All REIT now

The downside of the investment instruments available on the Polish real estate market is that they are saddled with low rates of return and low levels of liquidity plus the risks associated with investing in shares. REITs could be the remedy

The dynamic development of the Polish real estate market is no secret – as can be seen merely by glancing at data from the Central Statistical Office (GUS).  Their 2005 figures showed year-on-year increases of 40 pct in the average price per square meter for residential property and about 30 pct for the industrial-commercial and office property. This growth was maintained at similar levels in 2006 and it is not unreasonable to hope that it will continue. This is reflected in the upward trend in transaction value. Last year’s biggest transactions on the office real estate market hit USD 300 mln. The property market boom is the natural knock-on effect of a tiger economy and the appearance of new instruments and mechanisms on the market.

 Much done, but still too little    

 To date, the Polish legal system has responded to this type of need with investment fund regulations. On the back of these regulations, investment funds specializing in the real estate market started sprouting up two years ago. Currently, there are about ten. Nearly all of them take the form of closed-end funds, which means that the certificates they issue are available to investors only at the time of subscription, and their redemption date may even be as much as 8 years hence. To make matters worse, secondary trading in fund certificates on the Warsaw Stock Exchange is very thin on the ground, which results in these investments having low liquidity. Recently, open-ended funds have also entered the scene – they issue units that they are subsequently obliged to repurchase, but their units are not subject to secondary trading at all. Closed-end funds build up their portfolios chiefly through direct investment in real estate, followed by investments in safe, low yield money market instruments. The principle aim of closed-end funds is to protect as yet uninvested resources through investing them in safe derivative instruments. The effect of this investment policy is that closed-end funds have poor rates of return.  On the other hand, open-ended funds invest chiefly in construction sector joint stock companies whose Warsaw Stock Exchange index – WIG Budownictwo – is beating all records for the second year running, achieving a 120 pct annual growth rate. However, investments in construction sector companies – like all stock market investments – carry a considerable degree of risk.

What is missing in Poland as far as the real estate market is concerned is an investment instrument which would avoid the weak aspects of all these methods of investing in real estate – low rates of return, low liquidity, or the risks of investing in shares. More developed market economies have just such an instrument in the shape of Real Estate Investment Trusts, known simply as REITs.

Flexible and generous 

 How do they work?  A REIT is an entity issuing bonds aimed at accumulating funds for investment (mainly) in the real estate market. The first REITs were set up in the USA in the 1960s. In contrast to their name, their legal form does not restrict itself to the Anglo-American concept of a trust, but may be regulated in a variety of ways which differ from country to country. As an attractive form of investment, REITs are introduced in ever larger numbers in Europe (France, Netherlands, Belgium, Great Britain and shortly Germany and Italy), Asia and also Australia and South Africa. Despite the differences in the various legal systems, certain common features may be identified. As we already mentioned, a REIT buys real estate for its accumulated capital, frequently managing it as well, and in some cases it also finances the investment process. It generates regular income from the investments (e.g. from rents), and is also obliged to distribute a proportion of its income as dividends (in the USA it is 90 pct, in France 85 pct). In practice, the smooth-functioning of REITs is typically assured by their advantageous fiscal principles, in particular the elimination of double taxation of profits (the so-called ‘pass-through tax treatment’). For example, the draft German regulations only tax investors’ profits on capital, and exempt REITs from income tax. To take full advantage of such privileges,

a REIT must fulfil a number of additional conditions, e.g.:

the unrestricted transferability of the bonds that are issued;

the spread of ownership (e.g. a ban on one entity owning a majority share, in Germany the proposed maximum being 10 pct);

the requirement regarding the investment structure, mainly in real estate, and debt instruments associated with real estate;

the requirement to possess the real estate for a specified minimum period of time.

On other hand, the legal structure of REITs is variegated and dependent on the tradition of a given legal system. A REIT can be constituted as a trust, a legal entity (e.g. a joint stock company) or a unit without legal entity.  In the proposed German regulations, REITs come exclusively in the shape of joint stock companies and, moreover, by definition, they will be listed companies, similar to British and French REITs. That does not constitute any sort of abiding principle because in the USA a ‘private REIT’ is also possible. Where a REIT is a public company, it must also fulfil all the particular requirements specified for that type of company, ensuring, above all, transparency with regard to information on the investment.

Advantages for whom?

 It should be underlined that both individual and corporate/institutional investors can operate on the REITs market.  A REIT gives individual investors opportunities which in other instances are available only to large, professional real estate players. In this way, the individual investor can take advantage of potential and actual business opportunities on the real estate market, even if he doesn’t have the resources that are required for direct investments in real estate. Institutional investors are encouraged to invest in REITs by the predictable growth of capital which is achieved due to the high rate of shares in profits and the guaranteed preservation of liquidity.

Currently, there are over 200 REITs in the USA. Their estimated assets are now nigh on USD 500 bln, and their mid-year rates of return on investment have been about 14 pct over the last 30 years. In turn, the European FTSE EPRA/NAREIT Global Real Estate Index, which reflects the situation in the real estate market sector, enjoyed mid-year growth rates of 24 pct over the last five years.

These considerations inevitably lead to the conclusion that REITs could provide an important supplement to the real estate market, as broadly understood, in Poland. However, their introduction requires the creation of specific legal regulations, particularly in relation to their legal form, structure of ownership, revenues and investment portfolios, as well as their guaranteed advantageous principles of taxation.          

Agata Jurek-Zbrojska

legal advisor,

lecturer at Faculty of

Investments and Real Property SGH

Bartosz Clemenz

legal advisor,

admitted in Warsaw and New York

attorneys at Warsaw Salans Office