8th Edition

REIT Guide Second Print

Table of Contents Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 What is a REIT? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1. The Origin of the REIT Vehicle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 The U.S. REIT Story . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 The Birth of the Canadian REIT Vehicle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2. Anatomy of a REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 The Declaration of Trust and Management Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 How Will Investors Receive their Returns from REITs? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Statutory Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 What Type of Property is Most Suitable for a REIT? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 3. Canadian Tax Issues for REITs and Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 REIT Tax Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Investor Tax Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Comparison of Open-Ended and Closed-Ended Mutual Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 4. The REIT Vehicle in the Canadian Marketplace . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 History of Capital Flows into the Canadian Real Estate Industry from 1970 to the Present . . . . . . . . . . . . . . . . . . . . . .21 REITs Provide a Vehicle for Buying Real Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22 5. Challenges of Converting to a REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Transaction Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Matters to Consider BEFORE Proceeding with a REIT Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Extent of Investment of the Sponsor in the Ongoing Operation of the REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Making the Economic Case for the REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24 Structuring the REIT vehicle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 Accounting and Reporting Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 Legal and Administrative Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 6. The REIT vs. a Corporate Structure: Differences in Management Focus . . . . . . . . . . . . . . . . . . . . . . . . .29 Investment Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Operating and Financial Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 Financial Reporting Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37 Corporate Governance Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41 7. Canadian vs. U.S. REITs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42 From An Owner’s Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42 From an Investor’s Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44 8. Why Royalty Trusts and Investment Trusts Differ from a REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45 9. Difference Between the Structure of a Non-Business REIT and a Business REIT . . . . . . . . . . . . . . . . .48 10. How to Evaluate a REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52 What to look for in a REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52 How Should REITs Be Evaluated? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53 What are the Risk Factors? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 Other Factors to Consider . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 11. Scorecard and Predictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55 Scorecard of Predictions from 1997 Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55 U.S. Market as a Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57 Future Trends and Predictions for Canadian REITs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58 Appendix 1 – Operating Cash Flow Available: REIT vs. Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59 Appendix 2 – Impact of Tax Deferred Distributions on the Adjusted Cost Base of Units . . . . . . . . . . . . . . .64 Appendix 3 - Comparison of Available Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 Appendix 4 - Continuous and Periodic Disclosure Requirements of a REIT . . . . . . . . . . . . . . . . . . . . . . . . . .68 Glossary of REIT and Real Estate Terms Commonly Used in Canada and the US . . . . . . . . . . . . . . . . . . . . .71 Acknowledgement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78

8 eighth edition

The information and analysis contained in this book is not intended as a substitute for competent professional advice. The material that follows is provided solely as a general guide and no action should be initiated without first consulting your professional advisor.

Introduction Since 1994, when we issued our first edition of the Canadian Real Estate Investment Trust (“REIT”) guide, there have been tremendous changes in the REIT marketplace. REITs in Canada and the United States have ‘matured’ as an investment vehicle and have strong institutional and unitholder support. Income trusts based on other types of commercial enterprises have in recent years been extremely popular in the Canadian equity markets, notwithstanding recent challenges with respect to the structures of cross-border income trusts and the related tax considerations. Even more recently, there has been discussion of potential limitations on investments in income trusts by large institutions such as pension plans. Add to that the evolution of legislation with respect to unitholder liability, and you have a very dynamic environment. The combined Canadian base of real estate, business and royalty trusts has made the study and understanding of all the issues and opportunities associated with such trusts even more relevant. Accordingly, we are pleased to provide our Canadian REIT Guide, 8th Edition, through a second printing. Don Newell April 2004 For more information on REITs in Canada or on the contents of this Guide, please contact any member of our REIT team: Toronto Don Newell (Leader) Elizabeth Abraham Frank Baldanza Pat Bouwers Eddy Burello John Cressatti Ciro DeCiantis

416-601 6189 [email protected] 416-643 8008 416-601 6214 416-601 6217 416-643 8724 416-601 6224 416-601 6237

Calgary Trevor Nakka Frank Rochon

403-267 1858 403-267 1716

Halifax Claudio Russo

902-496 1812

Montreal Manon Morin

514-393 5255

Vancouver Garth Thurber

604-640 3110

What is a REIT? A Real Estate Investment Trust ("REIT") is a term that originated in the United States and has since been adopted in Canada to describe vehicles used for collective investments in real estate. A REIT, from a Canadian perspective, is either a publicly listed closed or open-ended trust that allows investors to purchase units of a trust that holds primarily income producing real estate assets. The larger REITs are internally managed and will generally also have their own internal property management operation, which helps to lower the cost of operations. The smaller REITs, in order to remain competitive, have developed a shared management platform where the assets and strategic management are shared, usually with the sponsor, and the property management function is either internal or external to the REIT. All trusts whether open or closed are governed by trust indentures and investment guidelines, which require the particular REIT to comply with requirements set out in the trust indenture and to follow the stated investment guidelines. The trust indenture covers such matters as payment of distributions and limitations on the REIT's borrowing capacity. Some of the key features of a REIT are: High yield through regular distributions - The REIT trust indenture typically contains a clause, which requires the REIT to distribute a percentage of its distributable income (a defined term) to its unitholders. Every REIT defines how it calculates its distributable income. The investment market demands that at a minimum the REIT include in its trust indenture a clause that it will distribute at least its taxable income to its unitholders and avoid the two levels of tax. It has been the policy of Canadian REITs to distribute between 75% and 95% of distributable income to unitholders. Cash distributions have led to average yields, as measured against the unit price of the REIT, of between 7% to 13%. The distributions of a REIT are taxed very differently than a corporate dividend received by a shareholder of a publicly listed company. Capital appreciation - Although the REIT vehicle is viewed primarily as a risk adjusted yield investment, it also has the potential for capital gain. Increases in asset values and anticipated income growth are reflected in the unit price. REIT units currently tend to reflect a unit price equal to or greater than their net asset values, whereas public real estate stocks generally trade at a discount to their net asset value. Taxation - Another feature that makes a REIT attractive to Canadian investors is the favourable tax treatment of income earned within a REIT and the fact that unitholders can partially manage their tax affairs. The REIT's taxable income is initially determined in a similar manner to that of a corporation. So long as the taxable income of the trust is allocated to its unitholders, the REIT will not be subject to tax. Distributions to unitholders usually will be comprised of a capital distribution, generally equal to the Capital Cost Allowance ("CCA") claimed by the REIT, and non-sheltered taxable income. An investor can further defer the taxable portion of the distribution by holding the investment in his or her registered retirement savings plan ("RRSP"). However, any withdrawal from the RRSP, including the tax-deferred distribution, will be subject to tax.

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Distributable Income - Most REITs define distributable income as net income as stated in the financial statements of the REIT (could be consolidated if the REIT has subsidiaries) prepared in accordance with Generally Accepted Accounting Principles ("GAAP"), adding back depreciation, capital losses and future income tax expense, but excluding amortization of leasing costs, future income tax benefit and capital gains. Market Performance - REIT units have exhibited an interesting trend when compared to other Canadian equities. Because they generate contractual revenues, they are able to maintain a high yield and are therefore evaluated differently from other equity investments. When compared to REITs, the Canadian equity markets tend to be much more susceptible to short-term economic conditions. Focused Asset Base - The Canadian REITs generally have a strategic focus as to which types of assets they wish to hold in their portfolio. This allows investors to focus on a specific category of properties within the real estate industry. The Canadian REITs have investments in the following asset classes: Office, Retail, Apartment, Nursing and Retirement Homes and Industrial. This encompasses almost all areas of the real estate sector that generate stable income. Real estate development is the one exception. Developments are usually carried out by corporations (private or public) because development does not suit the REIT vehicle for the following reasons: (1) it requires a substantial outlay of capital, which in turn absorbs a portion of the REIT's capacity to acquire productive assets or, if financed through an equity issue, has a dilutive effect in the short-term on distributable income per unit; (2) it takes a considerable length of time to become cash flow positive; and (3) it exposes the REIT to development risks. Except for the larger REITs, which generally carry out re-development as part of their strategic plan to enhance the value of their existing properties, REITs do not typically engage in development for the above reasons.

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1. The Origin of the REIT Vehicle The U.S. REIT Story REITs were initially created by the United States Congress in the 1960's as a vehicle through which small investors could gain access to large-scale, income-producing real estate properties. However, when REITs were originally set-up in the United States, they were merely allowed to own the properties, with third-party companies being responsible for the operations. This divergence between the ownership and management role did not receive the approval of the market place and REITs remained a secondtier investment. Additionally, REITs suffered from a lack of popularity due to other tax sheltered real estate investments, such as limited partnerships. These entities were able to pass on losses to investors, which were then used to lower personal taxes. As REITs were unable to pass losses on to unitholders, they could not compete with the tax-advantages of limited partnerships. However, in 1986 Congress passed the Tax Reform Act of 1986 ('the Act'), which effectively limited the tax shelter advantages of limited partnerships. The Act also enabled REITs to take on the management function. This reform, coupled with a depressed real estate industry in the early 1990's, made REITs a more attractive vehicle than private companies. It enabled them to access capital sources through the public marketplace, with many eager investors taking part due to the depressed state of the industry and belief in a recovery in the future. REITs have gained the acceptance of both the corporate world and private investors. As a result the REIT segment of the real estate industry has grown significantly with close to 200 publicly traded REITs currently on the NAREIT Composite Index, which now boasts a market capitalization of over US$175 billion (as at May 30, 2002).

Diversification of US REIT Market by Property Type Self-Storage 4% Hotels 6%

Health Care 4%

Specialty 2% Mortgage 2%

Diversified 9%

Office/Industrial 32% Residential 21% Retail 20%

Source: NAREIT May 30, 2002

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The Birth of the Canadian REIT Vehicle Although Canadian tax legislation was not identical to that of the United States, Canada had investment vehicles that provided similar results to those available under U.S. tax rules. The closest vehicles available in Canada when REITs were beginning to boom in the United States were limited partnerships, open-ended mutual funds and closed-end investment trusts. Any reference in this guide to a "mutual fund" or a "listed closed-ended trust" assumes that the trust has at least 150 unitholders throughout the period of existence. Furthermore, it is assumed that the trust complies with all other restrictions (e.g. type of assets owned and income earned) that are imposed on a trust in order for it to qualify as a mutual fund trust for Canadian income tax purposes. Publicly listed limited partnerships have never been a significant market force in the Canadian public equity markets. They were unappealing to investors due to legislation that classified them as foreign property for the purposes of RRSPs and certain other deferred income arrangements. From the investors' point of view, limited partnerships did not prove to be profitable. The huge collapse of the real estate market in the 19871997 period resulted in significant numbers of limited partners losing their entire investment. Initially, the open-ended mutual funds showed significant growth and provided above average investment returns. In the mid-1990s, they lost their appeal and marketability as public vehicles with the downturn of the Canadian economy. The flaw of the structure of open-ended mutual funds was that they were obligated to redeem their units for cash based on appraisal values. The appraisal values were not forward looking. As the real estate market deteriorated, investors rushed to reduce their exposure to real estate. Redemptions increased and in order to fund these redemptions the open-ended mutual funds sold their liquid properties. However, due to the deteriorating market conditions it was difficult to sell the properties at their net asset value (the basis for the redemption), which ultimately led to the collapse of the open-ended structure, as the REITs were not able to redeem their units at the calculated redemption price. The openended mutual fund, with obligatory cash redemption prices based on appraisal values, does not fit well with the long-term nature of real estate assets. One of the solutions to preserve the investor investment in the open-ended mutual funds was to allow these REITs to be re-structured as closed-ended mutual funds. The close-ended mutual fund was born out of the collapse of the open-ended mutual fund. These funds do not have the obligation to redeem units, as any investor wishing to liquidate their investment must do so via a trade on one of the Canadian Exchanges. However, to maintain their mutual fund status, the closed end funds have to comply with many more tax regulations. Today's closed-end mutual fund trusts are the Canadian equivalent to the U.S. REITs and, in many respects, have been made to function like a U.S. REIT. In 2001 and in the first half of 2002, we have again seen the re-emergence of open-ended mutual fund trusts. The new open-ended mutual fund trusts have severely limited the unitholder's ability to redeem units so as to match depressed sales of real estate property (if any) with redemptions. The valuation of the units is not based on an appraisal, but on the market value of the unit. (Refer to Section 3 for a more detailed review of the differences between and open-ended and closed-ended mutual fund trusts). The first Canadian REIT was listed on the Toronto Stock Exchange in 1993, and since then a further eighteen REITs have been created by way of Initial Public Offerings (IPO's). The mergers of RealFund with Riocan and of Avista with Summit, both in 1999, and the consolidation of CPL Long Term Care REIT and Retirement Residences REIT in 2002, have reduced this number to sixteen REITs listed on the Canadian Stock Exchanges as of June, 2002. To date, the most significant period for initial public listings of REITs in Canada was 1997 when seven new REITs were formed. Since 1997, an additional seven new REITs, excluding the effects of merger activity, have been listed to take advantage of the opportunities for accelerated growth. REITs enjoyed another year of growth in 2001 and 2002 should see another three to five new REITs being listed. As the REIT market has moved from the "handcuffed days" of the late 1990's and has performed responsibly by complying with the obligations set out in the declarations of trust and investment guidelines, investors have tended to allow the REITs to operate more like traditional real estate companies by removing or loosening many of the imposed restrictions.

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2. Anatomy of a REIT The Declaration of Trust and Management Structure Canadian REITs have adopted self-imposed rules through their trust declarations to safeguard the unitholders. The contents of the trust declaration are crucial as it defines the obligations and restrictions adopted by the REIT. Every investor should read carefully the REIT's investment guidelines, the market segment it intends to operate in, and the limitations that have been imposed on the REIT's operations. Initially in the early 1990's, a REIT's declaration of trust reflected conditions imposed by a hostile market. Trust declarations contained, amongst other things, the following: 1. Definition of Distributable Income. 2. The minimum amount of distributions (usually at least equal to the taxable income of the REIT). 3. The amount the REIT was permitted to borrow, usually a specified percentage of the Gross Assets. 4. Restrictions placed on the issue of new units. 5. The prohibition or the restriction of cross-collateralization of its assets. 6. Limiting recourse of its lenders and major service providers to the assets of the REIT. 7. The obligation to adopt an environmental policy. 8. Limiting the ability or restriction to acquire undeveloped property to a prescribed percentage of Total Assets. 9. The ability to lend money with or without security. 10.The ability to invest funds in other REITs. 11. Make up of the board of trustees and requirements for independent trustees. Amendments to the declaration of trust must be approved by a majority of unitholders, however the amendments to the investment guidelines and certain specified operating policies require at least 66 2/3% of the unitholders to approve the change. As the REIT industry has matured and the real estate investment climate has continued to improve, unitholders have shown a willingness to accept certain departures from the rigid standards established in the 1990's and allow the REITs to take on more operational risks. Investors should be aware that the trust declaration can be amended, subject to certain limitations, to allow the REIT to become more aggressive; however, any change will always be subject to market acceptance. If the change is perceived by the market to be too aggressive the REIT's unit value will tend to decrease to reflect the additional risk in relation to other REITs. A REITs governance structure is similar to that of a corporation. The trustees represent the unitholders and nearly all REITs have built into their declaration that the majority of the trustees must be independent of management or the sponsor. The trust declaration will also require that the independent trustees be appointed to key committees such as the audit and compensation committee. The trustees will implement and oversee the management structure to operate the REITs on a day-to-day basis. The smaller REITs still use a shared platform management structure rather than an internally managed structure. However, unlike the external management agreements of the 90's, where the REIT entered into an arrangement with a "third party" (usually related to the management of the sponsor) to execute the strategic and asset management functions, the REIT today has first call on the time and energy of the shared management and can terminate the shared arrangement at a relatively low cost. As a general rule, REITs that have gross assets in excess of $600 million will be internally managed, while smaller REITs (gross assets of $200 to $500 million) will utilize external management. The shared platform described above is designed to lower the cost of what would be full time strategic and asset managers, and yet at the same time allow the REIT to own and control its intellectual capital. The external management devotes part, but not all, of its time to managing the REIT, hence the lower cost of management.

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In the United States, most REITs have been forced to adopt the structure of internal management because the investment community has placed a discount on external managers.

How Will Investors Receive their Returns from REITs? A unitholder in a REIT will receive either a monthly or quarterly distribution (the majority of the REITs make monthly distributions). The tax-deferred percentage of the distribution will depend on the REIT's ability to claim capital cost allowance and other accelerated deductions for tax purposes. Most REITs, at the beginning of the year, will announce their anticipated distributions and the percentage of the distribution (assuming no acquisitions or dispositions) that will be deferred from tax. The calculation of the tax deferred portion of the distributions only applies to operating income and exclude capital gains that may be realized by the REIT during the year. For Example: Assume that a REIT with 20 million units issued and outstanding with an issue price of $10 each has net income before depreciation for the year of $20 million. The REIT has the ability to claim a Capital Cost Allowance of $10 million, which also equals their depreciation for accounting purposes, leaving a taxable income of $10 million. The Trust declaration states the REIT is required to claim maximum tax deductions, including CCA, and to distribute an amount equal to at least its taxable income or 90% of the distributable income - subject to the trustees' discretion. In this case, the trustees have imposed no additional deductions or increases in computing the distributable income, and have therefore distributed $18 million to its unitholders. Therefore each unitholder will have received a distribution of $0.90 per unit of which $0.50 is subject to tax. The remaining $0.40 (i.e. the excess of the distribution over taxable income) will reduce the unitholder's adjusted cost base and will be deferred from taxation until such time as the units are disposed of. (Refer to Appendix 3 [check final document for Appendix] for the implications of the taxdeferred portion of distributions on the adjusted cost base of units.) At the end of the calendar year, the REIT will determine all its capital gains or losses and allocate such gains or losses to the unitholders (usually based on the time each unit is held throughout the year by a unitholder). Usually the 90% distribution, which is based on the operations of the REIT, is often far in excess of the taxable income of the REIT (in this case, 50% [$20 million - $10 million = $10 million]). Generally, if there are taxable capital gains, such additional taxable income usually will not cause the REIT to make any further distributions as it has already made distributions far in excess of its taxable income. Where there are taxable capital gains, the effect is to increase the percentages of the income being taxed. Assume further that in addition to $20 million of net income reported, the REIT recorded $1.2 million of taxable capital gains and $400 thousand of recaptured CCA, increasing the taxable income by $1 million (i.e. 50% of the $1.2 million capital gain, plus the $400,000 recapture).

