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REITs: safe as houses

Melanie Stern is Section Editor of Families in Business magazine.

Real Estate Investment Trusts (REITs) are the best way to invest in a number of properties under a single security, and carry a number of benefits for wealth family portfolios, explains Melanie Stern

'Bricks and mortar' has always been the advice of every wise parent to their first-time investing children, and is still smart money across the spectrum of portfolios.

Real Estate Investment Trusts (REITs), trusts or corporations that buy and manage a portfolio of properties on behalf of their investors, are equally popular vehicles for real estate investment – especially for wealthy individuals, family offices and family foundations. As a fixed income instrument they pay a dividend regardless of actual performance, but additionally provide access to on-exchange liquidity because they are traded as securities, and offer a range of attractive tax benefits:

- REITs allow investment in multiple properties, of all kinds, in many locations, bundled into one security;
- REITs are bound by law to pay a dividend, regardless of how the underlying security performs;
- REIT portfolios are managed for their clients by professionals;
- REITs are bound by law to pay out between 90-100% (depending on country) of their taxable income as dividends;
- REITs usually only require a minimal initial investment;
- REITs make good risk-adjusted returns tools, offering a low correlation with equities and thus low volatility.

"REITs are designed to distribute almost all of their net income, giving investors exposure to the property sector in its purest form – if I buy shares in any regular property company in Hong Kong, that company can in theory invest my money in a dot-com of other unrelated type of business," says Clive Rough, Hong Kong-based partner with law firm Freshfields Bruckhaus Deringer. "If I invest in a REIT, under the regulations behind these products, they are restricted to investing in property. REITs may also offer a higher yield than what can be achieved through other fixed income investments."

The family edge
A number of REITs across the world are majority-owned or managed by the founding families. In America it is accepted that real estate has always been – and on the whole remains – a regional, entrepreneurial business. Only in the early 1990s when real estate markets bottomed out did these family businesses decide, somewhat grudgingly, to go public – but with hindsight, this led to the positive expansion of the market on an international scale. An example of one well-known American REIT, Chicago's General Growth Properties (GGP) founded in 1954 by the Bucksbaum brothers, is still managed by descendents of the founding family. "As owners of a major stake in GGP, the Bucksbaum's interests are aligned with those of each and every GGP shareholder," the family says.

The strength of a REIT management team is a crucial element in its success, and some believe that a family business behind a REIT suggests stronger business ethics and conduct than non-family management, which in turn is thought to produce better results. In the post-corporate scandal world, this goes a long way.

"Family controlled firms should perform better than other firms, and for real estate firms, in Hong Kong for example, the evidence confirms that view," says Ko Wang, real estate lecturer at California State University and editor of the Journal of Real Estate Research. "Unless the REIT is controlled by a founding family member with a reputation to maintain, I would not bet on those firms."

Management is also important because most REITs are listed, meaning that they carry strict governance rules and filing requirements from the official financial regulators of their respective domiciles. One need only look back to last year's shareholder outcry at the UK's BskyB when Rupert Murdoch's board selected his son James to head up the satellite TV arm – whatever family companies do to prove their professionalism, the odour of nepotism lingers for many. For this reason, a good many family-owned REITs, as per other family-owned large or listed companies, tend to have non-executive and/or non-family directors on their boards and REIT management teams.

Wang sees only one other potential downside to family-held REITs. "The trade-off could be increased agency costs – expropriation of minority rights – and my gut feeling is that, for these REITs, those agency costs could dominate the benefits," the professor says.

In 2003 the REIT market's performance exemplified its use as an investment choice. The National Association of Real Estate Trusts (NAREIT) Equity REIT Index, composed of US trusts, gained 35.3% on a total return basis for the year, though analyst forecasts for the overall market in 2004 are somewhat diverse, ranging from 3% to 12%.

A number of quality investible indexes, both national and international, track REITs, including the NAREIT indices, the Dow Jones and Morgan Stanley REIT Indexes. Putting into perspective the family contingent of this market, at least 12 of the REITs in the NAREIT Real Estate 50 Index are family-controlled, with five of those in the top 20 when ranked by market capitalisation. Most of the leading global financial exchanges provide access to REITs.

The story so far
REITs have been available to American investors since 1960, when they were created by Congress as a kind of mutual fund to allow investment in multiple properties, with tax legislation updated in 1963 to allow REITs not just to own but also to manage their properties. Australia is the next most established REIT marketplace after America, having offered Listed Property Trusts (LPTs) for many years. There are over 600,000 investors in nearly 50 LPTs listed on the Australian Stock Exchange, and the sector outperforms everything else on the exchange.

In Europe, legislation is fragmented by country – currently there is no UK framework – but elsewhere the market is slowly opening up. Last autumn, France introduced the opportunity for domestically-listed real estate companies to register as Sociétés d'Investissements Immobiliers Cotées (SIICs), based on the American REIT model; countries like Poland and Germany are prominent due to substantial American REIT interests held there.

In Asia progress is in motion. Japan revised its Investment Trust Law in 2000 and a year later, became the first Asian country to launch REITs when two funds began trading on the Tokyo Stock Exchange; South Korea launched its Real Estate Investment Trust Act in 2001 – currently three REITs are listed on the country's stock exchange.

Last summer the passing of legislation by Hong Kong's financial regulator, Securities and Futures Commission, permitted real estate developers there to launch REITs on the country's stock exchange. This was followed last year with the Fortune REIT, a fund comprising five large shopping malls sold to the REIT by its parent company, Li family-owned conglomerate Cheung Kong Holdings. Listed on the Singapore Stock Exchange, the Fortune REIT raised over HK$2 billion and analysts predict that the dividend for its first six months will fall around 6.7%, generally seen as a good yield.

Observers are upbeat about the developments, but say there is still an underlying issue to be resolved for Asia. "REITs are still at an infancy stage in Asia and for it to be successful, there must be a paradigm shift among property owners' and investors' mindsets towards a yield-driven market rather than relying heavily on capital growth returns," Dr Yu Lai Boon, Asia Pacific head of research for law firm Jones Lang LaSalle, believes. "There is also a lack of high-quality properties to be injected into REITs in Japan. However, it is certain that as both developers and investors get familiar with these instruments, more Asian countries will introduce them in time."

Overall, the outlook for the global REIT market is exciting, given that there is clear momentum gaining in new and lucrative markets, and equal legislative progress. Despite the plethora of investment tools available to family portfolios – and perhaps because of recent bad press for some of those – investors continue to look to bricks and mortar as a prudent, and even sexy, choice.  

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