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1 Tony Milton MRICS & APREA (CREIF) & SeekingAlpha
An introduction to REITs (Real Estate Investment Trusts); Examination of their advantages / disadvantages; Look at their growth across Asia & globally; and Tony Milton MRICS & APREA (CREIF) & SeekingAlpha

2 General Information Object: To make REIT investment as attractive as private, direct ownership, most jurisdictions allow RIETs to be structured as tax free vehicles to avoid double taxation: firstly on Corporation Tax at the REIT level; and secondly on the dividends at an individual level. Originally, REITs were set up as passive vehicles: externally advised; no development; and generally restrictive in permissible activities. As time passed, many of these features were seen to be less beneficial to investors than originally thought, and many were subsequently relaxed. Governments have to encourage developers to transform into and / or sell to REITs by acknowledging that they would be reluctant to do so, if faced with huge capital gains tax bills. Developers “have their hands-tied” given the restrictions on development and leverage, so it is common for Asian REITs to be ‘sponsored’ eg CapitaLand; Mapletree; Lippo; Lotte; Banyan Tree.

3 Number of USA REITs

4 Market Capitalisation of USA REITs

5 Not All REITs are the Same
Before 2000 REITs had a very limited presence (in around 9 countries), but since then over 25 others (many in AsiaPac) have adopted REIT or REIT like structures. Most REIT structures are similar, but differences include: Tax eg Hong Kong which is tax-free anyway (which has acted as a disincentive to developers in REIT conversion). Debt levels eg Australia & Japan don’t have any. Restrict the level of development activities (typically to 10% of asset value). Accounting treatment ie as fixed assets with depreciation, or to IFRS without depreciation but regular revaluation (and consequently higher distributable incomes). Externally, independently managed. Concerning payment of management fees in units ie increasing distributable income.

6 REITs are sometimes marketed as bond-like vehicles REITs are sometimes marketed as bond-like vehicles Because of their stable cash position and generally more conservative investment policies. However, this is a feature of the underlying business and not the legal relations between the investors and the business entity (the REIT). Investors are investors in the equity tranche of a living business entity, and thus, they are exposed to up and downside risk like any other stock owners.

7 The 3 crucial misconceptions about REITs
Sometimes marketed as bond-like vehicles (see above). REITs are sometimes thought of as being highly correlated to the equity markets, but are infact a non-correlating asset class that do not move in step with stock markets, which is important for portfolio construction. In smaller markets there maybe some correlation eg between Hong Kong & Singapore, but this is less so for Japan and only slightly so in Australia. The correlation can be explained by the impact major developers can have on smaller countries broader economies ie real estate news can drive movements in the wider market. Nonetheless, REITs are a component of the equity market, so tend to correlate with the broader equity market, not with bonds. Asian real estate markets are sometimes thought of as being highly correlated to one another. With the exception of Hong Kong and Singapore, research has shown only “moderate” correlation, because local supply & demand factors are much more important.

8 Advantage No.1: Liquidity
A defining characteristic - public equity markets provide a high level of liquidity, distinguishing REITs from the relative illiquidity of the properties they own. This distinction is fundamental, as it enables investors to efficiently access and manage their capital; obtain daily market-cleared prices; and adjust their investment allocations to take advantage of attractive opportunities. Consequently, REITs provide a liquid vehicle for investing in real estate (an inherently illiquid asset class). Note – this is a major disadvantage of private / non-traded REITs in the US and elsewhere.

9 Advantage No.2: Transparency
Another defining attribute for REITs is transparency. REITs are subject to the discipline and regulations of public markets (or corporate governance), including audited financial statements & oversight by a board of directors (or trustees). Direct real estate investments generally do not offer the same transparency or governance standards, especially in global markets. But, some say that it’s a very short stretch indeed to imagine that a corporate administrator might be unethical, incompetent, or charge outrageous fees.