Taxable Income before CCA CCA Taxable Income Distribution to Unitholder Sheltered Distribution Non-Sheltered Distribution Percentage of distribution subject to tax

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CAPITAL GAINS

NO CAPITAL GAINS

$21 million $10 million $11 million $18 million $7 million $11 million

$20 million $10 million $10 million $18 million $8 million $10 million

61.1%

55.5%

Statutory Requirements In terms of financial disclosures and reporting rules, REITs are governed by Security Exchange Regulations and the recommendations of the Canadian Institute of Chartered Accountants (CICA) with most REITs also adopting the recommendations of the Canadian Institute of Public and Private Real Estate Corporations (CIPPREC) for further guidance. REITs financial statements will generally follow a presentation format similar to that of a real estate corporation with the major exception being the equity section. A REIT does not have retained earnings. Movements in unitholders' equity for the current and comparative years are disclosed in a separate Statement of Unitholders' Equity. Also, like corporations, REITs are required to disclose in their financial statements the net income per unit on both basic and diluted bases. As a securities exchange registrant, a publicly traded REIT must also comply with all relevant statutory requirements. These include compliance with: 1. Listing requirements; 2. Continuous disclosure (including quarterly financial reporting, annual reports and annual information returns, press releases, material change reports and management's discussion and analysis); and 3. National policies and other security commission policies and regulations. These statutory requirements impose a significant level of responsibility on the REIT's management and also impose a cost burden, such as filing fees, printing and translation costs, professional fees and the costs of an information system needed to comply with all these requirements. (Refer to Appendix 4 for a table that details the typical Continuous and Periodic disclosure requirements of a REIT.)

What Type of Property is Most Suitable for a REIT? There are many different types of property that a REIT can hold in its portfolio and the type of property chosen impacts the risks and returns to investors. Property types that are more susceptible to market cycles such as Retail and Hotel properties should provide higher returns, as the stability of those returns can be affected by short-term changes in the market. Hotels are the most susceptible to market changes due to the short-term nature of their income stream and the impact of cyclical fluctuations on business (e.g., consumer confidence). The impact of the percentage of occupancy and room rate, which is directly influenced by short- term fluctuations in the economy, will be immediately reflected in the income and cash flow of the business. This, in turn, will impact the cash available for distributions to unitholders. Retail properties are more stable than Hotels, but if a significant downward trend occurred in the economy and was reflected in consumer spending, the downturn would impact on the ability of retail tenants to maintain and meet their lease obligations. This will be further exacerbated if the rent earned from such tenant is tied to the sales of the lessee (i.e. percentage rents). However, if consumerspending turns bullish, a Retail REIT could earn significantly higher returns than, say, fixed rental properties. Office and Industrial properties are less sensitive to short-term changes in the economy, largely due to the long-term nature of their rental agreements. Tenants in these types of properties are less prone to move to another location at expiry of their lease so long as the landlord satisfies the tenants demands during the lease. Good management ensures lease expirations are spread out such that generally no more than 15% of the portfolio matures in any one year. The amount of space rented to any one group is also controlled: so should a vacancy occur because of bankruptcy or expiry, the vacant space is unlikely to have a significant impact on the overall rental stream and therefore, will not have a material adverse impact on distributions. This makes this class of REIT a less risky investment than a Retail or Hotel REIT.

8

Apartment and Retirement REITs are viewed as the most stable, as they are the least sensitive to economic cycles. The portfolio of tenants is more stable, and the percentage of space occupied by a tenant is considerably smaller than that of a retail or office tenant. There are no anchor tenants, and a tenant in an apartment or retirement home is unlikely to abandon leases simply due to a change in the economy. The increased stability of this segment of the REIT sector is reflected in a higher unit price and hence a lower distribution yield (sometimes single-digit). This class is favoured by defensive or risk averse investors. Some REITs believe that a diversified portfolio consisting of Retail, Office and Industrial properties provides the investor with greater stability while at the same time offers the potential for growth. Each REIT seeks to capture for itself a market niche and a strong following from its investors. Significant development projects (i.e. new construction projects) have difficulty in gaining market appeal in the REIT sector due to the lack of available cash flow for distribution to unitholders during the development and lease-up periods. However, the appeal of these projects on a very limited basis increases if the development is coupled with a strong underlying existing income stream (for example, in the case of an expansion to an existing property). Most REITs have limited themselves to a relatively minor portion of their total assets being directed to development projects. Of the sixteen REITs in the Canadian market sector today there are five with Diversified portfolios, four in the Apartment and Retirement sectors, four in the Hotel industry, two in the Office/Industrial sectors, and one in the Retail sector. (Refer to pie graph below). This is in contrast to the U.S. Market, which has a significant portion of its properties in the Industrial/Office (33.1%), Residential (21.0%) and Retail (20.1%) markets. (Source - NAREIT).

Diversification of The Canadian Market into Asset Type Retail 6%

Diversified 31%

Residential 19%

CREIT, Morguard, Summit, Cominar, IPC US Legacy,Chip,Royal Host,InnVest Retirement Residences (including CPL) O&Y, H&R

Office/ Industrial 13%

Res REIT, CAP REIT,NPR RioCan

Retirement 6%

Hotel 25%

9

At July 30, 2002

REIT Total Returns by Property Type

120%

Diversified 100%

Hotel Total Return (%)

80%

Office/Industrial

60% 40%

Residential

20%

Retail

0% 1997

1998

1999

2000

2001

Q1 2002

Retirement

-20%

TSE 300 Index -40%

Source: RBC Capital Markets REIT Quarterly April 5, 2002

The REIT total returns by property type chart reflects the volatility of the types of REITs. i. Period of measurement commences December 31, 1996 or date of initial public offering. ii. The % return is measured by the increase or decrease of the unit price, plus distributions over the year end price for the previous year (or the issue price of the Initial Public Offering ("IPO")).

10

3. Canadian Tax Issues for REITs and Investors REIT Tax Issues Basic income tax rules In Canada, a REIT is organized as a trust, which may be either a closed end or open ended trust. To qualify as a mutual fund trust and take advantage of the related income tax benefits, a REIT must comply with a number of rules under the Income Tax Act, including the following: 1. The trust must be a unit trust resident in Canada. 2. The trust's only undertaking is restricted to the acquiring, holding, maintaining, improving, leasing or managing of any real property (or interest in real property) that is capital property of the trust, and the investing of its funds in property (other than real property or an interest in real property). 3. Generally, a class of units must be qualified for distribution to the public and there must not be fewer than 150 unitholders of such units. A private REIT can be established without being listed on a public exchange. However, a private REIT does not qualify as a mutual fund trust, and therefore the units of such a REIT are not RRSP eligible. The readers should review the actual income tax rules or obtain professional advice when assessing the impact of the mutual fund trust rules on the establishment and management of a REIT. If a REIT should ever fall offside of the mutual fund trust rules, the income tax consequences are severe for the REIT and its unitholders. Refer to a comparison of open-end and closed-end mutual funds later in the section for more details. The Income Tax Act also provides special rules for mutual fund corporations. A REIT is usually organized as a mutual fund trust instead of as a mutual fund corporation for a number of reasons. For example, a mutual fund trust can distribute all of its income to its unitholders without paying income tax; generally, the income is taxed in the hands of the unitholders. A mutual fund corporation generally is subject to income tax on its taxable income (with some special rules for dividend income and capital gains) and the shareholders generally are subject to income tax on the dividends from the corporation. The mutual fund corporation, for obvious reasons, has not been favoured as a publicly listed public vehicle. A mutual fund trust does not pay capital taxes, while a mutual fund corporation is subject to capital taxes. A mutual fund trust cannot be established or maintained primarily for the benefit of non-resident persons; otherwise, the trust may lose its mutual fund trust status. Usually the trust indenture of a REIT will include a provision that non-residents cannot own more than 49% of the REIT. A REIT cannot own real property that is inventory for income tax purposes, as it is prohibited from carrying on business to comply with its mutual fund status. As an example, a developer in the business of building and selling houses cannot directly use a mutual fund trust as a public vehicle. Under certain circumstances, property can be transferred to a corporation or to a partnership on a taxdeferred basis. However, the Income Tax Act does not provide similar tax-deferral provisions for transferring property to a trust (whether open- or closed-ended). A vendor will be subject to tax on any capital gains and recapture of capital cost allowance realized on the transfer of property to the trust. There may be alternative ways of deferring a vendor's income tax payable on the transfer of property to a REIT; however, these methods are beyond the scope of this Guide and a professional tax advisor should be consulted. A REIT must file a T3 trust income tax return within 90 days from the end of its taxation year. Also, a REIT generally will have to file a T3 Summary, and file and distribute T3 Supplementary slips to report income and capital gains to unitholders. The unitholder will incorporate the T3 slips into their tax filing. A REIT must be able to produce timely and accurate income tax information to meet its filing deadline, which is half of the six-month period that a corporation has to file its income tax return. A trust that fails to file and distribute the relevant information on time is liable to penalties under the Income Tax Act. A REIT 11

should also consider whether it has to file other tax forms; for example, the NR4 Summary and NR4 Supplementary slips in respect of non-resident unitholders, T3RI or T3F returns (as discussed below) and various foreign reporting forms. A REIT should be aware that some of its unitholders might be other trusts or partnerships that have tax return filing deadlines that are the same as the REIT. Also, some individual investors may want to receive their tax information slips well before April 30. In practice, a REIT will usually determine the amount of the distributions for the year that represent taxable income and capital gains and complete the T3 Supplementary slips well in advance of the 90-day deadline (usually between 45-60 days after its year-end) to satisfy the needs of these investors. Failure to meet this deadline may tarnish the administration image of the REIT.

Taxable Income and Allocation of Such Income A REIT is subject to regular income tax on its taxable income, including taxable capital gains; however, if all of the income and capital gains are allocated to the unitholders, (as is required by the declaration of trust) the REIT will be able to deduct these amounts from its income to reduce its taxable income to zero. A REIT is given the choice, like a corporation or partnership, to deduct capital cost allowance (CCA) in respect of its depreciable property. However, the declaration of trust typically requires the REIT to claim maximum tax deductions, including CCA, to reduce or eliminate the REIT's taxable income. However, like individuals, a mutual fund trust is subject to CCA restrictions in respect of rental properties. Essentially, CCA on rental property cannot create or increase a loss in respect of the net rental income or loss of the REIT. CCA is one of the primary means by which a REIT provides tax-deferred distributions to its unitholders. A REIT may also deduct, over five years, the cost of issuing or selling its units. Unlike CCA, deductions in respect of financing costs can increase the taxable loss of the REIT, which can be carried forward and applied against future years. If a REIT incurs a non-capital or a net capital loss for income tax purposes, the tax loss cannot be passed to the unitholders. A non-capital loss (operating losses) can be carried forward for up to seven taxation years and applied against future taxable income and capital gains of the REIT. A net capital loss can be carried forward indefinitely, but can only be applied against taxable capital gains. Both types of losses can also be carried back for up to three taxation years; however, a REIT will not typically have any income that has been taxed in the REIT in prior years. A mutual fund trust can receive a capital gains refund in certain circumstances. The refund is determined by a formula that depends, in part, on the amount of redemptions during the year. A REIT should consider the capital gains refund if it has redeemed units during the year and has (a) capital gains for the year or (b) a balance of refundable capital gains tax on hand from the prior year.

Other Income and Capital Taxes A REIT is not subject to Large Corporations Tax (LCT) and provincial capital taxes (if applicable) since a mutual fund trust is not a corporation. A subsidiary of a REIT, which is a corporation, will be subject to LCT and provincial capital taxes. A REIT is also not subject to the tax on capital of financial institutions. While individuals, including trusts, are generally subject to alternative minimum tax, mutual fund trusts are specifically exempt. Also, a mutual fund trust is not subject to Ontario Corporate Minimum Tax since the trust is not a corporation. A mutual fund trust may apply to the Canada Customs and Revenue Agency to be a registered investment for the purposes of certain registered plans, such as registered retirement savings plans and registered retirement income funds. A REIT that is a registered investment and holds foreign property in excess of the 30% threshold is subject to a tax of between 0.2% and 1.0% of the cost of the foreign property in excess of the threshold for each particular month (pursuant to Part XI of the Income Tax Act). What constitutes foreign property for the purposes of Part XI taxes is beyond the scope of this Guide. 12

A registered investment must file a T3RI registered investment income tax return within 90 days after the end of the taxation year. A mutual fund trust that is not a registered investment but wants to establish that its units were not foreign property for the year must file a T3F information return within 90 days after the end of the taxation year. Certain types of trusts that are registered investments are subject to a tax of 1.0% of the fair market value at the time of the purchase of property that is not a prescribed investment for each particular month (pursuant to Part X.2 of the Income Tax Act). However, as long as the REIT meets all of the conditions of being a mutual fund trust, it should not have any Part X.2 taxes payable. Certain trusts with non-resident beneficiaries are subject to a 36% tax on certain income (pursuant to Part XII.2 of the Income Tax Act). This tax is designed to prevent non-residents from avoiding Canadian tax by using a trust to earn income from a business carried on in Canada or to realize capital gains from the disposition of taxable Canadian property. As long as a REIT is a mutual fund trust, it is not subject to Part XII.2 tax. A REIT that has one or more non-resident unitholders must withhold and remit non-resident income tax under Part XIII of the Income Tax Act on the taxable income, other than capital gains of the non-resident holders. To accomplish this, the REIT provides to the transfer agent the estimated taxable income and the percentage of distribution by the trust to the non-resident(s) that will be subject to tax, other than designated capital gains. Based on this amount, generally 25% is withheld from the taxable portion of the distributions; however, the withholding tax percentage rate of 25% can normally be reduced where an income tax treaty between Canada and the country in which the unitholder resides is in existence. For example, the Canada-U.S. income tax treaty generally limits the withholding tax rate to 15% for income distributed from a trust in Canada to a beneficiary of the trust who is a resident of the United States.

Miscellaneous Items When a REIT is created, it may not immediately qualify as a mutual fund trust because some of the conditions described above are not met. If certain conditions are met within 90 days of its first taxation year-end, a REIT can elect to be a mutual fund trust from the beginning of that first taxation year. The Income Tax Act contains provisions that permit, under certain conditions, a tax-deferred rollover of property on a qualifying exchange from (1) a mutual fund corporation, or (2) a mutual fund trust, to another mutual fund trust. A discussion of these rules is beyond the scope of this Guide. Two or more REITs may be able to merge in a tax-efficient manner under these rules. An example of the application of these provisions was RioCan REIT's merger with RealFund REIT, and Summit REIT's merger with Avista REIT. In general, an inter-vivos trust must have a taxation year that ends on December 31. However, a mutual fund trust may elect to have a December 15 year-end instead for tax purposes. A REIT may choose this earlier year-end for administrative or other reasons. Before a REIT decides to choose a December 15 tax year-end, it should review the other tax rules related to this election. For example, if a REIT is a limited partner of a limited partnership that has a December 31, 2001 fiscal year-end, the income from that partnership for the December 31, 2001 fiscal year must be included in the REIT's income for the December 15, 2001 tax year.

13

Prior to 2001, it was unclear whether a REIT could become a limited partner in a limited partnership. The concern was that the REIT, as a limited partner, could be considered to be carrying on the business of the partnership. If this was true, this could put a REIT offside of the mutual fund trust rules and therefore result in the loss of its mutual fund status. The change to the Income Tax Act in 2001 clarified the position and allowed a REIT to be a limited partner of a limited partnership. The new rule deems a mutual fund trust that is a limited partner in a limited partnership to undertake an investment of its funds in the partnership and not to carry on any business of the partnership. A REIT should remember that an investment in a limited partnership might represent an investment in foreign property for the purposes of the foreign property rules for certain registered plans. A REIT may issue its units, or options on its units, to employees of the REIT. Generally, an employee will be deemed to have received a taxable employment benefit equal to the value of the REIT units when the units are acquired, less (a) the amount paid by the employee for the units plus (b) the amount paid by the employee for any option to acquire the units. Under certain circumstances, the employee may be able to claim a tax deduction equal to one-half of the above taxable benefit. REITs and employees should carefully review the various tax rules pertaining to the acquisition of REIT units and options by employees. A trust is generally subject to the 21-year deemed realization rules. These rules essentially require a trust to realize its accrued capital gains on most capital property every 21 years; otherwise, a trust could theoretically hold property with accrued capital gains and defer income tax forever. A mutual fund trust is not subject to these rules. A financial institution is subject to special income tax rules, including determining its taxable gains and losses on certain debt and shares annually, i.e. the securities are valued on a mark-to-market basis. A REIT is specifically exempt from these rules since a financial institution is defined to exclude a mutual fund trust. A mutual fund trust may make an election with respect to treating all Canadian securities, as defined in the tax law, as capital property. A REIT may want to consider making such an election to ensure the dispositions of its Canadian securities are taxed on account of capital rather than income. Under Canadian generally accepted accounting principles, an enterprise generally accounts for current and future income taxes in its financial statements. A future income tax liability may arise, for example, when the undepreciated capital cost of its depreciable property (such as a building) for tax purposes is less than its net book value for accounting purposes due to capital cost allowance claimed in excess of depreciation. However, a REIT may not have to account for future income taxes in its financial statements if it meets the conditions set out by the Emerging Issues Committee of the Canadian Institute of Chartered Accountants ("EIC-108".) A REIT meeting the criteria of EIC-108 does not account for future income tax as it applies to assets held by the REIT or its subsidiary partnerships. However, most REITs disclose the temporary difference between the book value and tax basis of their assets and liabilities by way of a note to their financial statements. This exemption does not apply where the REIT carries on certain activities by way of a subsidiary corporation. In this case, the corporation is required to account for its future income taxes; therefore, on consolidation, the future income tax liability (or asset) will be disclosed in the REIT's consolidated financial statements.

