Description
This is a presentation that covers What is REIT? Why REIT? Benefit of REIT. Overview of REIT market worldwide. Overview of REIT markets in India.
R EAL E STATE I N V E STM E NT TR U STS
Index
Page
What is a REIT ? Why REITs? The benefit of REITs Overview of REIT markets worldwide Overview of REIT markets in India
T R U S T S
2 1 10 2 19 3 21
R E A L
E S T A T E
I NV E S T M EN T
1
Introduction to REITs
What is a REIT ?
Real Estate Investment Trusts (REITs) are companies that own incomegenerating commercial real estate, through a simple and transparent trust structure that pays out all (or most) of its distributable cash flows (net profit + non cash expenses) to its unit holders.
Typical REIT structure
Unitholders (Equity)
Bank (Debt)
Distributions
Capital
Interest Acts on behalf of unitholders
Management fee REIT manager Management services
R E I T ?
REIT
Trustee’s fees
Trustee (holds properties for the benefit of unitholders)
Ownership
Property income
W HA T
I S
A
Property assets
2
Characteristics of a typical REIT
Tax transparency
? REITs are tax transparent vehicles in most of the established jurisdictions such as
Singapore, Australia, USA and Japan
? Tax transparency was introduced to promote the sector and to create a real
estate investment product with liquidity and access to the masses
? Tax transparency seeks to reproduce the returns achieved through direct
property ownership
Substantial income distribution
? REITs are legally obligated to distribute substantially all of their distributable cash
flows in the form of dividends to retain their ?tax transparent? status
? Payout ratios are generally in the range of 90—100% ? The high payout ratio results in investors receiving a high yield on their
investment
? As there is no/ minimal retained earnings, capital to acquire new properties is
raised from the capital markets (debt or equity)
Focused investment mandate
R E I T ?
? REITs have clear investment mandates focused on owning and managing income-
generating real estate
? REITs typically have prescribed asset allocation criteria, such as ? Minimum % of assets that must be invested in real estate or related assets
? Limits on investment in vacant land or development projects
? This stability in investment strategy contributes towards more certain and
I S
A
predictable management behavior
W HA T
3
Characteristics of a typical REIT (cont’d)
Liquidity and governance
? Units in REITs are listed, hence making them easily traded by investors ? REITs are typically listed in stock exchanges with established REIT legislations
and subject to the stock exchange’s listing requirements and regulations
? Listing results in ? Greater degree of disclosure, transparency and corporate governance ? Opportunity for small investors to own a part of large commercial assets
without having to commit substantial amounts of capital
? Provides investors with a quick exit option (for an asset class that is
typically illiquid)
Conservative gearing
? REITs are typically conservatively geared as they are restricted by legislations ? In certain jurisdictions there are legislated maximum gearing limits ? Singapore: <35% without credit rating and up to 60% with investment
grade credit rating
? Hong Kong: Maximum of 45% ? However, even in markets where no gearing restrictions exist, the market
maintains a high level of discipline
? U.S. REITs average gearing: 40—50% ? Japan REITs average gearing: 25—45% ? Australian LPT’s average gearing: 35—45%
W HA T
I S
A
R E I T
?
4
REITs are conceptually very different from property developers
Comparing REITs and property developers
Key features Earnings profile
REITs Driven entirely/ predominantly by recurrent rental income Low and defined level of gearing and retained earnings, as governed by regulations in mature Asian markets such as Singapore High degree of visibility due to regulations requiring a minimum 90% dividend payout ratio
Property developers Combination of property sales, development, rental income and non-property investments Likely high gearing ratio and retained earnings due to the nature of business involving large capex requirements No certainty of payout ratio as it is at company’s discretion due to capital intensive nature of business High development risk with volatile cash flows dependent on construction completion profile
Capital structure
Distribution policy
Risk profile
Low risk, passive investment vehicle with a high certainty of cashflow from rental income underpinned by legally enforceable contracts usually spanning several years
Corporate governance
Very high levels of corporate governance as Governed by stock exchange in which they are REITs are governed by specific legislations and listed and local regulatory bodies two layers of professional expertise (i.e.) trustee and REIT manager Typically tax transparent vehicles Taxed at source
R E I T
?
Taxation
A
W HA T
REITs are designed to offer a very pure and low-risk exposure to a portfolio containing quality income-producing real estate
5
I S
Introduction of REITs in the US has led to increased investor demand and greater access to capital for real estate companies
? The REIT structure was initially introduced to provide investors with the opportunity
to participate in the benefits of owning larger-scale and diversified real estate
? REIT platform provides companies with access to the capital markets, both public
and private
? Corporation or trust that qualifies as a REIT generally does not pay corporate
income taxes — Taxes are paid by shareholders on the dividends received and any capital gains — Dividends from REITs generally are not eligible for the reduced 15% tax rate applicable to regular corporate dividends
? In order for a corporation to qualify as a REIT in the US, it must comply with certain
provisions
? Distribute 90% of its taxable income as dividends
? Be primarily in the business of owning and operating investment property
— 75% of its assets in real estate — 75% of its gross income from rents or interest on mortgages on real property
? R E I T
? Have no more than 20% of its assets consist of stock in taxable REIT subsidiaries ? Have a minimum of 100 shareholders ? Have no more than 50% of total shares held by 5 or fewer individuals
W HA T
I S
A
6
Types of REITs
? Equity REITs - Own and operate income producing real estate. Equity REITs have
increasingly become primarily real estate operating companies that engage in a wide range of real estate activities including leasing, development of real property and tenant services
? Mortgage REITs - Lend money directly to real estate owners and operators or
extend credit indirectly through the acquisition of loans or mortgage-backed securities
? Hybrid REITs - Own properties and make loans to real estate owners and operators ? 20 REITs registered with the SEC but are not publicly traded and approximately
800 REITs are not registered or publicly traded
W HA T
I S
A
R E I T
?
