By Phillip Britt and Matthew Bechard
Through global expansion and foreign adoption of
similar structures, REITs are going worldwide
While there remains ample room for domestic expansion of the publicly traded real estate industry, many observers point outside the U.S. as the place where we may see the focus on publicly trade real estate going forward. Changes in tax laws across the globe have made investing in U.S. REITs a viable alternative for foreign investors, and the high yields and solid returns have made them an attractive option as well. At the same time, an increasing number of countries are passing their own legislation creating indigenous REIT-like structures. The quest for new markets, a need to meet customer demands and a desire to bolster shareholder returns have led U.S. REITs to expand their portfolios into other countries.
While foreign investors have been attracted to U.S. real estate for some time, only a fraction of that capital has been allocated to U.S.-based REITs. Questions about the strength of the dollar as well as tax concerns are currently cited as the biggest impediments to foreign investment in U.S. real estate (see page 66 for more on foreign investment in U.S. REITs and a list of U.S. tax treaties).
| REITs Across the World |
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However, the international awareness of publicly traded real estate as a viable investment alternative is growing, thanks in no small part to the expansion of the REIT model across the globe.
"If we compare REIT markets today versus where they were just 10 years ago, you can see there's been quite a rapid proliferation of REIT markets around the world," says Scott Crowe, director, global real estate strategist with UBS Asset Management. "In fact, in the next five years you should see this accelerate even more. Markets such as Europe have already had the introduction of a REIT model via France, but we're also hoping that Germany, Italy and Spain will introduce such a model within the next three to five years, and the timing could be a lot quicker."
Crowe says the timing of the broader European addition of REITs will be driven by the success of the U.K. REIT model, which he expects to see finalized within the next 12 to 18 months.
Once these countries enact legislation, real estate companies are quick to avail themselves of the tax advantages. France, for example, had 10 firms elect status as Societes d'Investissements Immobiliers Cotees (the French REIT equivalent) in 2004, with more expected to follow suit once some of the young REITs became a little more time-tested, according to Les Loffman, national director of REIT services for Ernst & Young.
"The tax efficiency of REITs, and the premium that investors will pay for this tax efficiency, is pushing public real estate companies [ones that aren't REITs] in Europe to convert to REITs," says Jan Eckert, Ernst & Young real estate group partner based in Switzerland.
As corporations, foreign entities tend to pay much higher taxes than they do as REITs, Loffman points out. In France, for example, a firm would pay a 33 percent tax on annual earnings. As a REIT, the entity wouldn't pay that tax, though it would have to pay a 16.5 percent conversion fee—half of the typical corporate tax.
Additionally, the entity in some countries (e.g., France) can pay the exit fee over a period of years, rather than all at one time. After paying the fee, the entity no longer has to pay the annual tax as long as it distributes the threshold amount to its shareholders, typically 85 percent to 90 percent, depending on the country.
There have also been some preliminary discussions about a "Euro-REIT" that would be a transcontinental entity. For such a REIT to become a reality, however, European Commission directives must be approved. These directives require unanimous approval. Even with the approval, the directives may be difficult to incorporate into national laws. Each country has established its own rules for REIT qualification. The Netherlands, like the U.S., has rules concerning the minimum number of REIT shareholders and the maximum number of shares any one shareholder can own, Eckert points out. Belgium and France don't have such rules.
REIT proliferation is by no means limited to Europe. In fact, about 65 percent of listed real estate globally is in a REIT structure, Crowe says. More than 20 countries currently have some form of established REIT-like structure, according to Ernst & Young (for a complete list of the international tax treatment of REITs visit www.realestateportfolio.com). Singapore authorized REITs in 1998, but the first one wasn't listed until 2002. Puerto Rico amended its earlier REIT rules in 2000. Korea started authorizing REITs in 2001. Hong Kong drafted its rules in 2003. Other countries are expected to follow suit.
Kenneth Campbell, managing director with ING Clarion Real Estate Securities, points to Australia and its listed property trusts (LPTs) as a case study for the viability of publicly traded real estate outside of the U.S. Australia also happens to be home to one of the world's largest real estate companies and most significant international operators, Westfield Group (ASX: WDC).
"The LPT vehicle, which is very closely modeled to the U.S. REIT vehicle, has been around for roughly 30 years but has only taken off in the last 10 years. So, LPTs have had a similar history as the U.S. taking a while to get the investor community comfortable with the investment."
On the other hand, the effective ban on Japanese REITs was lifted in late 2000 with the first two companies going public in September 2001. Since then, roughly a dozen other J-REITs have gone public and Japanese investors have embraced them for their relatively high yields,
according Steve Burton, director at ING Clarion Real Estate
Securities. The industry's market cap has gone from nothing to $15 billion in three years, Campbell adds.
Drawing Shareholder Interest
It is important to note when looking at the global landscape that there is no one single definition of a REIT, Crowe says. REITs differ from country to country in terms of their ownership, dividend distribution and other requirements. In fact, a foreign REIT may look quite different from a U.S. REIT.
