Update to the Trend: REITs in 2022

Kevin Kim:

Good morning or afternoon for those of you on the East Coast. My name is Kevin Kim. I'm a partner here at Geraci LLP. I lead the Corporate and Securities Division. And this webinar today we wanted to do an update and the discussion about REITs in talking about some basic concepts associated with compliance and eligibility, and then also kind of talk about where we're headed when it comes to the tax legislation and just market conditions when it comes to the importance of committed capital. So before we get started, I want to make sure we do some housekeeping. So first things first, for housekeeping, please direct your questions to the q and a feature in your Zoom. You can bring the bar up and hit that q and a button and type in any question you like. Second, after the close of the webinar, an email is going to be going out to the attendee list and to deliver the slides and also some additional information about the webinar.

And then lastly, we're adding a new feature to our webinars. We're using the Zoom poll functions. So one should go out to you shortly and please do your best to fill it out if you can. We would love to hear about your business and learn more about you as a lender or as a person interested in the business. Alright, let's get started. So first of all, our agenda for today, we're going to talk about REITs in 2022. We're going to go over the requirements, nothing's changed, but want to make sure we reiterate them, go over the compliance issues. We're also going to talk about some of the commonplace issues and compliance problems that come up because it is the second half of the tax year for most of you. And this is when some of the issues come up. We've had some clients have to navigate these issues. We'll talk about that.

We'll also kind of defeat some myths similar to last year's webinar on the same topic. And we'll also talk about the future for REITs and funds in general in the private lending industry. So let's get started. So first things first, the general requirements for REITs. This is not just for mortgage REITs, this is REITs in general. First things first, REITs are taxed as a corporation and they have to elect REIT status. There's some basic requirements that REITs have to achieve to maintain REIT status. The most important of course, that it owns real estate or real estate related assets, but actually it's 75%. It's a common myth that you have to all real estate. Now in our industry, we're not going to have a problem here because our funds that we deal with all are comprised of mortgages or real estate, and so we're never going to actually face this issue. But more institutional REITs and even some of the larger REITs that we deal with, we'll start diversifying their portfolio with maybe some real estate related securities, maybe investing in other types of assets like maybe CDs or other things like that. And those are actually eligible. So there are certain assets that are considered eligible and are real estate related assets. One of the most important things, and this is one of the threshold issues that a REIT has to distribute 90% of its taxable income to its investors. Now, this is actually the minimum threshold. The problem with this threshold is that 90% is actually not good enough if you look at it in the grand scheme of things because that remaining 10% becomes tax, the corporate tax rate. So we want to avoid that, right? So typically speaking, we advise that the REIT achieve a hundred percent distribution of its taxable income as it pertains to operations. These two last ones are the big ones, and we're going to talk about the compliance issues that come up with them. Most commonly struggled with issues when it comes to REITs. And the first one is the a hundred investor test.

And this is a really very important because a REIT must have a hundred investors and a lot of people out there think it's going to be you have to do it by the end of the following tax year after you elect as a REIT. And actually what it is is you have to meet that requirement by January 31st the following tax year after you elect. So if you were to elect, let's just say it's July right now, we were to elect in July, Hey, I'm going to REIT now you have the rest of the tax year and then the first month of January to make sure that you have a hundred investors. And so this is where things become challenging and a lot of clients struggle with the idea of, well, I have a hundred investors, I have more than a hundred investors. I don't really have to worry about this, do I?

And the balancing act comes in with, well, do you want to make sure that you're navigating these issues on a day-to-day basis, or do you want to contract this out because that's where the shareholder accommodators come in. And so these shareholder accommodation services, we call them penguin investors, and it's a funny word I know. I think the reason why we call them penguin investors is because they kind of just sit there and they don't really do much and they're fancy, but they're relied on very heavily. And typically speaking right around November is when we'll start working with new REITs to contract with these accommodation services to onboard the investors they have. The companies will have a broker dealer and all that set up in place and effectively bring on onboard 125 preferred equity investors. We'll have to amend the documents to accommodate those investors coming in.