7
Typical REIT structure
Overview—UPREIT
? Structure adopted by a majority of today’s REITs
Overview—Down-REIT
? Created for those REITs which did not have or desire to form an
? Created to avoid recognition of taxable income on the
transfer of appreciated property to a REIT
umbrella partnership and also to provide additional structuring flexibility
? Partner owner becomes a partner in a limited partnership with
REIT shareholders REIT (typically a corporation)
the REIT
REIT shareholders REIT (typically a corporation)
Down-REIT partnership
Umbrella partnership (typically holds all property interests)
Contributing property owners
Down-REIT partnership (typically holds specific property interests)
Contributing property owners
Benefits
? Financing mechanism ? Oftentimes OP units are convertible into common shares (e.g.,
Considerations
? Management typically owns OP units while investors own REIT common
shares
? Short-term liquidity concerns for OP unit holders ? Restriction of retained earnings ? Distribution of 95% of taxable income to retain preferential tax
beneficial ownership)
? Favorable tax treatment ? Conduit tax treatment, meaning income is not double-taxed ? Distributions to shareholders do not incur corporate tax
treatment
? REITs are unable to deduct losses in excess of the amount of investor
?
? Liquidity and diversification ? Tradability of shares enables the REIT to tap a wide investment
R E I T
capital at risk
? Forced growth ? Vulnerability to sentiment (e.g., volatility in share prices)
pool
? REITs offer a more diversified portfolio than the average
A
investor/owner could obtain individually
? Access to capital ? Allows owners to tap into the wider capital markets to finance
W HA T
I S
acquisitions and developments
8
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Economic benefits of REIT legislation
Economy
? REITs are a stabilizing factor in real estate markets ? REITs are long term buy-and-hold investors—they ?capture? property and rarely
Investors
Issuers
Reduced real estate market volatility
sell
? The development of a public market improves information transparency and leads
to improvements in corporate governance and financial discipline
? Development of public markets for both equity and debt makes it possible to
spread commercial property risk to a wider array of investors
? Emergence of a new financing method provides a substitute for traditional banking
finance
R E I T S
? Helps to ?even out? the flow of capital into the real estate sector
Alternative capital source
? Avoids property related loans becoming a disproportionately large component of
banks’ lending portfolios
? Reduces systemic risk of over reliance on bank lending ? Provides an alternative avenue for supply of capital being allocated to the sector
B E NE F I T
O F
? In jurisdictions where REIT legislation does not exist, there is typically a
T HE
significantly higher proportion of corporate ?owner-occupiers?
R E I T S ?
Optimize ownership/ capital allocation
? The introduction of REITs helps transfer property ownership from corporate owners
to professional institutional investors and managers
? This process permits corporates to redeploy their capital into their core business
function and improve their return on equity
10
W HY
Economic benefits of REIT legislation (cont’d)
Economy
? Introduction of REIT legislation should lead to a fall in the sector’s overall cost of
Investors
Issuers
capital
? Tax leakage eliminated ? REIT investors likely to accept lower hurdle rate in return for liquidity and
Cost of capital benefits
increased transparency
? Lower cost of capital has overall positive implications for the Chinese property
market
? Greater amount of retained yield for investors ? Reduces speculative nature of real estate investments as generally REITs are
required to hold assets over the long term
R E I T S
? Increased capital flowing to REITs can be expected to produce increased real estate
development activity
B E NE F I T
Increased GDP contribution
O F
? This increase in activity has ?flow on? benefits for the construction industry and
related activities such as real estate agents, the legal profession, insurers, providers of financial services, architects, surveyors etc.
? Expansion in such a substantial sector of the economy leads to higher levels of
overall economic activity
W HY
R E I T S ?
T HE
11
REITs offer investors the best of both bond and equity features
Economy Investors Issuers
Fixed income bonds
? Fixed (low) yield ? Downside protection ? No growth
Equities
? Volatile pricing ? Downside risk ? Potential for strong growth ? Variable beta correlations
R E I T S
REITs
? Attractive yield
O F
B E NE F I T
Yield with asset backing
? Comparatively limited volatility in unit
price
? Stable with potential for growth from
Growth with diversification
strong fundamentals, organic and acquisitions based strategies
T HE
W HY
R E I T S ?
REITs are a hybrid security as they offer positive characteristics of debt & equity while acting as an important risk/return diversification tool
12
Why are REITs attractive to investors?
Economy Investors Issuers
Income stability
? REITs typically are required to distribute at-least 90% of their distributable cash
flow
? Income is underpinned by legally enforceable lease agreements ? Limited leverage ? Minimal or no development risk
Capital stability and growth
? REIT unit price volatility is much lower than those of general equities ? Long-term unit price capital growth potential is driven by execution of key growth
strategies such as organic growth to increase rental streams, acquisition based growth to increase assets size and by prudent capital management
R E I T S
Access to quality real estate
? Provide institutional investors with an alternative to direct real estate investment
with increased flexibility
? Provide retail investors with an opportunity to invest in high-value institutional
O F
B E NE F I T
quality real estate assets that would otherwise not be possible
Liquidity and valuation
? Packaging illiquid real estate into liquid listed securities that offer diversification,
transparency, expert management and regular research coverage
? Low transaction costs in buying/selling REIT units vs. trading underlying assets ? Individuals can ?redeem? small investments quickly by selling the units in the
T HE
open market and with little cost
R E I T S ?
