus, OH..................................... 6 25,686,579 2.36
San Antonio, TX.................................. 5 22,435,227 2.06
Medford-Ashland, OR.............................. 6 21,492,838 1.97
South Bend, IN................................... 3 21,364,178 1.96
Los Angeles-Long Beach, CA....................... 4 20,327,301 1.87
Daytona Beach, FL................................ 7 20,100,638 1.85
Shreveport-Bossier City, LA...................... 9 18,723,589 1.72
New Orleans, LA.................................. 3 18,539,781 1.70
Fort Worth-Arlington, TX......................... 2 17,133,863 1.57
Montgomery, AL................................... 3 16,964,772 1.56
Denver, CO....................................... 2 16,273,211 1.49
Salt Lake City-Ogden, UT......................... 4 16,229,091 1.49
Cleveland-Lorain-Elyria, OH...................... 5 15,983,402 1.47
Fort Myers-Cape Coral, FL........................ 4 14,330,519 1.32
Las Vegas, NV-AZ................................. 1 14,238,341 1.31
Chattanooga, TN-GA............................... 6 13,302,118 1.22
Amarillo, TX..................................... 4 13,275,948 1.22
Miami, FL........................................ 3 12,705,731 1.17
Nashville, TN.................................... 2 12,000,529 1.10
Other(2)......................................... 79 239,137,068 21.94
--- -------------- ------
Total.................................. 251 $1,089,383,582 100.00%
=== ============== ======
---------------
(1) Derived from the most recent published data (April 2000) of the U.S. Census
Bureau regarding population of MSAs and PMSAs.
(2) Represents each area in which we own properties that represents less than 1%
of our total real estate investments.
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LEASES AND LEASE EXPIRATIONS
Substantially all of our properties are leased under long-term, triple-net
leases, under which the tenants typically pay all operating expenses of a
property, including, but not limited to, all real estate taxes, assessments and
other government charges, insurance, utilities, repairs and maintenance. We
believe that our properties are covered by adequate commercial general, fire,
flood and extended loss insurance provided by reputable companies, with
commercially reasonable deductibles and limits.
Our properties are subject to leases with initial terms that range
generally from 10 to 20 years, with a weighted average initial lease term of
approximately 13.6 years. As of June 30, 2001, the weighted average remaining
lease term for our leases was approximately 11.4 years. The leases typically
have options to renew upon the same terms and conditions for one or more
additional periods of five to 10 years each exercisable at the option of the
tenant (ranging from a total of five to 40 years). With respect to the leases
for properties acquired from Sonic Automotive during August 1999, Sonic
Automotive is required to renew, for an additional five years, the initial terms
of leases representing 75% of the total rental payments for such Sonic
Automotive leases expiring in any given year. The calculation of weighted
average initial lease term and weighted average remaining lease term assumes
that Sonic Automotive renews leases as specified above.
The following table sets forth the schedule of lease expirations for our
235 leases in place as of June 30, 2001 for each of the 20 years beginning with
2001, assuming that none of the tenants (other than Sonic Automotive) exercises
or has exercised renewal options and that Sonic Automotive renews leases as
specified above.
PERCENTAGE OF
TOTAL RENTAL REVENUE TOTAL ANNUALIZED
NUMBER OF REPRESENTED RENTAL REVENUE
EXPIRING BY EXPIRING LEASES REPRESENTED BY
YEAR OF LEASE EXPIRATION LEASES (IN THOUSANDS) EXPIRING LEASES
------------------------ --------- -------------------- ----------------
2001................................................ -- -- --
2002................................................ -- -- --
2003................................................ -- -- --
2004................................................ -- -- --
2005................................................ -- -- --
2006................................................ 1 $ 154 0.1%
2007................................................ 6 2,291 2.0
2008................................................ 28 14,591 13.0
2009................................................ 19 10,564 9.4
2010................................................ 7 2,582 2.3
2011................................................ 13 5,457 4.9
2012................................................ 10 3,069 2.7
2013................................................ 74 33,623 30.0
2014................................................ 52 27,716 24.7
2015................................................ 12 4,882 4.4
2016................................................ 5 1,972 1.8
2017................................................ -- -- --
2018................................................ 2 192 0.2
2019................................................ 1 525 0.5
2020................................................ 4 3,496 3.1
2021 and thereafter................................. 1 957 0.9
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FEDERAL INCOME TAX CONSEQUENCES
The following sections summarize the federal income tax issues that you may
consider relevant. Because this section is a summary, it does not address all of
the tax issues that may be important to you. In addition, this section does not
address the tax issues that may be important to certain types of shareholders
that are subject to special treatment under the federal income tax laws, such as
insurance companies, tax-exempt organizations (except to the extent discussed in
"-- Taxation of Tax-Exempt U.S. Shareholders" below), financial institutions and
broker-dealers, and non-U.S. individuals and foreign corporations (except to the
extent discussed in "-- Taxation of Non-U.S. Shareholders" below).
The statements in this section are based on the current federal income tax
laws governing our qualification as a REIT. We cannot assure you that new laws,
interpretations of laws or court decisions, any of which may take effect
retroactively, will not cause any statement in this section to be inaccurate.
We urge you to consult your own tax advisor regarding the specific federal,
state, local, foreign and other tax consequences to you of purchasing, owning
and disposing of our securities, our election to be taxed as a REIT and the
effect of potential changes in applicable tax laws.
TAXATION OF CAPITAL AUTOMOTIVE REIT
We elected to be taxed as a REIT under the federal income tax laws when we
filed our 1998 tax return. We have operated in a manner intended to qualify as a
REIT and we intend to continue to operate in that manner. This section discusses
the laws governing the federal income tax treatment of a REIT and its
shareholders. These laws are highly technical and complex.
In the opinion of our tax counsel, Shaw Pittman LLP, (i) we qualified as a
REIT under Sections 856 through 859 of the Code with respect to our taxable
years ended through December 31, 2000; and (ii) we are organized in conformity
with the requirements for qualification as a REIT under the Code and our current
and proposed method of operation will enable us to meet the requirements for
qualification as a REIT for the current taxable year and for future taxable
years, provided that we have operated and continue to operate in accordance with
various assumptions and factual representations made by us concerning our
business, properties and operations. We may not, however, have met or continue
to meet such requirements. You should be aware that opinions of counsel are not
binding on the IRS or any court. Our qualification as a REIT depends on our
ability to meet, on a continuing basis, certain qualification tests set forth in
the federal tax laws. Those qualification tests involve the percentage of income
that we earn from specified sources, the percentage of our assets that fall
within certain categories, the diversity of the ownership of our shares, and the
percentage of our earnings that we distribute. We describe the REIT
qualification tests in more detail below. Shaw Pittman LLP will not monitor our
compliance with the requirements for REIT qualification on an ongoing basis.
Accordingly, no assurance can be given that our actual operating results will
satisfy the qualification tests. For a discussion of the tax treatment of us and
our shareholders if we fail to qualify as a REIT, see "-- Requirements for REIT
Qualification -- Failure to Qualify."
If we qualify as a REIT, we generally will not be subject to federal income
tax on the taxable income that we distribute to our shareholders. The benefit of
that tax treatment is that it avoids the "double taxation" (i.e., at both the
corporate and stockholder levels) that generally results from owning stock in a
corporation. However, we will be subject to federal tax in the following
circumstances:
- we will pay federal income tax on taxable income (including net capital
gain) that we do not distribute to our shareholders during, or within a
specified time period after, the calendar year in which the income is
earned;
- we may be subject to the "alternative minimum tax" on any items of tax
preference that we do not distribute or allocate to our shareholders;
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- we will pay income tax at the highest corporate rate on (i) net income
from the sale or other disposition of property acquired through
foreclosure that we hold primarily for sale to customers in the ordinary
course of business and (ii) other non-qualifying income from foreclosure
property;
- we will pay a 100% tax on net income from certain sales or other
dispositions of property (other than foreclosure property) that we hold
primarily for sale to customers in the ordinary course of business
("prohibited transactions");
- if we fail to satisfy the 75% gross income test or the 95% gross income
test (as described below under "-- Requirements for REIT
Qualification -- Income Tests"), and nonetheless continue to qualify as a
REIT because we meet certain other requirements, we will pay a 100% tax
on (i) the gross income attributable to the greater of the amount by
which we fail the 75% or 95% gross income test, multiplied by (ii) a
fraction intended to reflect our profitability;
- if we fail to distribute during a calendar year at least the sum of (i)
85% of our REIT ordinary income for such year, (ii) 95% of our REIT
capital gain net income for such year, and (iii) any undistributed
taxable income from prior periods, we will pay a 4% excise tax on the
excess of such required distribution over the amount we actually
distributed;
- we may elect to retain and pay income tax on our net long-term capital
gain;
- if we acquire any asset from a C corporation (i.e., a corporation
generally subject to full corporate-level tax) in a merger or other
transaction in which we acquire a "carryover" basis in the asset (i.e.,
basis determined by reference to the C corporation's basis in the asset
(or another asset)), we will pay tax at the highest regular corporate
rate applicable if we recognize gain on the sale or disposition of such
asset during the 10-year period after we acquire such asset. The amount
of gain on which we will pay tax is the lesser of (i) the amount of gain
that we recognize at the time of the sale or disposition and (ii) the
amount of gain that we would have recognized if we had sold the asset at
the time we acquired the asset. The rule described in this paragraph will
apply assuming that we make an election under Section 1.337(d)-5T(b) of
the Treasury regulations upon our acquisition of an asset from a C
corporation; and
- we will incur a 100% excise tax on transactions with a "taxable REIT
subsidiary" that are not conducted on an arm's-length basis.