But it's nice because once they're in and you establish that framework, you never have to worry about it ever again. They handle everything with the investors. You never have to really worry about it as long as you want to maintain the REIT status. But it's important to remember that the deadline is the end of January of the following tax year, not the end of the following tax year. The other issue that comes up is very challenging to meet is the closely held prohibition. And what this means is that five investors cannot own 50% or more of the REIT. This has to be met by the second half of the tax year every year. So when you first elect the second half of the falling tax year, and then after that every second half of the falling tax year of the year, and this is important because this is where a lot of new REITs will get tripped up because the calculation, the IRS is established when it comes to accounting investors, it's done on a fully diluted basis.

So you can't rely on an entity or a trust. You have to look through those entities and get to a warm body. And on top of that, because it's the IRS, they've complicated the definition of what an individual means and they have all these weird rules about it, and we'll get to that in a second. But the threshold issue really for a lot of clients when we do a consult on a fund or converting a fund to a REIT, we always talk about this and we've had a lot of clients think, realize maybe we won't get there in time, maybe we shouldn't establish this right away, or maybe we should establish it now and then turn the lights on later when we know we're going to hit it in the following tax year. So that's important to think through and those are the requirements. Okay, so big benefits reminder on everyone, big benefits.

We have four big benefits when it comes to REITs in general, and the first one on this list is new-ish. It came out in 2017 as part of the Tax Cut and Jobs Act under the Trump administration, and it was IRC section 199A. And everyone knows of this as the QBI pass through deduction or the qualified business income deduction for pass through entities and part of this code section while also establishing the 20% rule, 20% deduction for a lot of the pass through entities, LPs and LCs and S-Corp. It also established a blanket 20% deduction for all qualified REIT dividends. And why is this important from an eligibility standpoint and why this informs the trend in general, right? And so why did we see a lot of mortgage funds in the space and a lot of real estate funds on the real estate side switch over to a REIT strategy?

Was this particular deduction and why not just try to get this deduction on their own right? Well, the general deduction for, because we're a pass through and mortgage funds are typically done as a pass through, so usually real estate funds as well. Well, the reasoning for it is because if you were to rely on it just generally without being a REIT, there's a cap when it comes to the individual investor, it's dependent on the individual investor when it comes to their tax bracket and if they exceed a certain tax bracket, which they normally do in these privately offered funds, I think it's the 317 tax bracket, the highest tax bracket federal level. If they exceed that, then they're not eligible for the deduction regardless of the type of entity. And so it was not going to really work on a consistent basis. And so a lot of our clients decided, well, I want to be able to offer this consistently.

And so right around the end of 17, early 18, we started seeing a trend in this direction. I would say today the vast majority of existing debt funds have already transitioned over to this REIT strategy and many new about half of new debt funds will consider this as well. It's very, very popular amongst real estate investors as well. You see a lot of this being done for long-term hold strategies for industrial multifamily or even residential. It can be done across different asset classes as long as it's real estate. Now, one key thing to think through here, and we're going to talk about this later, is the Tax Cuts and Jobs Act established a sunset provision when it comes to 199A along with the qualified opportunity zone program and it's sunsets in 2025. And for those of you who follow Congress, and the way they do these things is they have in their infinite wisdom, they believe that sunsets allow them to have some negotiating power.

What the public doesn't realize is what does the Congress do when the actual sunset comes? Well, a lot of times the can just gets kicked. And so we'll talk about that later on when it comes to market conditions and the future for these programs. The last three are permanent. These have been always been the case for REITs, and they're very important as well. The first thing, the state withholding blocking, and this is very important for lenders who have investors all over the country, make loans all over the country. You have withholding issues and it becomes quite burdensome, especially for our national lenders. And so it blocks state withholding and makes your operations a lot more easy that way. Another thing that's important is it blocks UBTI and UBTI, for those of you who are uninitiated to the concept unrelated business taxable income. It's really a big issue for funds that are levered and more and more funds.