10 Advantage No.3: Management
A third defining characteristic for REITs is value creation by management. REIT management teams pursue acquisitions, dispositions and development activities, which have the potential to add value for shareholders beyond the companies' real estate holdings. These management teams can add value beyond that of their property assets by enhancing operating efficiencies. Managements can also drive value creation through effective capital allocation as they access capital through public markets or make accretive acquisitions.

11 Advantage No.4: Diversification
A fourth defining attribute for REITs is diversification by sector, property type, and geography. A portfolio of REITs may represent thousands of properties around the world, making it possible to diversify assets across geographic regions and property sectors. This diversification can help reduce risk at the property level, while providing access to a wide range of property markets with different return profiles & cycles. If recent markets have taught us one thing, it's that diversification really matters. By having a diversified asset base, investors can mitigate potential risks. Furthermore, by investing in an actively managed portfolio of real estate securities, investors may benefit from the insights of professional asset managers, who can adjust a portfolio's allocation based on their view of the risks and opportunities offered by various securities and market segments.

12 Advantage No.4: Diversification – cont’d
REITs now include agricultural land & plantations, prisons, solar power & data-storage facilities, student & social / manufactured housing (trailer parks), kindergartens, and even casinos! Some people are predicting REIT status applied to companies who develop landfills, roads, railroads, mines, and vineyards because the rule could be applied to any company which has immovable objects used in generating income. If this trend is allowed to continue, corporations like MacDonalds and Wendy’s could also register as REITs to avoid paying corporate tax. (See “Sector Info” page on REITinfo).

13 USA REITs by Sector

14 Advantage No.5: Strong Total Returns
A fifth defining attribute for REITs is the strong historical total returns compared with non-REITs. REITs have consistently produced strong returns relative to other equities and fixed-income securities, benefiting from a business model focused on generating consistent and growing cash-flows. As an investment in tangible assets, REITs also benefit from barriers to competition and property values that tend to rise with inflation. Real estate provides insurance against broader stock market movements, including those in the utilities, oil & gas, and consumer staples sectors. Historically (and outside of ), real estate has continued to perform and pay out income to investors, even when there are macroeconomic shocks to the market that impact these other sectors.

15 Advantage No.5: Strong Total Returns – cont’d
REITs have outperformed stocks and bonds in both the US and global markets during the modern REIT era. Going back even further, we see that US REITs have maintained their overall performance advantage over multiple decades. The FTSE NAREIT US Real Estate index of REITs outperformed the Standard & Poor's 500 index of stocks by an average of more than 6% points a year in 2009 through But REIT returns fell slightly more than stock returns in the financial crisis of 2008. In the last 10 years, REITs have done a better job protecting wealth than commodities; REITs have delivered 3 times the returns that commodities have without adding extra volatility. REITs do particularly well when they grow dividends faster than the rate of inflation. This has been the case in 19 of the 25 years from , when dividends rose approx 5.7% annually. This goes against conventional wisdom, which says that REITs do poorly when rates rise, so it depends upon how fast a REIT can raise rents, which in turn drive its earnings and dividends. Similarly, again conversely, rising interest rates and / or inflation have helped REIT returns in the past.



18 Advantage No.6: Dividends
The sixth REIT attribute - dividends - is also arguably the most important because REITs generally have more stable / less volatile dividend streams than other sectors. Listed REITs are required to pay out at least 90% of taxable income as dividends, and the dividend yield on a REIT is thus a function of the rental income which can be achieved from the underlying properties. If the property manager is able to raise rents, the dividend yield could rise from present levels as more rental income is achieved. On the flipside, weak demand could see rental yields decline, hurting dividend yields of REITs. Some REITs have a history of consistently raising their dividends, resulting from cash-flow growth that can come organically from rising rents and occupancies, or externally from development and acquisitions.

19 Advantage No.6: Dividends – cont’d
Regular Dividends-REITs provide a consistent form of income for the investors in the form of dividends as most of the investments by REITs are based on long term lease agreements which increases the reliability. REIT shave been found to be paying more dividends than any of the stocks out there in the market in many countries. Much of REITs' returns come from dividends. REITs recently offered an average yield of about 3.5%. That compares quite favorably to the 2% yield for the S&P 500 and the 10-year Treasury yield of 1.6%. In a market starved for yield, the current average US REIT yields about 3.8% compared to 2% for the S&P 500 which is a strong incentive for investment.