14

Investor Tax Issues Basic Income Tax Rules A REIT unitholder usually receives a distribution from a REIT on a monthly or quarterly basis. The distribution from the REIT represents income, capital gains or a return of capital, or some combination thereof. The REIT investor is subject to income tax on the income and capital gains components of the distribution unless an exempt holder, such as an RRSP, holds the REIT units. The taxable income allocated to the unitholder reduces the taxable income of the REIT. Distributions received from a REIT are different than dividends received from a corporation. Generally, an individual is subject to income tax on 5/4 of a taxable dividend received from a Canadian corporation and the individual will be entitled to a dividend tax credit, which overall reduces the effective tax rate on the dividend. Other than a few specific exceptions, the income from a REIT does not retain the character of income that was generated within the REIT. The income from a REIT is generally characterized as other income from trust property for income tax purposes. For example, if a REIT's taxable income is $11 million, of which $10 million is derived from rental income and $1 million is interest income, a 0.1% investor, for tax purposes, does not receive an allocation of $10,000 of rental income and $1,000 of interest income on the T3 supplementary form. Instead, that investor would simply receive $11,000 of income classified as other income. Rental income is generally included in the definition of earned income for RRSP purposes, but the rental income earned by a REIT is not rental income in the hands of the unitholder. Therefore, taxable income received by an individual REIT holder does not qualify as "earned income" for the purpose of calculating the investor's RRSP contribution limit for the following year. Fortunately, the Income Tax Act does contain rules that permit a REIT to designate certain types of income to essentially retain its character upon distribution to the unitholder. For example, a REIT may designate a taxable capital gain distributed to the unitholders to be a taxable capital gain to such unitholders. As a result, an investor will pay income tax on only one-half of the share of the capital gain realized and distributed by the REIT. A REIT may also designate a dividend received from a taxable Canadian corporation and distributed to the unitholders to be a dividend received by the unitholder. An individual investor could then benefit from the dividend tax credit. Provided the REIT has allocated its taxable income to its unitholders, each investor in the REIT will receive a T3 Supplementary slip either directly from the REIT or indirectly through the brokerage house with whom the units are held on behalf of the investor. The unitholder will then be able to determine what portion of the distributions represents capital gains, dividends from Canadian corporations (usually flowing from the REIT's corporate subsidiaries) and other income. These amounts are then reported on the investor's personal income tax return. The return of capital distributed by the REIT, i.e. the amount of the distribution paid by the REIT in excess of the taxable income (which includes, if applicable, capital gains), is generally not taxable immediately to the unitholder. However, the unitholder's adjusted cost base (ACB) of the units will be reduced by such amount, as discussed below. A return of capital distribution is attractive to the unitholder as it essentially represents tax-deferred cash flow from the REIT.

15

Generally, the units of a REIT represent capital property to the unitholder. As a result, a REIT investor may realize a capital gain or capital loss on the disposition of the REIT units. A capital gain will arise when the proceeds of disposition from the units sold exceed the adjusted cost base of the units plus any selling costs. Conversely, a capital loss arises when the proceeds of disposition are less than the adjusted cost base plus selling costs. For income tax purposes, a taxable capital gain is equal to onehalf of a capital gain, while an allowable capital loss is equal to one-half of a capital loss. The Income Tax Act contains a number of restrictions in the utilization of capital losses; for example, capital losses can only be applied to reduce capital gains in the current year, or by carrying back net capital losses three years or forward for an indefinite period. The capital losses may also be deferred by the superficial loss rules. The adjusted cost base of a REIT investor's units is initially the cost of purchasing a particular REIT's units plus any additional acquisitions of the same REIT's units less capital distributions and dispositions of the same REIT's units. The adjusted cost base of the units will decrease by the amount, if any, by which the distributions received from the REIT exceed the taxable income and capital gains allocated by the REIT to the unitholder. As illustrated in Appendix 2, a REIT investor's adjusted cost base will generally decrease over time as capital is returned to the unitholder. The adjusted cost base calculation is required when a REIT unitholder decides to sell (or dispose) of all or portion of his or her units. The holder has to calculate and maintain a separate adjusted cost base for units of each particular REIT held. As most REITs do not track the individual adjusted cost base, each unitholder must keep account of his or her adjusted cost base. To eliminate the need to calculate the capital distributions from the date of acquisition, the unitholder should calculate annually the adjusted cost base of their unitholdings. The adjusted cost base of the units is averaged against all units held in a particular REIT. Also, if the adjusted cost base should become negative, the unitholder is deemed to have realized a capital gain equal to the absolute value of the negative amount. For example, if a unitholder's adjusted cost base of a particular holding of REIT units is $300 and the REIT distributes $1,000 to the unitholder, of which $600 is taxable income, the adjusted cost base will become negative $100 ($300 prior adjusted cost base - [$1,000 distribution - $600 other income]). The unitholder will immediately realize a capital gain of $100 and is required to report, at the year-end, a capital gain of $100. The adjusted cost base of the units would then be adjusted from negative $100 to zero. A capital gain realized on the sale of REIT units to a qualified donee, such as a registered charity, would attract a more favourable tax rate; that is, the gain is only one-quarter taxable to the unitholder (rather than the normal one-half inclusion rate for capital gains). Parents may be interested to know that the income from a mutual fund trust is not subject to the "kiddie tax" rules. Therefore, a child who receives income from a REIT may not be subject to the highest marginal tax rate on such income. Of course, the attribution rules must be considered and respected, which could make the child's REIT income taxable in the parent's hands. The purchase and sale of REIT units is not subject to various forms of provincial land transfer taxes.

16

Deferred Income Arrangements A mutual fund trust unit is a qualified investment for (a) registered retirement savings plans ("RRSPs"); (b) registered education savings plans ("RESPs"), (c) registered retirement income funds ("RRIFs") and (d) deferred profit sharing plans ("DPSPs"). Such plans can defer the income tax otherwise payable on the taxable income and capital gains distributed by a REIT. RRSPs, RRIFs, DPSPs and certain other taxpayers are subject to a 1.0% per month tax under Part XI of the Income Tax Act in respect of holding foreign property in excess of the 30% threshold. Generally, the units of a REIT will not be foreign property if the REIT is a mutual fund trust that (1) has not acquired any foreign property or (2) did not have foreign property the cost of which exceeded 30% of the cost of all of the REIT's property determined on a non-consolidated basis. If a REIT is a registered investment (as discussed above), then its units will not be foreign property.

Corporate Unitholders A Canadian-controlled private corporation that is a REIT unitholder will have to consider the refundable dividend tax rules in respect of investment income and taxable capital gains from the REIT. The federal income tax rate on such income is approximately 35.79%, which includes the additional 62/3% tax. The corporation may receive a refund of 262/3% of the federal tax through the payment of taxable dividends at the ratio of $1 dividend refund for each $3 of taxable dividends. The taxable dividend in turn will be subject to tax in the hands of the individual recipient. Recent amendments to the Income Tax Act now permit a Canadian private corporation to include in the corporation's capital dividend account the non-taxable portion of a capital gain distributed from a trust. Previously, there was no such mechanism within the tax law and a private corporation and its shareholders were essentially subject to additional taxation. To illustrate the new rule, let's say a private corporation is allocated, from a REIT, capital gains of $2,000. One-half of the capital gains, or $1,000, will be taxable in the hands of the corporation. The non-taxable half of the capital gain, or the other $1,000, will be added to the corporation's capital dividend account. Generally, on payment of a capital dividend, a shareholder can receive a capital dividend from a Canadian private corporation tax-free. The income tax "integration" has improved thanks to the change in the tax law. A corporate investor in a REIT should be aware that the investment in a REIT is not an eligible investment for the investment allowances provided in the LCT and provincial capital tax regimes. This compares unfavourably to the investment in shares of corporations, which are generally eligible investments. Also, Ontario has certain look-through rules in respect of an interest in a trust; a corporation subject to Ontario capital tax has to include its share of the taxable capital of the trust in its capital tax calculation.

17

Non-Resident Unitholders As previously discussed, a non-resident that receives income from a trust is generally subject to Part XIII of the Income Tax Act (non-resident withholding tax) at the rate of 25%, or usually less if the non-resident resides in a country that has a tax treaty with Canada. It is interesting to note that the allocation of capital gains designated by a trust to a non-resident is not subject to Part XIII tax. Real property in Canada is taxable Canadian property and non-residents are generally subject to Canadian tax on the disposition thereof. The non-taxable allocation of capital gains to non-residents from a REIT is unusual, since Canada usually protects its right to tax non-residents on income and capital gains realized in respect of real property in Canada. As mentioned above, a mutual fund trust cannot be established or maintained primarily for the benefit of non-residents; therefore, the tax benefit to non-residents is somewhat limited. Canada imposes a further rule to tax significant non-resident unitholders of a REIT on capital gains arising from the disposition of taxable Canadian property. A unit of a mutual fund trust is considered to be taxable Canadian property if, at any time during the preceding five years, 25% or more of the issued units of the trust belonged to the taxpayer, to persons not dealing at arm's-length with the taxpayer, or any combination thereof. Otherwise, the units of a mutual fund trust are not considered to be taxable Canadian property. If the REIT units of a non-resident are considered to be taxable Canadian property, the disposition of one or more units by the non-resident that results in a capital gain will be taxable in Canada. The nonresident will have to file a federal tax return (and possibly a provincial tax return), report the capital gain and pay the applicable income tax. The non-resident should consider whether there is any relief from Canadian tax on the gain under a tax treaty; given that a REIT will usually hold a large portion of its assets in Canadian real estate, relief under a treaty may not be available. The non-resident seller (vendor) of a REIT unit does not need to obtain a pre-clearance certificate under section 116 of the Income Tax Act since a unit of a mutual fund trust is excluded property. Therefore, the non-resident vendor and purchaser do not have to be concerned with section 116 of the Income Tax Act. The section is designed to force the non-resident to obtain a clearance certificate, prior to the sale of the taxable Canadian property. The non-resident will calculate the gain or loss on the disposition and, if applicable, pay to Canada Customs and Revenue Agency a withholding tax on the capital gains. The non-resident will have to determine the income tax consequences, in the country in which the investor resides, of making an investment in Canada, and whether or not any relief for Canadian income taxes paid is available in that country.

18

Comparison of Open-Ended and Closed-Ended Mutual Funds The open-ended mutual fund trust was the birth vehicle of the modern day REIT, however it proved to be incorrectly structured and therefore the wrong vehicle of choice during the downturn in the economy in the late eighties and early nineties. The reason for the demise of open-ended mutual fund trusts was the requirement of the trust to redeem the units for cash at the demand of the unitholder. This redemption structure did not fit well with the relative illiquidity of real estate assets. With redemptions being greater than unit sales during the fall of the real estate market, a major cash crunch caused the REITs to sell off their real estate assets, usually at a discount, to fund the redemptions, which were paid out on the bases of appraised values of the underlying assets. One of the underlying assumptions of the appraised value approach was that the REIT would continue as a going concern and would not be forced to sell off real estate assets at a discount to redeem units. The closed end mutual funds that arose from the ashes of these open-ended structures alleviated this problem by eliminating the redemptions requirement. Unitholders were restricted to selling their units through stock market exchanges and were unable to redeem their units through the trust. We have recently seen the open-ended mutual fund trust re-emerge with an adjusted structure as it applies to the redemption obligation and sale of units. This has been achieved by essentially restricting the amount of redemptions and limiting the cash component of the redemption amount. Also, unitholders must first seek to sell their units through the stock market exchanges and, failing that, can request the REIT to redeem their units under certain conditions. The cash flow requirements associated with redemption under the adjusted open-ended structure are minimized via two main clauses in the trust indenture. The first is the ceiling placed on the number of unit redemptions allowed during a specified time period. This results in a limited cash requirement for redemptions during the specified time period. The other clause that can be added allows for the redemption amount to be honoured via an interest bearing note payable issued by the REIT in lieu of cash. This essentially converts excess redemptions in a period into debt. The combined effect of these two clauses considerably reduces the redemption risk associated with the original open-ended mutual fund trust structure. The redemption structure and the ability to hold foreign property are the most significant differences between the open-ended and closed-end mutual fund trusts. This structure also allows for increased investment in foreign property relative to the closed ended mutual fund trust, while maintaining the requirements under tax law to qualify as a mutual fund trust. A mutual fund trust must be, amongst other things, a unit trust resident in Canada. A unit trust must be an inter vivos trust and the beneficial interests in the trust must be described by reference to units of the trust.

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From a tax perspective, mutual fund trusts are commonly referred to as "open-ended" or "closed-ended" based on the two types of unit trusts available under the Canadian income tax act. Both types of mutual fund trusts must comply with specific tax rules to maintain their tax status as a mutual fund. A closed-end unit trust must meet a number of conditions under the Income Tax Act, including the following: 1. The trust must be resident in Canada. 2. The trust's only undertaking is restricted to the acquiring, holding, maintaining, improving, leasing or managing of any real property or an interest in real property that is capital property of the trust, and the investing of its funds in property (other than real property or an interest in real property). 3. At least 80% of the trust's property must be real property and interests in real property situated in Canada, and other qualifying property, including cash, shares, bonds, debentures and mortgages. 4. Not less than 95% of the trust's income must be derived from, or from the disposition of, investments described in the above point number 3. 5. Not more than 10% of the trust's property may consist of bonds, securities or shares of any one corporation or debtor (except for issuances by certain governments in Canada).An open-end unit trust, which must also be resident in Canada, has fewer requirements under the Income Tax Act to comply with in order to maintain its status as a mutual fund and they include the following: 1. The issued units of the trust must include units having conditions that essentially require the trust to redeem the units at the demand of the unitholder, i.e. the units are retractable. 2. The fair market value of the units described above must be 95% or more of the fair market value of all of the issued units of the trust (without regard to voting rights attaching to units of the trust). The reader should review the actual income tax rules or obtain professional advice when assessing the impact of the mutual fund trust and unit trust rules on the establishment and management of a REIT. If a REIT should ever fall offside of the mutual fund trust and unit trust rules, the income tax consequences could be severe to the REIT and its unitholders. While the open-ended unit trust conditions are fewer in number, if market conditions change, it may be more difficult for a new REIT to adopt the restrictive redemption requirements. Since a REIT will usually hold a large portion of its assets in rental real estate, it may be difficult for a REIT to have the retraction requirements when its assets are relatively illiquid. Historically, most REITs have opted to meet the conditions of the closed-end unit trust rules, which do not contain any mandatory retraction requirements. The downside with closed-end unit trusts is the number and type of restrictions; open-ended unit trusts provide much more flexibility in terms of the type and amount of investments.

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4. The REIT Vehicle in the Canadian Marketplace History of Capital Flows into the Canadian Real Estate Industry from 1970 to the Present 1970's The 1970's saw a boom in the Canadian real estate market, due primarily to an influx of European money caused by the political threat of Russian advancement and a decrease in investment risk, both of which resulted in increased development. Companies such as TrizecHahn, Cadillac Fairview and Cambridge Shopping Centres were formed to meet the increased development demand. In order to access the pools of money, development took place in the form of joint ventures and syndications.

1980's The 1980's saw the peak of syndication, coupled with exploding capital growth tied to real property. As real estate investor confidence grew, there was a major increase in the extent of leverage used to finance real estate activity. The increased leverage brought increased risk, which eventually caused the banks to start calling their loans. Real estate investors incurred large losses since the syndication agreements failed to include a "cash umbrella'; therefore, they were unable to pay off their loans, resulting in banks and lending institutions becoming large holders of real estate as they foreclosed on their loans. In the U.S., REITs begin to emerge as an investment vehicle.

1990's The large losses incurred in the 1980's caused real estate investors to shift their focus in evaluating real estate. Investors returned to 1960 ideals of evaluating real estate based on cash flows and not as speculative investments. Real estate was no longer able to provide investors with high returns and money began to flow out of the sector into "new economy" (i.e. high tech companies) that were able to provide investors with the desired rates of return. With the collapse of the limited partnership syndicated market and the open-ended mutual fund trusts, the closed-end mutual fund trust emerged in Canada.

2000's The growth in the new economy has slowed and is adjusting to more sustainable levels. Inflation in the North American economy has fallen below 2%. Interest rates have decreased in line with the downturn in the economy, and many organizations with variable mortgage rates have benefited, as their cost of capital has declined. As a result the risk adjusted yields of REITs have become very attractive in comparison to a bond in the low interest rate markets of 2001. REITs now represent one third of the TSE real estate market capitalization and have clearly become the dominant vehicle for accessing public real estate equity; all but one of the 20 real estate equity issues in 2001 were REIT transactions. The Canadian real estate industry is in need of a recapitalization and REITs are one of the vehicles that could provide the necessary new capital and liquidity. A REIT is simply a form of securitization for real estate, an area in which Canada lags behind the United States, even though the U.S. has only 23% of its real estate market securitized. This is very low when compared to the United Kingdom (40%) or Singapore and Hong Kong (80%). Given the capital requirements of real estate, securitization is expected to be prevalent worldwide.

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REITs Provide a Vehicle for Buying Real Estate The public real estate market rebounded from its 5-year slump in the early 90's. From 1996 onwards there has been a significant increase in the market capitalization of the public real estate sector. The Canadian REITs created in 1997 were perceived as high yield investment funds (real estate values were at a low enough level to provide good returns). In addition, funds flowed through the older REITs raising equity by way of convertible debentures. The challenge for the REITs going forward will be to continue to source accretive properties if the interest rate climate reverses, without a decrease in the yield rate on REIT's unit. To date, because of the increase in the unit value and reduced yields coupled with the favourable interest rate climate, REITs have been able to acquire accretive properties. The real estate industry sees the REIT, as a stand-alone sector, and not part of the income trust sector. In reality however, the broader market views REITs as a sub-section of the income trust group. The challenge for the REIT sector is to change the perception of the investing public. The REIT sector has to clearly educate and demonstrate to investors that it is a different business. The risks and rewards of REIT ownership are different and, equally important so too are the corporate governance requirements. A REIT is not only a yield vehicle but also offers many attributes that the income trusts generally do not offer, such as stability where the underlying assets and related financing are of a long-term nature. As most REITs are able to effectively pass through the CCA claim, they are able to defer the tax on a certain percentage of the distributions. The REIT tenant base is usually spread over many tenants thereby limiting exposure to concentration risk. The large REITs are owners of multiple geographically diverse properties. Generally, investors have not been educated in assessing the risks and rewards of the various subsets of the income trust group. Refer to Section 6 for a comparison of the REIT vehicle as compared to other income trusts.

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5. Challenges of Converting to a REIT Transaction Costs The formation and capitalization of a REIT is typically a long, complicated and expensive process. The time between the initial thought process and completion of the initial public offering ("IPO") is usually six months or more. Costs to be incurred in the formation of a REIT include: • Underwriters' fees (often 5% to 6% of the total dollar value of the public offering); • Legal fees for counsel to the newly formed REIT (usually in the $600,000 to $1.2 million range, depending on the size and complexity of the issue); • Legal fees for the underwriters' counsel ($250,000 to $600,000, again depending on the size and complexity of the issue); • Audit fees ($350,000 to $800,000, depending on the amount of attest work required, the condition of the books and the availability of audited records); • Accountants and/or legal fees for tax advisory services (depends largely on the complexity of the transaction); • Appraisals, Phase I environmental reports and engineering reports ($200,000 to $300,000); and • Printing and translation cost ($200,000 to $300,000). A rule of thumb for estimating total transaction costs is 7% to 8% of the total issue. Other than the underwriters' fees, these costs are largely incurred prior to the closing of the initial public offering. This means that a sponsoring entity (i.e. the company or persons promoting and organizing the REIT) takes significant risks prior to knowing whether the public offering will be successful. A change in economic or market conditions (e.g. interest rate movements), or an unanticipated event (such as a terrorist attack, or not being able to close on a part of the portfolio), can leave a sponsoring entity with a significant bill for professional fees, with nothing to show for it. This does not include the human cost of the strain placed on the organization over the six or more months to the IPO date. Because of this, the sponsor of the REIT should be prepared on two fronts: 1. The sponsor must thoroughly evaluate the feasibility of the REIT that is being proposed, and obtain the appropriate professional advice, including the reactions of the relevant investment bankers, before proceeding in a significant manner. Some of the specific matters that need to be addressed are set out below. 2. The sponsor must be prepared to accept the risk of having to absorb the up-front costs should the transaction be unsuccessful and fall through; the organization should not only have the financial capacity but also the human capacity to absorb the above-noted costs.

