Is everything alright with REITs?

As property markets recover or continue to improve, investors, both private and institutional, are crossing the border in search of solid earnings. Are REITs what they are looking for?

Mladen Petrov

The popular saying "the grass is always greener on the other side" has never been more apt when it comes to investment in real estate and one specific type of real estate investment in particular. European investors are now looking at the US market, while the Americans keep asking questions about investment opportunities in China and India. What connects them all are real estate investment trusts.

Let's talk business
Even though the law in some CEE countries does not support the existence of REITs, funds are now eyeing up Poland as an important source of capital for such investment. Last year saw the debut on the Warsaw Stock Exchange of the Bulgarian-based REIT company InterCapital Property Development. The firm debuted on the New Connect market, which is run by the Warsaw Stock Exchange but conducted outside the regulated market as an alternative trading system. The Bulgarian REIT has since raised EUR 1.84 mln from the Bulgarian and Warsaw stock exchanges, but this represents only 6.2 pct of what the fund was looking to raise on the two bourses. The company currently has two projects: Marina Cape on the Bulgarian Black Sea shore and a holiday estate in Borovetz, near Sofia. In Q1 2011 the fund's stock is to be moved to the bourse's Main List market, with plans to raise around EUR 13.5 mln via a capital increase, both on the Sofia and Warsaw bourses, for a new investment located in Sofia.
Recently, senior executives from Franklin Templeton Real Estate Advisors, the real estate investment arm of global investment manager Franklin Templeton Investments, met with institutional investors and private bankers to discuss investment opportunities in REIT projects.  Currently the firm's open-ended fund has under USD 1 bln in REIT assets globally. In line with its investment principles and strategy, the firm offers institutional investors exposure to global real estate investment through both private real estate funds and public real estate securities. The company manages portfolios of publicly listed companies that derive the majority of their earnings from real estate or real estate-related businesses.
"There is a lot of interest, globally, in diversifying portfolios through buying shares in REITs. USA is the highest on the list, followed by China and India (via exposure through Singapore and Hong Kong) - two countries with emerging middle classes showing a very healthy appetite for new facilities, both retail and residential. In Poland we are also meeting with clients who haven't previously been exposed to real estate. We've noticed that some investors are heavily focused on their own markets and are thus missing out on exciting opportunities. It is enough to look at Australia, a country which has almost been insulated from the crisis. There has been a change in the perception of what real estate investment in the region means," believes Dan Fulop, the senior vice president of Franklin Templeton Real Estate Advisors.

Back on track
REIT investment usually constitutes 5?20 pct of an investment portfolio. The US has the largest REIT market with a 60 pct share in GPR 250 REIT, the major industry market index. European REITs represent 15 pct of the companies constituting the index. Among investors, REITs are considered safer instruments due to the vast geographical and sector diversification they offer. According to their strategies, the majority of such companies are oriented towards developing steady income-generating properties, with the sale of real estate not usually being the priority. Last, but not least, REITs qualify as an affordable investment due to their 1-5 pct management fee, which, at least in some cases, is lower than the fee charged by Polish funds.
After hitting the market bottom in 2009, the majority of REITs across the globe are now well along the recovery path. According to a study by financial advisory firm Expander, prior to the financial crisis, from the end of 2001 until the middle of 2007, the return on REIT investment stood at over 320 pct, with European REITs achieving even a five-fold return on investment over this period. After the crisis, in 2010 the global REIT market developed faster than the stock and bond markets. Last year GPR 250 REIT's rate of return was 1.8 times higher than the rates of return of global stock markets. In the case of US-based  REITs the return was even 2.8 times higher. Furthermore, looking at the financial results of the ten largest REITs in the world in 2010, their shareholders made on average 25 pct. In comparison, according to Expander, Polish real estate funds achieved an average 6 pct profit in the same year.
It is not surprising, therefore, that investors are starting to explore their options and are now also eyeing up shares in REITs across the globe. "Polish investors are becoming more sophisticated," Dan Fulop observes. "They are realising that investing in real estate doesn't mean only buying one building or an apartment. We perceive Poland as one of the top prospective investor countries in Europe for the fund. Generally speaking, we are seeing an improvement across the globe, and with travelling currently increasing we are also bullish on the hotel market and Asia in general," he adds.

Promotion needed
Tomasz Gołys, a financial analyst with Expander Advisors, emphasises the fact that REITs are still an unpopular form of investment in the region, with investors steering away from them as their working mechanisms remain unclear. The largest REIT companies in the world, however, are well-known to the average investor in the region, as the list includes companies such as Simon Property Group, Unibail-Rodamco and Segro. Therefore, he is also calling for the further popularisation of REITs in Poland. "Franklin Templeton's Franklin Global Real Estate Fund invests over 35 pct of its capital in REIT companies around the world. Funds like this benefit from global asset diversification - such companies operate in America, Asia and Europe. This is an interesting offer for those investors who are looking to invest abroad. Over the last year this particular fund gained 20 pct," claims Tomasz Gołys.
Private investors are not the only ones being targeted by such funds. Given that the proper laws are in place, pension funds could also find themselves amongst those investing in such schemes, as is the case in Bulgaria. According to Bulgarian law, pension funds can possess up to 10 pct of the shares in such companies. In fact, one fund can own more shares via a number of sub-funds. For the time being, however, there are no signs that the law is going to change in Poland, leaving REITs on the shelf with other less-popular investment products. Grzegorz Chłopek, the vice-president of ING PTE, the biggest pension fund in Poland, admits that pension funds are actually interested in REITs as such, and adds that: "According to the law we can't invest directly in real estate. As a pension fund we need closed-end funds for that purpose. An investor should be given the opportunity to exit an investment at all times, an option which most REITs don't offer. This is why the share of such investments remains insignificant at this point. Funds like ours invest in real estate on the stock exchange, acquiring the stocks of listed developing companies, Mr Chłopek explains.
Franklin Templeton's Dan Fulop will not go into any details when describing the profile of the potential Polish private investors interested in REITs. According to Michał Abramczyk, a real estate advisor with Polish high-street bank Noble Bank: "Customers are not that keen on exotic real estate investments. The wounds after the burst of the Dubai bubble are still fresh. There is a lot of excitement about Asian real estate markets, but this year will show whether the hype is well-grounded. We still believe that further market corrections are on their way. It's worth remembering that REIT shares are a long-term investment, as exiting an investment early is costly, so one should stick with it till the end. For the time being, long-term investment offers in Poland feature similar levels of return on investment," Mr Abramczyk concludes.

Tax-free and exotic
According to the Expander Advisors financial advisory, a real estate investment trust (REIT) is a tax designation for a corporate entity investing in real estate that reduces or eliminates corporate income taxes. In return, REITs are required to distribute 90 pct of their income, which may be taxable, into the hands of the investors. REITs require special legislation to exist, which is the reason why they are almost non-existent ? at least in their original form ? across Europe. In the CEE region such trusts exist only in Bulgaria. REITs were introduced in Bulgaria in 2004. Now there are around 60 such funds in the country. In reality the number of active funds is some two thirds lower, with the funds primarily creating land banks without going ahead with actual development activity. REITs create an opportunity for institutional investors, such as pension funds, to invest in development projects. Across the EU, REITs are also an available form of investment under similar formats in countries such as Germany, Holland, Belgium, France, Italy and Greece. Finland was the last EU country to join the club. Finnish REITs were established last year when ?the tax exemption law? was passed by the Finnish parliament. Together with the ?Law on Real Estate Funds?, this enables the operation of tax efficient residential REITs.