REQUIREMENTS FOR REIT QUALIFICATION
In order to qualify as a REIT, we must be a corporation, trust or
association and meet the following requirements:
1. we are managed by one or more trustees or directors;
2. our beneficial ownership is evidenced by transferable shares, or by
transferable certificates of beneficial interest;
3. we would be taxable as a domestic corporation, but for Sections 856
through 860 of the Code;
4. we are neither a financial institution nor an insurance company subject
to certain provisions of the Code;
5. at least 100 persons are beneficial owners of our shares or ownership
certificates;
6. not more than 50% in value of our outstanding shares or ownership
certificates is owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include certain entities) during
the last half of any taxable year (the "5/50 Rule");
7. we elect to be a REIT (or have made such election for a previous
taxable year) and satisfy all relevant filing and other administrative
requirements established by the Internal Revenue Service that must be
met to elect and maintain REIT status;
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8. we use a calendar year for federal income tax purposes and comply with
the record keeping requirements of the Code and the related Treasury
regulations; and
9. we meet certain other qualification tests, described below, regarding
the nature of our income and assets.
We must meet requirements 1 through 4 during our entire taxable year and
must meet requirement 5 during at least 335 days of a taxable year of 12 months,
or during a proportionate part of a taxable year of less than 12 months. We were
not required to meet requirements 5 and 6 during 1998. If we comply with all the
requirements for ascertaining the ownership of our outstanding shares in a
taxable year and have no reason to know that we violated the 5/50 Rule, we will
be deemed to have satisfied the 5/50 Rule for such taxable year. For purposes of
determining share ownership under the 5/50 Rule, an "individual" generally
includes a supplemental unemployment compensation benefits plan, a private
foundation, or a portion of a trust permanently set aside or used exclusively
for charitable purposes. An "individual," however, generally does not include a
trust that is a qualified employee pension or profit sharing trust under Code
Section 401(a), and beneficiaries of such a trust will be treated as holding our
shares in proportion to their actuarial interests in the trust for purposes of
the 5/50 Rule.
We believe we have issued sufficient common shares with sufficient
diversity of ownership to satisfy requirements 5 and 6 set forth above. In
addition, our declaration of trust restricts the ownership and transfer of the
common shares so that we should continue to satisfy requirements 5 and 6. The
provisions of our declaration of trust restricting the ownership and transfer of
the common shares are described in "Description of Shares of Beneficial
Ownership -- Restrictions on Ownership and Transfer."
We currently have several direct corporate subsidiaries and may have
additional corporate subsidiaries in the future. A corporation that is a
"qualified REIT subsidiary" is not treated as a corporation separate from its
parent REIT. All assets, liabilities, and items of income, deduction, and credit
of a qualified REIT subsidiary are treated as assets, liabilities, and items of
income, deduction, and credit of the REIT. A qualified REIT subsidiary is a
corporation, all of the capital stock of which is owned by the parent REIT.
Thus, in applying the requirements described herein, any qualified REIT
subsidiary of ours will be ignored, and all assets, liabilities, and items of
income, deduction, and credit of such subsidiary will be treated as our assets,
liabilities, and items of income, deduction, and credit. We believe our direct
corporate subsidiaries are qualified REIT subsidiaries. Accordingly, they are
not subject to federal corporate income taxation, though they may be subject to
state and local taxation.
A REIT is treated as owning its proportionate share of the assets of any
partnership in which it is a partner and as earning its allocable share of the
gross income of the partnership for purposes of the applicable REIT
qualification tests. Thus, our proportionate share of the assets, liabilities
and items of income of the Partnership and of any other partnership or limited
liability company treated as a partnership for federal income tax purposes in
which we have acquired or will acquire an interest, directly or indirectly (a
"Subsidiary Partnership"), are treated as our assets and gross income for
purposes of applying the various REIT qualification requirements.
Tax legislation enacted in 1999 allows a REIT to own up to 100% of the
capital stock of one or more taxable REIT subsidiaries, which we refer to as
TRSs, beginning on January 1, 2001. A TRS is a fully taxable corporation that
pays income tax at regular corporate rates on its taxable income. A TRS may earn
income that would not be qualifying income if earned directly by the parent
REIT. Both the subsidiary and the REIT must jointly elect to treat the
subsidiary as a TRS. Overall, no more than 20% of the value of a REIT's assets
may consist of securities of one or more TRSs. In addition, the TRS rules limit
the deductibility of interest paid or accrued by a TRS to its parent REIT to
assure that the TRS is subject to an appropriate level of corporate taxation.
The rules also impose a 100% excise tax on transactions between a TRS and its
parent REIT or the REIT's tenants that are not conducted on an arm's-length
basis. Although we currently do not have any TRSs, we may form one or more TRSs
in the future.
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INCOME TESTS. We must satisfy two gross income tests annually to maintain
our qualification as a REIT:
- at least 75% of our gross income (excluding gross income from prohibited
transactions) for each taxable year must consist of defined types of
income that we derive, directly or indirectly, from investments relating
to real property or mortgages on real property or temporary investment
income (the "75% gross income test"). Qualifying income for purposes of
the 75% gross income test includes "rents from real property," interest
on debt secured by mortgages on real property or on interests in real
property, dividends or other distributions on and gain from the sale of
shares in other REITs, and gain from the sale of real property and
mortgage loans; and
- at least 95% of our gross income (excluding gross income from prohibited
transactions) for each taxable year must consist of income that is
qualifying income for purposes of the 75% gross income test, other types
of interest and dividends, gain from the sale or disposition of stock or
securities, income from certain hedging transactions, or any combination
of the foregoing (the "95% gross income test").
The following paragraphs discuss the specific application of these tests to
us.
Rental Income. The Partnership's primary source of income derives from
leasing properties to dealer groups. The leases generally are on a "triple-net"
basis, requiring the tenants to pay substantially all expenses associated with
the operation of the properties, such as real estate taxes, insurance,
utilities, services, maintenance and other operating expenses and any ground
lease payments.
Rents under the leases will constitute "rents from real property" only if
the leases are treated as true leases for federal income tax purposes and are
not treated as service contracts, joint ventures, financing arrangements or some
other type of arrangement. The determination of whether the leases are true
leases depends on an analysis of all surrounding facts and circumstances. In
making such a determination, courts have considered a variety of factors,
including the following:
- the intent of the parties;
- the form of the agreement;
- the degree of control over the property that is retained by the property
owner (e.g., whether the tenant has substantial control over the
operation of the property or whether the tenant was required simply to
use its best efforts to perform its obligations under the agreement);
- the extent to which the property owner retains the risk of loss with
respect to the operation of the property (e.g., whether the tenant bears
the risk of increases in operating expenses or the risk of damage to the
property); and
- the extent to which the property owner retains the burdens and benefits
of ownership of the property.
We believe that each lease will be treated as a true lease for federal
income tax purposes. Such belief is based, in part, on the following facts:
- the Partnership (or its subsidiaries, as the case may be) and the tenants
intend for each relationship between them to be that of a lessor and
lessee and such relationship will be documented by lease agreements;
- the tenants have the right to exclusive possession and use and quiet
enjoyment of the properties during the term of the leases;
- the tenants bear the cost of, and are responsible for, day-to-day
maintenance and repair of the properties, and dictate how the properties
are operated, maintained and improved;
- the tenants bear all of the costs and expenses of operating the
properties during the terms of the leases;
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- the tenants benefit from any savings in the costs of operating the
properties during the terms of the leases;
- the tenants generally are required to indemnify the Partnership or its
subsidiary against all liabilities imposed on the Partnership or its
subsidiary during the term of the leases by reason of (a) injury to
persons or damage to property occurring at the properties, or (b) the
tenants' use, management, maintenance or repair of the properties;
- the tenants are obligated to pay rent for the period of use of the
properties;
- the tenants stand to reap substantial gains (or incur substantial losses)
depending on how successfully they operate the properties;
- the useful lives of the properties are significantly longer than the
terms of the leases; and
- the Partnership or its subsidiary will receive the benefit of increases
in value, and will bear the risk of decreases in value, of the properties
during the terms of the leases.
If the IRS were to challenge successfully the characterization of the
leases as true leases, the Partnership would not be treated as the owner of the
property in question for federal income tax purposes and the Partnership would
lose tax depreciation and cost recovery deductions with respect to such
property, which in turn could cause us to fail to qualify as a REIT. See
"-- Distribution Requirements."
Shareholders should be aware that there are no controlling Treasury
regulations, published rulings, or judicial decisions involving leases with
terms substantially similar to those contained in the leases that address
whether such leases constitute true leases for federal income tax purposes. If
the leases are recharacterized as financing arrangements or partnership
agreements, rather than true leases, part or all of the payments that the
Partnership receives from the tenants may not be considered rent or may not
otherwise satisfy the various requirements for qualification as "rents from real
property." In that case, we likely would not be able to satisfy either the 75%
or 95% gross income test and, as a result, would lose REIT status. We received
an opinion of counsel at the time of our initial public offering that the leases
entered into at that time were true leases. We have also received an opinion of
Shaw Pittman LLP that the leases entered into as of the date hereof are true
leases. Such opinions are not binding on the IRS. We will use our best efforts
to structure any leasing transaction for properties acquired in the future such
that the lease will be characterized as a "true lease" and the Partnership will
be treated as the owner of the property in question for federal income tax
purposes. The Partnership has generally entered into leases substantially
similar to those entered into at the time of the initial public offering. We
will not seek an advance ruling from the IRS and do not intend to seek an
opinion of counsel that the Partnership will be treated as the owner of any
other leased properties for federal income tax purposes, and thus there can be
no assurance that future leases will be treated as true leases for federal
income tax purposes.