Matters to Consider BEFORE Proceeding with a REIT Transaction The following matters should be addressed as early as possible in the process, and in a reasonable amount of detail, through consultations with the lead underwriter, securities lawyers, auditors, tax advisors and others. While it is impossible to predict all outcomes, and there will invariably be late changes in the structuring of a REIT transaction or shifts in market conditions, significant up-front planning can greatly improve the chances of a positive outcome and at the same reduce, or at least control, the outsourced services costs.

Extent of Involvement of the Sponsor in the Ongoing Operation of the REIT The extent to which the sponsoring entity (often a public or private real estate corporation) wishes to remain involved in the ongoing operations of the REIT will drive many of the other decisions. The sponsor may remain involved in a number of ways: 23

1. Providing asset and strategic management and advisory services to the REIT at the REIT level. 2. Providing property management services. 3. Retaining a significant ownership interest. 4. By entering into a development relationship with the REIT whereby the REIT will acquire properties being developed or redeveloped by the sponsor; typically, the REIT will also provide mezzanine financing on the development projects. The advantages of continued involvement include: 1. The REIT having access to competent and experienced management, before it has acquired the critical mass to hire its own management. 2. The positive market perception when the sponsor retains a significant stake in the ongoing success of the REIT. 3. The potential "symbiotic" relationship between a corporation that manages and develops properties, and an investment vehicle that holds the mature property portfolio. The challenges to the sponsor in maintaining involvement include: 1. Ensuring that potential investor concerns over conflicts of interest are addressed, especially where the sponsor retains a controlling interest. Appropriate governance practices need to be in place, often in the form of independent trustees, to address these concerns. 2. The effect on the sponsor's financial statements - The sponsor may or may not want to consolidate or equity account for the REIT. Consolidation and/or equity accounting is likely to result in limitations on the amount of profit that can be recognized on intercompany transactions. For example, the sale of development properties by a sponsor to a REIT that is consolidated by the sponsor will result in deferred or delayed gain recognition by the sponsor. 3. The potential strain on the sponsor's management resources - The additional burden caused by having a second entity being managed out of one office can be significant. In most cases, a REIT will retain a relationship of some sort with its sponsoring entity, at least at the outset. In each case, the implications of this ongoing relationship need to be considered carefully from a number of fronts: 1. Tax implications - The tax implications include the complexities of structuring the REIT and related entities and the maintenance of the trust as a tax-efficient flow-through entity. 2. Accounting and Reporting - The sponsor should review the accounting and reporting implications of continued involvement on its own financial statements, especially where it retains control or significant influence over the REIT. 3. Availability of Management Resources - Again, the sponsor needs to ensure that its existing management has the capacity to manage a second entity, which also happens to be a public entity. 4. Marketability of the REIT IPO - Market perception of the ongoing relationship needs to be carefully considered.

Making the Economic Case for the REIT This is usually done through consultations with investment bankers, tax and other professional advisors, preferably ones that have been involved in numerous REIT transactions. The following micro-economic factors should be considered in making this assessment: 1.

Return on assets - The sponsor should obtain or prepare a projection of the property operating results for at least the next three to five years. This can be done in conjunction with obtaining independent appraisals of the properties.

2.

Appraisal - A reputable independent appraisal firm should be involved as early as possible, to assist in the valuation of the properties to be acquired by the REIT, usually from a related party. The independent appraiser usually gives a market range, with a premium being assigned to the portfolio assembly. This appraisal data and its verification usually assists the sponsor in preparing a projection of the property operating results. 24

3.

Environmental Assessment - A Phase I study should be conducted on each property where such Phase I reports are older than one year, to ensure that the portfolio is free of environmental risks.

4.

Quality of the Assets - The properties being transferred should be mature, well performing properties, which do not require significant redevelopment. Because a REIT pays out much of its income to its investors, significant property redevelopment is not something that should be carried out in a REIT vehicle.

5.

Stability of the Cash Flows - In the case of office and industrial properties, this will largely be determined by lease rollovers. Properties that have significant potential lease rollovers or contractual decreases in rents will require special attention when structuring the transaction. It may be that the sponsor will have to provide certain guarantees or "head leases" in order to make the property stable enough to be attractive to investors.

6.

Diversification of the Portfolio - The more concentrated the portfolio is in one geographic location, the more risky the investment is from an investor's point of view, and therefore, the investor should demand a higher return, which, in turn, will reduce the market value of the portfolio.

7. Degree of Financial Leverage - The higher the financial leverage, the higher the potential return to the investor, but this also serves to increase risk. REITs are usually conservatively leveraged, especially if the portfolio includes properties that do not have contractual rents (e.g. hotels) or properties in less stable markets. 8.

Debt Mix - REITs tend to favour fixed rate mortgages, to increase the stability of the cash flows.

9.

Tax on the Transfer of the Assets to the REIT - Because a tax-free rollover is not available on the transfer of property directly to a REIT, tax on recaptured depreciation and capital gains is likely to be incurred by the transferor. Although there are tax-planning strategies that can be used to minimize these taxes, tax on the transfer of the assets could make a REIT transaction cost-prohibitive.

10. Other Taxes and Costs on the Transaction - Early in the process, management should consult its professional advisors to identify opportunities for minimizing other costs such as land transfer tax and GST. 11. Distributable Income and Distributions - Management must adopt a definition of distributable income that will allow the REIT to operate within its normalized cash flow from operations and yet remain competitive in the market, after taking into account its anticipated cash distributions to its unitholders. Distributions are usually defined as a specified percentage of the distributable income. 12. Tax Consequences to the Eventual REIT Unitholders - A significant selling feature of a REIT unit is the extent to which distributions will be paid on a tax-deferred basis. It is important that the sponsor determine how much capital cost allowance and other deductions will be available to the REIT to provide such tax-sheltered distributions to unitholders. 13. Critical Mass - The gross asset base of a proposed REIT must be large enough such that the anticipated public float justifies the issue costs and the ongoing operating costs. The following macro-economic factors should be considered: 1.

Overall condition of the Capital Markets - A new issue will obviously fare better when market conditions are favourable.

2.

Appetite for Yield-Producing Investments - Throughout calendar 2001 and early 2002, there was significant appetite for stable, yield producing investments due to the dot-com meltdown. However, a sudden change in demand can greatly impact the offering price, to the point where the transaction may no longer make economic sense to the sponsor.

3.

Prevailing Interest Rates - A low interest rate environment is usually positive for a REIT, as the REIT is able to earn additional income through the spread between the yield on its properties and the interest cost on its borrowing. When bond yields are low, investors look for higher-yield vehicles, making REIT units an attractive alternative. Also, debt maturities of high interest rate loans in a low interest rate environment present opportunities for increases in yield on the REITs properties. 25

Structuring the REIT vehicle The following are among the items that should be considered when structuring the REIT's Management and Board of Trustee composition. 1.

Management of the REIT - REITs are either internally managed (i.e. they have their own officers and management) or externally managed, usually by the sponsor entity. Internal management (strategic and asset management) is now being demanded by the markets for the larger REITs that have the requisite critical mass. More recently, where the REIT is externally managed, there has been a move to a shared management platform with the sponsoring entity. The REIT, in these circumstances, has first call on the time of the shared management resources. Certain conflicts need to be addressed, such as whether the REIT will compensate the sponsor on a flat-fee basis or on a cost-reimbursement basis. The method of compensation will have potential GST, income tax, and accounting and reporting implications, and should be addressed in advance.

2.

Management of the Properties - Again, REITs that have attained a certain critical mass of properties may find it more economical to internally manage their properties. Often, however, it makes sense for external property managers to be hired, especially where the property managers have history with the property being transferred, and the properties are geographically widespread.

3.

Composition of the Board of Trustees - This will depend somewhat on the degree of continuing involvement that the sponsor wishes to have. In most cases, the more independent trustees there are, the more investors are likely to feel like their interests will be protected, especially where the sponsor retains control or significant influence.

4.

Governance - Good governance is essential for the continuing success of the REIT, as the market places a premium on this attribute. The market needs to be made aware of the REIT's commitment towards a strong corporate governance mandate.

5.

Degree of Continuing Involvement of the Sponsoring Entity - See the previous discussion on this topic.

Accounting and Reporting Issues Applicable accounting recommendations and securities commission reporting rules will significantly impact how a REIT transaction and IPO are reported to investors. Financial, accounting and income tax matters that should be considered prior to formation of the REIT are: 1. Does the transaction qualify for fair value accounting (both from the REIT and the sponsor's point of view)? 2. How will the sponsoring entity report its investment in the REIT units (consolidation, joint venture, equity or cost method)? 3. Are there any restrictions on the amount of gain or loss that the sponsoring entity can recognize on the transfer to the REIT? 4. How will any financial instruments exchanged in the transaction be accounted for (e.g. convertible debentures, secured debt)? 5. What reporting will be required in the future for related party transactions (i.e. between REIT and sponsor)? 6. Accounting for current and future income taxes on the transaction. 7. Impact on the carrying values of other assets and liabilities on the balance sheet of the sponsor (e.g. deferred financing costs, intangible assets, etc.).

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Legal and Administrative Considerations Legal and administrative considerations include:

Long Form Prospectus Applicable securities legislation in most provinces will require a long form prospectus, which includes a preliminary prospectus to be filed in advance of marketing the IPO, and a final prospectus when pricing has been agreed upon and the securities commissions and stock exchanges have given their approval on the prospectus documents. A long form prospectus for a REIT IPO usually includes, at a minimum: Significant detail around the structure of the transaction, properties to be transferred, management of the REIT and risk factors; • Historical financial information for the properties to be acquired, which includes balance sheets for the last two years and income statement and cash flow statement for the last three years; • An auditors' report on the historical financial information (Note - this requirement should be addressed early in the process in case the historical information has not previously been audited); • Full management discussion and analysis on the historical financial statements; • A pro-forma balance sheet and income statement for the properties, which includes the historical financial information for the most recently completed year adjusted for the effects of the proposed IPO and transfer of property; • A compilation report on the pro-forma financial statements; • Interim financial statements where a significant period of time has passed since the most recently audited balance sheet date covered by the historical financial information in the prospectus; • A review report on the unaudited interim financial statements from the REIT's auditors; • An opening balance sheet and auditors' report thereon for the REIT; • A forecast statement of net income and distributable income for the REIT, covering a period of twelve to eighteen months (This is not a statutory requirement, but is usually required by the lead underwriters and is); and • An auditors' report on the examination of the forecast. These requirements change from time to time. Guidance on the requirements should be obtained by discussing the applicable securities legislation with the REIT's securities lawyers and auditors. The contents and timing of the prospectus should be agreed upon and a working group established as early as possible in the process. When there are concerns about the interpretation of securities legislation or the requirements for the prospectus, it is often advisable to obtain advance clearance from the securities commissions on the reporting requirement. Potential investors do not look favourably upon a significant change in the contents of the prospectus between preliminary and final.

Legal Agreements Legal documents to be drafted by the REIT's legal counsel, include: • Trust indenture; • Underwriting agreement; • Property management agreement (if applicable); • REIT management agreement (if applicable); • Property purchase and sale documents; • Development and Services agreements (if applicable);

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• Debt assignment and/or assumption consents and agreements; • Lease assignment and consents (if applicable); and • Mortgage assignments and consents (if applicable). Although these documents will likely change several times throughout the process, it is important to agree, in principle, with the underwriters on what material legal documents will be required and the key elements of such agreements early in the process.

Securities Commission and Stock Exchange Approval The filing of a preliminary prospectus allows securities commissions to review the transaction and determine whether to give approval to the proposed sale of securities. Because there are thirteen securities commissions in Canada (one in each of the provinces and the territories), one of the securities commissions will usually act on behalf of all of the others, although all of the commissions have the right to comment on the prospectus. Comment letters issued by the commissions may include: • Questions on the accounting treatment proposed or used in the prospectus financial statements; • Questions and directives on the contents of the prospectus document; and • Questions on the legal structure and compliance with securities legislation. Responses to comment letters should be developed in consultation with the appropriate legal counsel and the REIT's auditors. Upon filing of the preliminary prospectus, management will obtain a conditional approval for a listing on the relevant stock exchange, which may also comment on the prospectus, its contents and the marketing of the units.

Other Matters and Legal Documents Required The securities commissions, underwriters and other parties to the transaction will require, among other items: • A comfort letter from the REIT's auditors on the financial information contained in the preliminary prospectus, since the various auditors' reports will not be signed until the final prospectus. • Consent letters from any parties whose reports will be referred to or reproduced in the prospectus (such as the auditors, appraisers, etc.). At a minimum, the auditors' consent letter will need to be filed with the final prospectus. • A comfort letter from the auditors to the underwriters to assist the underwriters in fulfilling their due diligence requirements under securities legislation. The contents of the letter should be agreed upon between the underwriters, management and the auditors well in advance of the date of the final prospectus to minimize last minute disruptions to the IPO process. • The due diligence process by the underwriters' legal counsel. This will include, among other things, a review of material agreements, leases and financial information, as well as questions of management and the auditors.

Summary Because the REIT formation process is so complex, it is imperative that as little as possible be left to chance. The probability of a successful REIT formation and IPO is greatly increased by appropriate, upfront consultation and planning.

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6. The REIT vs. a Corporate Structure: Differences in Management Focus Having discussed the current investor appetite for REITs, why they are growing and at present are the vehicle of choice for real estate ventures to access the capital markets. We have also highlighted some of the key considerations in the process of forming a REIT; the next logical step is to discuss certain aspects of management's focus or behaviour once an entity is up and running as a REIT. To give this discussion the proper context, let's briefly recap some of the characteristics that make REITs so appealing to today's investors. This is by no means meant to be an exhaustive analysis of REIT attributes, but simply an attempt to highlight those attributes that the market rewards and which in turn influence management's behaviour.

High current prevailing yields relative to other yield-oriented investments • In the moderate-growth real estate industry of recent years, the high income distribution of REITs is strongly preferred by investors who seek to own real estate investments as a yield instrument; conversely, non-REIT equities with low payout ratios are generally valued by the market only if they offer unique assets, such as development or high growth.

Stability and predictability of income • In most cases, income is contractual in nature, arising from leases with initial lease terms ranging from five to ten years. • These contractual revenue streams are appealing to investors, particularly in a weakening economy, a low interest rate and low inflation environment, and/or in the volatile equity markets of recent years.

Conservative financial structures and operating policies • The extent of leverage in REITs tends to be conservative, limited by self imposed provisions of the trust declaration to anywhere from 40% to 60% of the gross assets (with a current trend towards higher than 60%), resulting in lower debt/equity ratios and higher interest coverage. • The strong financial position and solid fundamentals, coupled with the high current yields and moderate growth offered by REITs, are very appealing on a risk-adjusted basis.

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The mutual fund trust structure provides significant tax flow-through benefits to investors • Approximately 40% to 80% of 2001 distributions were paid to investors on a tax-deferred basis. • Such tax-deferred distributions are treated as a reduction in the unitholders' adjusted cost base ("ACB") and, accordingly, will be afforded taxable gains treatment when the units are ultimately sold (assuming, of course, that the unit price remains constant to the price paid). These attributes, while making REITs attractive to investors, create some unique challenges for the management of a REIT and require a mindset or a focus that is in many respects quite different from that applied to a traditional corporation. At a high level, this mindset is epitomized by discipline and to a large extent, a culture of conservatism. While discipline and some element of conservatism would seem to be the cornerstones of prudent management in any organization, the need for these in a REIT is heightened by the substantially lower materiality and increased sensitivity with which the market views fluctuations in the earnings of a REIT, due to the immediate impact that such fluctuations could have on a REIT's ability to sustain its distributions. The high degree of precision used by the market to evaluate a REIT's distributable income leaves little room for "surprises" in its results, and negative surprises will have a punitive result on the unit price. To help illustrate how this mindset manifests itself in practice, we will examine management's focus within the context of four broad categories: • Investment considerations - how do these attributes affect the investment opportunities that a REIT will pursue?; • Operating and financial considerations - how do these attributes affect the operational and financial practices of a REIT?; • Financial reporting considerations - how do these attributes influence the financial reporting practices of a REIT?; and • Corporate governance considerations - how do these attributes impact the corporate governance practices of a REIT?

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Investment Considerations As with any organization, the investment decisions that a REIT makes need to be aligned with the interests and objectives of its stakeholders. As we previously outlined, REIT investors are, for the most part, motivated largely by yield (cash they receive / cash they invest) whereas investors in a corporation tend to be motivated largely by earnings and long-term capital growth. In order to meet unitholders' expectations of stable monthly cash flows, the management of a REIT will, by necessity, tend to adopt a more conservative investment approach that will generate secure monthly cash flows. To highlight this tendency, we will look at a few common investment considerations and the specific factors that the management of a REIT must consider relative thereto:

REIT

Corporation

Speculative Investments

Although certain speculative opportunities, such as the acquisition of land for future development, may make good business sense (i.e. offer the potential for significant returns in the long run), the lack of current earnings and cash flows to support distributions would effectively preclude a REIT from directly pursuing any material speculative opportunities.

A corporation is not compelled to make recurring cash distributions and therefore it is able to pursue more speculative opportunities that offer the potential for significant future growth.

Development Projects

A REIT will typically participate in development projects by way of mezzanine financing arrangements that include an option to acquire an interest in the property once it is fully developed. This type of arrangement provides a REIT with earnings and cash flows (in the form of interest on the mezzanine debt) to make distribution payments during the development period.

Again, because a corporation is not compelled to make recurring cash distributions, it can engage in development activities directly.

Quality of Property

The management of a REIT must balance the need to generate secure stable earnings and cash flows with the yield objectives of its stakeholders. Income-oriented investors tend to undervalue REITs with portfolios of, relatively speaking, higher quality assets and lower yields. This is evidenced by the absence of "trophy" assets in REIT portfolios, as they would not meet the REIT's yield threshold.

The composition of a corporation's portfolio is shaped by management's strategy and investor demands, rather than any specific yield criteria.

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Investments Considerations (continued) REIT

Corporation

Diversification

Diversification in a REIT portfolio increases the inherent stability of its cash flows and therefore its distributions, by reducing the exposure to individual markets and risks (i.e. geographic, sectors, etc.).

While diversification is also a sound risk management strategy for a corporation, the negative effects of an over-exposure to a particular depressed market is not as immediate as in a REIT since the corporation has retained earnings to help "weather the storm" and it is not compelled to make monthly distributions.