? REITs allow institutional funds to make incremental investments in lumpy real
estate as and when new investment funds are received
? Institutions receive daily ?mark to market? value of their investments
13
W HY
Why are REITs attractive to investors? (cont’d)
Economy Investors Issuers
Diversification
? Provides diversification in multiple forms ? Types of properties ? Locations ? Tenants
Tax flow through
? REITs are typically tax transparent vehicles in a number of established jurisdictions
such as Singapore, Australia and USA
? Even in jurisdictions where they are not tax transparent vehicles, an investor’s tax
consequence of an investment through a REIT is identical to investing in the same property directly—no tax distortion
R E I T S
O F
Expert ?multilevel? management and governance
? Benefit from experienced, professional real estate managers ? Additional scrutiny by the trustee ? Governed by specific regulations and corporate governance measures
B E NE F I T
Defensive asset class
? Consistent yield-based investment has defensive asset class characteristics ? Income-generating investment grade property is a ?safe haven? during uncertain
T HE
times
W HY
R E I T S ?
14
REITs offer a valuable business restructuring tool for property developers
Pure-play property development company
Economy
Investors
Issuers
Assets built to sell (residential type developments) Existing development company
Assets built to hold (commercial type developments)
R E I T S
Restructured development company following a REIT spin-off
O F
B E NE F I T
Income from sales
Capital
Existing development company Recurrent Retained Distributions rental ownership income Mgt services Assets built to hold (unstabilised commercial type developments) Stabilised commercial assets injected into REIT Mgt Fees
Ownership Profits
T HE
W HY
R E I T S ?
Assets built to sell (residential type developments)
REIT management company
15
Why are REITs attractive to issuers?
? For property companies with a mixture of development properties and investment
Economy
Investors
Issuers
Segregating risk profiles
properties, investors sometimes value the companies based on a higher risk level, (i.e.) applying higher discount to all properties, including the lower risk investment properties
? By separating an ?integrated? property company into a REIT and a property
development and management company, the company can potentially broaden its investor base to include investors with different risk and return preferences; hence increasing valuation and liquidity
? A developer can monetize an investment portfolio while retaining a significant de-
consolidated investment in the REIT and full control over the manager
More asset light business structure with higher return on assets
? Provides access to cost effective third partly REIT equity and a favorable ?mark to
R E I T S
market? equity analyst valuation on the retained investment in the REIT
? Providing management services to the REIT produces an annuity style fee income
independent of the underlying asset ownership
? Due to the lack of capital employed, these fee based activities generate a higher
O F
B E NE F I T
return on capital employed – more ?asset light? structure with improved return on assets
T HE
Ready buyer for future assets developed Provide a source of funds for reinvestment
? REIT can act as a ready buyer of future development assets allowing a property
developer to more quickly re-cycle its development capital, leading to faster and more certain development returns, all without loss of control of the completed asset
? Injecting assets into a REIT allows a property developer to free up equity capital for
R E I T S ?
higher yielding new investments
W HY
16
Why are REITs attractive to issuers? (cont’d)
? Although ample funding channels are available via both the bank and debt capital
Economy
Investors
Issuers
Develop alternative funding channel
markets, REITs will provide a highly cost effective alternative funding channel for acquisition or development of commercial assets
? Faster re-cycling of development capital improves competitiveness and greater
ability to increase development activity scale
Narrow trading discount to NAV and realise shareholder value
R E I T S
? Certainty of future cash flows, transparency of their structures and high levels of
corporate governance enable REITs to trade at significantly higher values (i.e. premium to NAV) than the same portfolios retained on the companies’ balance sheet
? Enables creation of immediate shareholder value to property companies that trade
at a significant discount to NAV
W HY
R E I T S ?
T HE
B E NE F I T
O F
17
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What is a REIT ? Why REITs? The benefit of REITs Overview of REIT markets worldwide Overview of REIT markets in India
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Introduction of REIT legislation gathering pace
Finland Netherlands—1969 U.K. 2007 Canada— 1994 U.S.— 1960 India
WO R L DW I DE
Belgium—1985 France—2003
Germany Italy China South Korea—2001 Japan—2001 Taiwan—2005 Hong Kong—2003 Philippines
Thailand—2002 Singapore—2002 Malaysia—2002
Australia—1971
M A R KE T S
New Zealand—1971 Existing public REIT markets REIT structures under consideration
O V E R V I E W
O F
R E I T
19
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Real estate funds in India
? Currently, only venture capital funds have been allowed to offer real
estate funds.
? The venture capital arms of HDFC, Prudential ICICI, Kotak Mahindra,
IL&FS and real estate mutual funds (REMFs) are currently available only to high net worth individuals and institutional and global investors. These include funds such as ICICI Venture, HDFC, Kotak Mahindra and Kshitij Venture Capital (Pantaloon), all of which have floated real estate funds.
? According to SEBI regulations, individual investors in an REMF must
invest at least USD 11,500.
? The current players, however, have set the minimum contribution at
far higher levels: ICICI and HDFC look for a minimum investment of USD 500,000, while Fire Capital asks for USD 1 million.
? Though SEBI has allowed real estate funds, they do not enable retail
participation.
21
How big is the Indian REITs opportunity?
? CRISIL estimates real estate stocks will grow from the current USD 500 billion
levels to above USD 1400 billion by 2010. This is based on the GSDP estimates for 2003-04 and an average annualised yield of 10 per cent.
? CRISIL expects REITs have the potential to hold at least a 5 per cent share (more
than USD 70 billion) of the total real estate market by 2010.
