The economic impact of establishing a listed real estate industry

By Courtney Darby

REITs and their various international counterparts come in all shapes and sizes—from Australia's Listed Property Trusts (LPTs) to Japan's J-REITs—and all have faced their fair share of challenges. But what kind of mark have they made on their national economies and real estate markets? Portfolio talked with several leading international experts who discussed how countries have developed their respective REIT-like vehicles and the impact these vehicles have had on national economies and investors.

Any country looking to establish a securitized real estate industry via a REIT-like entity has hurdles to overcome, according to J.D. Sittons, client portfolio manager of REIT strategy for JP Morgan Securities, Inc. He says one of the greatest barriers is the conversion tax placed on companies converting to REITs. Depending on the country, the capital gains tax a prospective REIT must pay could itself discourage creation of the proposed REIT.

On top of varying tax issues, investor apprehension could be another factor. Michael Brooks, executive director of the Real Property Association of Canada (RealPac), says that investors in Canada initially were skeptical of real estate securities, particularly REITs.

"The public had a run of several Canadian corporations that made big mistakes. After that, investors were quite [sour] on real estate securities until about 1997," Brooks says. "However, once they realized that the CEO of a REIT can't bet the farm and has to answer to investors, [they saw REITs in a more positive light]."

Growth of Global REIT Markets Nearly all of the growth in the securitization of real estate assets i.e., listed real estate on the stock market) has been through REIT structures. The growth of the global REIT market is demonstrated below $U.S. billion.

Source: UBS, Thomson Financial Datastream

According to Brooks, once investors have warmed to REITs and the potential benefits they bring, the response can be tremendous.

"REITs have helped put the real estate market in stable hands [in Canada]. We haven't had a significant (real estate) bankruptcy in 15 years," Brooks says. "The majority of institutional-grade assets are in REITs or soon will be."

The equity market cap of Canadian REITs grew to more than $16 billion in 10 years, says Brooks. He also notes that the REIT market in Canada, as in the U.S. and other countries, has continually outperformed the broader public equity markets in recent years.

"The REIT market has been outperforming the overall Canadian Stock Exchange every year since 1995, with the exception of 2000 because of the dot-com era," Brooks says.

Economic Boost

Scott Crowe, director and global real estate strategist with UBS Asset Management, has also seen the benefit, particularly in newer Asian REIT markets.

"Japan's land prices were falling for the past 15 years, which has been both a symptom and a cause of a sluggish economy," Crowe says. "As part of restructuring the economy, the government introduced REITs four years ago. They've grown from nothing to a $25 billion market cap."

Japan's real estate market is seven times larger than it was three and a half years ago, and it has the potential to grow to $100 billion in the next six years, according to Crowe, much of which is credited to REITs.

"REITs have been a significant tool in restructuring the Japanese real estate market," Crowe says.

Crowe also says that Singapore's REIT market (S-REITs) is another positive example.

		Global REIT Comparison

"REITs in Singapore are quickly securitizing the domestic market and will buy up the real estate in no time," Crowe says. "Currently, S-REITs own 36 percent of the malls and 10 percent of industrial."

Another example is the successful Australian LPTs, which own nearly half of the real estate market in Australia. Similarly, the listed real estate market in France has increased by 50 percent since the introduction of SIICs (French REITs) in 2003, and the industry is expected to grow further. With the advent of new tax legislation establishing SIIC2, companies now are allowed to sell their real estate to SIICs in exchange for SIIC shares. By opting for this method, companies will only have to pay half of the capital gains tax liability. However, this option will only be available until 2007.

Other countries anticipate that some of the success of Australian LPTs, S-REITs and J-REITs will repeat with their own attempts to introduce REITs. "The German REIT is viewed as a panacea for the slow economic development of Germany's real estate markets, and I also think [the German REIT] is being used to mask the problems they have with open-end funds," European Investors Managing Director Jim Rehlaender says.

"The REIT structure will bring a highly transparent, well regulated concept to the marketplace, and be an economic benefit for the government as well as for the local population," Rehlaender says.

Richard Adler, managing director with European Investors, says the benefits from adopting a REIT structure go beyond those for a specific country and create broader advantages for real estate markets worldwide.

"If one country establishes a REIT it then creates pressure on neighboring countries to do so as well," Adler says. "Because REITs have had so much success in the U.S. and Australian economies, they provide an incentive for other countries to adopt the structure. When you have two highly visible, successful examples, it makes the benefits a lot clearer to those considering it."

Economic Issues

While REIT-like vehicles abroad, particularly in Asia, have done well so far, not everyone agrees that a REIT-like vehicle is the answer to all economic woes, or boosting the local real estate market.

"In Japan they are gung-ho on the REIT market, but real estate is not necessarily best held in the public market," says Susan Hudson-Wilson, founder of Property & Portfolio Research, Inc. She also says that a REIT-like vehicle is not the answer for all seasons and all countries.

"REITs are not a ubiquitous solution. It is just another way to raise capital," Hudson-Wilson says. "If you want alternative ways to raise capital, then REITs are one way to do that."

While Hudson-Wilson is not in favor of using REITs as a quick fix, she does see the benefits when they are implemented for the right reasons.

"REITs can provide more capital resources for real estate and enlarge access to real estate markets," Hudson-Wilson says. "You also increase the liquidity of the real estate market … and you've taken assets impossible for mere mortals to buy, placed those assets in companies whose shares are publicly traded, and thereby made it available to lots of different people."

Rehlaender says determining the specific economic impact of REIT structures is difficult, but the vehicles are attractive for other reasons. "The REIT has stimulated more capital flows into the markets where it's been introduced, but the impact it has on a local economy is hard to determine. What it definitely does is provide another outlet for governments and businesses to sell their real estate."

Dale Anne Reiss, global director of real estate, hospitality and construction for Ernst & Young, says that, although REITs are a sophisticated investment vehicle, they won't drastically change a local economy upon being introduced. "REITs are another form of holding real estate. To a certain extent that adds to the availability of real estate, but it's not going to change the world," Reiss says.

Despite that sentiment, JP Morgan's Sittons says that countries that have enacted tax transparent REIT legislation are seeing shares trade at premiums to underlying values of real estate. And, according to UBS, 75 percent of all listed real estate is held in the form of a REIT or REIT-like vehicle.

"Because the return profile of REITs is consistent with real estate, they tend to be priced at or above NAV," Crowe writes in UBS' July 13 "Global Real Estate Perspectives."

Growing Securitized Market

Additionally, nearly all the growth in the securitization of real estate equity has been through REIT-like vehicles.

"REITs provide an efficient substitute between direct and indirect real estate, while overcoming liquidity issues and widening the capital base," Crowe writes. "Given the development of new markets such as Japan and France, the introduction of new markets such as Hong Kong and potentially the U.K. and other continental European markets, we believe the growth of the global REIT market will continue."

UBS estimates that the listed real estate market cap will exceed $1 trillion over the next six to eight years, driven largely by $600 billion of developing REIT markets globally. In fact, it is estimated that only about 8 percent of available global real estate currently is owned by listed or publicly traded companies.

Investors increasingly are holding REITs or REIT-like vehicles as part of their real estate allocation. Currently, 15 percent of equity real estate allocations in the U.S. are in REITs, according to UBS. In Australia that number is much higher, at 70 percent, while in the Netherlands half of investors' equity real estate allocations are in REITs.

While there may be debate over how much of an impact REITs have had, one thing is clear: REIT-like vehicles have received a warm welcome worldwide, and it appears that will continue to be the case going forward.