In addition, rent that the Partnership receives from real property that it
owns and leases to tenants will qualify as "rents from real property" (which is
qualifying income for purposes of the 75% and 95% gross income tests) only if
several conditions are met under the REIT tax rules.
- The rent must not be based, in whole or in part, on the income or profits
of any person although, generally, rent may be based on a fixed
percentage or percentages of receipts or sales. The Partnership has not
entered into any lease based in whole or part on the net income of any
person and does not anticipate entering into such arrangements.
- Neither we nor someone who owns 10% or more of our shares may own 10% or
more of a tenant from whom the Partnership receives rent. Our ownership
and the ownership of a tenant is determined based on direct, indirect and
constructive ownership. The constructive ownership rules generally
provide that if 10% or more in value of our shares are owned, directly or
indirectly, by or for any person, we are considered as owning the shares
owned, directly or indirectly, by or for such person. The applicable
attribution rules, however, are highly complex and difficult to apply,
and the Partnership may inadvertently enter into leases with tenants who,
through application of such rules,
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will constitute "related party tenants." In such event, rent paid by the
related party tenant will not qualify as "rents from real property,"
which may jeopardize our status as a REIT. The Partnership will use its
best efforts not to rent any property to a related party tenant (taking
into account the applicable constructive ownership rules), unless we
determine in our discretion that the rent received from such related
party tenant is not material and will not jeopardize our status as a
REIT. We believe that the Partnership has not leased property to any
related party tenant.
- The rent attributable to any personal property leased in connection with
a lease of property is no more than 15% of the total rent received under
the lease. In general, the Partnership has not leased personal property
under its current leases. If any incidental personal property has been
leased, we believe that rent from the personal property would be less
than 15% of total rent from that lease. If the Partnership leases
personal property in connection with a future lease, it intends to
satisfy the 15% test described above.
- The Partnership generally must not operate or manage its property or
furnish or render services to its tenants, other than through an
"independent contractor" who is adequately compensated and from whom the
Partnership does not derive revenue. The Partnership may provide services
directly, if the services are "usually or customarily rendered" in
connection with the rental of space for occupancy only and are not
otherwise considered "rendered to the occupant." In addition, the
Partnership may render directly a de minimis amount of "non-customary"
services to the tenants of a property without disqualifying the income as
"rents from real property," as long as its income from the services does
not exceed 1% of its income from the related property. The Partnership
also may provide any type of services to its tenants through a TRS. The
Partnership has not provided services to leased properties itself or
through an independent contractor. In the future, the Partnership intends
that any services provided will not cause rents to be disqualified as
rents from real property.
Based on the foregoing, we believe that rent from leases should qualify as
"rents from real property" for purposes of the 75% and 95% gross income tests.
As described above, however, there can be no complete assurance that the IRS
will not assert successfully a contrary position and, therefore, prevent us from
qualifying as a REIT.
On an ongoing basis, we will use our best efforts not to cause the
Partnership to:
- charge rent for any property that is based in whole or in part on the
income or profits of any person (except by reason of being based on a
percentage of receipts or sales, as described above);
- rent any property to a related party tenant (taking into account the
applicable constructive ownership rules), unless we determine in our
discretion that the rent received from such related party tenant is not
material and will not jeopardize our status as a REIT;
- derive rental income attributable to personal property (other than
personal property leased in connection with the lease of real property,
the amount of which is less than 15% of the total rent received under the
lease); and
- perform services considered to be rendered to the occupant of the
property, unless such services generate rents not in excess of 1% of all
amounts received or accrued during the taxable year with respect to such
property, other than through an independent contractor from whom we
derive no revenue or if the provisions of such services will not
jeopardize our status as a REIT.
Because the Code provisions applicable to REITs are complex, however, we
may fail to meet one or more of the foregoing.
Interest Income. The Partnership may offer financing to dealer groups for
the development of property used by dealerships and earn interest with respect
to such financings. Those financings generally will be secured by the related
real property. For purposes of the 75% and 95% gross income tests, amounts
received or accrued (directly or indirectly), which are based in whole or in
part on the income or profits of
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any person are generally not treated as interest. An amount received or accrued
will generally be treated as interest even if it is based (1) on a fixed
percentage or percentages of receipts or sales or (2) on the income or profits
of a debtor if the debtor derives substantially all of its gross income from the
related property through the leasing of substantially all of its interests in
the property, but only to the extent the amounts received by the debtor would be
characterized as "rents from real property" if received by a REIT. Furthermore,
to the extent that interest from a loan that is based on the cash proceeds from
the sale of the property securing the loan constitutes a "shared appreciation
provision" (as defined in the Code), income attributable to such participation
feature will be treated as gain from the sale of the secured property, which
generally is qualifying income for purposes of the 75% and 95% gross income
tests.
Interest on obligations secured by mortgages on real property or on
interests in real property generally is qualifying income for purposes of the
75% gross income test. However, if the Partnership or a subsidiary receives
interest income with respect to a loan that is secured by both real property and
other property and the highest principal amount of the loan outstanding during a
taxable year exceeds the fair market value of the real property on the date the
Partnership or the subsidiary acquired the loan, the interest income from the
loan will be apportioned between the real property and the other property. This
apportionment may cause us to recognize income that is not qualifying income for
purposes of the 75% gross income test. We intend to structure any such financing
arrangement such that we will continue to qualify as a REIT.
Tax on Income From Property Acquired in Foreclosure. We will be subject to
tax at the maximum corporate rate on any income from foreclosure property (other
than income that would be qualifying income for purposes of the 75% gross income
test), less expenses directly connected to the production of such income.
"Foreclosure property" is any real property (including interests in real
property) and any personal property incident to such real property:
- that is acquired by a REIT at a foreclosure sale, or having otherwise
become the owner or in possession of the property by agreement or process
of law, after a default (or imminent default) on a lease of such property
or on an indebtedness owed to the REIT secured by the property;
- for which the related loan was acquired by the REIT at a time when
default was not imminent or anticipated; and
- for which the REIT makes a proper election to treat the property as
foreclosure property.
A REIT will not be considered to have foreclosed on a property where it
takes control of the property as a mortgagee-in-possession and cannot receive
any profit or sustain any loss except as a creditor of the mortgagor. Generally,
property acquired as described above ceases to be foreclosure property on the
earlier of:
- the last day of the third taxable year following the taxable year in
which the REIT acquired the property (or longer if an extension is
granted by the Secretary of the Treasury);
- the first day on which a lease is entered into with respect to such
property that, by its terms, will give rise to income that does not
qualify under the 75% gross income test or any amount is received or
accrued, directly or indirectly, pursuant to a lease entered into on or
after the day that the REIT acquired the property that will give rise to
income that does not qualify under the 75% gross income test;
- the first day on which any construction takes place on such property
(other than completion of a building, or any other improvement, where
more than 10% of the construction of such building or other improvement
was completed before default became imminent); or
- the first day that is more than 90 days after the day on which such
property was acquired by the REIT and the property is used in a trade or
business that is conducted by the REIT (other than through an independent
contractor from whom the REIT itself does not derive or receive any
income).
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Tax on Prohibited Transactions. A REIT will incur a 100% tax on net income
derived from any "prohibited transaction." A "prohibited transaction" generally
is a sale or other disposition of property (other than foreclosure property)
that the REIT holds primarily for sale to customers in the ordinary course of a
trade or business. We believe that none of our assets (including those held by
the Partnership and its subsidiaries) are held for sale to customers and that a
sale of any such asset would not be in the ordinary course of its business.
Whether a REIT holds an asset "primarily for sale to customers in the ordinary
course of a trade or business" depends, however, on the facts and circumstances
in effect from time to time, including those related to a particular asset.
Nevertheless, we will attempt to comply with the terms of safe-harbor provisions
in the Code prescribing when an asset sale will not be characterized as a
prohibited transaction. We may fail to comply with such safe-harbor provisions
or may own property that could be characterized as property held "primarily for
sale to customers in the ordinary course of a trade or business."
Relief from Consequences of Failing to Meet Income Tests. If we fail to
satisfy one or both of the 75% and 95% gross income tests for any taxable year,
we nevertheless may qualify as a REIT for such year if we qualify for relief
under certain provisions of the Code. Those relief provisions generally will be
available if our failure to meet such tests is due to reasonable cause and not
due to willful neglect, we attach a schedule of the sources of our income to our
tax return, and any incorrect information on the schedule was not due to fraud
with intent to evade tax. We may not qualify for the relief provisions in all
circumstances. In addition, as discussed above in "-- Taxation of Capital
Automotive REIT," even if the relief provisions apply, we would incur a 100% tax
on gross income to the extent we fail the 75% or 95% gross income test
(whichever amount is greater), multiplied by a fraction intended to reflect our
profitability.