? India offers a greater opportunity for REITs than any other country in the world. ? The yields on commercial real estate across metros in India are higher than those
prevalent in the global real estate markets.
? Apart from the information technology (IT) and IT-enabled services (ITES) sectors,
biotechnology, insurance, banking and consulting businesses have also been growth segments driving the demand for real estate.
? A higher demand can be seen in the retail segment with an expected influx of
clothing and lifestyle stores, restaurants and beverage chains, entertainment and leisure complexes.
22
REIT MARKET IN INDIA - PROBLEMS
REIT market in India - Problems
? Unorganised ,largely fragmented sector characterised by small players with local
presence
? Near absence of professionally managed world class companies with a pan-india
Limited availability of world class realty
presence
? Significant scope for improvement in terms of location, layout and design,
construction techniques, material quality, amenities offered to create long term value and face industry downturns.
? Absence of an enabling role by ensuring the supply of quality real estate as in
Hong Kong and Singapore.
? Lack of property management companies providing quality services such as
construction, development, repair and maintenance on properties
IN INDIA
High cost of transaction
? The current regulation s in India involve high transaction costs, and present
problems in ensuring clear land titles and prolonged delays in obtaining clearances.
? Lack of adequate disclosures on land/property transactions, underreporting of
M A R KE T S
taxable income and absence of uniform accounting norms for revenue recognition.
? As land/property transactions need to overcome regulatory constraints, avoid
Lack of transparency and information
R E I T
stamp-charges on multiple transactions, and lack of clarity on titles, disclosures are minimal
? The accounting norms allow both percentage completion and project completion
O F
O V E R V I E W
methods to be adopted, which results in non-uniform revenue recognition in the industry
? There is a complete absence of a credible database on real estate markets, in
terms of property demand and supply, absorption rates, geographic price data, occupancy rates, rentals, and capitalisation rates for commercial, retail, and residential property segments.
2 10
REIT market in India - Problems
?
Illiquid secondary markets
An efficient secondary real estate market facilitates a price discovery process by enabling market demand-supply forces to arrive at the efficient price. In such a market, whenever the prices fall below their intrinsic value, the demand would rise to the extent the price equilibrium is restored. Similarly, whenever the prices rise above their intrinsic value, sellers would increase in the market to ensure rationality in the market. duty/registration charges constrain the development of the secondary market.
? Currently, the lack of information and transparency and the high stamp
? No standardised, accepted practices for property valuations at present
IN INDIA
? As a result, there are no meaningful benchmarks available among properties
M A R KE T S
Valuation of properties is not standardised
? Valuations are rarely based on the discounted cash flow (DCF) method of valuation,
which is an accepted method for valuing assets in the industrial sector. In the absence of standardised valuation techniques, it is difficult to identify intrinsic valuations from the premium assigned by speculators.
? The impact of extraneous variables such as interest rates and inflation are also not
factored in adequately into the valuations of properties.
? Lack of proper land records.
R E I T
O F
Other problems
? Inadequate town and infrastructure planning for a sustained, planned growth. ? Ineffective bankruptcy laws. ? Multiplicity of development laws and non-standardisation of laws across states
O V E R V I E W
leading to delays and increasing costs.
2
REIT MARKET IN INDIA - SOLUTIONS
REIT market in India - Solutions
The disclosures should be both mandatory and discretionary. Mandatory disclosures will include:
? Interested party transactions
Mandatory disclosures and strict norms to enforce independence, objectivity and transparency
? Payment of fees to REIT managers ? Tenant profiles, tenures and occupancy rates, total number of tenants, top
ten tenants and their contributions (per cent) to gross rental income, lease maturity profile
? Asset profile - geographic diversification, sector classification, ownership
concentration.
? Substantial unit-holdings of 5 per cent or more to be informed to stock
IN INDIA
exchange and REIT trustee (including subsequent changes in percentage levels of holdings)
? The registration or licensing of REIT managers should be compulsory. ? The asset management company (AMC) guidelines must allow unit-holder
M A R KE T S
R E I T
Enhanced corporate governance practices
meetings at the request of 50 or 100 unit holders or 10 per cent of unit holders (whichever is less), and removal of REIT managers by approval of 50 per cent of unit holders. Credit rating linked relaxations and incentives with:
? A maximum cap on borrowings relaxed if REIT has a credit rating from a
O F
O V E R V I E W
recognized credit rating agency
? The maximum cap on borrowings further relaxed in case REIT has an
investment grade rating from a recognized credit rating agency
?
Only rated REITs permitted to raise funds through a new funds offer.
2
REIT market in India - Solutions
? A detailed valuation undertaken at least once a year by an independent
professional agency.
Proper Valuation of properties
? Desk-top valuation (instead of a full valuation) undertaken at least 4 times a
year
? Interested party transactions requiring at least two detailed, independent
valuations
IN INDIA
? A centralized database containing details of property prices across locations,
M A R KE T S
new projects undertaken and property purchases should be created.
An independent, centralised database
? This will help track the price index across geographies as a benchmark for
the sector, property absorption rates, demand-supply gaps and direction of price movements.
O V E R V I E W
O F
R E I T
2
Conclusion
REITs can be a potent tool in institutionalising the real estate sector in India. However, there is a need for strict disclosures and other regulatory norms as well as an enabling framework, before REITs can be formally introduced in the country.
References
? India REITs: Are We Prepared Yet? – Insight - CRISIL Ratings
? REIT Asset Management India – David Cohen ? REITs Recommendations – Sub Committee appointed by AMFI ? REITs for Rookies – FAQs – Deutsche Bank
REFERENCES
2
doc_509527495.ppt
This is a presentation that covers What is REIT? Why REIT? Benefit of REIT. Overview of REIT market worldwide. Overview of REIT markets in India.