Other

In recent years, the larger Canadian REITs have virtually all elected to internalize their asset management and property management functions. Provided that a REIT has the appropriate critical mass, an internalization strategy is an attractive proposition because it allows a REIT to: • Better control its operating costs • Remove investor perception regarding conflict of interest • Increase the return on its assets, including the spread on new acquisitions, to the extent of the profit element embedded in property and asset management expenses • Compete for joint venture capital (i.e. from institutional investors that do not possess internal real estate expertise), thereby allowing it to increase the size of its portfolio resulting in increased earnings, cash flow, economies of scale and diversification • Increase the return on its interest in co-owned assets by earning management and other fees from its co-owners • Build its own Brand Name.

The only difference for corporations that have internal management expertise is that corporations are not restricted from providing third-party management services.

However, it is important to recall that, in general, a REIT is precluded from directly providing third party management services for assets in which they do not have an interest. Such services do not qualify as an allowable activity for a mutual fund trust under the Income Tax Act (Canada). 32

Operating and Financial Considerations Much like the investment considerations just reviewed, the operations of a REIT are significantly influenced by investor expectations of stable monthly cash distributions. Consequently, management of a REIT must constantly evaluate the impact of their operating and financial decisions on monthly cash flows. This focus is quite different from a corporation where management can operate with a focus on long-term growth and capital appreciation. To facilitate this discussion we will examine the operations of a REIT within the following categories: • Budgeting and Cash Management • Leasing • Tenant Inducements • Financing • Distributions This categorization is by no means intended to be a comprehensive framework for examining the operations of a REIT but simply to highlight certain considerations that are unique to a REIT as compared to a corporation. REIT Budgeting and Cash Management

Corporation

An effective budgeting and cash management process is central to a REIT's ability to deliver the stable and reliable distributions that the market expects. This expectation forces a REIT to: • Have a detailed monthly budget that is well planned and well monitored to avoid any unanticipated or overlooked cash expenditures

The focus of in a corporation tends to be more on earnings, with a quarterly time horizon. Also, the cash management in a corporation does not require the same degree of precision as in a REIT since a corporation is not required to pay out substantially all its earnings on a monthly basis.

• Spread any large expenses over a period of time to preclude a "cash crunch" in any given month • Perform accurate cut-off and accrual procedures - once a cash distribution is made in a month, it can't be recalled. Leasing

Effective management of lease maturities significantly increases the stability of a REIT's cash flows and, as a result, distributions by:· • Limiting the REIT's exposure to renewal risk • Spreading out cash flow demands for leasing costs. The current rule of thumb is to limit lease maturities to no more than 10 to 20% of leaseable space in any given year. 33

While the benefits of effectively managing lease maturities accrue to corporations in the same way as they do for REITs, the risk of not doing so is compounded in a REIT format due to the potentially negative effect on the stability of a REIT's cash flows and distributions.

Operating and Financial Considerations (continued) REIT Tenant Inducements

Corporation

In a REIT, decisions with respect to the nature of inducements granted to tenants are significantly influenced by the definition of distributable income in the trust declaration. For example, certain REITs define their distributable income to add back the amortization of deferred leasing costs while others do not; without "crunching" the numbers, the impact of different forms of tenant inducements (i.e. free rent or inducements) on the cash flows of the REIT can vary significantly depending on the definition adopted (please refer to Appendix 1). • If amortization of deferred leasing costs is not added back in the determination of distributable income, the decision whether to grant a cash inducement or provide the tenant with a period of free or lower than market rate rent is cash neutral to a REIT • If, on the other hand, amortization of deferred leasing costs is added back in the determination of distributable income, inducements in the form of free or lower than market rate rent would provide significant cash flow advantages to the REIT. It is also worth noting that by not adding back amortization of deferred leasing costs in the calculation of distributable income, a REIT can, to the extent that such amortization exceeds actual leasing costs for the same period, retain cash to finance ongoing capital expenditures and leasing activity (please refer to Appendix 1). In recent years, all of the public REITs have moved towards a definition of distributable income that does not add back amortization of deferred leasing costs.

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Since the concept of distributable income does not exist in a corporation and a corporation is not compelled to make monthly distributions, decisions regarding the nature of tenant inducements are cash flow neutral to the corporation.

Operating and Financial Considerations (continued) REIT Financing

Corporation

In looking at some of the unique financing considerations in a REIT, we will consider debt and equity financing separately. Debt: We previously noted the conservative leverage of REITs, which is limited by the self-imposed restrictions of the trust declaration. Optimizing the use of this limited leverage to finance accretive acquisitions is a key objective for management. An important statistic in evaluating a REIT's growth prospects is its "leverage capacity", which is a dollar measure of the acquisitions that a REIT could complete without having to issue additional units. In addition to managing its leverage capacity, it is important for management to effectively stagger the maturities of its existing mortgages in order to: • Limit the REIT's exposure to renewal risk • Spread out cash flow demands for financing costs The current rule of thumb is to limit maturities to no more than 10 to 15% of its mortgages in any given year. Equity: Where a REIT is at or near its leverage capacity, its ability to access the capital markets on favourable terms is essential for asset base growth and, by implication, for increases in distributions and cash flows. In all cases (debt or equity), management's ability to quickly and effectively invest the proceeds from financing transactions in accretive opportunities is essential to avoid the temporary dilution of investor returns.

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The existence of retained earnings and the absence of strict leverage restrictions in a corporation allow for greater flexibility in its financing.

Operating and Financial Considerations (continued) REIT Distributions

Corporation

Market expectations of REIT investments are such that investors demand high-yielding (relative to other income oriented investments) and moderately growing distributions with minimal volatility. One of the primary criteria that investors use to evaluate a REIT is the sustainability of its distributions. For this reason, the trend among Canadian REITs has been to increase distributions at a marginally slower rate than distributable income so as to build a margin that would allow the REITs to withstand volatility in their underlying cash flows and still maintain their distributions. Over time this approach will also allow the REITs to retain more of their distributable income and thereby internally generate cash flows to contribute towards covering ongoing capital expenditures and leasing costs.

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This is not a consideration that management in a corporation needs to address since a corporation is not compelled to make distributions.

Financial Reporting Considerations REIT Unique implications of certain GAAP for REITs

Corporation

REITs and corporations alike are required to follow GAAP. However, certain accounting standards can have some unique implications for a REIT. For example, in 2000, CIPPREC introduced a new recommendation regarding accounting for tenant inducements in the form of free or lower than market rate rent. Under this standard, the total amount of cash to be received from leases that provide a free rent concession is accounted for on a straight-line basis over the term of the lease and rental revenue recognized during free rent periods (representing future cash receipts) is reflected in accounts receivable. Such straight-lining creates potentially significant differences between cash flows and earnings that are not adjusted for in the calculation of distributable income. As such, during free rent periods, a REIT would be required to pay distributions in excess of its actual cash flows and, conversely, the REIT would have cash flows in excess of its distributable income during the remainder of the lease. In a mature, well-staggered lease portfolio, the net effects of straight-lining rents would generally not be material.

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Because a corporation is not compelled to make recurring monthly distributions, the potential implications of straight-lining rents are not as significant.

Financial Reporting Considerations (continued) REIT Selection and application of accounting policies

Corporation

Within GAAP there may also be more than one acceptable accounting treatment for a particular transaction, requiring management to exercise professional judgement in the selection and application of accounting policies (although these situations are becoming fewer as GAAP becomes more prescriptive). Management's judgment in this regard can have a significant impact on reported net earnings and, in the case of a REIT, since net earnings is the starting point for calculating distributable income, these choices also impact monthly distributions and cash flows. Generally speaking, REITs tend to be conservative in their financial reporting practices. This conservatism stems from the fact that aggressive accounting policies result in higher earnings and distributable income but without the corresponding cash flows to make distributions to unitholders. For example, consider the timeless capitalize vs. expense scenario: In a REIT, if an expenditure is treated as a period cost, the impact on cash flows is limited to the amount of the actual expenditure. If that same expenditure was judged by management to be capital in nature, the impact on cash flow is equal to the amount of the actual expenditure plus the incremental distributions to unitholders (equal to the payout ratio times the expenditure). It is important to note the trade-off here. If an item is expensed, more cash is retained in the REIT, however, if the same item is capitalized, less cash is retained in the REIT as distributions will be higher and therefore the yield to investors will be higher.

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Again, because a corporation is not compelled to make monthly distributions its cash flows do not necessarily need to mirror its earnings as closely as in a REIT format.

Financial Reporting Considerations (continued) REIT Margin for error

Corporation

We previously noted the high degree of precision with which the market evaluates REIT earnings and the need for management to avoid "surprises" The same can be said for errors. Management must adopt the same degree of precision relative to identifying and correcting errors in its financial reporting because errors could result in excessive cash distributions being paid out to investors. Because market pressures will not allow a REIT to decrease its distributions without significant penalty to its unit price, there is no economically feasible means of recouping such payments.

In a perfect world, a corporation would also report results with a high degree of precision, however, in practice, materiality in a corporation tends to be slightly higher because there is not the same immediate and direct effect on cash flows as in a REIT.

Also, since misstatements in one period eventually reverse themselves, immaterial amounts in a given period can be compounded by additional misstatements in the subsequent period of reversal. Transparency of disclosure

The nature of a REIT as a yieldoriented vehicle makes transparency of disclosure essential to allow investors to properly evaluate REITs against other less dynamic yield investments, such as bonds. After all, there is less trepidation in what you know than what you don't know.

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Transparent disclosure is equally desirable in a corporation. The only difference is that the market will generally consider a number of other variables, in addition to yield, in evaluating a corporation, depending on the nature of the unique assets or management.

Corporate Governance Considerations While the substance of good governance applies to all organizations equally, the yield-oriented nature of REITs makes certain elements of corporate governance, namely risk management practices, particularly relevant and worth mentioning. Since the first edition of this REIT Guide was published, much has happened with respect to corporate governance. Particularly in the United States, the Securities and Exchange Commission (the "SEC") has been very aggressive in setting out its expectations of boards of directors, audit committees, management and auditors. The Blue Ribbon Committee report in 1999 was one of several recent publications that have attempted to drive the evolution of board membership and mandates. The Enron debacle, the economic downturn, the unprecedented events of September 11, 2001 and other recent business failures have combined to create a financial reporting environment unlike any in recent history, bringing the role of the audit committee to the forefront. This environment is creating significant challenges for public entities and their management, boards of directors, audit committees and auditors. Reliable and transparent financial reporting is particularly important in this troubled environment. This requires the attention of all these major constituencies to execute their responsibilities without exception and requires them to work together to produce high-quality financial reporting. In Canada, the Joint Committee on Corporate Governance issued its report in 2001. The report contains many recommendations and descriptions of good governance practices that can be useful to most public entities. In addition, the sponsoring organizations and the securities regulators are likely to enact rules, regulations or professional standards related to the proposed recommendations. In March 2002, The Toronto Stock Exchange (the "TSX") issued its draft corporate governance disclosure guidelines (the "Amended Guidelines") applicable to TSX listed issuers. This set of guidelines, subject to comments received, will influence the direction of Canadian public entities with respect to board composition and behaviour. In a "post-Enron" world, Canadian boards and audit committees will need to: • be able to demonstrate (if necessary) that they have applied appropriate governance practices with respect to the identification and management/control of "principal business risks"; • learn from each other (i.e., what are "current practices" in this area); • understand what constitutes "best practice" (i.e., what boards should be doing). The value proposition for boards and audit committees is that with a better understanding of both "current practices" and "best practices" in this time of great change, these boards and audit committees will: • be able to discharge their responsibilities for providing assurance to unitholders and stakeholders about the integrity of the entity's reported financial performance, and • have greater confidence with respect to the effectiveness of internal controls and the management of principal business risks, resulting in reduced anxiety about their litigation exposure and an enhanced ability to add value in the deliberations of the board of trustees.

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For the immediate future, boards and audit committees will focus their attention on: • exposures to and disclosures of: – off-balance sheet financing – related-party transactions – special purpose enterprises – stock or unit options • internal controls • identification, measurement and management of business risks • auditor independence and scope of services • quality of accounting policies and disclosure There will continue to be scrutiny of corporate governance by regulators, government and the marketplace at large for the foreseeable future, so it is very important that REIT boards and management pay particular attention to all aspects of this fast-moving environment. Most REITs have followed the corporate governance guidelines issued by the Toronto Stock Exchange (TSX). The REITs have all adopted a policy whereby the majority of the trustees are independent. Most REITs have adopted and incorporated into their declaration of trust that the members of the audit committee must consist solely of independent trustees. Likewise, the makeup of the compensation committee is nearly always made up of independent trustees.

Risk Management It has been stressed several times throughout this Guide that the market rewards those REITs that can deliver stable, reliable cash flows and attractive risk-adjusted yields (the key phrase here being riskadjusted). Since investors typically benchmark REIT performance against other less dynamic yield instruments, such as bonds or utilities, implementing effective risk identification and management processes can reduce the risk premium investors attach to the REIT investment, and thereby enhance the market's perception of its value. An effective risk management process that is well articulated and disclosed to the public and internally can also help a REIT distinguish itself from its competitors when competing for capital. The lower the perceived risk of a REIT, the greater the value that investors will place on the returns it delivers. After all, if comparing two REITs that offer substantially the same returns, the market will favour the REIT with the lower degree of risk associated with it: the same or higher prospective returns combined with lower perceived risks is a compelling combination for any investor. Therefore, risk management should not necessarily be viewed as a matter of compliance but rather an opportunity to create a competitive advantage in attracting capital, which, as we previously noted, is central to a REIT's ability to grow. Please see Appendix 3 for further detail on the principal differences between operating a REIT versus a corporation.

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7. Canadian vs. U.S. REITs From An Owner's Perspective What are the decisions that holders of real estate must make as far as determining which capital markets to access (i.e. US or Canadian)? While Canadian REITs were created based on the U.S. REIT vehicle, there are significant differences in the operational facets of each. These differences, while not affecting the overall nature and function of the REIT, could affect the decision made by an organization or investor as to which is the most appropriate for their purposes. The operational differences tend to arise due to the government-regulated nature of the U.S. REIT as opposed to the self-regulated nature of the Canadian REIT. The following table outlines some of the operational differences that exist between U.S. REITs and Canadian REITs: Feature

U.S. REIT

Canadian REIT

Governed by

• Requirements of Internal Revenue code.

• Self Imposed Trust Declaration and certain requirements of the Income Tax Act.

Vehicle

• May be a corporation, trust or association (most are corporations)

• Must be an open- or closed-ended mutual fund trust.

• As long as the corporate vehicle meets the requirements of the tax law, then it can have the appearance and tax advantages of a trust. Investors

• Minimum of 100 investors, with no more than 50% of units held by five or fewer individuals.

• Minimum of 150 unitholders, and be listed on a recognized Canadian Exchange.

Revenue Rules

• At least 75% of gross income must consist of real property rents, mortgage interest, gains from sale and other real estate related sources

• At least 95% of its income must be derived from the disposition of, or income earned from, qualifying investments.

• At least 95% must be from the sources in the 75% test plus "passive income" sources such as dividends and interest.

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(This rule does not apply to openended mutual funds.)

Feature

U.S. REIT

Asset Rules

At the close of each quarter of the taxable year: 1. At least 75% of gross asset value of total assets is represented by real estate assets, cash and cash items, and government securities 2. Not more than 25% of the value of total assets is represented by securities other than those included in 1 above 3. Not more than 20% of the value of total assets is represented by securities of one or more taxable REIT subsidiaries

Canadian REIT • At least 80% of its property must be held in any combination of real property in Canada and other qualifying investments • No more than 10% of its property (on a non-consolidated basis) consisted of bonds, securities or shares in the capital stock of any one corporation or debtor. (The above rules do not apply to open-ended mutual funds.)

4. Not more than 5% of the value of the assets is represented by securities of any one issuer, other than those securities included in 1 & 3 above 5. The REIT does not hold securities possessing more than 10% of the total voting power or having more than 10% of the total value of the outstanding securities of any one issuer, other than those securities included in 1 & 3 above. Distributions

• Generally, must be at least 90% of Taxable Income without regard to distributions and excluding net capital gains.

• Set individually by the trust declaration, however usually around 85%-95% of distributable income.

Taxation

• Income is not taxed as long as it is distributed to investors. Income that is not distributed will be taxed at normal corporate rates.

• Income is not taxed within the trust as long it is distributed to unitholders.

Transfer of Real Estate to the REIT

• Companies able to move assets to REIT on a tax deferred basis.

• Limited ability to move assets to REIT on a tax deferred basis.

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Feature Liability of Investors

U.S. REIT

Canadian REIT

• Liability of investors is limited due to use of corporate structure.

• Unlimited Liability (However, it is generally believed that there are no material differences between a trust and a corporation) • All REITs have adopted a strategy to reinforce their limited liability only to the assets of the REIT and not to unitholders. They have done this by incorporating a clause in their material contracts under which the service providers (i.e. Mortgages, lease contracts, and other material service providers) acknowledge that their only recourse is either to a specific asset of the REIT (e.g. the mortgage over a property) or all the assets of the REIT • Some REITs have partially achieved legal limited liability through the use of corporations or limited liability partnerships.

From an Investor's Perspective Given the above differences between the Canadian and U.S. REIT structure, is there an opportunity for Canadian investors to choose a U.S. REIT as their investment vehicle rather than a Canadian REIT? Generally speaking, Canadian investors can freely invest in a U.S. REIT, unless it is through an RRSP in which case the investment must adhere to the applicable restrictions regarding foreign content limits in an RRSP. The "Foreign Content" Rule requires that an investor only hold up to 30% of his or her RRSP in foreign investments, otherwise penalties will be imposed. Therefore, Canadian investors wishing to use U.S. REITs as an investment vehicle in their RRSP must be careful to ensure that an acquisition of a U.S. REIT is less than 30% of the total portfolio market value, when considered together with any other foreign holdings in the RRSP. The only other option to increase foreign content is to invest in a Canadian mutual fund which has up to 30% invested in foreign securities, as they are designated as a 100% Canadian investment for RRSP purposes (The Canadian REIT structure restricts foreign ownership to 30% of its assets). In this way an investor can increase his or her foreign content to a maximum of 51% of the total investment (30% directly foreign owned and the remaining 70% invested in Canadian Mutual funds with 30% foreign investment) and still remain eligible for the RRSP.

