1. Property Companies and REITs: Real Estate in the Public Markets
Colin Lizieri

2. Market Types Public Markets: Generally single central market place
Regulated order processing systems
Price and deal transparency
Liquidity
Market makers / brokers role defined
Market makers limited impact on prices?
Private Markets
Generally no central market place
Highly restricted transparency and info.
Asymmetric information?
Market maker, broker role self-defined
Market makers may influence prices

3. Equity Markets Generally public markets
Regular price, volume, performance data
Brokers, market makers and orders
For firms:
Raise capital: initial public offering and seasoned offerings
Benchmark on market views of firm’s activity
For investors
Income (dividends) plus capital growth
Liquidity and portfolio rebalancing
Ownership of (residual) asset base
Risk and volatility

4. Equity Market Pricing Homogenous products, supply, demand
Role of Players:
brokers, analysts, informed investors and noise traders
Pricing principles:
Investors want capital growth and income
Investors trade off risk against return
Pricing: Dividend discount model or Net Asset Value
Asset values and the Law of One Price
Risk return trade-off and Betas

5. Pricing in Public Markets - DDM
Dividend Discount Model:
Price represents discounted value of future income stream:
P0 = D1/(1+r) + D2/(1+r)2 + D3/(1+r)3 + … Dn/(1+r)n + …
Assume that dividends grow at g% per annum, then
P0 = D1 / (r-g)
The dividend yield d = (r-g) = D1 / P0
We can observe the dividend yield
If we know or can estimate g then we can find required return r
If we know or can estimate r, then we have market’s view of g

6. Pricing in Public Markets: NAV
There are various claims on the value of the firm
The equity holders stand behind:
The debt holders
The government
Preference shareholders etc.
The equity holders own the “residual value of the company”
Take a property company with a simple structure
The assets are the real estate
There is debt to be paid
Property Values – Liabilities = Net Asset Value
NAV / Number of Shares = NAV per share
Shouldn’t that be the share price? If not, why not?

7. Real Estate in Public and Private Markets
Real Estate in Private Markets
Direct ownership of portfolios
Investing in private real estate vehicles and funds
No central market place
Information asymmetry, transparency, illiquidity
High transaction costs, monitoring costs, management costs
Real Estate in Public Markets
Property companies and REITs
Exchange traded fund vehicles
Liquidity, price transparency, transaction costs
Volatility and correlation
But … Are Public Vehicles Real Estate Investments?

8. Property Companies vs. REITs
Corporate Entities – Taxable
Management Control over Activity
Gearing, non-core activities, disposal and acquisition
Dividend policy and retained earnings
REITs
Regulations on Activities and Structure
Core real estate activity
Borrowing restrictions (?)
Distribution policy
Ownership rules
Real Estate Income not taxed within the vehicle

9. Example: UK Property Companies to 2006
Closed End Investment Vehicles
Taxable corporate entities
Distinguish between:
Property Investment Companies
Property Developer-Trader Companies
Often relatively low free-float
Often relatively high management holdings
Sector was shrinking with major players delisting or restructuring,
Growth potential with arrival of REITs

10. Real Estate in the UK Equity Market
As at December 2006
43 UK Listed Companies, Market Cap £54.1bn
Represents just 2.86% of total market cap
Major firms:
Land Securities (34) £10.8bn
British Land (39) £8.9bn
Liberty International (66) £5.1bn
Hammerson (77) £4.5bn
Slough (87) £3.7bn
Brixton (160) £1.5bn Top Six = 64% market cap
Helical Bar (353) £0.4bn
Development Securities (441) £0.3bn
A Reminder of Scale:
Royal Dutch Shell (1) £117.1bn
BP (2) £110.8bn
HSBC (3) £106.8bn
Glaxo (4) £78.1bn
Vodafone (5) £74.4bn

11. Performance 1988-2006 Equities Bonds Prop Co Mean 2.96% 2.15% 3.20%
Equities
Bonds
Prop Co
Mean
2.96%
2.15%
3.20%
Compound
2.68%
2.12%
2.70%
St Dev
7.48%
2.56%
10.02%
Skew
-0.626
-0.182
-0.378