R EAL E STATE I N V E STM E NT TR U STS
Index
Page
What is a REIT ? Why REITs? The benefit of REITs Overview of REIT markets worldwide Overview of REIT markets in India
T R U S T S
2 1 10 2 19 3 21
R E A L
E S T A T E
I NV E S T M EN T
1
Introduction to REITs
What is a REIT ?
Real Estate Investment Trusts (REITs) are companies that own incomegenerating commercial real estate, through a simple and transparent trust structure that pays out all (or most) of its distributable cash flows (net profit + non cash expenses) to its unit holders.
Typical REIT structure
Unitholders (Equity)
Bank (Debt)
Distributions
Capital
Interest Acts on behalf of unitholders
Management fee REIT manager Management services
R E I T ?
REIT
Trustee’s fees
Trustee (holds properties for the benefit of unitholders)
Ownership
Property income
W HA T
I S
A
Property assets
2
Characteristics of a typical REIT
Tax transparency
? REITs are tax transparent vehicles in most of the established jurisdictions such as
Singapore, Australia, USA and Japan
? Tax transparency was introduced to promote the sector and to create a real
estate investment product with liquidity and access to the masses
? Tax transparency seeks to reproduce the returns achieved through direct
property ownership
Substantial income distribution
? REITs are legally obligated to distribute substantially all of their distributable cash
flows in the form of dividends to retain their ?tax transparent? status
? Payout ratios are generally in the range of 90—100% ? The high payout ratio results in investors receiving a high yield on their
investment
? As there is no/ minimal retained earnings, capital to acquire new properties is
raised from the capital markets (debt or equity)
Focused investment mandate
R E I T ?
? REITs have clear investment mandates focused on owning and managing income-
generating real estate
? REITs typically have prescribed asset allocation criteria, such as ? Minimum % of assets that must be invested in real estate or related assets
? Limits on investment in vacant land or development projects
? This stability in investment strategy contributes towards more certain and
I S
A
predictable management behavior
W HA T
3
Characteristics of a typical REIT (cont’d)
Liquidity and governance
? Units in REITs are listed, hence making them easily traded by investors ? REITs are typically listed in stock exchanges with established REIT legislations
and subject to the stock exchange’s listing requirements and regulations
? Listing results in ? Greater degree of disclosure, transparency and corporate governance ? Opportunity for small investors to own a part of large commercial assets
without having to commit substantial amounts of capital
? Provides investors with a quick exit option (for an asset class that is
typically illiquid)
Conservative gearing
? REITs are typically conservatively geared as they are restricted by legislations ? In certain jurisdictions there are legislated maximum gearing limits ? Singapore: <35% without credit rating and up to 60% with investment
grade credit rating
? Hong Kong: Maximum of 45% ? However, even in markets where no gearing restrictions exist, the market
maintains a high level of discipline
? U.S. REITs average gearing: 40—50% ? Japan REITs average gearing: 25—45% ? Australian LPT’s average gearing: 35—45%
W HA T
I S
A
R E I T
?
4
REITs are conceptually very different from property developers
Comparing REITs and property developers
Key features Earnings profile
REITs Driven entirely/ predominantly by recurrent rental income Low and defined level of gearing and retained earnings, as governed by regulations in mature Asian markets such as Singapore High degree of visibility due to regulations requiring a minimum 90% dividend payout ratio
Property developers Combination of property sales, development, rental income and non-property investments Likely high gearing ratio and retained earnings due to the nature of business involving large capex requirements No certainty of payout ratio as it is at company’s discretion due to capital intensive nature of business High development risk with volatile cash flows dependent on construction completion profile
Capital structure
Distribution policy
Risk profile
Low risk, passive investment vehicle with a high certainty of cashflow from rental income underpinned by legally enforceable contracts usually spanning several years
Corporate governance
Very high levels of corporate governance as Governed by stock exchange in which they are REITs are governed by specific legislations and listed and local regulatory bodies two layers of professional expertise (i.e.) trustee and REIT manager Typically tax transparent vehicles Taxed at source
R E I T
?
Taxation
A
W HA T
REITs are designed to offer a very pure and low-risk exposure to a portfolio containing quality income-producing real estate
5
I S
Introduction of REITs in the US has led to increased investor demand and greater access to capital for real estate companies
? The REIT structure was initially introduced to provide investors with the opportunity
to participate in the benefits of owning larger-scale and diversified real estate
? REIT platform provides companies with access to the capital markets, both public
and private
? Corporation or trust that qualifies as a REIT generally does not pay corporate
income taxes — Taxes are paid by shareholders on the dividends received and any capital gains — Dividends from REITs generally are not eligible for the reduced 15% tax rate applicable to regular corporate dividends
? In order for a corporation to qualify as a REIT in the US, it must comply with certain
provisions
? Distribute 90% of its taxable income as dividends
? Be primarily in the business of owning and operating investment property
— 75% of its assets in real estate — 75% of its gross income from rents or interest on mortgages on real property
? R E I T
? Have no more than 20% of its assets consist of stock in taxable REIT subsidiaries ? Have a minimum of 100 shareholders ? Have no more than 50% of total shares held by 5 or fewer individuals
W HA T
I S
A
6
Types of REITs
? Equity REITs - Own and operate income producing real estate. Equity REITs have
increasingly become primarily real estate operating companies that engage in a wide range of real estate activities including leasing, development of real property and tenant services
? Mortgage REITs - Lend money directly to real estate owners and operators or
extend credit indirectly through the acquisition of loans or mortgage-backed securities
? Hybrid REITs - Own properties and make loans to real estate owners and operators ? 20 REITs registered with the SEC but are not publicly traded and approximately
800 REITs are not registered or publicly traded
W HA T
I S
A
R E I T
?
