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

2. March 20062 What is a REIT (1) ?  An Investment Club Needing cash in big, irregular increments, not a steady stream of cash flow Needing cash in big, irregular increments, not a steady stream of cash flow Can be open ended or closed ended Can be open ended or closed ended Vertically integrated: property development, property management, and portfolio Vertically integrated: property development, property management, and portfolio  Sources of Funds: Capital markets, equity subscriptions Capital markets, equity subscriptions Private investors Private investors Little or no debt (“equity” REITs) Little or no debt (“equity” REITs)  Uses of Funds: Buys land and develops projects, rents out units Buys land and develops projects, rents out units Expenses in staff costs are minimal Expenses in staff costs are minimal Expenses for property management are incremental costs to the hard asset. Expenses for property management are incremental costs to the hard asset.

3. March 20063 What is a REIT (2) ?  The balance sheet consists of Investment in developed properties on the asset side, and Investment in developed properties on the asset side, and Equity capital on the liability side 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 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 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 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 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

4. March 20064 The Disconnect  Mortgage finance and property development are out of synch: Lack of Affordable and Bankable Housing Solutions (supply/demand imbalance) Mortgage markets are under-developed due to scarcity of housing stock Developers not producing due to lack of long term mortgage takeout

5. March 20065 The Need  Investment in real estate development Needs patient, long-term capital Needs patient, long-term capital Can be highly risky, calling for equity-like returns Can be highly risky, calling for equity-like returns Requires a focus on property type to leverage experience and expertise of management Requires a focus on property type to leverage experience and expertise of management  Capital is needed for Land acquisition Land acquisition Land development Land development Funding soft costs Funding soft costs In-site infrastructure In-site infrastructure These expenses typically comprise 35 to 50 percent of total project costs

6. March 20066 The Projects  Large scale, expensive to execute  Commercial income-producing properties  Residential, community format 1. Large scale projects (1,000 housing units or more) delivered in rational production stages a.Achieve economies of scale b.Utilize mass production techniques c.Spread cost of infrastructure over many housing units, financed in the mortgage 2. World class urban design, incorporating a.mix of housing styles and options, b.mix of socio-economic groups, c.providing for quality of life amenities, green areas, recreation and community facilities, d.retail and commercial spaces 3. 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)

7. March 20067 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

8. March 20068 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

9. March 20069 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 Australia1971 Hong Kong2003 Japan2000 Korea2001 MalaysiaLate 1980’s Singapore2002 Taiwan2003 Latin America Mexico2004 Brazil1993 Country Year Introduced Europe Belgium1995 France2003 Germany2006 Italy1994 Luxembourg1988 Netherlands1969 Spain1994 United Kingdom2006 North America Canada1994 United States1960

10. March 200610 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

11. March 200611 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

12. March 200612 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?

13. March 200613 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 by taxing returns only once earnings from investment in income-producing properties is recycled immediately, not warehoused for new projects. earnings from investment in income-producing properties is recycled immediately, not warehoused for new projects.

14. March 200614 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.