ASSET TESTS. To maintain our qualification as a REIT, we also must satisfy
two asset tests at the close of each quarter of each taxable year.
- At least 75% of the value of our total assets must consist of cash or
cash items (including certain receivables), government securities, "real
estate assets," or qualifying temporary investments (the "75% asset
test").
- "Real estate assets" include interests in real property, interests in
mortgages on real property and stock in other REITs. We believe that
the properties qualify as real estate assets.
- "Interests in real property" include an interest in mortgage loans or
land and improvements thereon, such as buildings or other inherently
permanent structures (including items that are structural components of
such buildings or structures), a leasehold of real property, and an
option to acquire real property (or a leasehold of real property).
- Qualifying temporary investments are investments in stock or debt
instruments during the one-year period following our receipt of new
capital that we raise through equity or long-term (at least five-year)
debt offerings.
- For investments not included in the 75% asset test, (A) the value of our
interest in any one issuer's securities may not exceed 5% of the value of
our total assets (the "5% asset test") and (B) we may not own more than
10% of the voting power or value of any one issuer's outstanding
securities (the "10% asset test").
For purposes of the second asset test, the term "securities" does not
include our equity ownership in another REIT, our equity or debt securities of a
qualified REIT subsidiary or a TRS, or our equity interest in any partnership.
The term "securities," however, generally includes our debt securities issued by
a partnership, except that non-participating debt securities of a partnership
are not treated as securities for purposes of the "value" portion of the 10%
asset test if we own at least a 20% profits interest in the partnership.
We intend to select future investments so as to comply with the asset
tests.
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If we failed to satisfy the asset tests at the end of a calendar quarter,
we would not lose our REIT status if (i) we satisfied the asset tests at the
close of the preceding calendar quarter and (ii) the discrepancy between the
value of our assets and the asset test requirements arose from changes in the
market values of our assets and was not wholly or partly caused by the
acquisition of one or more non-qualifying assets. If we did not satisfy the
condition described in clause (ii) of the preceding sentence, we still could
avoid disqualification as a REIT by eliminating any discrepancy within 30 days
after the close of the calendar quarter in which the discrepancy arose.
DISTRIBUTION REQUIREMENTS. Each taxable year, we must distribute dividends
(other than capital gain dividends and deemed distributions of retained capital
gain) to our shareholders in an aggregate amount at least equal to (1) the sum
of 90% of (A) our "REIT taxable income" (computed without regard to the
dividends paid deduction and our net capital gain or loss) and (B) our net
income (after tax), if any, from foreclosure property, minus (2) certain items
of non-cash income.
We must pay such distributions in the taxable year to which they relate, or
in the following taxable year if we declare the distribution before we timely
file our federal income tax return for such year and pay the distribution on or
before the first regular dividend payment date after such declaration.
We will pay federal income tax on taxable income (including net capital
gain) that we do not distribute to shareholders. Furthermore, we will incur a 4%
nondeductible excise tax if we fail to distribute during a calendar year (or, in
the case of distributions with declaration and record dates falling in the last
three months of the calendar year, by the end of January following such calendar
year) at least the sum of (1) 85% of our REIT ordinary income for such year, (2)
95% of our REIT capital gain income for such year, and (3) any undistributed
taxable income from prior periods. The excise tax is on the excess of such
required distribution over the amounts we actually distributed. We may elect to
retain and pay income tax on the net long-term capital gain we receive in a
taxable year. See "-- Taxation of Taxable U.S. Shareholders." For purposes of
the 4% excise tax, we will be treated as having distributed any such retained
amount. We have made, and we intend to continue to make, timely distributions
sufficient to satisfy the annual distribution requirements.
It is possible that, from time to time, we may experience timing
differences between (1) the actual receipt of income and actual payment of
deductible expenses and (2) the inclusion of that income and deduction of such
expenses in arriving at our REIT taxable income. For example, we may not deduct
recognized capital losses from our REIT taxable income. Further, it is possible
that, from time to time, we may be allocated a share of net capital gain
attributable to the sale of depreciated property that exceeds our allocable
share of cash attributable to that sale. As a result of the foregoing, we may
have less cash than is necessary to distribute all of our taxable income and
thereby avoid corporate income tax and the excise tax imposed on certain
undistributed income. In such a situation, we may need to borrow funds or issue
preferred shares or additional common shares.
We intend to calculate our REIT taxable income based upon the conclusion
that the Partnership is the owner for federal income tax purposes of all of the
properties. As a result, we expect that depreciation deductions with respect to
all such properties will reduce our REIT taxable income. If the IRS were to
successfully challenge this position, we might be deemed retroactively to have
failed to meet the distribution requirement and would have to rely on the
payment of a deficiency dividend in order to retain our REIT status.
Under certain circumstances, we may be able to correct a failure to meet
the distribution requirement for a year by paying deficiency dividends to our
shareholders in a later year. We may include such deficiency dividends in our
deduction for dividends paid for the earlier year. Although we may be able to
avoid income tax on amounts distributed as deficiency dividends, we will be
required to pay interest to the IRS based upon the amount of any deduction we
take for deficiency dividends.
PARTNERSHIP ANTI-ABUSE RULE. The Treasury Department has issued a
regulation (the "Anti-Abuse Rule") under the partnership provisions of the Code
that authorizes the IRS, in certain "abusive"
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transactions involving partnerships, to disregard the form of the transaction
and recast it for federal tax purposes as the IRS deems appropriate. The
Anti-Abuse Rule applies where a partnership is formed or utilized in connection
with a transaction (or series of related transactions) with a principal purpose
of substantially reducing the present value of the partners' aggregate federal
tax liability in a manner inconsistent with the intent of the partnership
provisions. The Anti-Abuse Rule states that the partnership provisions are
intended to permit taxpayers to conduct joint business (including investment)
activities through a flexible economic arrangement that accurately reflects the
partners' economic agreement and clearly reflects the partners' income without
incurring any entity-level tax. The purposes for structuring a transaction
involving a partnership are determined based on all of the facts and
circumstances, including a comparison of the purported business purpose for a
transaction and the claimed tax benefits resulting from the transaction. A
reduction in the present value of the partners' aggregate federal tax liability
through the use of a partnership does not, by itself, establish inconsistency
with the intent of the partnership provisions.
The Anti-Abuse Rule contains an example in which a corporation that elects
to be treated as a REIT contributes substantially all of the proceeds from a
public offering to a partnership in exchange for a general partner interest. The
limited partners of the partnership contribute real property assets to the
partnership, subject to liabilities that exceed their respective aggregate bases
in such property. In addition, the limited partners have the right, beginning
one year after the formation of the partnership, to require the redemption of
their limited partnership interests in exchange for cash or REIT shares (at the
corporation's option) equal to the fair market value of their respective
interests in the partnership at the time of the redemption. The example
concludes that the use of the partnership is not inconsistent with the intent of
the partnership provisions and, thus, cannot be recast by the IRS. Based on the
foregoing, we believe that the Anti-Abuse Rule will not have any adverse impact
on our ability to qualify as a REIT. However, the Anti-Abuse Rule is
extraordinarily broad in scope and is applied based on an analysis of all of the
facts and circumstances. As a result, there can be no assurance that the IRS
will not attempt to apply the Anti-Abuse Rule to us. If the conditions of the
Anti-Abuse Rule are met, the IRS is authorized to take appropriate enforcement
action, including disregarding the Partnership for federal tax purposes or
treating one or more of its partners as non-partners. Any such action
potentially could jeopardize our status as a REIT.
RECORD KEEPING REQUIREMENTS. We must maintain certain records in order to
qualify as a REIT. In addition, to avoid a monetary penalty, we must request on
an annual basis certain information from our shareholders designed to disclose
the actual ownership of our outstanding stock. We have complied, and we intend
to continue to comply, with such requirements.
FAILURE TO QUALIFY. If we failed to qualify as a REIT in any taxable year,
and no relief provision applied, we would be subject to federal income tax
(including any applicable alternative minimum tax) on our taxable income at
regular corporate rates. In calculating our taxable income in a year in which we
failed to qualify as a REIT, we would not be able to deduct amounts paid out to
shareholders. In fact, we would not be required to distribute any amounts to
shareholders in such year. In such event, to the extent of our current and
accumulated earnings and profits, all distributions to shareholders would be
taxable as ordinary income. Subject to certain limitations of the Code,
corporate shareholders might be eligible for the dividends received deduction.
Unless we qualified for relief under specific statutory provisions, we also
would be disqualified from taxation as a REIT for the four taxable years
following the year during which we ceased to qualify as a REIT. We cannot
predict whether in all circumstances we would qualify for such statutory relief.
TAXATION OF TAXABLE U.S. SHAREHOLDERS
As long as we qualify as a REIT, a taxable "U.S. shareholder" must take
into account distributions out of our current or accumulated earnings and
profits (and that we do not designate as capital gain dividends or retained
long-term capital gain) as ordinary income. A U.S. shareholder will not qualify
for
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the dividends received deduction generally available to corporations. As used
herein, the term "U.S. shareholder" means a holder of common shares that for
U.S. federal income tax purposes is:
- a citizen or resident of the United States;
- a corporation or partnership, including any entity treated as a
corporation or partnership for federal income tax purposes, created or
organized in or under the laws of the United States or of a political
subdivision thereof;
- an estate whose income is subject to U.S. federal income taxation
regardless of its source; or
- any trust with respect to which (A) a U.S. court is able to exercise
primary supervision over the administration of such trust and (B) one or
more U.S. persons have the authority to control all substantial decisions
of the trust.