7
Typical REIT structure
Overview—UPREIT
? Structure adopted by a majority of today’s REITs
Overview—Down-REIT
? Created for those REITs which did not have or desire to form an
? Created to avoid recognition of taxable income on the
transfer of appreciated property to a REIT
umbrella partnership and also to provide additional structuring flexibility
? Partner owner becomes a partner in a limited partnership with
REIT shareholders REIT (typically a corporation)
the REIT
REIT shareholders REIT (typically a corporation)
Down-REIT partnership
Umbrella partnership (typically holds all property interests)
Contributing property owners
Down-REIT partnership (typically holds specific property interests)
Contributing property owners
Benefits
? Financing mechanism ? Oftentimes OP units are convertible into common shares (e.g.,
Considerations
? Management typically owns OP units while investors own REIT common
shares
? Short-term liquidity concerns for OP unit holders ? Restriction of retained earnings ? Distribution of 95% of taxable income to retain preferential tax
beneficial ownership)
? Favorable tax treatment ? Conduit tax treatment, meaning income is not double-taxed ? Distributions to shareholders do not incur corporate tax
treatment
? REITs are unable to deduct losses in excess of the amount of investor
?
? Liquidity and diversification ? Tradability of shares enables the REIT to tap a wide investment
R E I T
capital at risk
? Forced growth ? Vulnerability to sentiment (e.g., volatility in share prices)
pool
? REITs offer a more diversified portfolio than the average
A
investor/owner could obtain individually
? Access to capital ? Allows owners to tap into the wider capital markets to finance
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acquisitions and developments
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Overview of REIT markets in India
T R U S T S
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R E A L
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Economic benefits of REIT legislation
Economy
? REITs are a stabilizing factor in real estate markets ? REITs are long term buy-and-hold investors—they ?capture? property and rarely
Investors
Issuers
Reduced real estate market volatility
sell
? The development of a public market improves information transparency and leads
to improvements in corporate governance and financial discipline
? Development of public markets for both equity and debt makes it possible to
spread commercial property risk to a wider array of investors
? Emergence of a new financing method provides a substitute for traditional banking
finance
R E I T S
? Helps to ?even out? the flow of capital into the real estate sector
Alternative capital source
? Avoids property related loans becoming a disproportionately large component of
banks’ lending portfolios
? Reduces systemic risk of over reliance on bank lending ? Provides an alternative avenue for supply of capital being allocated to the sector
B E NE F I T
O F
? In jurisdictions where REIT legislation does not exist, there is typically a
T HE
significantly higher proportion of corporate ?owner-occupiers?
R E I T S ?
Optimize ownership/ capital allocation
? The introduction of REITs helps transfer property ownership from corporate owners
to professional institutional investors and managers
? This process permits corporates to redeploy their capital into their core business
function and improve their return on equity
10
W HY
Economic benefits of REIT legislation (cont’d)
Economy
? Introduction of REIT legislation should lead to a fall in the sector’s overall cost of
Investors
Issuers
capital
? Tax leakage eliminated ? REIT investors likely to accept lower hurdle rate in return for liquidity and
Cost of capital benefits
increased transparency
? Lower cost of capital has overall positive implications for the Chinese property
market
? Greater amount of retained yield for investors ? Reduces speculative nature of real estate investments as generally REITs are
required to hold assets over the long term
R E I T S
? Increased capital flowing to REITs can be expected to produce increased real estate
development activity
B E NE F I T
Increased GDP contribution
O F
? This increase in activity has ?flow on? benefits for the construction industry and
related activities such as real estate agents, the legal profession, insurers, providers of financial services, architects, surveyors etc.
? Expansion in such a substantial sector of the economy leads to higher levels of
overall economic activity
W HY
R E I T S ?
T HE
11
REITs offer investors the best of both bond and equity features
Economy Investors Issuers
Fixed income bonds
? Fixed (low) yield ? Downside protection ? No growth
Equities
? Volatile pricing ? Downside risk ? Potential for strong growth ? Variable beta correlations
R E I T S
REITs
? Attractive yield
O F
B E NE F I T
Yield with asset backing
? Comparatively limited volatility in unit
price
? Stable with potential for growth from
Growth with diversification
strong fundamentals, organic and acquisitions based strategies
T HE
W HY
R E I T S ?
REITs are a hybrid security as they offer positive characteristics of debt & equity while acting as an important risk/return diversification tool
12
Why are REITs attractive to investors?
Economy Investors Issuers
Income stability
? REITs typically are required to distribute at-least 90% of their distributable cash
flow
? Income is underpinned by legally enforceable lease agreements ? Limited leverage ? Minimal or no development risk
Capital stability and growth
? REIT unit price volatility is much lower than those of general equities ? Long-term unit price capital growth potential is driven by execution of key growth
strategies such as organic growth to increase rental streams, acquisition based growth to increase assets size and by prudent capital management
R E I T S
Access to quality real estate
? Provide institutional investors with an alternative to direct real estate investment
with increased flexibility
? Provide retail investors with an opportunity to invest in high-value institutional
O F
B E NE F I T
quality real estate assets that would otherwise not be possible
Liquidity and valuation
? Packaging illiquid real estate into liquid listed securities that offer diversification,
transparency, expert management and regular research coverage
? Low transaction costs in buying/selling REIT units vs. trading underlying assets ? Individuals can ?redeem? small investments quickly by selling the units in the
T HE
open market and with little cost
R E I T S ?
