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Real Estate Investment Trusts (REITs)

by | May 24

Dr. Isil ErolProperty EconomicsReal Estate Investment Trusts (REITs)What will we learn today?• An introduction to property funds &property trusts in Australia.• What is a REIT?• Key differences between property funds &REITs• The US REIT Market• Australian REITs or A-REITsProperty Fundsin AustraliaüProperty funds specialize in acquiring, developing, andmanaging property investments.üManaged funds and superannuation funds have some propertyinvestments in their portfolios.üProperty funds are:üthe dominant force in the markets for Australian primeproperties, although they were badly shaken in 2008 bythe GFC.üExcept for development companies, property funds areestablished as trusts or “property trusts”.Property Trustsin Australia• The investors of trusts are “unit holders” who are the“beneficial owners” of the properties and have limitedliability.• The trust structure enables the income and capital gainstax liabilities of the properties to be “passed through” tothe unit-holders.• “Listed” property trusts – called as Australian REITs inFebruary 2008 to be more consistent with internationalterms.REAL ESTATE INVESTMENT TRUSTS (REITs)What is a REIT?§ Operating companies that own, develop and manage mainlycommercial real estate§ Pass-through of income.§ Taxation of income is passed through to shareholder level.§ REIT’s taxable income is paid out as dividends to shareholders whopay taxes on the dividends.§ Revenue must primarily come from property investments.§ Required to distribute most of their taxable income.What makes REITs different?§ Shareholders have limited liability protection (as shareholders incorporations).§ Unlike a corporation, however, REITs are NOT taxed at the entity level ifthey satisfy a set of conditions on an ongoing basis:§ At least 100 investors.§ To ensure diversified portfolio, no 5 investors can own more than 50% of aREIT’s shares.§ Must distribute at least 90% of its taxable income to shareholders as dividends.§ 75% of the asset value must consist of real estate assets (properties,mortgages & MBSs), and also cash and government securities.§ At least 75% of the gross income from real estate assets.§ In exchange for meeting these and several otherrequirements, REITs, do not pay income taxes.§ This leaves more cash flow available to pay dividends toinvestors (who pay taxes on the dividends).1. Ownership Test: “Five or Fewer Rule.” REIT cannot be a closely held corporation: no five or fewerindividuals may own more than 50% of REIT’s stock, and there must be at least 100 differentshareholders.2. Asset Test: >= 75% of a REIT’s total assets must be real estate, mortgages, cash, or federalgovernment securities, and 75% or more of the REIT’s yearly gross income must be derived directlyor indirectly from real property (including mortgages, partnerships, and other REITs). No more than20% of its assets can consist of stock of a Taxable REIT3. Income Test: >= 75% of income from primarily passive sources like rents and mortgage interest.Cannot be “merchant builders” developing properties for quick sale or flipping properties. Propertysales must obey; held for at least four years and the aggregate adjusted basis of the property soldper year does not exceed 10% of the aggregate basis of all assets of the REIT as of the beginning ofthe year.4. Distribution Test: At least 90% of a REIT’s annual taxable net income must be distributed toshareholders as dividends each year .To retain REIT tax status (dividends deductible from corporate taxableincome), REITs must continually pass 4 tests:REITs are segmented• Equity versus Mortgage REITs.• Equity REITs invest in and operate in residential and commercialproperties.• Mortgage REITs purchase mortgage loans and MBSs.• Real estate lenders.• Hybrid REITs.• Public versus Private REITS• Publicly traded (Listed).• Public but non-listed – via a network of broker-dealers.• Private.Similarities between Property Funds & REITsØ invest in office buildings, shopping centres, data centers, andØ provide both diversification and income through their dividend yields.