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8. Why Royalty Trusts and Investment Trusts Differ from a REIT In the current environment of low interest rates and volatile equity markets, a variety of Income Trusts have gained widespread appeal among investors. Royalty Trusts and Investment Trusts are often confused with a REIT. While both REITs and these other trusts are forms of income trusts and are similar in many respects, there are also significant differences that investors should be aware of in evaluating investment alternatives. Trusts that are established primarily to earn royalty income are referred to as a Royalty Trust, whereas trusts that are established to earn income from debt and shares are referred to as an Investment Trust. A Royalty Trust is used to pool capital, generally through the sale of units to public investors, to acquire a royalty interest in energy related resource properties, such as oil and gas, synthetic oil, coal and iron ore. Typically, a Royalty Trust will acquire a 99.99% royalty interest in a resource property from a corporation, which continues to operate the property and earn fees there from. The purchase of the royalty interest in an oil and gas property results in the trust incurring a Canadian oil and gas property expense ("COGPE"). The COGPE can be claimed as a deduction against the royalty income earned. The diagram below illustrates a simple structure for a Royalty Trust.

Investors

Trust

99.99% Royalty Interest

Management Company

Operating Company

Resource Property (Oil and Gas)

The income earned by a Royalty Trust is generally derived from the extraction and sale of the energy related commodities. The operating income generated by a Royalty Trust is generally higher than that of a resource corporation because a Royalty Trust will focus on mature producing properties, thereby minimizing the substantial risks and costs of exploration. Much like a REIT, investors in a Royalty Trust receive cash distributions based on the available cash flow and income of the trust. There is no income tax payable at the trust level if all taxable income, including any taxable capital gains, is distributed to unitholders annually. Also similar to a REIT, such distributions generally exceed the taxable income of the trust, due to non-cash resource deductions claimed in the trust (COGPE is similar to a CCA claim for a REIT). As such, a portion of the cash distribution is sheltered from current income taxes at the investor level. However, as noted in Section 3, distributions in excess of allocated income (i.e. the tax sheltered portion of the distribution) represent a return of capital, which reduces the adjusted cost base of the investors' trust units, resulting in a larger capital gain when the units are ultimately sold or redeemed (albeit such capital gain is only 50% taxable under current inclusion rates). It is worth noting that in the early years of its reserve life, the tax-deferred portion of Royalty Trust distributions is generally larger than that of a REIT, due to certain special deductions relating to the acquisition of resource properties; in fact, it is common for Royalty Trust distributions to be free of current income tax for a number of years. The tax efficient attributes of REIT and Royalty Trust distributions distinguish these two vehicles from other income trusts, which generally provide substantially less tax deferral. Other similarities between a REIT and a Royalty Trust include: • Access to investment opportunities and markets that would not otherwise be available to individual investors that have limited funds • Diversification across various types of properties and geographic markets • Liquidity as compared to direct investment since these trust units are generally listed on a stock exchange and publicly traded. Despite the forgoing similarities, there are two fundamental differences between a Royalty Trust and a REIT: A Royalty Trust is dependent upon a depleting asset base; and its returns are inextricably linked to resource commodity prices, subject to hedging strategies, which tend to be extremely volatile and economically sensitive. 45

The funds advanced to the trust by public investors are used to invest in the debt and equity of an Acquisition company ("Acquico"). Acquico will be used to purchase the shares of the operating company, immediately followed by an amalgamation of Acquico and the operating company. The allocation of the initial capitalization of the Acquico (debt and equity) will depend on the anticipated future income generated by the operating company ("Opco"). Normally, the debt and interest rate will be set such that the current and future taxable income of the company will be reduced to zero through the interest charged on the debt. Unlike a REIT and a Royalty Trust, the CCA deduction will be taken by the Opco and not the trust, and the remaining taxable income is usually reduced to zero by way of an interest charge on the loan from the trust to Opco. Excess cash remaining in the Opco after the payment of such interest can be paid to the trust as follows: • Reduce the paid up capital of the corporation (capital dividend), which results in a lower ACB of the shares of the corporation but the dividend flows to the trust tax-free. • Repurchase shares of the corporation - may result in a deemed dividend and a capital gain or loss. • Pay a taxable dividend. Any cash that is distributed to the trust by Opco on a tax-deferred basis (i.e. through the capital dividend option noted above) will be flowed through to the unitholders on a tax-deferred basis, reducing the ACB of their units by the same amount. The trust will include any capital gain or taxable dividend in computing its taxable income and consequently each unitholder will be responsible for the tax on his / her personal share of that taxable income. This dual structure of a corporation and a trust may result in certain tax inefficiencies, which need to be carefully monitored. Where a corporation is used to operate the business, any gains and recapture on the sale of the assets held by the operator may be subject to tax at the operator level, and such tax may not be deferred. The popularity of the Royalty Trusts, Investment Trusts and REITs is partly due to the significant tax advantages offered by their returns. For tax purposes, certain income distributed by the trust will retain its nature (dividends and capital gains); distributions are received by unitholders in some combination of income, dividends, capital gains and return of capital. Consequently, the overall tax rate applicable to trust investments is generally lower than for other steady-yield investments such as bonds. Where a portion of the distribution is treated as a return of capital, it would not be immediately taxable to an investor; instead, it would reduce the adjusted cost base of the units. As previously noted, the capital portion of the distribution results from the tax shield created from depreciable or depletable assets held directly through the trust or the capital dividend received by the trust from an underlying operating company. The following table summarizes key attributes of the various types of income trusts.

Type of Trust

Underlying Asset

Royalty Trust

Oil and gas

Royalty Trust

Oil and gas/coal

Investment Trust

Commercial activity (e.g. storage, shipping)

REIT

Income producing properties

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Risk Category

Average Yield

Life of Asset Base

High

11% - 14%

7 - 15 years

Medium

9%

20 - 30 years

Medium / Low

8.5-10%

Indefinite

Low

7%- 10%

Indefinite

10. How to Evaluate a REIT What to look for in a REIT The following characteristics appear to be prevalent, in varying degrees, among those Canadian REITs that have been most widely accepted and rewarded by the market: • An experienced sponsor with a proven track record for the property type of the REIT; • A focused portfolio (i.e., by either property type or location); • Strong net operating income, cash flow and sustainable income growth (at present, investors are looking for a 7% to 10.5% current return, with a 3% growth factor); • Limited debt (REITs that have debt of more than 60% of their market capitalization have been penalized by the market in the past. This philosophy has changed in recent times; as investors gain confidence in the REIT they are willing to allow a greater amount of leverage.) If debt exists, it should have a fixed rate of interest, and have a long-term maturity to eliminate the effects of interest rate swings on the REIT's yield; • Management that holds a significant investment in the REIT (10% to 20%) as this aligns management's behaviour with investors' goals; • Sufficient size to capture the brokerage community's interest, to ensure adequate liquidity and attract institutional investors. The REIT must have also achieved economies of scale with respect to its fixed overhead costs (to achieve this, the REIT's initial asset size should be in excess of $250 million with an ability to quickly grow its asset base to over $500 million); • An infinite life (rather than a finite one), and the ability to use sales proceeds to finance accretive new property acquisitions, and not be required to distribute capital gains; and • Distributions in the range of 80% to 95% of its distributable income. This will allow the REIT to use its retained operating funds to grow its asset size without going to the market for potentially dilutive (at least in the short-term) capital injections. Secondary Factors • management fees; • other REIT costs; • degree of tax deferral; • exposure to lease rollovers; • obligations to distribute income; • degree of reliance on acquisitions for future income; • amount of cash in the REIT and anticipated timing of future market issues; • historical performance of REIT and its manager; • level of disclosure in reporting to unitholders; • investment criteria for new properties; • operating plan of the REIT; • environmental risks and controls; • guidelines on dilution; • sunset provisions; • non-conflict and non-competition provisions for the manager; and • governance issues.

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The Canadian REIT market is still very active. However, the size of new issues has risen for a number of reasons: need to create a greater critical mass of properties, complexity of the transaction, need to create liquidity for investors, need to reduce trustee and general operating costs as a percentage of revenue, and to be competitive with the established REITs. As a result, the typical size of a REIT has increased significantly from 1997. Currently, the recommended minimum asset base of a REIT is between $250 and $350 million, with a built-in capacity through the declaration of trust to take on more debt (generally subject to a 60% limitation). It is possible for a potential REIT to access the market below $250 million; however, the REIT must have a dominant niche or be able to grow very rapidly.

How Should REITs Be Evaluated? The price of a REIT is based primarily on its anticipated income stream and, in recent years, some recognition has also been given to the management structure, the underlying asset values and the potential for capital appreciation. Assuming an investment in a REIT yields x% compared with alternative investments yielding y%, the investor assesses whether or not the spread provides adequate compensation for the incremental risk associated with a REIT investment. Recently there have been conflicting views among investors, analysts and management about how REITs should report profitability and what is the most effective measure of a REIT's performance. This debate is ongoing, as many believe that current reporting practices of REITs do not allow for comparability with other companies in the market. A REIT's value is derived from its ability to deliver consistent cash distributions, as well as appreciation in the underlying assets. In periods of low expected capital appreciation and low interest rates, the emphasis in valuation will be on yield. Yield is typically calculated by dividing the following year's target distributions per unit by the current market price per unit. Taxable investors will be interested in the post-tax yield, while non-taxable investors will concentrate on pre-tax yield. Even if the pre-tax income of the trust remains constant, the post-tax yield will change over time as the tax shelter in the REIT changes. In times of rising interest rates, the implied inflation may result in higher rents and thus capital appreciation of the underlying real estate assets. During such times, investors who seek a means by which to measure the future capital appreciation potential will likely begin considering the discount or premium to net asset value (NAV) in their valuation.

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What are the Risk Factors? There are risks associated with owning a REIT, including all the usual risks of real estate ownership. Other major risks faced by REITs include: • Volume of trading in units may be low (in 2001, the average trading volume increased significantly over the previous period); • Potential dilution from new issues; • Because Canadian REITs are unincorporated trusts, they do not offer limited liability (in practice, liability to unitholders is minimized through the use of non-recourse debt, insurance, and low debt to equity ratios); • Non-compliance with the Canadian Income Tax Act rules, results in the REIT losing mutual fund status; • Possible decline, over time, of pre-tax equivalent yield as CCA deductions will decline if no new significant properties are purchased; • Possible decline in pre-tax equivalent yield if the REIT invests the maximum amount allowed under its trust declaration in mortgage receivables, since the interest income cannot be shielded by CCA; • Unit market values will fluctuate with changes in interest rates and market conditions; • Management's ability to buy quality real estate at high capitalization rates with positive leverage (if new issue proceeds are kept in cash or if poor purchases are made, yield expectations may not be sustained and returns to unitholders may be diluted); and • The tax shelter is a partial deferral only; unitholders will be subject to capital gain on the ultimate sale of their units as a result of their cost base being reduced over time by the tax-sheltered portion of distributions (taxation of this gain can be further deferred if the units are held in an RRSP).

Other Factors to Consider In addition to the above risks, other factors to consider in owning units of a REIT include: • Conflict of interest by management/unitholders; • Government regulations; • Competition for REIT-quality real estate property - limited product; • The bar for entering the REIT market has gone up to over $200 million in assets and is increasing; • Evaluation of environmental risk (with underwriters and lenders becoming increasingly concerned about environmental risks, the trust will need to implement policies to monitor the risk, and it will be necessary for these risk exposures to be reflected in the financial statements of the REITs); and • Challenges by the Ontario Securities Commission and other regulatory authorities - as GAAP evolves for the REIT segment.

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11. Scorecard and Predictions In the 7th Edition of the Guide that was released in 1997, we commented on developments in the REIT market and the evolution of the market in the not too distant future. We have now revised the accuracy of our predictions relative to the actual developments in the table below. We have also used our knowledge and experience in this sector and looked to the U.S. REIT industry to hypothesize what the future holds for the REIT market in Canada.

Scorecard of Predictions from 1997 Guide How did we fare on our predictions for our last issue of the REIT Guide? Prediction

Response

REITs will become a large market in Canada.

With the disappearance through acquisition of Cambridge, Bentall, Cadillac and Oxford, and the creation of 10 new REITs, this has become a reality. REITs are now the dominant vehicle for public ownership of real estate in Canada.

REITs may enter into joint venture developments by financing a turnkey development by way of mortgage financing. In other words, the developer leases the space and pre-sells the project to the REIT. The REIT acts as the project's financier.

This structure was more prevalent in the initial years of the REITs, and is still a preferred structure of certain REITs that engage in mezzanine financing arrangements to pursue development opportunities.

REITs may acquire new properties through lines of credit, and then approach the capital market for new capital by way of public issues. This eliminates the dilution of earnings and the blind pool concept, while also allowing for more predictable cash flows.

This is now a standard strategy of the REITs.

REITs may move into investing a greater percentage of their capital in U.S. properties.

This has not really transpired to date, except for CPL Long Term Care REIT (now part of Retirement Residences REIT) and IPC US Income Commercial REIT.

New REITs will eventually emerge in the hospitality and apartment sectors.

There has been the emergence of REITs in both these sectors, including RES REIT, CAP REIT and NP REIT in the apartment sector and Legacy REIT, CHIP REIT and Royal Host REIT in the hotel sector.

Look for REITs to return to the market on a periodic basis in order to raise capital. New and existing REITs will also likely be considerably larger than those that exist today, the greater size being necessary for them to compete in the marketplace. Portfolios may be exchanged for REIT units if access to the market becomes too difficult.

All these predictions have become a reality.

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Prediction We may see the emergence of Master Trusts, which are trusts that hold units in the existing REITs as well as other income trusts. More quasi-corporate REITs will also enter the market, as existing portfolio holders will look to sell their portfolios through the use of taxdeferred rollovers. (In quasi-corporate REITs, the structure is such that income is flowed out as participating interest to the investors.)

Response This has not happened to the extent we had anticipated.

Other future trends include: Continued downward pressure on base-fees for externally managed REITs;

More REITs have converted from external to internal management.

External and internal managers rewarded by performance;

H&R REIT has recently moved to reward senior management through distribution performance.

Monthly distributions to better match yield instruments (i.e. GIC's, T-Bill's);

This is standard for nearly all REITs.

Expansion of distribution reinvestment plans (DRIP);

This has been slow to take-off but is now accelerating as a method used by the REITs to raise equity.

Expansion of option plans for the manager (external and internal);

Unit option plans are now in place and has been expanded since 1997.

REITs reducing distributions as a percentage of distributable income, but not the dollar amounts;

This trend has become a reality.

Growth being favoured to the overall yield performance of the REIT;

This has not happened. With few exceptions, corporations have not been able to deliver growth, which has been reflected in their share price.

Re-emergence of the mortgage REIT; and

This has not happened.

Pension funds selling real estate portfolios in exchange for units.

Has not yet happened with a few exceptions, e.g.: Canada Life. Rather, pension funds have acquired large Canadian corporations such as Cambridge, Cadillac Fairview and Oxford Properties.

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U.S. Market as a Guide The U.S. REIT Market has been in existence for a substantially longer period of time than the Canadian Market and has already undergone a significant number of developments and changes. Given that the Canadian Market tends to follow the examples of the U.S. Market, we would expect that these developments in the U.S. will provide a guide as to potential changes in the Canadian REIT Market in the future. Some of the major changes in the U.S. REIT Market have arisen from the introduction of the REIT Modernization Act ("RMA") in 1999, effective 2001. • Taxable REIT Subsidiaries: Prior to the RMA, REITs in the United States were only able to own up to 10% of the voting securities of a non-REIT corporation and the securities of a single non-REIT corporation was not allowed to exceed 5% of the REIT's assets. The result was that REITs could not control a subsidiary to provide non-customary services to tenants, such as concierge systems, parking garages, fitness centres, etc. Independent contractors had to be used to provide these services resulting in a loss of control in relation to the quality of the service and a loss of income to the REIT. The REIT Modernization Act has removed this impediment by allowing REITs to own up to 100% of a "Taxable REIT Subsidiary" - a company set up to provide non-customary services to the REIT's tenants. This will enable REITs to generate more revenue via service opportunities not previously available to them. This expansion of services beyond the traditional real property rents could also provide significant growth opportunities for Canadian REITs, who do not have the restrictions of their U.S. counterparts. • Reduction in Distributions: Another result of the RMA was to reduce the required distribution to unitholders from 95% of taxable income (which excludes distributions and net capital gains) to 90%. This will enable highly leveraged REITs to hold earnings for the purpose of repaying debts or for expenditures to improve the capital value of properties through renovations. This will also allow REITs to hold cash reserves to help cover expenses in times of economic slowdown. These reductions in distribution percentages may flow through to the Canadian market, with REITs retaining a larger portion of their income to help fund acquisitions and reduce debt. • Consolidation of REITs: Another development that is being predicted for the U.S. REIT market is the consolidation of REITs as they follow the trend of other industries moving from regional to national entities. The experts believe that the U.S. REIT Market will eventually consist of a few "Mega-REITs" and a large number of smaller sized REITs. The creation of "Mega-REITs" is attractive to the industry and investors alike as it provides a number of benefits, including being able to take advantage of significant economies of scale, creating a vehicle that will appeal to large institutional investors (especially pension funds), greater liquidity, and diversification benefits. The consensus is that while consolidations will occur, each REIT will remain focused on a specific property type and seek instead to diversify within that area, for example - adding a more upscale type of property to the portfolio or geographical diversification. Other expectations for developments in the United States include: • Disposition of properties in markets or asset classes where the REIT does not have the ability to become a major player • Increasing asset holdings in areas where there is a shortage of supply in the current environment • Re-developing or re-tenanting properties to create higher yield in existing properties • Reviewing internal processes and technology to create cost savings and increase effectiveness • Focussing on Human Resources to promote REITs as an employer to choice to attract high quality personnel.

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Future Trends and Predictions for Canadian REITs It is difficult to predict the future of any industry with absolute certainty; however, here are some trends that we believe Canadian REITs may follow in the future: • REITs become the vehicle of choice to access public capital for real estate investment; • Increased use of leverage to create improved yields; • New REITs being formed as open-ended Mutual Fund Trusts rather than closed-end trusts; • Federal tax concessions to allow REITs to use corporate structures similar to U.S. REITs for legal liability and tax purposes; • More Canadian REITs entering the U.S. market through open-ended Mutual Fund Trusts; • Pension funds or similar institution selling real estate portfolio’s (Direct or IPO) in exchange for REIT units holding between 10-20% of the outstanding units of a particular REIT; • Distributions as a percentage of distributable income will continue to decline and stabilize around 75%; • Barriers to entry continue to rise, with smaller REITs being niche players; • Large Canadian corporations with U.S. properties converting to a U.S. REIT; • Pressure on REITs to continue to build asset base in excess of $.5 billion and increase equity float; • Consolidation of REITs to achieve asset base in excess of $3 billion and equity in excess of $1billion, which will create a "Super REIT" category; • Significant increase in market transaction volumes for the REIT sector with increased liquidity being rewarded in the unit price value, especially in the Super REITs; • Market will give more weight to potential growth in the unit pricing; • External managers, except for the smaller REITs, will not be acceptable to the market; the smaller REITs will pursue a shared management platform (typically with the sponsor), with the REIT having first call on the intellectual capital of management; • Where external management exists, the cancellation of such contracts will not have a material financial impact on the REIT; • More REITs will enter into strategic relationships with a developer (usually the sponsor). The REIT taking a financial risk via its mezzanine loans and being compensated with a higher interest yield on such loans, and the developer assuming the development risk; • REITs accessing capital through bought deals or private placement, and • Transparency of results, corporate governance and make up of the independent trustees will become increasingly important in assessing management's performance, good corporate governance and risk levels.

