Perhaps real estate investors and their attorneys have reason to be cautiously optimistic: economic reports released this week indicate signs of life in the real estate market.  As reported by the Associated Press, the National Association of Realtors saw increases in pending home sales for the ninth straight month.  And for the first time in six months, construction spending saw an increase.  Optimists say these numbers, in conjunction with recent reports that home prices are climbing, indicate long-term recovery for both the residential and commercial real estate sectors.

Yet many analysts argue that these spikes are temporary.  The growth in construction spending amounted to a measly 0.04%, and the rise in pending sales contracts over the last nine months is attributable to the homebuyer tax credit, which the Obama Administration and Congress recently extended.

I suppose time will tell which analysis is correct.  But while commentators continue to debate, real estate investors have shifted their focus from traditional residential and commercial endeavors to a sector less affected by the downturn: healthcare properties.

Multi-tenant senior living, assisted living, and hospice facilities have not experienced the vacancy rates that multi-tenant residential, industrial, and commercial facilities have.  In fact, with the Baby Boomer generation reaching retirement, the market for such accommodations continues to grow.  And while banks have foreclosed upon some facilities, federal regulations require the continued operation of such facilities (for obvious reasons), making the purchase of such properties at foreclosure a better gamble than, for example, a vacant apartment complex.  Of course, the specter of national healthcare reform only adds to this investment’s mystique.

A primary beneficiary of this growing market?  Real estate funds that sell interests in Real Estate Investment Trusts (REITs).  While the economic downturn has wiped out the profitability of many existing REITs, funds have turned to healthcare properties to develop appealing prospectuses.  Yet were it not for a decade-old federal enactment and a recent statutory modification, these funds (and their attorneys) would be hard pressed to find deals worth making.

First, some background.  The REIT acts like a mutual fund by providing individuals or institutional entities with a passive investment opportunity.  A corporation with REIT status can avoid corporate tax liability and thus funnel most of its income to investors.  A typical REIT acquires diverse pieces of property with investor money.  The REIT—typically via a subsidiary—cares for these properties, with the goal of turning a net profit through rental streams and appreciated land values.  If and when any income develops, the REIT distributes at least 90% of it among the trust’s investors.  REITs have become a common component of large investment portfolios.

However, REITs had a significant shortcoming for many years.  Until 1999, a REIT could not acquire a facility that provided services to tenants.  Under IRS rules, properties with a rental income stream arising from services provided—like hotels—were considered active investments, thus subjecting the acquiring entity to corporate tax liability on those rents.  That tax liability destroyed the profitability of investment in a REIT.

That limitation was partially removed by the REIT Modernization Act of 1999.  Passed by Congress and signed by President Clinton, the Act allowed for the expanded use of taxable REIT subsidiaries, or TRSs.  As explained by the National Association of REITs, the statute allows a corporation seeking REIT status to create a subsidiary to manage service-providing property.  That subsidiary is taxable like a standard corporation.  In turn, the REIT may hold up to 100% of the TRS’s stock without disqualifying rents received by the REIT from special tax treatment, so long as the TRS does not compose more than 20% of the REIT’s total assets (this limit was raised to 25% in 2008).

While the Act laid the groundwork for heavy investment in service facilities, the Act stopped short of authorizing such investment in healthcare facilities.  In fact, it expressly prohibited the use of this TRS model to manage healthcare properties.  However, as part of the Housing and Economic Recovery Act of 2008, Congress expanded the definition of “TRS” to include subsidiaries that manage healthcare properties.

Those real estate funds and their attorneys riding the wave of healthcare property investment would confirm that these legislative enactments have paid dividends (literally and figuratively) in an otherwise moribund real estate investment sector.