20 Advantage No.6: Dividends – cont’d
Historically, US REITs have offered higher dividend yields than other equities with similar risk profiles. Over the past decade, the average dividend yield for US REITs has trended downward from the 8% seen in the late 1990s to below 4% today (as many of these companies have reduced payouts to the minimum level required by law).


22 Advantage No.6: Dividends – cont’d
As a result, a greater proportion of total returns have come from price appreciation in recent years. That said, US REIT dividend yields remain higher than the yields of most other equity and fixed-income asset classes.

23 Advantage No.7: No Corporate Income Tax
REITs do not have to pay Corporate Income Tax. Instead they are required to pay out 90% of their taxable incomes as dividends. As a result, REITs can provide higher returns than other corporations because they have more cash available for distribution.

24 Advantage No.8: Secure Investment
Since REITs manage tangible assets (like real estate & land), the investment is more secure. Commercial real estate is generally not oversupplied so when demand picks up, albeit slowly, real estate values should rise. Hence, REITs can be considered as extremely stable, because the value of underlying properties will keep on appreciating with time, even though the rate of growth might be slow.

25 Advantage No.9: Hedge Against Inflation
REITs stand up against inflation as a hedge against it, since property values will keep on appreciating with the passage of time.

26 Advantage No.10: Increases Interest & Raises Capital
Provides individuals with the ability to invest in commercial real estate. Even small amounts of money can be invested in real estate via REIT. Buying a real estate property directly would mean investing a huge sum into a single project whereby REIT enables group buying which reduces the risks involved. Can help countries like Vietnam, India, the Philippines and China attract international finance to the real estate sector, which are otherwise closed or almost uninvestable to all but huge developers.

27 Disadvantages of REITs
REITs have become “grossly” overvalued: Choosing a good REIT is similar to looking for the nicest horse in a glue factory.

28 Disadvantages of REITs – Cont’d
The strong recent performance has resulted in more expensive valuations for the sector, which is being driven by an insatiable thirst for yield in the present low-interest rate environment. REITs outperformed stocks easily in the years before the crisis and in the four years since, as the FTSE NAREIT index has soared by over 300%, more than doubling the S&P 500’s gains of 141%. Japanese investors (in particular) have been piling into US REITs to take advantage of the extreme yield differentials as that country is using low rates to attempt to stimulate the economy. In addition to the dividends, however, the Japanese funds are also paying out appreciation, including unrealized gains. If the growth in REIT share prices begins to moderate, these funds will have to start selling shares to maintain their payouts and this could pressure prices as they own billions of US REIT securities.

29 Disadvantages of REITs – Cont’d
FFO measures a REIT's cash flow and REITs are currently traded at about 21.6 times their adjusted funds from operations, or FFO -- well above the 14.3 percent average of the last 13 years (and compared against P/Es of about 20 for P&G and Unilever). Note – Simon Property Group’s P/E is about 40, and American Tower’s 45. Institutions own more than 95% of the shares (including about 10% by the Japanese). When REITs eventually fall out of favor, the exit door will be very crowded. For the past 5+ years, REITs enjoyed extremely low borrowing costs. But since rates can't go LOWER than zero, there's limited upside for REITs. When (not if!) interest rates rise, REITs will have a hard time refinancing. Real Estate Investment Trusts (REITs) could soon turn from income investor darling to toxic portfolio sludge.

30 Disadvantages of REITs – Cont’d
Higher interest rates = higher cost of debt Since REITs are usually 30-40% geared the increased borrowing costs will eat into earnings, cause lower distributions to shareholders and therefore lower market price (and some REITs may have to borrow money to pay distributions!). Historically speaking, the 10-year Treasury rate would have to rise nearly 2% points to reach the 4.64% average since For example, if you have a REIT share / unit that is $1 and pays $0.05 cents distribution it is a 5% yield. But if rates go to say 3-5% expect investors to demand a yield on REITs of say 6-10%, therefore that same REITs that still pays $0.05 will have to fall to $0.50-$0.80 to be attractive enough and compensate for the risk taken.