In France, for example, at least 85 percent of the income must be distributed annually; the company must be listed on the country's regulated market, and must have at least 15 million euros in market capitalization, but there are few other rules for the organizational structure. In Hong Kong, a REIT must be structured in the form of a trust; can't own real estate outside of Hong Kong; must appoint an independent trustee, an "acceptable management company and an independent property valuer; must hold real estate for at least two years unless otherwise approved by unitholders; and must abide by other rules for organizational structure."
However, despite their structural differences these companies have one common mission: to provide a return to shareholders that is not too dissimilar to underlying real estate in the sense that if you include it in your portfolio, it provides levels of diversification, income and relative capital stability, Crowe says.
"The proliferation of REIT markets is very important and goes hand-in-hand with the globalization of our sector," Crowe says. "If we have this consistent, transparent framework around the world, it makes the whole idea of taking advantage of the global opportunity much more feasible." Investment in global real estate companies is also aided by the creation of global indices like the EPRA/NAREIT Global Index (see article).
An increasing number of investors, including individuals, pension funds, opportunity funds, and institutional interests are seeking real estate opportunities in regional (e.g., Europe) or global markets. The new REITs are drawing investors from inside their native countries as well as from across the border and overseas, says Jan Karel Weststrate, Ernst & Young senior manager for international tax services.
"Diversification is one of the main arguments for going global, and real estate represents very strong diversification benefits if you invest outside of your own markets. What you can see is the persistently low correlation between regions for real estate, and what's driving that is the fact that real estate is a local business," Crowe says. "But the benefit for the investor is a very strong increase in risk-adjusted returns by investing outside of one's own market."
Investors are also drawn to the higher yields paid by U.S. REITs and their international counterparts. As the world's population ages, the search for retirement income increases and REITs meet that growing need, Campbell says.
"It is really a worldwide demographic trend, Campbell says. "If the population is getting older and wants to retire and earn the extra money, governments become responsive to that as a need and that helps spread legalization of the pass-through, tax-efficient structure."
The change in tax laws in many nations may mean that REITs, like corporations, financial services companies and other entities before them, will become worldwide concerns rather than single-country entities. Globalization may also enable REIT operators and investors to take advantage of strengths of different economies and different currencies. However, certain jurisdictions, like Hong Kong, require that the REITs be domiciled in country. Other jurisdictions have no such restrictions.
U.S. Firms Take Notice
An increasing number of U.S. REITs in a variety of property sectors are expanding their holdings internationally for reasons having little to do with non-U.S. REITs. While most U.S. REITs are still finding growth opportunities domestically, more executives are exploring what advantages could be had outside their traditional borders.
Outlet mall owner Chelsea Property Group, Inc. earned a reputation as one of the most aggressive U.S. REITs on the international market. Its international portfolio and expertise overseas was one of the compelling reasons behind Simon Property Group's decision to acquire Chelsea in 2004. Industrial REITs AMB Property Corporation (NYSE: AMB) and ProLogis (NYSE: PLD) have expanded internationally to meet the needs of their customers.
International expansion seems to be a logical step for those companies that can rationalize the move and produce the necessary returns while preserving shareholder value. It helps if the property type is not a commodity in the particular region or country—which has limited the global push of most office and hotel companies. Because real estate is at its core a locally oriented business, companies need to be sure they have a knowledgeable team with local ties or experience to have the best chance for success.
For example, W.P. Carey & Co. LLC (NYSE: WPC) formed an international subsidiary in 1998, with the first international deal not coming until 2001. It took a few years for the first deal as W.P. Carey learned the new markets, customs, currencies and legal framework, says Ed LaPuma, managing director and chief investment officer for W.P. Carey's international subsidiary.
The increasing number of REITs and other public real estate companies on the worldwide market is a double-edged sword for U.S. entities, according to LaPuma. At the end of August, there were roughly two-dozen countries with a REIT structure in place or under serious consideration, according to Ernst & Young. The more foreign-based companies that establish REITs legitimizes this form of ownership in the eyes of investors, LaPuma explains. However, he says the increasing number of REITs also means more competition for real estate assets and investment capital.
One advantage for the more-established U.S. REITs is the relative inexperience of the managers of the new foreign REITs operating on a global scale, LaPuma says. They are going through the same learning curve that W.P. Carey experienced when it started its international subsidiary.
Loffman agrees that the first years could pose some challenges for foreign REITs, pointing out that many of the REITs in other countries are structured like many of the early REITs in the U.S.—with property ownership and management not under one roof. Property management of U.S. REITs now tends to be handled by REIT employees due to better efficiency. Yet it wasn't until the 1990s that U.S. REITs moved in this direction, some 30 years after the initial U.S. REIT authorization rules. Therefore, Loffman expects it to be a while before non-U.S. REITs head in that direction.
"You have to walk before you can run," Loffman says.
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