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Appendix 1 - Operating Cash Flow Available: REIT vs. Corporation

Table 1 Operating Cash Flow Available - After Distributions / Dividends Assume 10,100,000 units @ $10 each. REIT Investors want a yield of 10%

$ 101,000,000

REIT Revenue Base Rental Revenue Recovery Revenue Interest and other Income

$

Corporation

19,000,000 6,500,000 50,000 25,550,000

$ 19,000,000 6,500,000 50,000 25,550,000

Mortgage / Bank Interest Property Operating Costs Internal management Costs Transfer Agent Trustee / Directors Fees Legal, Audit, G and A Capital Tax Depreciation Amortization of Tenant Inducements Amortization of Leasing Costs

5,000,000 7,000,000 650,000 50,000 100,000 550,000 1,700,000 300,000 100,000 15,450,000

5,000,000 7,000,000 650,000 50,000 100,000 550,000 510,000 1,700,000 300,000 100,000 15,960,000

Income Before Income Taxes Income Taxes @ 38% Large Corporations Tax (less surtax credit) Net Income

10,100,000 10,100,000

9,590,000 3,644,200 275,000 5,670,800

Add: Depreciation / Amortization Cash Available for Distribution

2,100,000 12,200,000

2,100,000 7,770,800

10,370,000 1,830,000

233,124 $ 7,537,676

10%

0.2%

Distributions @ 85% / Dividends @ 3% Retained Operating Cash Flow

$

Yield

Conclusion > Cash Management in a REIT is extremely important > The better expenses can be controlled, the easier it is to meet the desired investor yield.

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Table 2 Operating Cash Flow Available - After Distributions / Dividends Assume 10,100,000 units @ $10 each. REIT Investors want a yield of 10%

$ 101,000,000

Note: Operations are the same as Table 1 - Except Over-accrual of Recovery income of $1,000,000 in Prior Year (Bad Debt in Current Year) REIT Revenue Base Rental Revenue Recovery Revenue Interest and other Income

$

Mortgage / Bank Interest Property Operating Costs Bad Debt Internal management Costs Transfer Agent Trustee / Directors Fees Legal, Audit, G and A Capital Tax Depreciation Amortization of Tenant Inducements Amortization of Leasing Costs

Income Before Income Taxes Income Taxes @ 38% Large Corporations Tax (less surtax credit) Adjusted Net Income Add: Depreciation / Amortization Cash Available for Distribution Distributions @ 85% / Dividends @ 3% Retained Operating Cash Flow

$

19,000,000 6,500,000 50,000 25,550,000

$ 19,000,000 6,500,000 50,000 25,550,000

5,000,000 7,000,000 1,000,000 650,000 50,000 100,000 550,000 1,700,000 300,000 100,000 16,450,000

5,000,000 7,000,000 1,000,000 650,000 50,000 100,000 550,000 510,000 1,700,000 300,000 100,000 16,960,000

9,100,000 9,100,000

8,590,000 3,264,200 286,000 5,039,800

2,100,000 11,200,000

2,100,000 7,139,800

9,520,000 1,680,000

Yield To maintain Yield of 10% - special Unit Distribution of

Corporation

9% $

$

214,194 6,925,606

0.2%

580,000

Conclusion > Cash Management in a REIT is extremely important > The better expenses can be controlled, the easier it is to meet the desired investor yield. > Assumes that all AR is collectable - distributable income will drop - drop in the unit price to reflect new yield. > No recourse - need to assume new set of investors each year.

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Table 3 Operating Cash Flow Available Differences in the Definition of Distributable Income Scenario 1 - Declaration of Trust defines Distributable Income as NI Per GAAP + Depreciation + Amortization (Leasing and Scenario 2 - Declaration of Trust defines Distributable Income as NI Per GAAP + Depreciation + Amortization (TI Only) Scenario 3 - Declaration of Trust defines Distributable Income as NI Per GAAP + Depreciation

Revenue Base Rental Revenue Recovery Revenue Interest and other Income

Scenario 1

Scenario 2

Scenario 3

$ 19,000,000 6,500,000 50,000 25,550,000

$ 19,000,000 6,500,000 50,000 25,550,000

$ 19,000,000 6,500,000 50,000 25,550,000

5,000,000 7,000,000 650,000 50,000 100,000 550,000 1,700,000 300,000 100,000 15,450,000 10,100,000 2,100,000 12,200,000

5,000,000 7,000,000 650,000 50,000 100,000 550,000 1,700,000 300,000 100,000 15,450,000 10,100,000 2,000,000 12,100,000

5,000,000 7,000,000 650,000 50,000 100,000 550,000 1,700,000 300,000 100,000 15,450,000 10,100,000 1,700,000 11,800,000

Mortgage / Bank Interest Property Operating Costs Internal management Costs Transfer Agent Trustee / Directors Fees Legal, Audit, G and A Depreciation Amortization of Tenant Inducements Amortization of Leasing Costs Net Income Add: Depreciation / Amortization Distributable Income (Refer to definitions above) Distributions @ 85% Retained Operating Cash Flow

$

10,370,000 1,830,000

$

10,285,000 1,915,000

$

10,030,000 2,170,000

Conclusion Definition of Distributable Income to exclude amortization can increase the amount of cash retained in the REIT.

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Table 4 Operating Cash Flow Available - Working Capital/Line of Credit Assumptions: Working Capital / Line of Credit Available Interest @ 7% Tenant Inducements - Year 1 Tenant Inducements - Year 2 onwards

(30,000,000) 4,000,000 1,000,000

REIT Line of Credit - Beg of Year Operating Cash Flow retained after Distributions (Note 1)

Year 1 (1,000,000) 900,000 (100,000)

Year 2 (9,667,000) 1,250,000 (8,417,000)

Year 3 (15,356,190) 1,600,000 (13,756,190)

Mortgage Principal Repayments TI's (Note 2) Interest on Increase in Line of Credit (Note 3)

(5,000,000) (4,000,000) (567,000)

(5,000,000) (1,000,000) (939,190)

(5,000,000) (1,000,000) (1,312,933)

Working Capital / Line of Credit - End of Year

(9,667,000)

(15,356,190)

(21,069,123)

Corporation Working Capital / Line of Credit - Beg of Year Operating Cash Flow retained after Dividends (Note 1)

Year 1 (1,000,000) 4,462,000 3,462,000

Year 2 (5,855,660) 4,812,000 (1,043,660)

Year 3 (7,466,716) 5,162,000 (2,304,716)

Mortgage Principal Repayments TI's Interest on Increase in Line of Credit (Note 4)

(5,000,000) (4,000,000) (317,660)

(5,000,000) (1,000,000) (423,056)

(5,000,000) (1,000,000) (511,330)

Working Capital / Line of Credit - End of Year

(5,855,660)

(7,466,716)

(8,816,046)

Note 1 Assume - operating Cash Flow increases due to lower mortgage interest. Assumes distributable income is calculated as Net Income + Depreciation + TI Amortization Note 2 If define Distributable Income as Net Income + Depreciation (I.e. excludes amortization on TI's) - results in higher retention of cash flow. Note 3 - REIT - Interest On Working Capital / Line of Credit Calculation Increase in Line of Credit Used Interest at 7%

$

Year 1 Year 2 8,100,000 $ 13,417,000 $ 567,000 939,190

Note 4 - Corporation - Interest on Working Capital / Line of Credit Calculation Year 1 Working Capital/Line of Credit Used $ 4,538,000 $ Interest at 7% 317,660 Conclusion REIT's generally need to go back to the market / raise more financing every three years. Greater emphasis on cash management given lower operating cash retained after distributions.

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Year 2 6,043,660 $ 423,056

Year 3 18,756,190 1,312,933

Year 3 7,304,716 511,330

Table 5 Impact of Different Forms of Tenant Inducements on Cash Flow Scenario 1 - Free Rent $1,000,000 Assumptions: 5 Year Lease Base Rent = Distributable Income $1,000,000 per Year - First Year Free Base Rent Distributable Income Distribution (80%) Cash Received Cash (Shortfall) / Surplus

Year 1 Year 2 Year 3 Year 4 Year 5 800,000 $ 800,000 $ 800,000 $ 800,000 $ 800,000 $ 800,000 800,000 800,000 800,000 800,000 (640,000) (640,000) (640,000) (640,000) (640,000) 1,000,000 1,000,000 1,000,000 1,000,000 $ (640,000) $ 360,000 $ 360,000 $ 360,000 $ 360,000 $

$

Total 4,000,000 4,000,000 (3,200,000) 4,000,000 800,000

Scenario 2 - Tenant Inducement - Tenant Allowance of $1,000,000 Assumptions: Base Rent = Cash Received 5 Year Lease - $1,000,000 per Year Capitalize the TI and amortize it over the lease period. This scenario assumes that distributable income is calculating by not adding back amortization of TI's. If distributable income was calculated by adding back amortization of TI's, cash savings would decrease. Refer to Table 3. Year 1 Year 2 Year 3 Year 4 Year 5 Total Base Rent $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 5,000,000 Amortization 200,000 200,000 200,000 200,000 200,000 1,000,000 Distributable Income 800,000 800,000 800,000 800,000 800,000 4,000,000 Distribution (80%) (640,000) (640,000) (640,000) (640,000) (640,000) (3,200,000) Tenant Allowance (1,000,000) (1,000,000) Add Back Amortization 200,000 200,000 200,000 200,000 200,000 1,000,000 Cash (Shortfall) / Surplus $ (640,000) $ 360,000 $ 360,000 $ 360,000 $ 360,000 $ 800,000 Scenario 3 - Tenant Inducement - Leasehold Improvement of $1,000,000 Assumptions: Base Rent = Cash Received 5 Year Lease - $1,000,000 per Year Leasehold Improvement can be capitalized with cost of building and amortized over life of Lease Since REITs add back depreciation to calculate distributable income, the capitalized amount of depreciation will be paid out over the life of the capitalized asset. (If improvement cannot be capitalized with building - see scenario 2) Year 1 Year 2 Year 3 Year 4 Year 5 Total Base Rent $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 5,000,000 Distributable Income 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 5,000,000 Distribution (80%) (800,000) (800,000) (800,000) (800,000) (800,000) (4,000,000) Tenant Allowance (1,000,000) (1,000,000) Cash (Shortfall) / Surplus $ (800,000) $ 200,000 $ 200,000 $ 200,000 $ 200,000 $ Conclusion Cash management is imperative. It is important to understand the impact of operating and leasing decisions on cash flow. Shortfall of cash will result in the REIT drawing more from line of credit - restricted by covenants. Note: Calculations ignore operating cost recoveries, operating expenses, G & A.

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Appendix 2 - Impact of Tax Deferred Distributions on the Adjusted Cost Base of Units For example, assume a unit was purchased at the beginning of the year for $10.00, the cash distribution for the year was $0.90 per unit and the allocation of taxable income was $0.60 per unit. At the end of the year, the unitholder's Adjusted Cost Base (ACB) would be $9.70, calculated as follows:

Year One Original Cost Cash Distribution Allocation of Taxable Income (per T3) ACB, End of Year One

$10.00 (0.90) 0.60 $ 9.70

In the second year, the cash distribution for the year was $1.00 per unit and the allocation of taxable income was $0.70 per unit. The ACB of the unit would now be $9.40, calculated as follows:

Year Two ACB, End of Year One Cash Distribution Allocation of Taxable Income ACB, End of Year Two

$ 9.70 (1.00) 0.70 $ 9.40

Then assume the unit is sold for $13.50 at the beginning of the third year; the unitholder would realize a capital gain of $4.10 (i.e., $13.50 proceeds of disposition - $9.40 ACB). Thus the tax-deferred portion of the distributions in Years One and Two has resulted in an increase in the capital gain of $0.60. Assume that the unitholder has held a unit in a REIT for six years and the ACB of the unit at the end of Year Six is reduced to $0.50. In Year Seven, the REIT distributes $1.50, of which $0.90 is taxable. ACB, Beginning of Year Seven Cash Distribution Allocation of Taxable Income ACB, End of Year Seven

$ 0.50 (1.50) 0.90 ($ 0.10)

As the ACB is negative, the negative amount will be deemed to be a capital gain and the $0.10 will be subject to tax. The ACB of the unit will be readjusted to zero and any further distribution received in excess of the taxable income will again be subject to tax at the capital gain tax rate. In the example, the ACB of the units will only become positive if the unitholder purchases additional units of the particular REIT.

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Appendix 3 - Comparison of Available Vehicles The purpose of the Appendix is to illustrate the principal differences between operating a REIT vs. a Corporation. 1

Structure and Regulation Real Estate Investment Trust Structure and Regulation

Public Corporation

• A REIT is an open-ended or closed-ended mutual fund trust.

• Incorporated

Private Corporation • Incorporated.

• Regulated by the stock exchange.

• Regulation created by the Declaration of Trust (Self Imposed Rules), which includes: 1. Restricted use of Proceeds 2. Eligible investments / noneligible investments 3. Distribution Policy 4. Self Imposed Covenants (restrictions on borrowing) 5. Restriction on issue of new units 6. How distributable income is calculated • Non-compliance with declaration of trust results in a loss of credibility. Advantages

• Increased capital

• Increased capital

• Improved financial position

• Improved financial position

• Enhanced ability to raise capital

• Enhanced ability to raise capital

• Liquidity and valuation • Tax effective investment vehicle (See detailed explanation of Tax Implications outlined below disadvantages) • Set up for yield not growth.

• Liquidity and valuation • High retention of earnings • Shares can be used for making acquisitions • Stock and stock options are useful in attracting management.

• Easier to align corporation with shareholder interests • Direct linkage between property performance and management compensation • Quicker decision making flexibility • Less regulation (cheaper to operate).

1This is a general Discussion and may not be applicable to a specific REIT, Public Corporation or Private Corporation.

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Real Estate Investment Trust

Public Corporation

Private Corporation

Disadvantages

• Disclosure of increased costs • Management demands (operations open to public scrutiny) • Loss of control • Pressure to maintain distributable income • Majority of earnings distributed to unitholders • Restricted by the definition of a "Mutual Fund Trust", need to comply with restrictions, no curing process if offside with definition and rules of mutual fund trust for income tax purposes • Initial Tax Consequences for transferring the assets to the REIT • Fishbowl Concept - REIT is open to exposure and scrutiny by the public. (Comparison to other REITs).

• Disclosure of increased costs • Management demands (operations open to public scrutiny) • Pressure to maintain growth / Earnings • Loss of control • Fishbowl Concept Company is open to exposure and scrutiny by the public. (Comparison to other real estate companies).

• Fewer options to raise capital (Expensive Capital).

Tax Considerations

• To avoid paying tax under Part I of the Income Tax Act, a REIT must distribute to its unitholders, an amount equal to its taxable income • Tax liability is that of the unitholder and not that of the REIT - no deferred income tax • Not subject to Large Corporations Tax, Capital Tax, Ontario Minimum Tax • An investment in a REIT is considered Canadian Property as long as the REIT does not invest more than 30% (generally based on cost) of its assets outside Canada • Subject to tax on income earned outside of the Trust i.e. in a corporation • Subject to tax on income earned outside of Canada (i.e. U.S.) - to the extent permitted can designate as a foreign tax credit to unitholders • Non-compliance with the Income Tax Act - could result in the REIT becoming an ineligible investment - often no curing process • Practically need to issue T3's by February 28.

• Large Corporations Tax, Capital Tax, Ontario Minimum Tax • Deferred income tax • Subject to tax on income earned in the United States - foreign tax credit.

• Large Corporations Tax, Capital Tax, Ontario Minimum Tax • Deferred income tax • Subject to tax on income earned in the United States - foreign tax credit.

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Accountability, Management Focus and Reporting Real Estate Investment Trust Accountability

Public Corporation

• Activities governed by Board of Trustees

• Activities governed by Board of Directors

• Activities governed by major shareholders

• Management is accountable to unitholders and analysts

• Management is accountable to shareholders, analysts

• Leeway for mistakes mistakes kept private (only known to shareholders and debtholders.)

• Mistakes will be reflected in unit value • Analysts focus on a line-byline basis - impact on distributable income. Management Focus

Private Corporation

• Mistakes will be reflected in share value. • Analysts focus on Revenue and Net Income. • Need to consider impact of decisions on quarterly and annual results

• Need to consider impact of decisions on monthly distributions

• Need to consider user needs - • Focus is creating long term value for focus is cash flow shareholders. • Need to consider impact of

• Need to consider impact of decisions on annual results • Focus is creating longterm value for shareholders.

decisions on covenants. Reporting

• Annual audited financial statements, release results 140 days after year-end • Given monthly distributions monthly accounting needs to be accurate • Emphasis on monthly cut-off and accruals, also need to produce quarterly results.

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• Annual audited financial Statements, release results 140 days after year-end • Produce quarterly results quarterly accounting needs to be accurate • Emphasis on quarterly cut-off, and accruals.

• Annual audited financial statements - if required by a user • Emphasis is on an annual basis.

Appendix 4 - Continuous and Periodic Disclosure Requirements of a REIT What Quarterly financial statements

Annual financial statements and MD&A

When

To Whom

• Within 60 days of end of 1st, 2nd, and 3rd financial quarter end

• TSX Company Reporting

• Within 140 days of financial year-end

• TSX Company Reporting

• OSC • Shareholders

• OSC • Shareholders

Annual Report

• Within 140 days of financial year-end

• TSX Company Reporting

Notice of shareholder meetings and management's proxy solicitation information circular

• Annual meeting must be held within 6 months of the fiscal year end

• TSX Company Reporting

Notice of record date and meeting date

• At least 25 days before record date

• TSX Market Data Services

• Shareholders

• OSC • Shareholders

• Canadian Depository for Securities • OSC

Distribution declaration· • Media Release

• Immediately after declaration and at least 7 days before record date

• TSX Dividend Administrator

TSE annual questionnaire

• July 31 each year (prepared as at June 30)

• TSX Company Reporting

Change in issued capital

• Monthly

• TSX Company Reporting

Annual Information Form

• Within 140 days of financial year-end

• OSC

Insider reports • Initial insider report • Report of insider trade

• Within 10 days of the trade

• OSC

Material Information • Media release (If information is a material change, file material change report with the OSC within 10 days of change)

• Pre-notification to TSX, prior to issuance of media release

• Market Surveillance • News Service

• Format of report found in OSC Rule 55-501 • TSX Market Surveillance • OSC • News Service

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What Rights offering

When

To Whom

• Immediate notice to TSX and OSC of proposed offering with draft circular. Record date must be at least seven trading days after final acceptance.