? REITs allow institutional funds to make incremental investments in lumpy real
estate as and when new investment funds are received
? Institutions receive daily ?mark to market? value of their investments
13
W HY
Why are REITs attractive to investors? (cont’d)
Economy Investors Issuers
Diversification
? Provides diversification in multiple forms ? Types of properties ? Locations ? Tenants
Tax flow through
? REITs are typically tax transparent vehicles in a number of established jurisdictions
such as Singapore, Australia and USA
? Even in jurisdictions where they are not tax transparent vehicles, an investor’s tax
consequence of an investment through a REIT is identical to investing in the same property directly—no tax distortion
R E I T S
O F
Expert ?multilevel? management and governance
? Benefit from experienced, professional real estate managers ? Additional scrutiny by the trustee ? Governed by specific regulations and corporate governance measures
B E NE F I T
Defensive asset class
? Consistent yield-based investment has defensive asset class characteristics ? Income-generating investment grade property is a ?safe haven? during uncertain
T HE
times
W HY
R E I T S ?
14
REITs offer a valuable business restructuring tool for property developers
Pure-play property development company
Economy
Investors
Issuers
Assets built to sell (residential type developments) Existing development company
Assets built to hold (commercial type developments)
R E I T S
Restructured development company following a REIT spin-off
O F
B E NE F I T
Income from sales
Capital
Existing development company Recurrent Retained Distributions rental ownership income Mgt services Assets built to hold (unstabilised commercial type developments) Stabilised commercial assets injected into REIT Mgt Fees
Ownership Profits
T HE
W HY
R E I T S ?
Assets built to sell (residential type developments)
REIT management company
15
Why are REITs attractive to issuers?
? For property companies with a mixture of development properties and investment
Economy
Investors
Issuers
Segregating risk profiles
properties, investors sometimes value the companies based on a higher risk level, (i.e.) applying higher discount to all properties, including the lower risk investment properties
? By separating an ?integrated? property company into a REIT and a property
development and management company, the company can potentially broaden its investor base to include investors with different risk and return preferences; hence increasing valuation and liquidity
? A developer can monetize an investment portfolio while retaining a significant de-
consolidated investment in the REIT and full control over the manager
More asset light business structure with higher return on assets
? Provides access to cost effective third partly REIT equity and a favorable ?mark to
R E I T S
market? equity analyst valuation on the retained investment in the REIT
? Providing management services to the REIT produces an annuity style fee income
independent of the underlying asset ownership
? Due to the lack of capital employed, these fee based activities generate a higher
O F
B E NE F I T
return on capital employed – more ?asset light? structure with improved return on assets
T HE
Ready buyer for future assets developed Provide a source of funds for reinvestment
? REIT can act as a ready buyer of future development assets allowing a property
developer to more quickly re-cycle its development capital, leading to faster and more certain development returns, all without loss of control of the completed asset
? Injecting assets into a REIT allows a property developer to free up equity capital for
R E I T S ?
higher yielding new investments
W HY
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Why are REITs attractive to issuers? (cont’d)
? Although ample funding channels are available via both the bank and debt capital
Economy
Investors
Issuers
Develop alternative funding channel
markets, REITs will provide a highly cost effective alternative funding channel for acquisition or development of commercial assets
? Faster re-cycling of development capital improves competitiveness and greater
ability to increase development activity scale
Narrow trading discount to NAV and realise shareholder value
R E I T S
? Certainty of future cash flows, transparency of their structures and high levels of
corporate governance enable REITs to trade at significantly higher values (i.e. premium to NAV) than the same portfolios retained on the companies’ balance sheet
? Enables creation of immediate shareholder value to property companies that trade
at a significant discount to NAV
W HY
R E I T S ?
T HE
B E NE F I T
O F
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Introduction of REIT legislation gathering pace
Finland Netherlands—1969 U.K. 2007 Canada— 1994 U.S.— 1960 India
WO R L DW I DE
Belgium—1985 France—2003
Germany Italy China South Korea—2001 Japan—2001 Taiwan—2005 Hong Kong—2003 Philippines
Thailand—2002 Singapore—2002 Malaysia—2002
Australia—1971
M A R KE T S
New Zealand—1971 Existing public REIT markets REIT structures under consideration
O V E R V I E W
O F
R E I T
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Real estate funds in India
? Currently, only venture capital funds have been allowed to offer real
estate funds.
? The venture capital arms of HDFC, Prudential ICICI, Kotak Mahindra,
IL&FS and real estate mutual funds (REMFs) are currently available only to high net worth individuals and institutional and global investors. These include funds such as ICICI Venture, HDFC, Kotak Mahindra and Kshitij Venture Capital (Pantaloon), all of which have floated real estate funds.
? According to SEBI regulations, individual investors in an REMF must
invest at least USD 11,500.
? The current players, however, have set the minimum contribution at
far higher levels: ICICI and HDFC look for a minimum investment of USD 500,000, while Fire Capital asks for USD 1 million.
? Though SEBI has allowed real estate funds, they do not enable retail
participation.
21
How big is the Indian REITs opportunity?
? CRISIL estimates real estate stocks will grow from the current USD 500 billion
levels to above USD 1400 billion by 2010. This is based on the GSDP estimates for 2003-04 and an average annualised yield of 10 per cent.
? CRISIL expects REITs have the potential to hold at least a 5 per cent share (more
than USD 70 billion) of the total real estate market by 2010.