I would say the vast majority of funds out there now are levered. And because these funds are so popular with plan asset investors, IRA, self-directed IRAs, solo 401k, but even now we're seeing attention come from charitable remainder trusts and pension plans and other endowments and so on and so forth. These tax plans are coming in as investors. Well, UBTI can often be a problem for them. It creates additional tax bill for a non-taxable plan. In certain instances it can be fatal for CRTs. So it's really important to think through and it's very important. We've got a lot of clients just choose to go this direction purely on this issue. Lastly, it blocks effective connected income or active trader business. And so this is very important when you have offshore investors coming into your fund. And also, one other thing is by virtue of it being a REIT, there are certain tax treaties with certain countries that reduce the withholding based off of the country of origin, the tax treaty, and it's country specific. Every country is different and it can get as low as 10% even, which is great because normally it's 30%.

Let's talk about the general structure that we use here at ey. Typically speaking is going to be the sub restructure and re stands for subsidiary REIT, right? You may have heard of this concept being thrown around. The idea here is that we do this because we want to have minimal disruption to the fund itself. We want the fund to remain status quo because there are a lot of them existing out there. So we established the subsidiary REIT underneath it as a wholly owned subsidiary, and we install the penguin investors is 125 preferred investors, a non-voting stock at the subsidiary level, and the subsidiary is going to hold all the assets, it's going to hold all the loans or hold all the real estate, basically be a holding company and feed all of its income up to the parent fund, which will thereby be distributed to the investors via the waterfall set in the private place memorandum.

This is important because of two big reasons. The first reason is disposability, and we talk about this in line with the concept of the sunset rule. If this were to go away, if this were to go away and this program is no longer a viable option for the sponsor to continue, it's not worth it anymore. It's too much headache, whatever, you can essentially just dissolve the subsidiary without having to deal with long-term ramifications. And also you don't have to really worry about trying to figure out, well, I want to unring this bell as being a REIT because if the fund were to be converted to a REIT, the fund would never be able to go back to status quo. And so this is a very much more flexible strategy. The second thing is that in the event of non-compliance, also you have the ability to dissolve and discharge it.

But also I think one of the big other reasons is convenience. I like the idea of having a separate entity that is purely designed for this and you can establish subsidiaries underneath it for purposes of leverage or whatever, what have you. And I find that it's much more widely adopted when it comes to our space because a lot of our clients, they like flexibility when it comes to these strategy. So all right, so moving on. Okay, so compliance concerns. So we want to get a little bit more in depth when it comes to some of the compliance issues that have been coming up. And now that this trend's been in operations in our space now for a couple of years, we've been seeing some issues come up. More often than not, it comes up with three big areas. The first area is going to be when it comes to bad income and bad income is a very challenging issue for a lot of debt funds because of various fees and also sometimes with loan types and foreclosure.

The other issue that comes up oftentimes more often than not is the closely held test, the five 50 rule. But before we get in there, we want to make sure we analyze the asset test because this is a little more nuanced than you might think. And in context of situations where you may want to increase your dry powder, you may want to start building some cash reserves for some opportunities that come forward. The definition of real estate, the asset test is actually broader than just purely owning feasible real estate or direct ownership in a mortgage. It's a little broader than that. And so it can include cash receivables, government securities, it can include real estate shares and other REITs instruments offered by publicly traded REITs. It is a little broader, and there are also some restrictions when it comes to this. You can't really have too much of one particular secure concentration issues.

And so you also can't have certain kinds of assets in here that represent too much. And so it's important to think through that as well. Very, very not common issues for our clients because typically speaking, as I said before, these funds are comprised of primarily mortgages and some real estate. So we don't really have this issue. But for clients that have a little more of a diversified strategy or more of a institutional strategy, it is important to think through. All right, so the other issues that come up are bad income. Bad income comes up a lot both at eligibility when we analyze the business for eligibility to become a REIT, but through operations, bad income really boils down to two big areas. First things first, it's are you earning income that's not considered passive income? Passive income meaning interest, rent, dividends from sale, really more active operating income.