A U.S. shareholder will recognize distributions that we designate as
capital gain dividends as long-term capital gain (to the extent they do not
exceed our actual net capital gain for the taxable year) without regard to the
period for which the U.S. shareholder has held its common shares. Subject to
certain limitations, we will designate our capital gain dividends as either 20%
or 25% rate distributions. A corporate U.S. shareholder, however, may be
required to treat up to 20% of certain capital gain dividends as ordinary
income.
We may elect to retain and pay income tax on the net long-term capital gain
that we receive in a taxable year. In that case, a U.S. shareholder would be
taxed on its proportionate share of our undistributed long-term capital gain.
The U.S. shareholder would receive a credit or refund for its proportionate
share of the tax we paid. The U.S. shareholder would increase the basis in its
stock by the amount of its proportionate share of our undistributed long-term
capital gain, minus its share of the tax we paid.
A U.S. shareholder will not incur tax on a distribution in excess of our
current and accumulated earnings and profits if such distribution does not
exceed the adjusted basis of the U.S. shareholder's common shares. Instead, such
distribution will reduce the adjusted basis of such common shares. A U.S.
shareholder will recognize a distribution in excess of both our current and
accumulated earnings and profits and the U.S. shareholder's adjusted basis in
its common shares as long-term capital gain (or short-term capital gain if the
common shares have been held for one year or less), assuming the common shares
are a capital asset in the hands of the U.S. shareholder. In addition, if we
declare a distribution in October, November or December of any year that is
payable to a U.S. shareholder of record on a specified date in any such month,
such distribution shall be treated as both paid by us and received by the U.S.
shareholder on December 31 of such year, provided that we actually pay the
distribution during January of the following calendar year. We will notify U.S.
shareholders after the close of our taxable year as to the portions of the
distributions attributable to that year that constitute ordinary income or
capital gain dividends.
TAXATION OF U.S. SHAREHOLDERS ON THE DISPOSITION OF THE COMMON SHARES. In
general, a U.S. shareholder who is not a dealer in securities must treat any
gain or loss realized upon a taxable disposition of the common shares as
long-term capital gain or loss if the U.S. shareholder has held the common stock
for more than one year and otherwise as short-term capital gain or loss.
However, a U.S. shareholder must treat any loss upon a sale or exchange of
common shares held by such shareholder for six months or less (after applying
certain holding period rules) as a long-term capital loss to the extent of
capital gain dividends and other distributions from us that such U.S.
shareholder treats as long-term capital gain. All or a portion of any loss a
U.S. shareholder realizes upon a taxable disposition of the common shares may be
disallowed if the U.S. shareholder purchases additional common shares within 30
days before or after the disposition.
CAPITAL GAINS AND LOSSES. A taxpayer generally must hold a capital asset
for more than one year for gain or loss derived from its sale or exchange to be
treated as long-term capital gain or loss. The highest
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marginal individual income tax rate is 39.6%. On June 7, 2001, President Bush
signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001.
That legislation reduces the highest marginal individual income tax rate of
39.6% to 39.1% for the period from July 1, 2001 to December 31, 2001, to 38.6%
for the period from January 1, 2002 to December 31, 2003, to 37.6% for the
period from January 1, 2004 to December 31, 2005, and to 35% for the period from
January 1, 2006 to December 31, 2010. The maximum tax rate on long-term capital
gain applicable to non-corporate taxpayers is 20% for sales and exchanges of
assets held for more than one year. The maximum tax rate on long-term capital
gain from the sale or exchange of "Section 1250 property" (i.e., depreciable
real property) is 25% to the extent that such gain would have been treated as
ordinary income if the property were "Section 1245 property." With respect to
distributions that we designate as capital gain dividends and any retained
capital gain that we are deemed to distribute, we may designate (subject to
certain limits) whether such a distribution is taxable to our non-corporate
shareholders at a 20% or 25% rate. Thus, the tax rate differential between
capital gain and ordinary income for non-corporate taxpayers may be significant.
A U.S. shareholder required to include retained long-term capital gains in
income will be deemed to have paid, in the taxable year of the inclusion, its
proportionate share of the tax paid by us in respect of such undistributed net
capital gains. U.S. shareholders subject to these rules will be allowed a credit
or a refund, as the case may be, for the tax deemed to have been paid by such
shareholders. U.S. shareholders will increase their basis in their common shares
by the difference between the amount of such includible gains and the tax deemed
paid by the U.S. shareholder in respect of such gains. In addition, the
characterization of income as capital gain or ordinary income may affect the
deductibility of capital losses. A non-corporate taxpayer may deduct capital
losses not offset by capital gains against its ordinary income only up to a
maximum annual amount of $3,000. A non-corporate taxpayer may carry forward
unused capital losses indefinitely. A corporate taxpayer must pay tax on its net
capital gain at ordinary corporate rates. A corporate taxpayer can deduct
capital losses only to the extent of capital gains, with unused losses being
carried back three years and forward five years.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING. We will report
to our shareholders and to the IRS the amount of distributions we pay during
each calendar year, and the amount of tax we withhold, if any. Under the backup
withholding rules, a shareholder may be subject to backup withholding at the
rate of up to 31% with respect to distributions unless such holder (1) is a
corporation or comes within certain other exempt categories and, when required,
demonstrates this fact or (2) provides a taxpayer identification number,
certifies as to no loss of exemption from backup withholding, and otherwise
complies with the applicable requirements of the backup withholding rules. A
shareholder who does not provide us with its correct taxpayer identification
number also may be subject to penalties imposed by the IRS. Any amount paid as
backup withholding will be creditable against the shareholder's income tax
liability. In addition, we may be required to withhold a portion of capital gain
distributions to any shareholders who fail to certify their non-foreign status
to us.
TAXATION OF TAX-EXEMPT U.S. SHAREHOLDERS
Tax-exempt entities, including qualified employee pension and profit
sharing trusts and individual retirement accounts and annuities ("exempt
organizations"), generally are exempt from federal income taxation. However,
they are subject to taxation on their unrelated business taxable income
("UBTI"). While many investments in real estate generate UBTI, the IRS has
issued a published ruling that dividend distributions from a REIT to an exempt
employee pension trust do not constitute UBTI, provided that the exempt employee
pension trust does not otherwise use the shares of the REIT in an unrelated
trade or business of the pension trust. Based on that ruling, amounts that we
distribute to exempt organizations generally should not constitute UBTI.
However, if an exempt organization were to finance its acquisition of common
shares with debt, a portion of the income that it receives from us would
constitute UBTI pursuant to the "debt-financed property" rules. Furthermore,
social clubs, voluntary employee benefit associations, supplemental unemployment
benefit trusts and qualified group legal services plans that are exempt from
taxation under paragraphs (7), (9), (17), and (20), respectively, of Code
Section 501(c) are
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subject to different UBTI rules, which generally will require them to
characterize distributions that they receive from us as UBTI. Finally, in
certain circumstances, a qualified employee pension or profit sharing trust that
owns more than 10% of our shares is required to treat a percentage of the
dividends that it receives from us as UBTI (the "UBTI Percentage"). The UBTI
Percentage is equal to the gross income we derive from an unrelated trade or
business (determined as if it were a pension trust) divided by our total gross
income for the year in which we pay the dividends. The UBTI rule applies to a
pension trust holding more than 10% of our shares only if:
- the UBTI Percentage is at least 5%;
- we qualify as a REIT by reason of the modification of the 5/50 Rule that
allows the beneficiaries of the pension trust to be treated as holding
our shares in proportion to their actuarial interests in the pension
trust; and
- we are a "pension-held REIT" (i.e., either (1) one pension trust owns
more than 25% of the value of our shares or (2) a group of pension trusts
individually holding more than 10% of the value of our shares
collectively owns more than 50% of the value of our shares).
Tax-exempt entities will be subject to the rules described above, under the
heading "-- Taxation of Taxable U.S. Shareholders" concerning the inclusion of
our designated undistributed net capital gains in the income of our
shareholders. Thus, such entities will, after satisfying filing requirements, be
allowed a credit or refund of the tax deemed paid by such entities in respect of
such includible gains.
TAXATION OF NON-U.S. SHAREHOLDERS
The rules governing U.S. federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships, and other foreign
shareholders (collectively, "non-U.S. shareholders") are complex. This section
is only a summary of such rules. We urge non-U.S. shareholders to consult their
own tax advisors to determine the impact of federal, state, and local income tax
laws on ownership of common shares, including any reporting requirements.
ORDINARY DIVIDENDS. A non-U.S. shareholder that receives a distribution
that is not attributable to gain from our sale or exchange of U.S. real property
interests (as defined below) and that we do not designate as a capital gain
dividend or retained capital gain will recognize ordinary income to the extent
that we pay such distribution out of our current or accumulated earnings and
profits. A withholding tax equal to 30% of the gross amount of the distribution
ordinarily will apply to such distribution unless an applicable tax treaty
reduces or eliminates the tax. However, if a distribution is treated as
effectively connected with the non-U.S. shareholder's conduct of a U.S. trade or
business, the non-U.S. shareholder generally will be subject to federal income
tax on the distribution at graduated rates, in the same manner as U.S.
shareholders are taxed with respect to such distributions (and also may be
subject to the 30% branch profits tax in the case of a non-U.S. shareholder that
is a non-U.S. corporation). We plan to withhold U.S. income tax at the rate of
30% on the gross amount of any such distribution paid to a non-U.S. shareholder
unless (i) a lower treaty rate applies and the non-U.S. shareholder files IRS
Form W-8BEN with us evidencing eligibility for that reduced rate or (ii) the
non-U.S. shareholder files an IRS Form W-8ECI with us claiming that the
distribution is effectively connected income.