12. But Are They Property Investments?
Equities
Bonds
Prop Co
IPD
Mean
2.96%
2.15%
3.20%
2.75%
Compound
2.68%
2.12%
2.70%
2.72%
St Dev
7.48%
2.56%
10.02%
2.27%
Skew
-0.626
-0.182
-0.378
0.180

13. But Are They Property Investments?
Stronger Correlation with Equity than Underlying Property?
Equities
Bonds
Prop Co
IPD
1.000
0.051
0.630
0.018
0.058
-0.172
0.227

14. Is This Just a Measurement Issue?
Property Market Returns are Valuation Based
May Lag Market Movements – Distorts Correlation
May Be “Smoothed” – Understates the Volatility
“Desmoothing” Procedures
Remove the Impact of Valuations in Data
Property Company Returns
Are Affected by Gearing
Are Affected by Overall Market Movements and Noise

15. Desmoothing the Index Should be no “memory” in the market
However, valuers actually adjust their prior valuation
Reported return is a blend of “true” and previous return
Rvt = a Rvt-1 + (1-a)Rt
Therefore Rt = {Rvt - a Rvt-1 } / (1-a)
where a is the “smoothing parameter”
Prop Co
IPD
Desmoothed
Mean
3.20%
2.75%
2.65%
Compound
2.70%
2.72%
2.53%
St Dev
10.02%
2.27%
5.06%
Skew
-0.378
0.180
0.724

16. Desmoothing in Action

17. Lagging and Correlation
Correlations:
Property Companies with:
Quarter
IPD
Desmoothed
0.227
0.326 1
0.434
0.492 2
0.531
0.359 3
0.460
0.068 4
0.409
0.093

18. Net Asset Value Fixed Assets Properties 10,000,000 Other 1,000,000
11,000,000
Current Assets:
Trading Prop 2,000,000
Debtors ,000
Cash ,000
3,000,000
Less Creditors due < 1 Yr 2,000,000
TOTAL CURRENT ASSETS 12,000,000
Less Creditors due > 1 Yr 3,000,000
Book Value, Shareholders (+NAV) 9,000,000
3,000,000 ordinary shares issued
NAV per share p

19. Discount to NAV Discount / Premium to NAV = (P – NAV) / NAV
NAV = 300 Price = 225 so ( )/300 = = 25% discount
Why Might Property Companies Trade at a Discount?
Tax - partic. Capital Gains Tax - liability
Uncertainty as to true NAV;
Minority holdings, control, agency issues
Liquidity and loss on forced sale
Risk: gearing and volatility; off balance sheet commitments
Noise traders
Pricing inefficiency?
In long run, Property Companies behave like underlying market

20. Double Taxation Own Shares in Property Company or Own Real Estate?
Tax Position: Own the Real Estate
Receive rental income, deduct costs: tax liability
Trade property at profit, pay capital gains tax
Tax Position: Shares in Property Company
Company rental income, less costs gives tax liability
Pays tax, distributes dividend to shareholder
Dividend taxable for shareholder
Company sells property, makes capital gain, pays tax
Investor sells shares, makes capital gain, pays tax
This Tax Leakage Leads to Demand for REITs

21. Real Estate Investment Trusts
REITs

22. Tax Efficient Real Estate Vehicles n. b
Tax Efficient Real Estate Vehicles n.b. some of these are offshore vehicles or pending final approval
Russia: CEMF
Netherlands: FBI
Belgium: SICAFI
Germany: OEFs, GREIT
UK REIT
Canada: REIT
Japan: J-REIT
France: SIIC
Italy: SIIQ
US: REIT
Korea: K-REIT
Mexico: REIT-FI
Malaysia: REIT
Singapore: S-REIT
Brazil, FII
South Africa: PUT
Australia: LPT
Source: adapted from Emmott (2004), NAREIT (2005)