And this really comes up when it comes to in mortgage, a lot of the times it has to do with certain fees that are being received for services rendered, right? And also income derived from the active trading of notes and then also active trading in real estate. And there's a difference between selling real estate for passive gains or passive income versus active trading. And for those of you who are uninitiated, the concept of dealer status by defined by the IRS, not by the SEC can come up. And that is what causes problems for REITs because the ultimate intent, the legislative intent behind the concept of a REIT was for it to be a passive investor. And so this is where we have the most common issue with clients is that, Hey, I want to sell loans. I want to sell loans out of my fund out of my REIT.

Can I do that? And the answer is yes, but we have to plan through it. And so there are volume issues before we start hitting those thresholds of active income. And also the idea of creating a taxable REIT subsidiary to sell the loans out of, or even selling it out of a parent fund. These are things to think through, not necessarily the end of the world, but it's important to make sure that you have your vendors and your advisors on speed dial to walk through these issues. But once we kind of create the plan, it's usually pretty palatable for most of our clients. Where things become tricky, and this is more for our real estate clients and real estate funds, is lodging income. And this has become more of an issue as we've shifted away from the conventional idea of just hotels to these short-term rentals because the short-term rentals can technically trigger lodging income because they're kind of an alternative to hotels.

This is a new area of law and it's not quite decided, and we get very nervous about this issue. So for those funds out there who are creating these REITs to invest in short-term rental real estate, it's important to think through, and this can be resolved through a couple of different strategies, namely master tenant arrangements, but it has to be thought through. Other things to think through when it comes to this is when it comes to foreclosure sales, bad income can come from close foreclosure sales. And so you have to make sure you navigate those issues carefully. The active sale of real estate versus the passive sale of real estate is important. And it's not saying we can't foreclose, and it's not saying you can't take back REO, and it's not saying you can't sell REO, but the method in which you do it and the frequency in which you do it is important.

And it's a case by case analysis because it's a volume calculation. And so it's really important that when you do this, you contemplate that with your CPA, your auditor, your attorney, to make sure that you're doing it correctly. Typically speaking, most of our clients will create the TRS, the taxable read subsidiary to do it out of just to have, avoid any kind of potential headache and make it easy on themselves. But it is to think through. Also, the last issue has to do with the actual type of loans. So this is more of a threshold issue. We will do this for funds that convert into REITs. We will ask them in your portfolio, do you have any loans that make may contemplate lease participation or equity participation in the proceeds of sale from the real estate after completion of the construction project? Things like that can cause issues.

Is the loan secure? Is this more for our commercial clients? Is the loan secured by, for example, a hospital or a hotel or short-term rentals? Can that cause a problem for this because of the lodging issues? Because now if you were to take it back, you own an asset that generates not rental income, but not passive income, but active income, operating income. And so these things are things that issues to spot not impossible to solve for because typically speaking, when it comes to those issues, we can solve for through master tenant relationships. So other kinds of compliance concerns, the a hundred investor test, from my perspective, I always tell clients it's not even worry about it, let's just hire the penguins because the challenge with managing investors and ins and outs and redemptions and making sure you can meet the a hundred threshold can be quite challenging. And if we pursue this sub strategy, you have to install investors at the subsidiary level. And the reverse argument is, well, I can control these people. Well, do you really want an additional obligation to manage where you can outsource this for a fee that's an expense to a third party company that handles all of it for you, and they're quite reliable and easy to use, and I find that it's worth the cost, particularly because the last thing you need is to manage another set of investors just to maintain compliance.

The most common compliance concern is this five and 50 test or the closely health test, and this is where a lot of brain damage comes in because the calculations can be quite challenging. The first issue is that it's a fully diluted calculation. So when we have the sub re structure, we're not looking just inside the subrate, the sub read is owned by the fund, we look through the fund and we look at its investors and we look past any entities or trusts or anything like that to get to a warm body to figure out do any five individual people, natural people own 50% or more of the REIT indirectly. The problem with this calculation is that the definition of an individual is broader than you think. It includes lineal ancestors and descendants, spouses, brothers and sisters. And so when it comes to a family and friends fund, it can be quite challenging.