RETURN OF CAPITAL. A non-U.S. shareholder will not incur tax on a
distribution in excess of our current and accumulated earnings and profits if
such distribution does not exceed the adjusted basis of its common shares.
Instead, such a distribution will reduce the adjusted basis of such common
shares. A non-U.S. shareholder will be subject to tax on a distribution that
exceeds both our current and accumulated earnings and profits and the adjusted
basis of its common shares, if the non-U.S. shareholder otherwise would be
subject to tax on gain from the sale or disposition of its common shares, as
described below. Because we generally cannot determine at the time we make a
distribution whether or not the distribution will exceed our current and
accumulated earnings and profits, we normally will withhold tax on the entire
amount of any distribution at the same rate as we would withhold on a dividend.
However, a non-U.S.
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shareholder may obtain a refund of amounts that we withhold if we later
determine that a distribution in fact exceeded our current and accumulated
earnings and profits.
CAPITAL GAIN DIVIDENDS. For any year in which we qualify as a REIT, a
non-U.S. shareholder will incur tax on distributions that are attributable to
gain from our sale or exchange of "U.S. real property interests" under the
provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). The term "U.S. real property interests" includes certain interests
in real property and stock in corporations at least 50% of whose assets consists
of interests in real property, but excludes mortgage loans and mortgage-backed
securities. Under FIRPTA, a non-U.S. shareholder is taxed on distributions
attributable to gain from sales of U.S. real property interests as if such gain
were effectively connected with a U.S. business of the non-U.S. shareholder. A
non-U.S. shareholder thus would be taxed on such a distribution at the normal
capital gain rates applicable to U.S. shareholders (subject to applicable
alternative minimum tax and a special alternative minimum tax in the case of a
nonresident alien individual). A non-U.S. corporate shareholder not entitled to
treaty relief or exemption also may be subject to the 30% branch profits tax on
distributions subject to FIRPTA. We must withhold 35% of any distribution that
we could designate as a capital gain dividend. However, if we make a
distribution and later designate it as a capital gain dividend, then (although
such distribution may be taxable to a non-U.S. shareholder) it is not subject to
withholding under FIRPTA. Instead, we must make-up the 35% FIRPTA withholding
from distributions made after the designation, until the amount of distributions
withheld at 35% equals the amount of the distribution designated as a capital
gain dividend. A non-U.S. shareholder may receive a credit against its FIRPTA
tax liability for the amount we withhold.
Distributions to a non-U.S. shareholder that we designate at the time of
distribution as capital gain dividends which are not attributable to or treated
as attributable to our disposition of a U.S. real property interest generally
will not be subject to U.S. federal income taxation, except as described below
under "-- Sale of Shares."
SALE OF SHARES. A non-U.S. shareholder generally will not incur tax under
FIRPTA on gain from the sale of its common shares as long as we are a
"domestically controlled REIT." A "domestically controlled REIT" is a REIT in
which at all times during a specified testing period non-U.S. persons held,
directly or indirectly, less than 50% in value of the stock. We anticipate that
we will continue to be a "domestically controlled REIT." In addition, a non-U.S.
shareholder that owns, actually or constructively, 5% or less of outstanding
common shares at all times during a specified testing period will not incur tax
under FIRPTA if the common shares are "regularly traded" on an established
securities market. If neither of these exceptions were to apply, the gain on the
sale of the common shares would be taxed under FIRPTA, in which case a non-U.S.
shareholder would be taxed in the same manner as U.S. shareholders with respect
to such gain (subject to applicable alternative minimum tax, a special
alternative minimum tax in the case of nonresident alien individuals, and the
possible application of the 30% branch profits tax in the case of non-U.S.
corporations).
A non-U.S. shareholder will incur tax on gain not subject to FIRPTA if (1)
the gain is effectively connected with the non-U.S. shareholder's U.S. trade or
business, in which case the non-U.S. shareholder will be subject to the same
treatment as U.S. shareholders with respect to such gain, or (2) the non-U.S.
shareholder is a nonresident alien individual who was present in the U.S. for
183 days or more during the taxable year, in which case the non-U.S. shareholder
will incur a 30% tax on his capital gains. Capital gains dividends not subject
to FIRPTA will be subject to similar rules.
BACKUP WITHHOLDING. Backup withholding tax (which generally is withholding
tax imposed at the rate of up to 31% on certain payments to persons that fail to
furnish certain information under the United States information reporting
requirements) and information reporting will generally not apply to
distributions to a non-U.S. shareholder provided that the non-U.S. shareholder
certifies under penalty of perjury that the shareholder is a non-U.S.
shareholder, or otherwise establishes an exemption. As a general matter, backup
withholding and information reporting will not apply to a payment of the
proceeds of a sale of common shares effected at a foreign office of a foreign
broker. Information reporting (but not backup
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withholding) will apply, however, to a payment of the proceeds of a sale of
common shares by a foreign office of a broker that:
- is a U.S. person;
- derives 50% or more of its gross income for a specified three year period
from the conduct of a trade or business in the U.S.;
- is a "controlled foreign corporation" (generally, a foreign corporation
controlled by U.S. shareholders) for U.S. tax purposes; or
- is a foreign partnership, if at any time during its tax year 50% or more
of its income or capital interest are held by U.S. persons or if it is
engaged in the conduct of a trade or business in the U.S.,
unless the broker has documentary evidence in its records that the holder or
beneficial owner is a non-U.S. shareholder and certain other conditions are met,
or the shareholder otherwise establishes an exemption. Payment of the proceeds
of a sale of common shares effected at a U.S. office of a broker is subject to
both backup withholding and information reporting unless the shareholder
certifies under penalty of perjury that the shareholder is a non-U.S.
shareholder, or otherwise establishes an exemption. Backup withholding is not an
additional tax. A non-U.S. shareholder may obtain a refund of excess amounts
withheld under the backup withholding rules by filing the appropriate claim for
refund with the IRS.
OTHER TAX CONSEQUENCES
STATE AND LOCAL TAXES. We and/or you may be subject to state and local tax
in various states and localities, including those states and localities in which
we or you transact business, own property or reside. The state and local tax
treatment in such jurisdictions may differ from the federal income tax treatment
described above. Consequently, you should consult your own tax advisor regarding
the effect of state and local tax laws upon an investment in our securities.
TAX ASPECTS OF OUR INVESTMENTS IN THE PARTNERSHIP AND SUBSIDIARY PARTNERSHIPS
The following discussion summarizes certain federal income tax
considerations applicable to our direct or indirect investments in the
Partnership and its subsidiary partnerships. The discussion does not cover state
or local tax laws or any federal tax laws other than income tax laws.
CLASSIFICATION AS PARTNERSHIPS. We are entitled to include in our income
our distributive share of the Partnership's income and to deduct our
distributive share of the Partnership's losses only if the Partnership is
classified for federal income tax purposes as a partnership rather than as a
corporation or association taxable as a corporation. An organization will be
classified as a partnership, rather than as a corporation, for federal income
tax purposes if it (1) is treated as a partnership under Treasury regulations,
effective January 1, 1997, relating to entity classification (the "check-the-box
regulations") and (2) is not a "publicly traded" partnership.
Under the check-the-box regulations, an unincorporated entity with at least
two members may elect to be classified either as an association taxable as a
corporation or as a partnership. If such an entity fails to make an election, it
generally will be treated as a partnership for federal income tax purposes. We
believe that the Partnership and its subsidiaries are classified as partnerships
for federal income tax purposes.
A publicly traded partnership is a partnership whose interests are traded
on an established securities market or are readily tradable on a secondary
market (or the substantial equivalent thereof). While the units will not be
traded on an established securities market, they could possibly be deemed to be
traded on a secondary market or its equivalent due to the redemption rights
enabling the limited partners to dispose of their units. A publicly traded
partnership will not, however, be treated as a corporation for any taxable year
if 90% or more of the partnership's gross income for such year consists of
certain passive-type income, including (as may be relevant here) real property
rents, gains from the sale or other disposition of real property, interest, and
dividends (the "90% Passive Income Exception").
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The Treasury Department has issued regulations (the "PTP Regulations") that
provide limited safe harbors from the definition of a publicly traded
partnership. Pursuant to one of those safe harbors (the "Private Placement
Exclusion"), interests in a partnership will not be treated as readily tradable
on a secondary market or the substantial equivalent thereof if (i) all interests
in the partnership were issued in a transaction (or transactions) that was not
required to be registered under the Securities Act, and (ii) the partnership
does not have more than 100 partners at any time during the partnership's
taxable year. In determining the number of partners in a partnership, a person
owning an interest in a flow-through entity (i.e., a partnership, grantor trust,
or S corporation) that owns an interest in the partnership is treated as a
partner in such partnership only if (i) substantially all of the value of the
owner's interest in the flow-through entity is attributable to the flow-through
entity's interest (direct or indirect) in the partnership and (ii) a principal
purpose of the use of the flow-through entity is to permit the partnership to
satisfy the 100-partner limitation.