23. US Real Estate Investment Trusts
Created in 1960s to allow smaller investors to participate in property markets
Tax neutral vehicles provided meet qualification rules:
Shareholder base: minimum of 100 shareholders
Limited insider dominance: maximum of 50% shares held by largest five shareholders
Asset test: at least 75% of total assets in real estate assets, cash or government securities
no more than 25% of assets may be represented by securities other than government securities
no more than 20% of assets within Taxable REIT Subsidiaries
Income test: at least 75% of gross income from rents of real property, interest on mortgages, gains on sales of property and dividends from REITs

24. The Growth of REITs

25. REITs Listed: Growth and Consolidation

26. The Growth of REITs From <$6bn 1990 to >$400bn end 2006
Based on series of liberalisation measures
Liberalisation in 1980s to solve real estate debt crisis
Early 1990s – creation of UPREIT structure
REIT Simplification Act, 1997
REIT Modernization Act, 1999
Key probably the UPREIT structure
Private investors can transfer assets into REIT
Investors get shares in return
Does not trigger capital gains tax event until shares sold
Allows orderly transfer into public markets

27. Some Myths and REITs: Diversification but not Real Estate?
Sources: NAREIT, NCREIT, DataStream

28. REIT Performance in Context
REITs
Direct
Equities
1.000
0.058
0.473
0.016

29. Some Myths and REITs: Discount to Net Asset Value
Traded Property Companies trade at discount to NAV
Alleged that REITs do not (e.g. by EPRA)
SIICs had very low discounts to NAV post-conversion
But UK REITs now trade at sharp discount to NAV
But:
How much is a tax effect?
US REITs DO NOT publish NAV
Analysts estimate NAV from income
May use discount rates higher than market cap rates.
May thus be an overstating of the benefits

30. REITs – Discount/Premium to NAV
Source: Green Street Advisors, 2005
Green Street estimate NAV from cashflow and cap rate figures.
REITs trade at times at substantial discounts to estimated NAV
However, they also trade at a premium at times.

31. Some Myths and REITs: Liquidity
REITs are supposed to remove illiquidity as a negative factor damping investment
Listed vehicles are more liquid than private vehicles
Turnover: IPD 15%, Property Co. 61% (IPF Liquidity Report)
Tradable transparent public market
Low transaction costs, lower information costs
But … REITs may be less Liquid than Property Companies
Property Companies 61%
REITs 22%
LPTs 21%
(IPF Liquidity Report, data for )

32. Australian Listed Property Trusts
A Tax-Transparent Trust Vehicle for Commercial Real Estate
LPTs take off in the 1990s, retail and institutional sales
Major market players (Lend Lease, AMP, ING, MacQuarie, DeutscheBank)
Come to dominate market: low cost of capital gives buying power
Now expanding outside Australia
Asian markets
USA
UK – e.g. Westfield, Lend Lease & UK shopping centres
Mainland Europe

33. LPT Performance
Direct
LPTs
Equities
1.000
-0.221
-0.101
0.618

34. SIICs Sociétés d’Investissements Immobiliers Cotées - French REIT
Note legislative process and speed:
Process begins 2001 with Industry working party
Opportunity with 2002 Presidential & General elections
Ministerial and political lobbying 2002
Placed in draft Finance Bill for 2003
Accounting and enabling legislation summer 2003
Passes into law end 2003
Many property companies transfer status early 2004
Further liberalisation 2004, 2006: UPREIT status?

35. SIICs - Structure Primary objective:
Construction or acquisition of income-producing property; or
Ownership of shares in companies with that objective
Must be traded on French exchange, minimum cap. €15million
Tax Exempt, provided:
Distribute 85% of net income to shareholders
Pay out 50% of cap gains within 2 years of realisation
Firms subject to an “exit” tax of 16.5% on unrealised capital gains, payable within four years of conversion

36. SIICs - Drivers Other competitor countries have REIT structures;
Much property investment going “offshore”;
Government needs cash – windfall €1.5 bn "exit" tax;
Expectation of tax from secondary trading;
Persistent discount to NAV for listed companies
Concern about pensions in France:
Switch to private from public system
Need for diversified portfolio / access to asset class
Capital issues:
Capital markets determine capital flows
Under Basel II, bank lending may be constrained