And so we want to make sure we deal with this issue. We've had a couple of situations where June rolled around and the client had elected last year and they hadn't met the requirement, and there are solutions for it. We typically have to figure out some redemption, and that's important to make sure that your documents have the ability to redeem when it comes to these fact patterns, but also sometimes the client will transition out the investor or convert them to a debt strategy or something else. And so there are solutions to this, but my preference is to the investor, to the client is let's avoid this if we can, because you have to really be confident that you can hit these numbers if you're starting up and right away becoming a, if you're an existing fund, that usually is not much of a problem for you, but it can become one. So it's important to look through and maintain this visibility at all times. Typically speaking, we recommend clients take a look right around March to May because by June, you have to know the answer and maintain that answer from June all the way to the end of the tax year if your tax year is the calendar year.

All right, so let's kind of go into some misconceptions. There's been a lot of misconceptions, and I get these on concepts all the time, and I think that's a lot of times people think that these are way more complicated than they really are. And one of the things, these are the four kind of commonly asked questions before we even get into these. We have this kind of general misconception that REITs can't be, REITs can't offer private securities. REITs can't be structured in a way under a Reg D, and that's completely false. And that comes because of two reasons, right? Market issues. You see a lot of publicly traded REITs out there, and that's wonderful. The second is because if you look at the eligibility test, there's the way they define the five, the way they refer to the five and 50 test is the close the held test.

Well, how can this thing be or publicly held requirement? Oh, doesn't that mean my registration? No, it just means that it can't be held by a certain small number of people. And so it's important to think through that because it's very, very much a commonly used strategy by smaller funds and programs out there because it was never designed just to be exclusively used by registered companies. And there's also not as much of a size issue either. A lot of times clients think that, oh, I have to be like a hundred million or 50 million bucks under management to do this at a minimum, not really. It is really a question of cost benefit for you. And there have been instances where a fund, we've looked at the fund, we talked to the sponsor, and we realize, well, this is probably not the best fit for you.

Your rate of returns too low, your margins are too thin, all your investors are non-taxable. It may not be worth your while in that context, but I do think that it's, in most instances, we found that it can be beneficial even at formation because you have some time. And so it really boils down to the sponsor's ability to raise capital. You must have a hundred investors in your fund to comply. We talked about this earlier. You can use a shareholder accommodator to provide the a hundred plus preferred equity investors to meet this requirements. You never have to worry about it ever again for that. The five and 50 test is actually more important. I think that that's the really, when it comes to this consideration, the threshold threshold issue is the five and 50 test. Will you meet that requirement by the end of the following tax year?

Because a lot of folks, they either under or overestimate their ability to raise capital and really has to be realistic By that time, will you have enough investors? Also, REITs cannot sell loans, not necessarily true. We talked about this earlier. REITs can sell loans. It's just a matter of volume. We want to avoid being considered active trader business and we don't want to be actively in the business of selling loans, but it can. And also creating a taxable REIT subsidiary or selling it out of the parent fund are both commonly used options for these types of strategies. Granted, there are some additional tax ramifications for that, but it's better than blowing up your REIT status. So I think it's a very valuable strategy in both ways, and it's definitely something you can do.

I want to talk about Outlook. This is where we spend a lot of our time with our existing clients who've done this already, and also potential sponsors who want to go this direction. First things first, I want to be very clear. Rates aren't going anywhere, right? They've always been around for over 20 years. It's this deduction that we're worried about this 20% deduction, and this has been the reason why a lot of clients have gone this direction. This has become very valuable. If you think about the way it works in these debt funds, the big downside of these debt funds is that the income is taxed at ordinary income. It comes from interest. And so it's unfortunate. So because of that, we've always tried to find a way to get down to closer to capital gains rate. Well, if you're doing a 20% pass deduction, the way it plays out is if you have a hundred thousand dollars distribution, the investors paying tax on 80 of it, 8,000.

And in that context, it's fantastic. It brings your tax bracket down significantly on that particular investment. And so this is a hot button issue because it's tied to the tax cut and jobs act. This section is meant to sunset. And so we have to really evaluate that and really look at the viability of this. And the only thing I can tell you guys is there's kind of two big ways to look at this, right? The first thing is the direction in which Congress is headed, right? Because we know that the Republicans have introduced and attempted to by introducing legislation to make this permanent. They've tried. So from an election perspective, kind of line item three here is from an election perspective, if there is a red wave in November during the midterms, and if in 2024 the Republican take power at the executive level, there's a high likelihood that this will become permanent.