We believe that the Partnership has qualified for the Private Placement
Exclusion since its formation and the Partnership intends to continue to qualify
for the Private Placement Exclusion unless it qualifies for another exception to
publicly traded partnership status. It is possible that in the future the
Partnership might not qualify for the Private Placement Exclusion.
If the Partnership is considered a publicly traded partnership under the
PTP Regulations because it is deemed to have more than 100 partners, the
Partnership would need to qualify under another safe harbor in the PTP
Regulations or for the 90% Passive Income Exception. We believe that the
Partnership would qualify for another safe harbor in the PTP Regulations or for
the 90% Passive Income Exception. It is possible that in the future the
Partnership might not qualify for one of these exceptions.
If, however, for any reason the Partnership were taxable as a corporation,
rather than as a partnership, for federal income tax purposes, we would not be
able to qualify as a REIT. See "-- Requirements for REIT Qualification -- Income
Tests" and "-- Requirements for REIT Qualification -- Asset Tests." In addition,
any change in the Partnership's status for tax purposes might be treated as a
taxable event, in which case we might incur tax liability without any related
cash distribution. See "-- Requirements for REIT Qualification -- Distribution
Requirements." Further, items of income and deduction of the Partnership would
not pass through to its partners, and its partners would be treated as
shareholders for tax purposes. Consequently, the Partnership would be required
to pay income tax at corporate tax rates on its net income, and distributions to
its partners would constitute dividends that would not be deductible in
computing the Partnership's taxable income.
INCOME TAXATION OF THE PARTNERSHIP AND ITS PARTNERS. The partners of the
Partnership are subject to taxation on their allocable share of the
Partnership's income. The Partnership itself is not a taxable entity for federal
income tax purposes. We are required to take into account our allocable share of
the Partnership's income, gains, losses, deductions and credits for any taxable
year of the Partnership ending during or with our taxable year, without regard
to whether we have received or will receive any distribution from the
Partnership.
PARTNERSHIP ALLOCATIONS. Although a partnership agreement generally will
determine the allocation of income and losses among partners, such allocations
will be disregarded for tax purposes if they do not comply with the provisions
of Section 704(b) of the Code and the Treasury regulations promulgated
thereunder. If an allocation is not recognized for federal income tax purposes,
the item subject to the allocation will be reallocated in accordance with the
partners' interests in the partnership, which will be determined by taking into
account all of the facts and circumstances relating to the economic arrangement
of the partners with respect to such item. The Partnership's allocations of
taxable income, gain and loss are intended to comply with the requirements of
Section 704(b) of the Code and the Treasury regulations promulgated thereunder.
TAX ALLOCATIONS WITH RESPECT TO CONTRIBUTED PROPERTIES. Pursuant to
Section 704(c) of the Code, income, gain, loss and deduction attributable to
appreciated or depreciated property that is contributed to a
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partnership in exchange for an interest in the partnership must be allocated in
a manner such that the contributing partner is charged with, or benefits from,
respectively, the unrealized gain or unrealized loss associated with the
property at the time of the contribution. The amount of such unrealized gain or
unrealized loss is generally equal to the difference between the fair market
value of contributed property at the time of contribution and the adjusted tax
basis of such property at the time of contribution (a "Book-Tax Difference").
Such allocations are solely for federal income tax purposes and do not affect
the book capital accounts or other economic or legal arrangements among the
partners. The Partnership was formed by way of contributions of appreciated
property and has received contributions of appreciated property since our
formation. Consequently, the Partnership Agreement requires such allocations to
be made in a manner consistent with Section 704(c) of the Code.
In general, the partners who contribute property to the Partnership will be
allocated depreciation deductions for tax purposes which are lower than such
deductions would be if determined on a pro rata basis. In addition, in the event
of the disposition of any of the contributed assets (including our properties)
which have a Book-Tax Difference, all income attributable to such Book-Tax
Difference will generally be allocated to the contributing partners, including
us, and will generally be allocated only their share of capital gains
attributable to appreciation, if any, occurring after the closing of any
offering of securities hereunder. This will tend to eliminate the Book-Tax
Difference over the life of the Partnership. However, the special allocation
rules of Section 704(c) do not always entirely eliminate the Book-Tax Difference
on an annual basis or with respect to a specific taxable transaction such as a
sale. Thus, the carryover basis of the contributed assets in the hands the
Partnership will cause us to be allocated lower depreciation and other
deductions, and possibly an amount of taxable income in the event of a sale of
such contributed assets in excess of the economic or book income allocated to us
as a result of such sale. This may cause us to recognize taxable income in
excess of cash proceeds, which might adversely affect our ability to comply with
the REIT distribution requirements. See "-- Requirements for REIT
Qualification -- Distribution Requirements." The foregoing principles also apply
in determining our earnings and profits for purposes of determining the portion
of distributions taxable as dividend income. The application of these rules over
time may result in a higher portion of distributions being taxed as dividends
than would have occurred had we purchased the contributed assets at their agreed
values.
The Treasury Department has issued regulations requiring partnerships to
use a "reasonable method" for allocating items affected by Section 704(c) of the
Code and outlining several reasonable allocation methods. The general partner of
the Partnership has the discretion to determine which of the methods of
accounting for Book-Tax Differences (specifically approved in the Treasury
regulations) will be elected with respect to any properties contributed to the
Partnership. The Partnership generally has elected to use the "traditional
method with ceiling rule" for allocating Code Section 704(c) items with respect
to the properties that it acquires in exchange for units. The use of this method
may result in us being allocated less depreciation, and therefore more taxable
income in a given year than would be the case if a different method for
eliminating the Book-Tax Difference were chosen. If this occurred, a larger
portion of shareholder distributions would be taxable income as opposed to the
return of capital that might arise if another method were used. We have not
determined which method of accounting for Book-Tax Differences will be elected
for properties contributed to the Partnership in the future.
BASIS IN PARTNERSHIP INTEREST. Our adjusted tax basis in our partnership
interest in the Partnership generally is equal to:
- the amount of cash and the basis of any other property contributed by us
to the Partnership;
- increased by
- our allocable share of the Partnership's income, and
- our allocable share of indebtedness of the Partnership; and
- reduced, but not below zero, by
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- our allocable share of the Partnership's loss,
- the amount of cash distributed to us, and
- constructive distributions resulting from a reduction in our share of
indebtedness of the Partnership.
If the allocation of our distributive share of the Partnership's loss would
reduce the adjusted tax basis of our partnership interest in the Partnership
below zero, the recognition of such loss will be deferred until such time as the
recognition of such loss would not reduce our adjusted tax basis below zero. To
the extent that the Partnership's distributions, or any decrease in our share of
the indebtedness of the Partnership (such decrease being considered a
constructive cash distribution to the partners), would reduce our adjusted tax
basis below zero, such distributions (including such constructive distributions)
would constitute taxable income to us. Such distributions and constructive
distributions normally will be characterized as capital gain, and, if our
interest in the Partnership has been held for longer than the long-term capital
gain holding period (currently one year), the distributions and constructive
distributions will constitute long-term capital gain.
SALE OF THE PARTNERSHIP'S PROPERTY. Generally, any gain realized by the
Partnership on the sale of property held by the Partnership for more than one
year will be long-term capital gain, except for any portion of such gain that is
treated as depreciation or cost recovery recapture. Any gain recognized by the
Partnership on the disposition of contributed properties will be allocated first
to the partners of the Partnership under Section 704(c) of the Code to the
extent of their "built-in gain" on those properties for federal income tax
purposes. The partners' "built-in gain" on the contributed properties sold will
equal the excess of the partners' proportionate share of the book value of those
properties over the partners' tax basis allocable to those properties at the
time of the contribution. Any remaining gain recognized by the Partnership on
the disposition of the contributed properties, and any gain recognized by the
Partnership on the disposition of the other properties, will be allocated among
the partners in accordance with their respective percentage interests in the
Partnership.
Our share of any gain realized by the Partnership on the sale of any
property held by the Partnership as inventory or other property held primarily
for sale to customers in the ordinary course of the Partnership's trade or
business will be treated as income from a prohibited transaction that is subject
to a 100% penalty tax. Such prohibited transaction income also may have an
adverse effect upon our ability to satisfy the income tests for REIT status. See
"-- Requirements for REIT Qualification -- Income Tests." We, however, do not
presently intend to allow the Partnership to acquire or hold any property that
represents inventory or other property held primarily for sale to customers in
the ordinary course of our or the Partnership's trade or business.
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UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated July , 2001, we have agreed to sell to the underwriters named
below, for whom Credit Suisse First Boston Corporation is acting as
representative, the following number of common shares:
NUMBER
UNDERWRITERS OF COMMON SHARES
------------ ----------------
Credit Suisse First Boston Corporation......................
CIBC World Markets Corp. ...................................
Friedman, Billings, Ramsey & Co., Inc. .....................
Raymond James & Associates, Inc. ...........................
BB&T Capital Markets, a division of Scott & Stringfellow,
Inc. .....................................................
Ferris, Baker Watts, Incorporated...........................
