By Peter Slatin

The benefits of complying with the financial reporting and disclosure requirements of Sarbanes-Oxley are the same for REITs as for any other company: meet them, and stay out of jail. It’s the kind of win-win strategy that only a bureaucrat could love.

Since the benefits are the same as for other companies, the challenges of compliance with the ever-unfolding demands of Sarbanes-Oxley (SOX) shouldn’t be different for REITs, either. And while for the most part that’s so, the SOX burden is falling with particular weight on the shoulders of small-cap companies. At a cost estimated by Dale Anne Reiss, global director of real estate, hospitality and construction for Ernst & Young, of between one and five cents a share depending on a company’s market cap, "it’s a question of value received versus cost incurred."

Many REIT experts predicted that the legislation would play a key role in spurring consolidation in the industry as smaller REITs seek partners to provide relief. At such companies, according to Ed Petrosky, real estate attorney with Sidley, Austin, Brown & Wood, "senior management might be thinner, and the responsibilities fall disproportionately on fewer shoulders." This is simple, yet interesting, arithmetic. It begs the question of whether senior managers will start searching for other shoulders to share the SOX yolk.

The cost impact of compliance may hit smaller REITs hardest, but larger REITs are also working hard to adjust, says Greg Hughes, chief financial officer of SL Green Realty Corp. (NYSE: SLG). "Maintaining compliance puts an onerous burden on the finance and accounting group, and the cost benefit is not there. It’s tough to rationalize."

Smart REIT executives are looking for ways to manage the cost, time and brain-drain and to simply get on with business. Petrosky says that many companies have formed disclosure committees headed by CEOs and CFOs, because they "need to sit down with the people on the front lines—the acquisition guy, the leasing guy—and make sure that everything that needs to be disclosed is being disclosed."

Companies are also looking for ways to just continue doing business. Speaking of last year’s successful spin-off of Gramercy Capital from his company, SL Green’s Hughes notes that "one of the considerations in having Gramercy be externally advised was the cost and staffing required to be in compliance to be an SEC-registered company. It’s too much of a burden for a startup company."

The great REIT consolidation that some industry leaders have been predicting for more than a decade has remained elusive; instead, we’ve seen a flowering of new equity and mortgage REITs since Sarbanes-Oxley was passed in 2002. Yes, there are mergers—Camden and Summit, for example—and consolidations—such as Great Lakes’ embrace by Transwestern. But even if SOX is a factor in these, as Camden executives agreed it was in their merger with Summit, it is more likely to play a role in the shakeout of REITs at the small-cap end that have other issues to deal with.

There is certainly no shortage of investors of every stripe—whether other REITs, institutions or private-equity players—looking for the weaker animals in the herd to isolate and devour. Some say it’s still early in this first post-SOX reporting season to ascertain its true impact.

However, Steven Scheinfeld, a partner in the corporate real estate practice at Fried Frank Harris Shriver & Jacobson, says that after going through the reporting process, "some of the smaller REITs are ready to throw in the towel, and the cost efficiencies of a merger will help tip the balance."

And although both advisors and managers agree that the costs that were incurred during the learning curve of the last 12 months to 18 months were higher than they will be going forward, any drop will be negligible.

Hughes adds that the initial uncertainty surrounding SOX has eased, giving way to a sense of acceptance that is sweeping through the industry. The SOX compliance dance "will ultimately become an unpleasant part of the routine."