But it's important that it remain top of mind with the congressional congressmen and senators that want to back this, want to support this. And so it's very important that you speak to your Congress people and your representatives and let them know that this is very important to you and you really think that it's beneficial. And I think it's not just beneficial to REITs. REITs are one area. It's not the only area. Remember, this benefits pass through businesses, right? LLCs, SCORP partnerships. And why is that important? Because most small businesses are structured as such, including yours. And so I think it's imperative that those small businesses get as much support as they need with the looming or actual already here recession. And so these types of deductions are going to be very important to businesses across the country. And so I think continuing that legislation is worthwhile from that perspective.

The other way to look at this also is how Congress treats sunset provisions in general. And from my experience, the most kind of commonplace thing I saw was EB five. And because I was so entrenched in EB five for many years, we were always basically watching if Congress was going to kick the can because as part of this big omni, the spending bill. And so every few years we would watch Congress to see if they're going to kick the can. And lo and behold, they did many, many, many times until it finally expired. I think it was like three or four kicks basically. And so one of the things that happens also with sunset provisions is that Congress typically in their, I guess their desire to not act will oftentimes just kick the can because it says tax legislation can also, it was initially passed through reconciliation. So the question becomes how do you kick the can again? And that likelihood is the reconciliation. So it's important to think through that as well. More importantly though, get your voices heard. I really encourage everyone to call their Congress people. I've found that phone calls work the best. I've done it with my old congress person who's also a Republican and let her know this is very important to my business. This is very important to my clients. I think you guys should really push forward to extend this as hard as you can.

And I also want to talk about in general the outlook for funds. And we've been talking about this for years now. And as I am biased, I'll have my own biases. As a securities attorney who loves to create funds for a living, that's what I do. That's what I'm known for. But I think beyond just the concept of a fund, the idea of having committed capital, the idea of having some type of committed balance sheet that you can rely on when things get volatile. And so thinking us back way, way in the stone age of private lending, that was the only source of capital back then. And as the industry grew and garnered more attention from the financial institutions and institutional investors, it started to pivot away from the model. It crafted similar to the commercial real estate sector, and started relying very much on the model design for the conventional real estate sector having a very, very robust secondary market.

And I'm not poo-pooing on the secondary market. I think it's a very valuable resource. I think they're also very valuable partners to our clients and to our lenders. But also it's important to have a balance, and it's important to make sure that you have some type of control over your loan, your lending activities and lending capabilities. Because if you have all your eggs in that one basket and things go bad, and we had some volatility earlier this month, earlier last month, we're likely going to have it again with the next rate hike. And it's just going to keep continuing. You want to make sure that you have some control over your destiny when it comes to funding loans. Right? Now, the clients who have done that and follow the blueprint when it comes to having a fund and also selling loans, the challenge is that they need more capital.

And that's always going to be the truth. You're going to have capital constraints, but it's better than having none. So I really encourage folks to really think through that or at least work towards some type of balance sheet strategy, whether it be a fund, a line of credit, maybe a really, really high net worth investor, family office supporting you, something to really get some more control over how you fund loans as opposed to complying with someone else's guidelines because they're running their business. Yeah, I mean, generally speaking, these are going to become much more valuable to investors because these tax deductions combined with the fixed rate of return and the higher rate of return that's going to be generated from these funds and the consistent non-correlated rate returns from these funds makes it a very popular investment when it comes to high net worth investors, retiree investors, and also just generally fixed income investors because why?