---------
Total............................................. 3,000,000
=========
The underwriting agreement provides that the underwriters are obligated to
purchase all of the common shares in the offering if any are purchased, other
than those shares covered by the over-allotment option described below. The
underwriting agreement also provides that if an underwriter defaults, the
purchase commitments of the non-defaulting underwriters may be increased or the
offering may be terminated.
We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to 450,000 additional shares at the public offering price less the
underwriting discounts and commissions. The purchase price also will be reduced
by an amount per share equal to the per share dividend that is declared or paid
on common shares initially purchased by the underwriters, but not declared or
paid on the shares to be purchased upon any exercise of the over-allotment
option. The option may only be exercised to cover any over-allotments of common
shares.
The underwriters propose to offer the common shares initially at the public
offering price on the cover page of this prospectus supplement and to selling
group members at that price less a selling concession of $. per share. The
underwriters and selling group members may allow a discount of $. per share on
sales to other broker/dealers. After the public offering, the representative may
change the public offering price and concession and discount to brokers/dealers.
The following table summarizes the compensation and estimated expenses, we
will pay:
PER SHARE TOTAL
------------------------------- -------------------------------
WITHOUT WITH WITHOUT WITH
OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT
-------------- -------------- -------------- --------------
Underwriting Discounts and Commissions paid
by us...................................... $ $ $ $
Expenses payable by us....................... $ $ $ $
Subject to certain exceptions as noted below, we have agreed that we will
not offer, sell, contract to sell, pledge or otherwise dispose of, directly or
indirectly, or file with the SEC a registration statement under the Securities
Act relating to, any common shares or securities convertible into or
exchangeable or exercisable for any common shares, or publicly disclose the
intention to make any offer, sale, pledge, disposition or filing, without the
prior written consent of Credit Suisse First Boston Corporation for a period of
90 days after the date of this prospectus supplement. Our lock-up agreement
contains exceptions that permit us to:
- file registration statements with the SEC registering for resale common
shares to be issued to unitholders upon redemption of units of the
Partnership in accordance with our customary practices;
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- issue common shares or units of the Partnership in connection with
acquisitions and in connection with joint ventures and similar
arrangements, as long as the recipients of those shares or units agree
not to sell or transfer those shares or units for 90 days after the date
of this prospectus supplement;
- issue common shares pursuant to our dividend reinvestment and stock
purchase plan;
- issue common shares upon the exercise of outstanding options or warrants;
- issue common shares upon redemption of units of the Partnership; or
- issue common shares and options pursuant to our benefit plans.
Our officers and trustees, Friedman, Billings, Ramsey & Co., Inc. and FBR
Asset Investment Corporation and their respective affiliates have agreed that
they will not offer, sell, contract to sell, pledge or otherwise dispose of,
directly or indirectly, any common shares, units of the Partnership, or
securities convertible into or exchangeable or exercisable for any common
shares, enter into a transaction that would have the same effect, or enter into
any swap, hedge or other arrangement that transfers, in whole or in part, any of
the economic consequences of ownership of our common shares, whether any of
these transactions are to be settled by delivery of our common shares or other
securities, in cash or otherwise, or publicly disclose the intention to make any
offer, sale, pledge or disposition, or enter into any transaction, swap, hedge
or other arrangement, without, in each case, the prior written consent of Credit
Suisse First Boston Corporation for a period of 90 days after the date of this
prospectus supplement. Common shares acquired by such parties in the open market
will not be subject to the lock-up agreements. In addition, the common shares
sold by Friedman, Billings, Ramsey & Co., Inc. as an underwriter pursuant to
this prospectus supplement will not be subject to its lock-up agreement.
As of June 30, 2001, Friedman, Billings, Ramsey & Co., Inc. beneficially
owned 129,700 common shares and a warrant representing the right to acquire
940,011 common shares. The purchase price of our common shares issuable under
exercise of the warrant is $15.00 per common share. The warrant was issued in
connection with our initial public offering in 1998 and is for a term of five
years expiring on February 19, 2003. We registered the common shares underlying
the warrant in connection with our initial public offering.
As of June 30, 2001, FBR Asset Investment Corporation, an affiliate of
Friedman, Billings, Ramsey & Co., Inc., beneficially owned 1,415,115 common
shares. The shares were purchased in 1998 in a private placement at $15.00 per
share. There is an effective registration statement on file with the SEC
covering the resale of these shares.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act, or contribute to payments that the underwriters may be required
to make in that respect.
In connection with the offering the underwriters may engage in stabilizing
transactions, over-allotment transactions, syndicate covering transactions,
penalty bids and passive market making in accordance with Regulation M under the
Securities Exchange Act.
- Stabilizing transactions permit bids to purchase the underlying security
as long as the stabilizing bids do not exceed a specified maximum.
- Over-allotment involves sales by the underwriters of shares in excess of
the number of common shares the underwriters are obligated to purchase,
which creates a syndicate short position. The short position may be
either a covered short position or a naked short position. In a covered
short position, the number of shares over-allotted by the underwriters is
not greater than the number of shares that they may purchase in the
over-allotment option. In a naked short position, the number of shares
involved is greater than the number of shares in the over-allotment
option. The underwriters may close out any short position by either
exercising their over-allotment option and/or purchasing shares in the
open market.
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- Syndicate covering transactions involve purchases of the common shares in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of shares to
close out the short position, the underwriters will consider, among other
things, the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through the
over-allotment option. If the underwriters sell more shares than could be
covered by the over-allotment option, a naked short position, the
position can only be closed out by buying shares in the open market. A
naked short position is more likely to be created if the underwriters are
concerned that there could be downward pressure on the price of the
shares in the open market after pricing that could adversely affect
investors who purchase in the offering.
- Penalty bids permit the representative to reclaim a selling concession
from a syndicate member when the common shares originally sold by the
syndicate member are purchased in a stabilizing or syndicate covering
transaction to cover syndicate short positions.
- In passive market making, market makers in the common shares who are
underwriters or prospective underwriters may, subject to limitations,
make bids for or purchase our common shares until the time, if any, at
which a stabilizing bid is made.
These stabilizing transactions, syndicate covering transactions and penalty
bids may have the effect of raising or maintaining the market price of our
common shares or preventing or retarding a decline in the market price of the
common shares. As a result the price of our common shares may be higher than the
price that might otherwise exist in the open market. These transactions may be
effected on The Nasdaq National Market and, if commenced, may be discontinued at
any time.
A prospectus in electronic format may be made available on the web sites
maintained by one or more of the underwriters participating in this offering.
The representatives may agree to allocate a number of shares to underwriters for
sale to their online brokerage account holders. Internet distributions will be
allocated by the underwriters that will make internet distributions on the same
basis as other allocations. Credit Suisse First Boston Corporation may effect an
on-line distribution through its affiliate, CSFBdirect Inc., an on-line broker
dealer, as a selling group member.
Some of the underwriters and their affiliates have engaged in, and may in
the future engage in, investment banking, commercial banking and other
commercial dealings in the ordinary course of business with us. They have
received customary fees and commissions for these transactions.
NOTICE TO CANADIAN RESIDENTS
RESALE RESTRICTIONS
The distribution of the common shares in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common shares are made. Any resale of the common shares in Canada must
be made under applicable securities laws which will vary depending on the
relevant jurisdiction, and which may require resales to be made under available
statutory exemptions or under a discretionary exemption granted by the
applicable Canadian securities regulatory authority. Purchasers are advised to
seek legal advice prior to any resale of the common shares.
REPRESENTATIONS OF PURCHASERS
By purchasing common shares in Canada and accepting a purchase confirmation
a purchaser is representing to us and the dealer from whom the purchase
confirmation is received that
- the purchaser is entitled under applicable provincial securities laws to
purchase the common shares without the benefit of a prospectus qualified
under those securities laws,
- where required by law, the purchaser is acting as principal and not as
agent, and
- the purchaser has reviewed the text above under Resale Restrictions.
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RIGHTS OF ACTION -- ONTARIO PURCHASERS
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
ENFORCEMENT OF LEGAL RIGHTS
All of the issuer's trustees and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be possible
for Canadian purchasers to effect service of process within Canada upon the
issuer or such persons. All or a substantial portion of the assets of the issuer
and such persons may be located outside of Canada and, as a result, it may not
be possible to satisfy a judgment against the issuer or such persons in Canada
or to enforce a judgment obtained in Canadian courts against such issuer or
persons outside of Canada.
TAXATION AND ELIGIBILITY FOR INVESTMENT
Canadian purchasers of common shares should consult their own legal and tax
advisors with respect to the tax consequences of an investment in the common
shares in their particular circumstances and about the eligibility of the common
shares for investment by the purchaser under relevant Canadian legislation.
LEGAL MATTERS
The validity of the common shares offered by this prospectus supplement
will be passed upon for us by Shaw Pittman LLP, a limited liability partnership
including professional corporations. In addition, the description of federal
income tax consequences contained in the accompanying prospectus under "Federal
Income Tax Consequences" is, to the extent that it constitutes matters of law,
summaries of legal matters or legal conclusions, based upon the opinion of Shaw
Pittman LLP. Certain legal matters relating to the securities will be passed
upon for the underwriters by Hunton & Williams.
EXPERTS
Our audited financial statements and schedules incorporated by reference in
this prospectus supplement and the accompanying prospectus and elsewhere in the
registration statement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their report with respect thereto, and are
incorporated by reference herein and therein in reliance upon the authority of
said firm as experts in giving said report.
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