Ø investors combine their funds (pool their equity) to purchase sharesof commercial properties and earn income.Key differencesüREITs mimic stocks and exchange-traded funds (ETFs).o REITs are traded like an exchange-traded fund or stock.üProperty funds mirror traditional mutual funds.o Invest in commercial and corporate properties,o investments in land and apartments, but alsoo Invest in securities offered by public real estate companies.o Property funds generally increase in value through appreciation and do notprovide short-term income to investors as do REITs.REITs invest directly into income-producing properties• A portfolio of properties and mortgages (income derived from leases, rentsor mortgage repayments).• Some REIT are broad in scope and invest in assets nationally, globallyor in emerging markets.• Others focus on a specific sectors such as data centres, cell phonetowers, self-storage and manufactured housing communities.• These alternative property types now make up a substantial part of the REITindustry and require special knowledge of these asset classes.• Health care REITs are growing.• Specialty Australian REITs (Pubs, data centres, aged-care and rural properties).§Property funds have higher expense ratios:§ Investors pay higher fees in mutual funds because the fundsprovide access to active management by specialists with dedicatedreal estate securities analyst teams.§Property funds are more attractive for buy-and-holdinvestors.§ Recall: increase in value through appreciation.THE US REIT MARKETUS REIT market has grown significantly since the early 1990§ In October 2001, the first REIT was added to the S&P 500 index– that includes 500 of the largest and most important UScorporations.§ As of December 2019, 31 REITs are included in S&P 500 Equityindex.§ 180 REITs trading on NYSE.Share of REITs in S&P 500 index, December 2019Since 2001, therepresentation of REITsin the S&P 500 hasgrown from 0.2% to2.8% (as of December31, 2019.During this time, themarket value of theconstituent REITs grewfrom $20 billion to $773billion.§ The public but non-listed REIT market has also grown significantlyover the past years.§ Shares in these companies are offered to individual investors via anetwork of broker-dealers.§ In 2016, the number of public, non-listed REITs were 47.Global REIT MarketAustralian REITs / A-REITsA Closer Look at Australian REITs§ For consistency with other countries, listed property trusts (LTPs) arecalled Australian REITs or A-REITs.§ ASX – Listed A-REITs.§ A-REITs own:§ many regional shopping centres (Scentre Group and Charter Hall Retail REIT),§ major office towers in city centres (Dexus REIT, Cromwell Property Group, CenturiaOffice REIT),§ business and industrial parks leased to corporations (Goodman Group),§ residential development (Ingenia Communities Group).Unit-holders§ Unit holders receive quarterly of half-yearly distributions, based on rent,net of interest payments, management fees and other (development)expenses.§ A-REITs pay tax if they do not distribute their taxable income to theirunit-holders, at penalty rates.§ They are encouraged to distribute all their net rental income andrealised capital gains.ASX All Ordinaries Index and S&P/ASX 200 REIT Index closingprices: 1999/12 and 2019/03Australian-listed propertymarket, represented bythe S&P/ASX 200 A-REITIndexThere are 19 ASX-ListedA-REITs that*own property and*derive a significantproportion of incomefrom rental returns.0.01000.02000.03000.04000.05000.06000.07000.001-Dec-199901-Jul-200001-Feb-200101-Sep-200101-Apr-200201-Nov-200201-Jun-200301-Jan-200401-Aug-200401-Mar-200501-Oct-200501-May-200601-Dec-200601-Jul-200701-Feb-200801-Sep-200801-Apr-200901-Nov-200901-Jun-201001-Jan-201101-Aug-201101-Mar-201201-Oct-201201-May-201301-Dec-201301-Jul-201401-Feb-201501-Sep-201501-Apr-201601-Nov-201601-Jun-201701-Jan-201801-Aug-201801-Mar-2019ASX All Ordinaries Index S&P/ASX 200 ReitThe sectoralCompositionof A-REITMarket,June 201844.6%27.6%13.9%9.6%3.4%1.2%43.7%25.7%12.8%13.5%3.3%1.0%0.0% 10.0% 20.0% 30.0% 40.0% 50.0%Retail REITsDiversifiedREITsOffice REITsIndustrialREITsSpecialisedREITsResidentialREITs % of Total Market Cap.% of Total AssetsWhat is market capitalisation?• The market capitalisation or market cap of a listed company is the market value ofits ordinary shares (or units):
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