Because we're not dealing with even the fixed income strategies that are commonly correlated. They're very volatile right now. And so this is a much more stable investment and the yields are still relatively healthy. So I think it's really worth considering when it comes to from an investor's perspective, and for those investors, for those of you who are investors who are looking for something to park some money into and you like income investing, this is a good place to do it. But more importantly is the viability of this 20% deduction is imperative. And I really encourage everyone to think through how they can support their own businesses and the industry at large and talk to their congresspeople and enforce the idea that this is really about supporting small businesses and also helping build more inventory, which every single Congress person claims to want. And so if it wasn't for our industry, we wouldn't have the inventory we do today, and we're continuing to participate in that narrative.

And so if we're not building, we're not able to lend, our borrowers are not able to build. So it's really important that we get in front of this. We'll start kind of pushing this issue through our association with the American Association Private lenders, but I think it's important, and I really think that you guys who are in this fight and having a read should be discussing this with your accomplished people right away. So that's the webinar. We have some questions. We're going to go some question and answer, so let's go through it real quick. First question is, are the a hundred plus investor and five and 50 rule for public REIT only or private REITs as well? No, it's for everybody. Everybody and public rates don't have a problem meeting these requirements because they're huge numbers of investors, right? So next question with respect to bad income, do special servicing fees count as passive source of income?

Servicing fees is kind of a loaded question. We have to basically take a servicing fee. We can pick it apart. And so typically speaking, servicing fees are not going to be considered bad income, but we have to make sure because they're typically paid to the manager actually, so they're not usually paid to the fund. But we should also look at that because if they are paid to the fund, we have to pick it apart and we have to look at whether it is an active service service fee or is it not? Question from Jeff, do you have any resources in-house or referrals to consultants to model quarterly value of REIT assets? So this is actually more of a general fund question. If your fund is comprised of mortgages, if your REIT is, if your read is comprised of mortgages, valuation is very simple. Mortgages are valued at book value done.

Now we're entering into the world of NPL. Real estate valuation policies and parent policies are important. It's important to consider with the best place to do that is probably talk to both real, your securities council and also at the same time your auditor or CPA, because they have to go through a dialogue to make sure that it makes sense for everybody, both the investors and the client's fiduciary responsibilities, but also in compliance with gap. Next question from ash. For those of us getting into the fund business, what recommendations do you have? Would you start at a regular fund and then convert out to a REIT only total assets reach X dollars recommendation on where to start? For newbies? The real kind of question to answer that question is the ability to meet that five and 50 test, because it is much more cost effective to start a fund with the paperwork already prepared and the entities prepared because it's just easier and less costly.

However, you pay for a service to have documents and things built out. If you were to elect in the given formation year, you have to make sure that you meet these requirements and then also the cost is worth your while. But because this has been done so frequently for at least at our firm, we've gotten the cost down a little bit. But the idea is if you can meet the requirements, you can raise enough capital where you have enough investor diversity by the buy the deadline, and I think it's definitely worth it because that tax deduction is massive. But if you can't and you're not sure you can or you're not even sure that you can, we tell clients it's a business decision internally, I would suggest that you evaluate whether do you really think that by the time next year rolls around, you're able to meet it?

If you can't, then it becomes should I build it in place of it? What's my capital pipeline looking like? Every sponsor is different when it comes to their ability to raise capital. So it's kind of hard to determine if they're confident. I tell 'em, just build it now and turn it on later. So five and 50, please expand on definition. Is the family of a spouse included, for example? Actually no, it's different. So the spouse is included, but the brother and the brother and sister are included. So my brother, my wife, my parents, grandparents, children, but the spouse is an investor, yes. So it depends on investing as well. So it really depends on how they invest, but generally speaking, it has to do with the particular investor. Can you explain the TRS structure and how, why it helps mitigate bad income? So the idea of a TRS structure, so the REIT itself cannot own have the bad income, but by creating a subsidiary that is not a REIT and is taxable, it can house the bad income and then you have to pay taxes on it.

