REMICs emerge as popular new capital source

Real Estate Weekly, Jan 26, 1994

At a time when traditional sources of capital remain scare, commercial property owners are now looking to the burgeoning REMIC market to raise the cash they need to pay off loans coming due.

"In today's marketplace, many commercial and multi-family residential property owners are finding that refinancing debt through traditional means remains difficult," said Roger L. Johnson, KPMG Peat Marwick's National Industry Director of Real Estate. "REMICs (real estate mortgage investment conduits) may be the answer to their prayers."

REMICs, a vehicle for converting pools of mortgages and related assets into publicly traded securities, proved to be an extremely popular way for residential property owners to access the capital markets last year.

"In 1993, property owners' need for cash, coupled with the capital market's appetite for mortgage-backed securities, drove REMIC securitization of single-family residential mortgages to record levels," Johnson said. "From all indications, this marriage of convenience is likely to spawn a whole new wave of commercial and multi-family REMICs in the upcoming year."

The Next Wave

Investor's hunger for mortgage backed securities shows no sign of abating - and that means opportunity for owners of commercial and multi-family properties looking for alternative sources of capital, said Thomas J. Lyden, director of REIT and REMIC Taxation for KPMG Peat Marwick's Washington National Tax office.

"Investment bankers are going to be seeking more raw material that can be turned into REMICs," he said. "And it would appear that this year commercial and multi-family residential property mortgages are going to be targeted by Wall Street to satisfy the demand for new offerings."

Lyden added that he expects the REMIC vehicle to perform as effectively for commercial or multi-family properties as it has for single-family residential.

"Although the REMIC structure was aimed primarily at facilitating transactions in the secondary mortgage market for single-family mortgage loans, the IRS regulations on REMICs contain several provisions intended to accommodate other mortgage types," he said.

The Flipside of Owners Refinancing

Johnson also suggested that in the future institutional investors such as insurance companies may be able to use the REMIC structure to minimize the drain on capital that comes with carrying underperforming real estate assets on their books.

"By putting underperforming loans into a separate 'company' - in this case, a REMIC - insurance companies could trim the amount of capital reserves necessary to satisfy regulatory requirements," Johnson said. "Securitizing these mortgages also could free up capital for other uses."

Johnson added: "Everybody talks about REMICs as being a valuable too for real estate companies, but these vehicles may have even more value for the other side - the institutional investors that floated the money to begin with, such as banks and insurance companies."

Qualifying for REMIC Treatment

Qualifying for REMIC treatment - and taking advantage of the associated tax benefits - is a fairly straight-forward process for real estate companies, said Lyden, who signed off on regulations governing REITs and REMICs during his tenure at the Internal Revenue Service.

Like a REIT, a REMIC does not pay tax on income generated by the mortgages it holds. Instead, that income is allocated among the REMIC interest holders.

"In essence, REMIC structuring is inhibited only by the requirement that the collateral comprise a static pool," Lyden said. "If that requirement is satisfied, the design of REMIC securities is limited only by the creativity of the investment banker underwriting the offering."

To qualify as a REMIC, a pool of mortgages and related assets must meet several tests concerning the composition of its assets and the nature of the mortgage-backed interests it issues.

"The first is an asset test, intended to ensure that a REMIC is nothing more than a pool of self-liquidating mortgages," Lyden said. "The second test dictates that all interests in a REMIC fall into two categories, regular or residual - distinctions made for federal tax purposes."

Using REMICs with REITs

Lyden also pointed out that there have been recent offerings that use REMICs in tandem with REITs to allow the latter to take advantage of certain benefits that would not otherwise be available to the REIT offerer.

"The REMIC gives the REIT offerer the opportunity to leverage REIT assets by issuing debt to raise capital for the properties in the REIT," Lyden said. "Moreover, it can lower the costs of borrowing on a property-by-property basis."

"By bundling and blending interest rates for short-and long-term debt and structuring advantageous payment schedules, the REMIC permits holders of real estate assets - whether real estate companies or REITs - to exploit the steep interest-rate yield curve."

In the discrepancy between low short-term interest rates and higher long-term rates lay opportunity for REMICs, Lyden added.