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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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