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  REIT structure backfiring during credit crunch

CapitalSource's entire reasoning for converting to REIT structure was to enjoy significant tax advantages. However, CSE posted an "overall effective tax rate in 2007, expressed as a percentage of consolidated pre-tax GAAP net income, [of] 33.2%." The Company is earnings most of its income within its TRS subsidiaries and not with the tax-sheltered qualified REIT subsidiaries. CSE is basically structured as conglomerate of three separate divisions: 1) a corporate finance TRS, 2) a healthcare net lease REIT, and 3) some sort of structured finance segment. It's a BDC, a healthcare triple net lease REIT, and a poorly performing mortgage REIT all in one. The poorly performing mortgage seems to be bringing the structure down right now. CSE bills itself as a SuperREIT, a hybrid diversified vehicle that can do it all. Unfortunately, the REIT structure is not quite as accommodating as CSE would like for it to be.

In the end,CapitalSource (CSE), a diversified REIT, reporting a disappointing $0.07/share fourth-quarter GAAP loss amidst serious derivative losses, mark-to-market losses on its MBS portfolio, and a growing provision for loan losses.

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  Can't generate the income needed to reap the benefits of being a REIT

CSE can't seem to generate enough taxable income to maximize the advantages of being a REIT. Instead of owning up and retaining the excess capital tax-free, CSE chose to keep pumping out dividends and diluting existing shareholders through its direct stock purchase plan -- during one of the worst credit crises in recent history. CapitalSource could have retained the capital and repurchased common shares as a better means of supporting shareholder value.

By their very nature, REITs maximize their value when they can fully utilize their tax-advantaged structure. CapitalSource, meanwhile, reported an effective tax rate of 33.2% for 2007. Being a mortgage REIT is not just about paying a dividend. It's about utilizing a complex structure to deliver returns on shareholder equity.

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