37. SIICs - Drivers Other competitor countries have REIT structures;
Much property investment going “offshore”;
Government needs cash – windfall €1.5 bn "exit" tax;
Expectation of tax from secondary trading;
Persistent discount to NAV for listed companies
Concern about pensions in France:
Switch to private from public system
Need for diversified portfolio / access to asset class
Capital issues:
Capital markets determine capital flows
Under Basel II, bank lending may be constrained

38. SIICs: Developments and Problems
SIIC II: an attempt to increase market size
UPREIT-like structure to permit inflow of assets
Relaxation of some of regulatory constraints
Corporate Float-Offs of Real Estate into SIICs
Tax and Ownership Problems
Tax issues for non-French investors
Limited control and ownership constraints
Metrovacesa – Gécina Deal
Metrovacesa (Spanish firm) buys controlling interest in French SIIC Gécina (€5.5bn deal, creating 2nd largest listed real estate fund in Europe)
Borrows money in Spain to finance the acquisition
Pays no tax on dividend payments from Gécina
Interest payments offset against profits to reduce tax bill

39. The UK REIT Industry has been seeking a REIT vehicle for many years
Pressure on Government and Treasury for change:
External – SIICs etc.
Capital Flow Offshore
Pensions issues – poor performance of equities etc.
Clear appetite for real estate: buy-to-let
Urban Task Force / Barker Report
Pre-budget announcement and Treasury Consultation Paper
Industry / interest group response
Positive noises but delays and the election cycle

40. The UK REIT, January 2007 Company and Listing Rules
Must be a closed ended company
Must be listed on main stock exchange (LSE not AIM)
Must have one class of (voting) shares
Must be resident in UK for tax purposes
Restrictions on large share-holdings (10% rule)
Activity Rules
Define a Tax Exempt Business (ring-fenced)
75% of firm’s profit from real estate (rents)
75% of firm’s assets = real estate
Must have three properties (not owner occupied)
Development activity OK for portfolio building (3 year rule)

41. The UK REIT, January 2007 Other Constraints and Rules
Gearing rule: Profit/Finance Costs  1.25
Conversion charge 2% of GAV – may be phased
Tax and Distribution
TEB not subject to corporation tax
90% of profit must be distributed as Property Investment Dividend (PID)
PID subject to withholding tax and treated as property income for shareholders
Capital allowances set against income in profits calculation
Cannot offset losses inside/outside TEB

42. UK REITs – Market Reaction

43. The UK REIT – Issues and Problems
Establishing a Critical Mass
Conversions of Property Companies
New entrants and listing requirements
The offshore industry and REITs
Specialist or Diversified Vehicles?
Professional versus retail investors
Investor interests versus management interests
Returns and Market Expectations
REITs as an income vehicle
Property values, yields and distributions
Growth, retained earnings and distributions
The state of the market and investor confidence

44. The G-REIT …
Must be public (German/EU) stock corporation, based in Germany
Minimum free float of 25%, 10% shareholder maximum
75% assets, 75% profits from real estate (residential restricted)
Must distribute 90% of distributable profits
Maximum 60% debt to asset value
Restrictions on trading
G-REIT exempt from corporation taxes
Investors fully taxable, withholding tax for non-domestic investors
Retroactive to January 2007?

45. Summing Up Listed Real Estate Offers Benefits:
Liquidity and Low Transaction Costs
Relatively Small Capital Requirement to Invest
Ability to Diversify Within and Across Countries
Listed Real Estate Has Disadvantages:
High Volatility Compared to Underlying
Higher Correlation with Equity than Real Estate market
Part of This is Measurement Issue
REITs Offer Advantages over Property Companies
Elimination of Double Taxation
Reduction of Discount to NAV Problem
Linked to Real Estate Market in Long-Run
Linked to Equity Market in Short-Run