31 The Global Economy Facing 4 Potential 0utcomes
A return to healthy growth (in which case REIT incomes should rise); A low-growth, low-inflation period in the doldrums (in which case the income appeal of REITs should help); A return of rapid inflation (as a real asset, property should offer some protection and REITs offer property and leverage); A deflationary slump. Only in the last case would REITs property suffer. So, the greatest impacts will be due to: market sentiment; the value of the underlying real estate; management’s ability to raise leasing rates and control costs.

32 A look at REITs Growth Across Asia and Globally Over the Last Decade
The recent introduction of real estate investment trusts (REITs) in Ireland and South Africa has taken the number of countries offering the vehicles to 34 with an approx market capital capitalisation of USD$1.1trn. The Asian REIT market is poised for significant growth, despite the Market Cap of the sector having increased from about USD$2bn in 2001 to USD$50bn after 5 years, and USD$127bn now, between around 145 Asian-based REITs, which still only amounts to about 4% of investment grade stock and the lowest level of securitised real estate in the world. Hence, if this were to increase to 25% that would equate to a sectoral value well in excess of USD$500bn. Currently Japan & Singapore account for about 40% & 30% of the market: Japan has approx 35 REITs with a total Market Cap of USD$60bn; and Singapore 16 REITs with a market capitalization of USD$19.3bn (HK has about 7 valued at USD$8.8bn. The gross asset value of real estate in Africa is only €113bn or 1% of the world’s total value, despite the fact that the continent controls 15% of world population. REITs own around 15-20% of commercial real estate in the US.

33 A look at REITs Growth Across Asia and Globally Over the Last Decade
REITs are well placed to capitalize on changing demographics as the urban landscape develops and changes to meet the needs of growing populations, changing demographics, and expanding industry hubs. Residential - the rise in young and medium-to-high income populations has led to more demand in high-end apartments with more amenities, which command higher rents. Offices - businesses in urban areas are continually looking for the best office properties to encourage work production as well as retain and attract the best talent. Many of the biggest office towers and A-class commercial properties are owned by REITs. Retail & Leisure - urbanization creates the need for attractive shops and restaurants to serve these populations, as well as hotels for visitors from other cities. REITs own some of the best retail and hospitality space, with leading name brand anchor tenants.

34 Australia Australia introduced REIT legislation in 1971 via “Listed Property Trusts” / LPT (renamed Australian Real Estate Investment Trusts or A-REITs in 2008), which are allowed to hold property in or outside of Australia. Many carry out the management & marketing other related services (including some investment and / or development), directly as “Stapled REITs.” In the last 30yrs about 70% of Australian property has been securitised. In 1988 the government introduced the concept of “Responsible Entities” (RE) via the Managed Investments Act whereby a Trustee holds the assets “in trust” for investors / unit-holders, with a separate manager responsible for the operational performance.

35 Malaysia REIT legislation was initially introduced in 1986 with amendments to the Companies Act 1965 and the Securities Industry Act 1983 permitting listed registered property trusts, but it was not until the Securities Commission Guidelines on Real Estate Investment Trusts, and Guidelines on Islamic Real Estate Investment Trusts (Islamic REITs), in 2005 that the market developed. Islamic REITs are a first of their type and 'shariah-compliant' whereby the REITs cannot invest in casinos, etc. All Malaysian REITs must pay out at least 90% of their net profit to unit-holders to be exempt from taxation; invest at least 50% of assets in real estate (but no more than 25% in cash or other funds); are exempt from Stamp Duty; must have a trustee, and managers who are 'approved' companies; cannot sell more than 70% to foreigners, and the 'sponsor' cannot hold more than 70%; and have at least RM100m / $30m in assets. Foreigners must pay 20% with-holding tax, landlords who sell to listed REITS are exempt from Capital Gains Tax.