So that's why we do it. Can real estate brokers provide notes available to purchase to existing REITs? Yes, REITs can buy loans. A lot of you have been selling loans to REITs out there to begin with. So nothing wrong with these REITs, even the small privately held reached to buy 'em either. Isn't mortgage valuation also functionality of maturity? It makes sense that if fixed FL deals held at par, but a 30 year DS year has real durations, so should that not be marked to market? That is a good question, Vince. That is an issue, but that's not an issue associated with gap. It's actually an association when it comes to valuation based off of your policies and procedures. The rules on gap have always been mortgages have been, you value 'em and book value, but that's a valid point. And so that has to do with valuation of the assets as it pertains to returns and how that influences returns and all those things. Same kind of constant when it comes to impairing a loan, it has to do internal policy and procedures. Once again, conversation with a CPA conversation with your attorney to go through all this to make sure we're planning this out. It can be, you can establish that policy all day long, make sure that it's disclosed and in conformity with fiduciary duty.

Next question, are loans considered securities? I do not have the time to answer that question, William, because I can go on a diatribe about this and do a three hour lecture on the issue of whether a loan is a security, but generally speaking, the answer I give and these types of webinars is they can become securities, but generally they're not considered securities, but they can become, and we have seen state and federal security regulators treat them as securities and investment contracts in the right circumstances. Typically speaking, it has to do when you have a co lender situation or a trusted investor situation where they're going a direct investment into the note, that's when they really think it's security. But once again, we have to think through it, look at the facts to evaluate it, to answer that question. The question here in the REIT, can you have multiple asset classes that are pursue with each other?

So multiple asset classes is probably not what you're trying to ask because multiple asset classes just means different types of assets. I think what you're trying to ask is can you have different classes of units or shareholders or members, right? And you can, the penguins, we have class, we have preferred class with them, and then common class held for the fund. The idea of that a Perry pursue with each other, I'm not quite sure I understand the question. I don't have the name of the person asking the question. Please feel free to ask me after the webinar directly, Mitch asked the question, Hey, Kevin, with a REIT, can you have unlimited IRA or is it max at 25%? So this is actually a myth. So REITs have no impact on the plan asset rules and ERISA rules and all that, right? That's a separate piece of legislation, right?

But those rules don't prohibit anything, right? Those rules, the plan asset rules don't prohibit anything. What they say is, once a fund hits 25% of plan assets, IRAs, 401Ks, Keo, pension, whatever, then all of these extra rules kick in. And the fund is considered itself a plan and the manager is considered a fiduciary and any other service provider considered fiduciary. And you have to conform with those plans, those rules, and you have to conform with the rules associated with prohibited transactions. This is also a very long conversation. We can talk about it offline, Mitch, but it does not grant you the ability to bypass the plan action rule whatsoever. Can real estate brokers sell notes we were talking about already? Yes. To existing REITs? Yes. Is there a database of contact REITs with available notes?

I actually don't know the answer to that question. For private lending specifically, if you're looking for information on funds beyond the SEC's EDGAR website, you can just search any kind of securities offering. I would direct it to my friend Rocky Butani, Private Lender Link. He's got a very good website, very beautiful website actually, that has a lot of information about lenders and some of them have funds. And the webinar, I don't know if the webinar will be recorded. Our team will send out slides and information later. I believe it will be on YouTube later, so that should be available for you as well. So that's all we have for today. I think we're a little bit early on time. So for those of you who have any other questions, you can always direct your questions to me. Last little bit of housekeeping before we close out the webinar, I want to put a little bit of a plugin for our upcoming conference in Las Vegas on August 21st to the 23rd at the Encore Hotel at Wynn, you can learn more about that at Geracicon.com, G-E-R-A-C-I-C-O-N.com. Captivate is our flagship conference that we throw. It's a private lending industry event. It's a little bit different in the sense that we invite a lot of high net worth RIA family office types to attend and network with sponsors who are in the space. We also have a who's who list of both capital providers and private lenders showing up. So if you're a borrower, right, if you're a real estate investor or a broker, we highly encourage you to attend as well because it's a great place to expand your network. And also all of your friendly faces at Geraci will be there. Please come through, hang out with me, have a drink, listen to me drone on, and hopefully we'll be able to hang out and have some fun. So once again, Captivate Conference coming up on August 21st to the 23rd at the Encore at the Wynn in Las Vegas, Nevada. I think that's all we have for today. I'll give you back some time. And thank you for joining us on this webinar for Geraci.