• TSX Company Regulation

Additional listing • Issue of shares or increase in number of shares reserved • Changes in capital

• Immediate notice of proposed transaction, prior acceptance by TSX is required

• TSX Company Regulation

Grant of options or other rights under share compensation arrangement

• Pre-approval of share compensation plan

• OSC

• OSC

• File Form 45-501F1 within ten days for private placements. • TSX Company Reporting • OSC

• Monthly reporting of grants made under share compensation arrangement; insider report may be required • Annual reporting to OSC.

Exercise of options or issue of units under approved unit compensation arrangement

• Monthly reporting of issue of units under unit compensation arrangement; insider report may be required

• TSX Company Reporting • OSC

• Annual reporting to OSC if less than 1% of issued and outstanding units issued within one calendar month, otherwise within ten days of the end of the month. Normal course issuer bid· • Pre-clear notice and media • File notice release with TSX only • Media release· • Within 10 days of month end • Monthly report of purchases • File insider report within ten • Insider report days of trade (The REIT is an insider of itself).

• TSX Regulatory & Market Policy

Redemption of listed securities

• Immediate notice to TSX at time of sending notices to shareholders. Pre-clear partial redemptions at least seven trading days before the record date.

• TSX Company Regulation

• Prior acceptance by TSX required before certificate of amendment issued

• TSX Company Regulation

Unit consolidation

• Letter of transmittal.

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• OSC • Unitholders

• OSC • Unitholders

• Unitholders

What

When

To Whom

Unit split by way of stock dividend

• Prior acceptance by TSX required. Same as dividend declaration and additional listing

• TSX Company Regulation

Charter amendments, including change of name

• Prior acceptance by TSX required. Immediate notice to TSE after certificate of amendment issued

• TSX Company Regulation

Supplemental listing • To list units of a class not already listed

• Prior acceptance by TSX required, using a preliminary prospectus or draft information circular

• TSX Company Regulation

Capital reorganization • Issue of securities upon exchange of securities, amalgamation / reorganization

• Immediate notice to TSX of proposed change, prior acceptance by TSE is required

• TSX Company Regulation

Change to unit certificates

• Immediately after any change to a certificate, a new specimen must be filed

• TSX Company Regulation

Change of Transfer Agent

• Minimum two weeks notice TSX Consent required

• TSX Company Regulation

Creation of restricted units

• Prior acceptance by TSX

• TSX Company Regulation

Material change report

• Within ten days of material change

• OSC

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• TSE Dividend Administrator

• OSC

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Glossary of REIT and Real Estate Terms Commonly Used in Canada Adjusted Funds from Operation (AFFO) Adjusted funds from operations is generally defined in Canada as the funds from operations (FFO) less ongoing capital expenditures, tenant improvements and other adjustments.

Amortization The gradual reduction of an amount over a period of time, such as the principal amount of a mortgage or the cost of an asset being written off against income.

Anchor Tenant The major tenant or tenants in a shopping centre, usually a department store, discount store, or supermarket. See Prime Tenant.

Annualized Return Expressing the return on an investment for a period other than one year as an equivalent return on an annual basis. Because annualized return is computed on a time value basis, it is not the same as an arithmetic average. Under some circumstances, such as when the total amount invested varies over the period, annualized return may provide a misleading or meaningless number.

Appraised Value An opinion of value formally expressed in writing by an independent appraiser based upon one or more of the three traditional analytic approaches: the cost approach, the market approach, or the income approach.

Book Value The carrying amount of an asset, as shown in the financial accounts of a company. The amount paid for an asset, less depreciation and/or amortization.

Canadian Institute of Public and Private Real Estate Companies (CIPPREC) Formed in 1970 as a non-profit real estate industry association, to represent the interests of Canadian real estate companies and to serve as a forum for the discussion of issues of concern to companies and REITs in all areas of real estate.

Capital Cost Allowance (C.C.A.) An income tax term in Canada. The equivalent of the accounting depreciation charge. C.C.A. is usually calculated on a declining balance basis and generally results in deductions for tax purposes, which are in excess to those claimed as depreciation for financial purposes.

Capital Improvements Expenditures that remedy a property's deterioration, appreciably prolonging a property's useful life, or adding to the value of the property.

Capitalization In real estate, a valuation methodology used to convert a single year's net operating income into an expression of a property's value. Arrived at by dividing the net operating income by the capitalization rate. 71

Capitalization Rate In real estate, the capitalization rate is the yield of a property computed by dividing the normalized net operating income by the property value, expressed as a percentage. For those more familiar with financial equities, the capitalization rate may be thought of as a measure of yield, analogous to the inverse of "earnings per share" as applied to a share of stock. A rate of return used to derive the capital value of an income stream. The formula is Capitalization Rate

=

annual income capitalization rate

Cash Flow The cash remaining after various expenses and expenditures are deducted from income. Cash flow can be defined in variety of ways depending upon which expenses and expenditures are deducted. In general, the unqualified term usually means net cash flow.

Declaration of Trust A set of rules adopted by the Trustees at the inception of the REIT, similar to the Memorandum of Incorporation and Articles of Association of a corporation. Sets out the definition of distributable income, prohibits investment in certain assets or activities, restricts the percentage of the REIT's assets that can be invested or loaned, defines borrowing limitations and restricts the REIT's ability to invest in certain activities. All material clauses usually require 2/3 of the unitholders to approve changes. Other clauses require only 51% of the unitholders to approve a proposed change.

Depreciation An accounting expense that allocates the cost of an asset over its estimated useful life. The undepreciated value of the asset is referred to as the net book value. Methods of calculating depreciation include straight line, declining balance and sinking fund. Also see Capital Cost Allowance.

Diluted Distributable Income Per Unit Distributable income per unit adjusted for the impact of any dilutive potential units that were outstanding during the reporting period.

Distributable Income A defined term adopted by each REIT, it is generally defined as net income of the REIT and its consolidated Subsidiaries (if applicable), as determined in accordance with Canadian generally accepted accounting principles ("GAAP"), subject to certain adjustments as set out in the Declaration of Trust, including adding back depreciation and amortization , future income tax expenses and excluding any gains or losses on the disposition of any asset, future income tax benefit and any other adjustments determined by a majority of the Trustees in their discretion.

Distributable Income Per Unit Distributable income divided by the weighted average outstanding units issued by the REIT during the reporting period.

Distribution Reinvestment Plan The plan adopted by a REIT, pursuant to which Canadian resident unitholders of that REIT will be entitled to elect to have cash distributions in respect of units automatically reinvested in additional units.

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EBIT Earnings before interest and taxes.

EBITDA Earnings before interest, taxes, depreciation and amortization.

Fair Market Value The value that a willing buyer would pay to a willing seller for a specific property where all material facts are known to both parties.

Free Rent A concession granted by a landlord to a tenant whereby the tenant is permitted, for a portion of the lease term, to occupy its space without payment of base rent, and sometimes without payment of any rental charges.

Funds from Operations (FFO) The cash remaining from net operating income after deduction of debt service and ground lease payments but not capital expenditures or income taxes. CIPPREC defines FFO as the equivalent of income before extraordinary items adjusted for future income taxes, depreciation and amortization of capital items and deferred leasing costs, any gain or loss on sale of or provision against capital items and undistributed profits of equity accounted investees and non-controlling interests. CIPPREC attributes the importance of FFO to the following reasons: • "properties are bought and sold based on projections of their cash flow; • the ability to finance properties is dependent on the cash flow the properties can generate; and • the shares of public real estate companies trade on the basis of multiples of cash flow from operations. The relationship between share or unit price and cash flow from operations is particularly strong for those companies or REITs engaged solely in the ownership of income properties".

Future Income Taxes A financial reporting practice whereby taxes are provided for in the accounts of the enterprise during the period transactions occur, regardless of when such transactions are recognized for tax purposes. In the real estate industry, the tax deferral generated by the difference between depreciation and capital cost allowance is usually a major component of future income taxes.

Gross Book Value At any time, the book value of the assets of the REIT and its consolidated subsidiaries, as shown on its most recent consolidated balance sheet, plus the amount of accumulated depreciation and amortization as reflected in the financial statements.

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Head Lease A head lease arrangement is such that one person - the head tenant - leases an entire property from the owner and then re-leases the property to other tenants.

Independent Trustee A Trustee who is "unrelated" (as defined in Section 474 of the Toronto Exchange Company Manual Guidelines on Corporate Governance) and is not "related" within the meaning of the Income Tax Act.

NAREIT National Association of Real Estate Investment Trusts, a U.S. trade association representing publicly traded and privately placed real estate investment trusts (REITs).

Net Asset Value Current real estate value or equity, net of debt. In common practice, current real estate value is considered to be the most recent appraised value, or if prior to the initial appraisal following acquisition, the asset's acquisition cost adjusted for capital expenditures and additional contributions or distributions.

Over-Allotment Option The option granted by a REIT to the Underwriters, exercisable for a period of 30 days after Closing, to purchase up to a stated additional number of Units on the same terms as the Offering, solely to cover the over-allotment.

Prime Tenant In a shopping centre or office building, the tenant who occupies the most space. Prime tenants are considered credit worthy and attract customers or traffic to the centre.

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Glossary of REIT and Real Estate Terms Commonly used in the USA (Most of these terms also apply to Canadian REITs)

Adjusted Funds from Operations (AFFO) In part to cope with the limitations associated with the calculation of Funds from Operations (FFO), many portfolio managers and analysts calculate adjusted funds from operations, or AFFO. Some analysts, companies, and portfolio managers prefer the terms cash available for distribution (CAD), or funds available for distribution (FAD) to AFFO. More important than which acronym you adopt is how you get from FFO to AFFO. Though there is some debate, most industry veterans derive AFFO by adjusting FFO for the straight lining of rents, as well as after establishing a reserve for costs, which, though necessary and routine, aren't costs that can be recovered from tenants. This includes certain maintenance costs and leasing costs.

Adjusted Funds from Operations (AFFO) Multiple A company's AFFO yield and its AFFO multiple are reciprocals of one another. Both are valuation measures. For a variety of reasons including P/AFFO multiples are roughly equivalent to P/E ratios AFFO multiples are more often cited as a valuation measure than AFFO yields. Some portfolio managers contend that comparing AFFO multiples to growth rates are a useful valuation screen. If a company's growth rate is equal to or exceeds its AFFO multiple, the REIT isn't overpriced. Most portfolio managers modify this screen by factoring into the equation an appropriate "discount rate."

Adjusted Funds from Operations (AFFO) Payout Ratio This is the single best measure of a company's dividend paying ability. It is calculated by dividing the company's per-share annual dividend by the current year's per share AFFO estimate.

Adjusted Funds from Operations (AFFO) Yield In addition to being one measure of valuation, AFFO yield is often used as a proxy for a company's nominal cost of capital. It is calculated by dividing a company's per-share AFFO estimate by its stock price. If a company with an AFFO yield of 6.5% buys a property at a going-in-stabilized return of 7.5%, it has acquired the property at a 100 basis point (or one percentage point) positive spread to its nominal cost of capital.

Cost of Capital Variously defined as the weighted average of the cost of equity and debt capital employed by a REIT. Unfortunately, an incorrect definition of this term is often commonly used, which equates the cost of equity capital to the REIT's current dividend yield or FFO yield. A REIT's "true" cost of capital is the investor's expected rate of return on his/her investment.

Debt Service Interest payments on debt and principal payments to retire debt. For accounting purposes, interest payments are considered to be expenses while principal payments are treated as capital expenditures.

DOWNREIT A side benefit of the UPREIT structure is that operating partnership units can be used as currency to acquire properties from owners who would like to defer taxes that would come due if the property(ies) were sold or swapped for stock. In response to this advantage of the UPREIT structure, a number of non-UPREITs have created so-called DOWNREITs. This makes it possible for them to buy properties using DOWNREIT partnership units. The effect is the same, however; the DOWNREIT is subordinate to the REIT itself, hence the name. 75

Funds from Operations (FFO) Equal to a REIT's net income after the adding back of real estate depreciation and amortization (not including the amortization of deferred financing costs). This is the measure of REIT operating performance most commonly accepted and reported by REITs, conceptually analogous to net income of non-real estate companies. The principal reason for the add backs is that real estate assets tend to appreciate, making an income statement that includes GAAP historical cost depreciation a misleading indicator of REIT profitability. This is a concept pioneered by the National Association of Real Estate Investment Trusts (NAREIT), a U.S. REIT association. It is intended to measure a REIT's operating results. NAREIT defines FFO as:"GAAP Net Income less gains or losses from sales of properties or debt restructuring plus depreciation of real estate." NAREIT offers the following explanation: "FFO is different from corporate 'earnings' in that historically, commercial real estate maintains residual value to a much greater extent than machinery, computers or other personal property."

Implicit 12-Month Total Return This is calculated by adding the REIT's year-over-year growth rate and its current stated annual dividend. This is a "guesstimate" of total return potential that is widely used. Some industry veterans criticize this guesstimate of total return because, among other things, it fails to take into account potential changes in multiples. As long as investors recognize its potential shortcomings, implicit 12-month total returns can serve as a useful screening tool when putting together a REIT portfolio.

Implied Cap Rate Net operating income (NOI) divided by a REIT's total market capitalization (the sum of its equity market capitalization and its total outstanding debt).

Interest Coverage Ratio Simplify referred to as the REIT's coverage ratio, it's the ratio of EBITDA to interest expense. Increasingly viewed as the best means of comparing and assessing REITs' financial leverage among REITs.

Net Asset Value (NAV) When evaluating public companies, investors generally focus on price-to-book ratios as one valuation measure. Unfortunately, price-to-book ratios are inappropriate for REITs insofar as a REIT's book value, which is based on historic cost figures, may not accurately reflect the earnings capacity of otherwise wellmaintained assets. Also, the balance sheet consolidations accompanying IPOs were often pursued using different accounting conventions, resulting in an apples-to-oranges comparison between companies. Thus, many analysts prefer to use net asset value as a surrogate for book value, which is appropriate insofar as book value is meant to represent an entity's liquidation value.

Positive Spread Investing Defined as when a REIT buys a property that has a higher initial yield than the current yield on the REIT's capital. For example, a REIT buys a property yielding 11% (property net operating income divided by the all-in cost of the property) at a time that its debt is borrowed at 8% interest and its equity is trading at an FFO yield (inverse of its FFO multiple) of 10%. If the REIT is funded half with equity and half with debt, it realizes a 200 basis point (11% minus 9%) positive spread.

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Real Estate Investment Trust (REIT) A real estate investment trust is a private or public trust (or corporation in the United States) that enjoys a special status under the U.S. tax code that allows it to pay no corporate income tax so long as its activities meet statutory tests that restrict its business to certain commercial real estate activities. Most states honour this federal treatment and do not require REITs to pay state income tax. By law, REITs must pay out 90% of their taxable income.

Return of Capital The portion of a REIT's dividend in excess of taxable income. Because REIT dividends are often higher than taxable income, principally due to depreciation, the amount by which the dividend exceeds taxable income is a return of capital to a shareholder, meaning that for a taxpaying shareholder it does not create currently taxable ordinary income, but instead reduces the shareholder's tax basis. At the final sale of the shares, the difference between tax basis and final net sales price is recognizable as a capital gain. To the extent the final capital gains rate is lower than interim ordinary income tax rates, REITs provide a tax shelter function for certain taxpaying investors, by allowing the deferral of tax on current cash received as dividends and taxing it at a lower rate upon disposition of the shares.

Straight Lining REITs straight-line rents because generally accepted accounting principles, or GAAP, require it. Typically, a tenant's monthly rent will increase over the life of a lease; this applies to commercial properties, not usually residential properties. Straight lining averages the tenant's rent payments over the lease's life. In other words, rental revenues are overestimated in the early years and underestimated in the later years.

Total Debt and Total Market Capitalization Together, these measures have been used to provide an assessment of leverage. Debt-to-Total Market Cap was the most often cited measure of leverage early on in the current REIT underwriting cycle (circa 1993). There are a number of problems associated with using it for that purpose, however. Chief among those is that it doesn't provide meaningful information regarding a REIT's ability to service its debt.

Umbrella Partnership REIT (UPREIT) A REIT structure in which the REIT does not own a direct interest in properties, but rather in an umbrella partnership that owns interests in properties. For this reason, this umbrella partnership is generally referred to as the operating partnership. It is also common for an operating partnership in an UPREIT structure to own interests in joint ventures in addition to properties. The UPREIT has been the structure of choice in most REIT initial public offerings over the past several years, owing to the tax deferral benefits this structure offers to the transferring company's principals. In a nutshell, the UPREIT structure allows the principals, who are transferring their properties from private ownership to public ownership via an IPO, to maintain their historical cost basis by transferring the properties to the operating partnership ("OP") rather than directly to the REIT. The REIT, in turn, is the general partner of, and owns a majority interest in, the operating partnership. If the properties were transferred directly to the REIT, it would result in a stepped-up cost basis in the properties for the new public entity and trigger a taxable event for the transferring principals. By transferring the properties to the operating partnership in exchange for operating partnership (OP) units, the principal's historical cost basis is maintained. The OP units are exchangeable on a one-for-one basis into REIT common shares and, over time, the principals can convert OP units to REIT common shares (triggering a taxable event), giving the principals the option to incur their tax liability in smaller increments. 77

Acknowledgement Material for the REIT Guide has been compiled from internal and external sources. Thank you to all the people at Deloitte who played a role in compiling and sourcing the material: • Elizabeth Abraham • Eddy Burello • Tony Cocuzzo • John Cressatti • Scott Cryer • Jacqui Hop Hing • Katie Hynd • Don Newell • Mike Shumate • Alan Walker We wish to acknowledge articles and material issued by the following: • Deloitte Touche Tohmatsu • CIBC World Markets Inc. • Dow Jones • Fortune Magazine • Green Street Advisors • Merrill Lynch & Co. • National Association of Real Estate Investment Trusts (NAREIT) • National Bank Financial • Prudential's Bernard Winograd • RBC Dominion Securities Inc. • Salomon Brothers Inc. To obtain additional copies of this Guide, please contact Don Newell at: Tel: 416-601 6189 Fax: 416-601 6444 To obtain information on U.S. REITs, please contact Don Newell or one of the following U.S. regional REIT experts: Jim Berry, Dallas Michael Carnevale, New York City James de Bree, Los Angeles Craig Donnan, Cleveland (U.S. REIT leader) Joe Ferst, Atlanta Tom Francis, San Francisco Doug McEachern, Los Angeles Tim Overcash, Northern Virginia Jim Sowell, Washington

© 2004 Deloitte & Touche LLP and affiliated entities.

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