? India offers a greater opportunity for REITs than any other country in the world. ? The yields on commercial real estate across metros in India are higher than those
prevalent in the global real estate markets.
? Apart from the information technology (IT) and IT-enabled services (ITES) sectors,
biotechnology, insurance, banking and consulting businesses have also been growth segments driving the demand for real estate.
? A higher demand can be seen in the retail segment with an expected influx of
clothing and lifestyle stores, restaurants and beverage chains, entertainment and leisure complexes.
22
REIT MARKET IN INDIA - PROBLEMS
REIT market in India - Problems
? Unorganised ,largely fragmented sector characterised by small players with local
presence
? Near absence of professionally managed world class companies with a pan-india
Limited availability of world class realty
presence
? Significant scope for improvement in terms of location, layout and design,
construction techniques, material quality, amenities offered to create long term value and face industry downturns.
? Absence of an enabling role by ensuring the supply of quality real estate as in
Hong Kong and Singapore.
? Lack of property management companies providing quality services such as
construction, development, repair and maintenance on properties
IN INDIA
High cost of transaction
? The current regulation s in India involve high transaction costs, and present
problems in ensuring clear land titles and prolonged delays in obtaining clearances.
? Lack of adequate disclosures on land/property transactions, underreporting of
M A R KE T S
taxable income and absence of uniform accounting norms for revenue recognition.
? As land/property transactions need to overcome regulatory constraints, avoid
Lack of transparency and information
R E I T
stamp-charges on multiple transactions, and lack of clarity on titles, disclosures are minimal
? The accounting norms allow both percentage completion and project completion
O F
O V E R V I E W
methods to be adopted, which results in non-uniform revenue recognition in the industry
? There is a complete absence of a credible database on real estate markets, in
terms of property demand and supply, absorption rates, geographic price data, occupancy rates, rentals, and capitalisation rates for commercial, retail, and residential property segments.
2 10
REIT market in India - Problems
?
Illiquid secondary markets
An efficient secondary real estate market facilitates a price discovery process by enabling market demand-supply forces to arrive at the efficient price. In such a market, whenever the prices fall below their intrinsic value, the demand would rise to the extent the price equilibrium is restored. Similarly, whenever the prices rise above their intrinsic value, sellers would increase in the market to ensure rationality in the market. duty/registration charges constrain the development of the secondary market.
? Currently, the lack of information and transparency and the high stamp
? No standardised, accepted practices for property valuations at present
IN INDIA
? As a result, there are no meaningful benchmarks available among properties
M A R KE T S
Valuation of properties is not standardised
? Valuations are rarely based on the discounted cash flow (DCF) method of valuation,
which is an accepted method for valuing assets in the industrial sector. In the absence of standardised valuation techniques, it is difficult to identify intrinsic valuations from the premium assigned by speculators.
? The impact of extraneous variables such as interest rates and inflation are also not
factored in adequately into the valuations of properties.
? Lack of proper land records.
R E I T
O F
Other problems
? Inadequate town and infrastructure planning for a sustained, planned growth. ? Ineffective bankruptcy laws. ? Multiplicity of development laws and non-standardisation of laws across states
O V E R V I E W
leading to delays and increasing costs.
2
REIT MARKET IN INDIA - SOLUTIONS
REIT market in India - Solutions
The disclosures should be both mandatory and discretionary. Mandatory disclosures will include:
? Interested party transactions
Mandatory disclosures and strict norms to enforce independence, objectivity and transparency
? Payment of fees to REIT managers ? Tenant profiles, tenures and occupancy rates, total number of tenants, top
ten tenants and their contributions (per cent) to gross rental income, lease maturity profile
? Asset profile - geographic diversification, sector classification, ownership
concentration.
? Substantial unit-holdings of 5 per cent or more to be informed to stock
IN INDIA
exchange and REIT trustee (including subsequent changes in percentage levels of holdings)
? The registration or licensing of REIT managers should be compulsory. ? The asset management company (AMC) guidelines must allow unit-holder
M A R KE T S
R E I T
Enhanced corporate governance practices
meetings at the request of 50 or 100 unit holders or 10 per cent of unit holders (whichever is less), and removal of REIT managers by approval of 50 per cent of unit holders. Credit rating linked relaxations and incentives with:
? A maximum cap on borrowings relaxed if REIT has a credit rating from a
O F
O V E R V I E W
recognized credit rating agency
? The maximum cap on borrowings further relaxed in case REIT has an
investment grade rating from a recognized credit rating agency
?
Only rated REITs permitted to raise funds through a new funds offer.
2
REIT market in India - Solutions
? A detailed valuation undertaken at least once a year by an independent
professional agency.
Proper Valuation of properties
? Desk-top valuation (instead of a full valuation) undertaken at least 4 times a
year
? Interested party transactions requiring at least two detailed, independent
valuations
IN INDIA
? A centralized database containing details of property prices across locations,
M A R KE T S
new projects undertaken and property purchases should be created.
An independent, centralised database
? This will help track the price index across geographies as a benchmark for
the sector, property absorption rates, demand-supply gaps and direction of price movements.
O V E R V I E W
O F
R E I T
2
Conclusion
REITs can be a potent tool in institutionalising the real estate sector in India. However, there is a need for strict disclosures and other regulatory norms as well as an enabling framework, before REITs can be formally introduced in the country.
References
? India REITs: Are We Prepared Yet? – Insight - CRISIL Ratings
? REIT Asset Management India – David Cohen ? REITs Recommendations – Sub Committee appointed by AMFI ? REITs for Rookies – FAQs – Deutsche Bank
REFERENCES
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