36 Singapore S-REIT were introduced in 2002 as Collective Investment Schemes or Business Trusts which must pay out net profit as dividends; hold at least 75% of assets in income-producing real estate (with no more than 10% of revenue coming from non-rental income); have at least 500 public shareholders that own a combined 25%; have at least S$1m in assets; be managed by an approved Trustee, and external Singapore based corporate manager. S-REITs are exempt from Stamp Duty, and foreign non-resident investors pay only 10% withholding tax on dividends.

37 Net asset (or book) value represents the value of the REIT’s underlying properties minus liabilities. A PB Ratio premium means that that are expectations of strong capital appreciation of the REIT’s underlying properties since the REITs are selling for more than what their underlying properties are worth, and is also a function of the premium investors are willing to pay for well-managed REITs which may have the ability to perform asset enhancements on existing properties.

38 S-REITs have delivered a strong 28% return including dividends (as at end-April 2013), and valuations have risen in tandem.

39 Hong Kong REIT legislation was announced in August Hong Kong is one of the most transparent but volatile stock exchanges in Asia, and the REIT regulations say that REITs must pay out at least 90% of their net profits to shareholders as dividends and own 3+ properties (which are not owner-occupied); hold at least 75% of their assets in real estate, government securities or cash; derive at least 75% of their income from rent, mortgages or property sales; not use more than 45% leverage (loan-to-value); engage in no more than 10% development work; and employ external property managers. They can invest overseas (obviously with an eye on the 'mainland'), and JV with others (so long as they have a controlling interest).

40 Taiwan T-REITs became legal in Taiwan wef July 2003 via the Real Estate Securitization Law in REITs can be public or private and investors only pay 6%-10% tax on a minimum investment of about NT10,000 / USD$350 to encourage small investors. Minimum initial capital ranges from NT$300m / USD$10m to NT$2bn / USD$65m depending on the scope of their plan, and they're prohibited from buying properties without that stable rental income. The trustee must be a publicly listed company, and can manage the properties or hire an outside management company. They are in effect closed end funds for real estate investment, because after the IPO they cannot raise funds by selling additional shares. The REIT must pays out at least 90% net income annually and at least 75% of the trust's assets must be in real estate assets. REITs can invest up to 20% of their assets in short term commercial paper, bank deposits, government bonds and such. The trustee may borrow up to 35% of the net value of the trust's assets. There should be at least 50 unit holders, a unit holder may now own over 50% of the REIT's units unless they are independent professional investors.

41 France French REITs were introduced in 2003 as Les Societes d'Investissements Immobilier Cotees / SIIC and must: pay out 85% of income; are exempt from taxes (including on the upto 15% of the income that is not distributed); must pay out 50% of their capital gains within 2 years (but don’t have to pay tax on the 50% balance); cannot be privately owned or have any one individual or corporate shareholder (or in co-operation with one another) owning more than 60% of the stock; must have at least Euro15m in capital; can (directly or via subsidiaries), engage in investment / development if the aim is to acquire building to lease (not tax exempt); can leverage up their borrowings as they are not subject to any formal gearing requirements; must have a “free float” of 15%+. Real estate companies which convert to REITs must pay 16.5% tax on unrealized capital gains. Foreign investors no longer need to establish and list a holding investment vehicle in France, but REITs must withhold 25% of distributions to foreign shareholders (often mitigated by double tax treaties

