Funding Real Estate Development: Real Estate Investment Trusts WB/IFC Housing Finance Conference Washington, D.C. March 15 – 17, 2006 Michael Bookstaber

What is a REIT (1) ? An Investment Club Needing cash in big, irregular increments, not a steady stream of cash flow Can be open ended or closed ended Vertically integrated: property development, property management, and portfolio Sources of Funds: Capital markets, equity subscriptions Private investors Little or no debt (“equity” REITs) Uses of Funds: Buys land and develops projects, rents out units Expenses in staff costs are minimal Expenses for property management are incremental costs to the hard asset. March 2006

What is a REIT (2) ? The balance sheet consists of Investment in developed properties on the asset side, and Equity capital on the liability side Profitability, measured by two items: Cashflow from operations: equals….rents less: (a) cost of property maintence. (b) payments on any mortgage debt, (c) staff expense Gains from sales of (matured) properties Staff costs are minimal because REITs outsource many key functions: property maintenance, project management of development of new properties Property management function is highly leveraged, similar to mortgage loan servicing As a result, REITs don’t need to retain “earnings”, they do need access to large pools of cash on an intermittent basis March 2006

The Disconnect Mortgage finance and property development are out of synch: Developers not producing due to lack of long term mortgage takeout Lack of Affordable and Bankable Housing Solutions (supply/demand imbalance) Mortgage markets are under-developed due to scarcity of housing stock March 2006

The Need Investment in real estate development Capital is needed for Needs patient, long-term capital Can be highly risky, calling for equity-like returns Requires a focus on property type to leverage experience and expertise of management Capital is needed for Land acquisition Land development Funding soft costs In-site infrastructure These expenses typically comprise 35 to 50 percent of total project costs March 2006

The Projects Large scale, expensive to execute Commercial income-producing properties Residential, community format Large scale projects (1,000 housing units or more) delivered in rational production stages Achieve economies of scale Utilize mass production techniques Spread cost of infrastructure over many housing units, financed in the mortgage World class urban design, incorporating mix of housing styles and options, mix of socio-economic groups, providing for quality of life amenities, green areas, recreation and community facilities, retail and commercial spaces Ongoing support services will be incorporated into each project: Waste management, Maintenance of common areas, security CONCLUSION: Value of housing will be perserved and enhanced by design and urban planning, ensuring good storehouse of value for lenders and homeowners (avoiding the creation of future slums) March 2006

The Problem Investment vehicles to effectively fund and manage projects are typically not available in developing markets. Why? Absence of long-term capital Governmental investment in urban planning and in big-ticket infrastructure is often lacking in developing markets Nascent equity markets Reluctance to use tax policy to foster investment March 2006

The Solution Real Estate Investment Trusts (REITs, USA-style) Attract long-term, patient capital Offer specialization by property type Offer development and on-going management Tax pass-through feature offers dividend-like returns to investors and equity-like upside of a medium to long-term horizon Attract investors who need current income and can shelter it for tax purposes Attract total return investors who benefit from upside stemming from turnover of value-enhanced properties March 2006

The REIT World The REIT concept is gaining acceptance around the world, in many developed countries, but also some emerging markets…. Country Year Introduced Asia-Pacific Australia 1971 Hong Kong 2003 Japan 2000 Korea 2001 Malaysia Late 1980’s Singapore 2002 Taiwan Latin America Mexico 2004 Brazil 1993 Country Year Introduced Europe Belgium 1995 France 2003 Germany 2006 Italy 1994 Luxembourg 1988 Netherlands 1969 Spain United Kingdom North America Canada United States 1960 March 2006

The Rationale Why are REITs the right investment vehicle for real estate development? PRINCIPLE ONE: Value enhancement comes from refurbishing old properties or creating new properties, and managing either until cash flow is established. PRINCIPLE TWO: Dividend yield from REITs is a payout of current cash flow, which does not need to be retained. maintenance of properties is an expense item offsetting rental income cash from creation of new properties is obtained from selling mature properties in portfolio or raising new equity from investors. CONCLUSION: Fixed income and medium to long-term upside combine to give investors a unique total return package, WHICH IS A GOOD PROXY FOR DIRECT INVESTMENT IN REAL ESTATE March 2006

The Risk Real estate development can be risky, yet REITs can offer risk mitigating features: Equity REITS use little or no debt, except for construction finance Focus on property type, leveraging management experience and expertise Diversification in funding sources stemming from either: pooled investment from a closed group of investors sale of stock to many, diverse individual shareholders Diversification in multiple property investments Income is generated from income produced via rents, fees from management of properties, and capital appreciation of properties March 2006

The Tax Angle Under U.S. REIT law: Payment of tax on REIT net earnings occurs only once, at the shareholder level, not at the corporate level… …provided that the REIT distributes at least 90 percent of its net income in dividends to shareholders. How critical is this tax “break” to the successful use of REITs as investment vehicles for real estate development? March 2006

The Tax “Break” Value WITH THE TAX “BREAK”… Pension funds (not taxable) can boost their investment yields using REITs. Real estate development thus draws on a significant pool of long-term investment funds Listed REITs add additional value of liquidity, thus becoming a form of securitized real estate. Their trading value is determined by dividend yield. REITs represent an efficient use of capital by taxing returns only once earnings from investment in income-producing properties is recycled immediately, not warehoused for new projects. March 2006

The Tax “Break” Value WITHOUT THE “TAX BREAK”… Encourages short term holdings in long-term assets. Encourages property development and divestiture before properties have matured, or before they have started to generate income. Long-term investors are disuaded from participating due to quick property turnover REITs of this type will undertake more risky investments, stemming from quick turnover. March 2006