42 Japan J-REITs were introduced (principally) via the Law of Investment Trusts and Investment Companies (LITIC), which created 2 different legal systems for J-REITs: the Investment Corporation System; and the Investment Trust System. Although they may exist as either corporate or trust entities, the overwhelming majority operate under the former as SPIVs (Special Purpose Investment Vehicles). They must: pay out at least 90% of taxable income as dividends; hold at least 75% of assets in real estate or related instruments; hold at least 70% in direct real estate; have at least 50 shareholders; not allow the 3 largest shareholders to own over 50% nor the 10 largest shareholders to own over 75%; have at least ¥5bn/$65m in capital & ¥1bn/$12.5m equity; withhold 20% from distributions as tax; not develop properties nor have subsidiaries own over 50% of another company. A parent (sponsor) company and asset manager, establish an investment corporation can act as a fund (securitization) vehicle for the J-REIT. The Asset Management Companies perform the management & marketing, administration, although there is often a close link with the sponsor. J-REITs can own any type of commercial property; sell bonds to raise finance; and (since 2008) are able to invest outside Japan. There is no statutory gearing limit applicable to J-REITs. However, in practice a J-REITs Articles of Association usually contain a gearing limit of 55%-60%. Japanese law also allows for SPIVs to be established that deal in securitization.

43 UK The UK introduced REIT legislation in 2007 which requires that REITs must: distribute at least 90% of rental income (“Property Income Distributions”) to shareholders (to avoid Corporate Income Tax); ensure that they have 125% rental income cover to debt interest; companies changing to this business structure must pay a one-time tax to the government of 2% of their gross assets; ensure that 75%+ of assets are property investments; ensure that if / when they engage in property development, it is for long-term (3 years+) investment purposes. Tax exempt profits are required to be distributed are not necessarily a company’s accounting profits. HMRC requires various adjustments to be made including tax deductible allowances on qualifying capital spend. Dividends are paid as Property Income Distributions or PIDs, taxable as property letting income (for shareholders who are not tax exempt) but will be treated separately from any other property letting business which they may carry on. PID dividend payments must be paid after the deduction of Withholding Tax at the basic 20% rate (2012) which the REIT must pay directly to HMRC on behalf of the shareholder. UK companies, charities, local authorities, UK pension schemes, PEPs, ISAs and Child Trust Funds are able to claim exemption from deduction of the withholding tax and receive their dividends gross.

44 New Zealand Legislation has always allowed trusts governed by deeds, but it is the 'Special Partnerships' have long been attractive SPVs for foreigners, since they too are tax exempt. The introduction of Portfolio Investment Entities (PIE) in 2007, and Limited Partnerships (LP) in 2008, have further increased the number of tax advantageous investment vehicles, though non-residents must pay 30% withholding tax (NRWT) on distributions.

45 Thailand REIT-like legislation was introduced in 2010 via the Trust for Transactions in Capital Markets Act (2007), that superceded and expanded the scope of the Property Fund for Public Offering (PFPO) legislation of 2002, which was introduced to deal with the aftermath of the Asian Financial Crisis. A bespoke REIT law is long anticipated (and delayed). Legally, Thai REITs must: distribute at least 90% of the net profit; de closed-ended funds with a minimum capital of Baht 500m / about USD$16m; have at least 250 unit holders for an IPO; have no more than 33.33% of unit holders who are “related persons”; not allow developers or other sponsors or previous owners (or other such “related persons”), or institutional investors hold more than 33% of the total units; invest at least 75% of the net asset value in property; derive at least 75% from income from rentals; only invest in properties which are at least 80% complete. Foreigners- No Thai taxes are imposed on foreign individual unit holders on income or Capital Gains, as income is viewed as commercial income by the taxman and so not subject to Withholding Tax, when paid to an overseas beneficiary. There is no specific exemption but foreigners are literally and in practice “outside” the scope of the Thai tax regime. Locals- Locals face 10-37% Income Tax or can deduct 10% Withholding Tax as a “final levy”, and Capital Gains are tax-exempt.

46 South Africa & Ireland: since 2013
Others USA since 1960 South Africa & Ireland: since 2013 Note - China & India have assets listed in foreign REIT markets eg Singapore, Hong Kong, Japan.

47 How Much Real Estate Should I Hold In My Portfolio
How Much Real Estate Should I Hold In My Portfolio? (Assuming $100k initial investment using the FTSE NAREIT Composite US REIT Index)

48 Calculation of Fair Value

49 Questions & Answers

50 For More Info see
Tony Milton MRICS & APREA (CREIF) & SeekingAlpha

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