If you’re considering investing in publicly-traded real estate investment trusts – REITs – there is the need first to understand the nature of the investment and then to sort through what at first sight is a bewildering array of possibilities, processes which may be daunting to some. In this piece, we take a look at what a REIT is and at the ways of getting into this interesting form of property investment. The focus is very much on ‘publicly-traded’ REITs – privately-owned property companies and those traded off-market are not readily available to the typical retail investor and anyway lack the liquidity – the ease of buying in and selling out – which is the hallmark of the listed REIT. In a separate piece we’ll look at the criteria by which you should judge a REIT for investment purposes.
What is a REIT?
First, some salient explanation of the publicly-traded real estate investment trust. Despite the word ‘trust’ in this label, a REIT is a normally-constituted company whose securities – often called ‘units’ rather than shares – are listed on a stock exchange. The company may be ‘closed’, meaning that any share issues after the initial flotation must be approved by existing shareholders, or ‘open-ended’ which, as with ordinary listed companies, means that future share issues – with attendant share capital dilution – are at the discretion of the board of directors.
To acquire REIT status, the company must conform to a set of legal and procedural rules which dictate (a) the type of business it operates and (b) its ownership structure. In essence, a REIT must generate the bulk of its income – the minimum is typically put at 75 percent – from rents on property owned by the company and it must pay a specified minimum – normally 90 percent – of that income, net of operating expenses and overheads, to its investors each year. As for shareholding structure, the rules in general terms are designed to ensure a broad spread of owners, with no one person or group able to dominate, and by that token an active market in the REIT’s securities.
Tax Neutrality – The Key Point of Difference
Whilst the rules differ in detail from one country to another, and there are other restrictions (such as in relation to borrowing), this same basic framework applies to REITs the world over. And once REIT status has been conferred, there is a uniform tax treatment of such companies. They are treated as ‘pass-through’, meaning that the income earned from approved activity is tax-exempt in the company’s hands, thus avoiding the double taxation which, absent special rules, applies with a conventional company’s earnings – first as corporate income tax and again on dividend paid to shareholders, in each case at whatever is the going rate in the country of domicile.
It’s this tax ‘neutrality’ which differentiates the REIT from other property companies. In principle, the pass-through should make a real estate investment trust more attractive for investment purposes than a conventional property company – it pays no tax on its primary income so that, all other things being equal, more of that income is available for distribution to its owners than is the case with conventional companies.
Bottom Line Difference Not So Marked
The point shouldn’t be taken too far though. The extent to which a REIT’s pass-through status will translate into a higher investment return is very much dictated by the tax regime in the REIT’s – and the investor’s – country of tax domicile. For example, because they pay no tax on their income, REITs cannot attach ‘imputation credits’ to their ‘PIDs’ – property income distributions – and those payments don’t attract the lower tax rate applied in some countries – such as the UK – to dividends, meaning that the distribution is likely to be taxed at the full marginal rate applicable to the recipient shareholder.
In January this year, Deloitte Real Estate published a helpful comparison of the UK tax treatment of investors in REITs as opposed to conventional companies. Assuming the latter pays corporate income tax at the full rate of 24 percent, and assuming individual as opposed to corporate investors, the net benefit to the REIT investor over the conventional company shareholder is 5.3 percent in the case of income taxed in the ‘basic’ and ‘higher’ tax bands, and just three percent for the REIT investor with income in the ‘additional’ band. The real beneficiaries of REIT tax treatment are investors which pay no tax on their incomes – notably UK pension funds and ISAs (individual savings accounts). According to the Deloitte tables, an approved ISA investment in a UK-REIT will better by 31.6 percent the return available to a conventional company shareholder.
The Ordinary Investor’s Way Into Property
Aside from tax though, an investment in a real estate investment trust provides the typical ‘retail’ investor with opportunities to get into property investment which are otherwise limited to high net worth investors. Indeed, this pooling of small investments to fund a large one is the raison d’etre of the REIT. In principle, a REIT could own a single very large – in terms of rental income – property but in practice almost all REITs in all countries where they operate have a portfolio of several – or a great many – properties. These may be in a discrete real estate sector – be it office accommodation, High Street shops or self-storage, for example – but for the most part REITs are diversified at least to the extent of holding a mix of office and retail properties.
Finding Out Stuff About REITs
So where might prospective REIT investors go in order to gauge the range of possible destinations for their investments? If the investor is flying solo at this stage, and the search is confined to UK-REITs alone, a good a place as any would be ‘Reita’, the REIT-dedicated website of the BPF – the British Property Federation – at http://bpf.org.uk/en/reita/index.php. There is a page listing all the current UK-listed REITs – some 24 of them – and clickable links to information about each. And since, at least till the rule changes mid-way through last year, all UK-REITs had to be listed on the London Stock Exchange, there’s useful information to be had at the LSE’s website, including of course current trading data on those 24 companies.
Another useful source of information, especially performance-related, on the UK’s real estate investment trusts is accounting firm BDO’s publication ‘UK-REIT Survey 2012’. There have been some changes to the line-up since last year – London & Stamford Properties recently merged with Metric Property Investments to form Londonmetric Property (LON:LMP), the REIT formerly known as Capital Shopping Centres recently re-branded itself as Intu Properties (LON:INTU), and at the beginning of this month listed self-storage operator Safestore Holdings (LON:SAFE) converted to REIT status. But otherwise the BDO survey makes for interesting and informative reading.
But there’s a much bigger REIT ‘universe’ available to UK-based investors and indeed, the domestic UK market is pretty small in relative terms. Those 24 companies – plus a further two registered offshore – have a current market capitalisation of around £25.5 billion, making the whole UK market just 70 percent in value terms of the largest US-REIT, Simon Property Group Inc (NYSE:SPG), currently valued on the NYSE at $54.81 billion (£35.94 billion). There are over 200 listed REITs in the United States, and their tax-neutral activities are not – as in the UK – restricted to receiving rents. Amercian REITs may also lend on mortgage security, or have a mix of rental and interest income, and there is much greater diversification and specialisation as to property sector in the US market. For example, whereas there is virtually no UK-REIT investment in housing, a number of American REITs are focused primarily or exclusively on residential real estate, including niche areas such as student and military accommodation.
And of course there is a dedicated US-REIT website – www.reit.com – with a huge amount of information available for research purposes.
Beyond the United States, real estate investment trusts are now an established part of the property sector in several countries, notably Australia and New Zealand (where they’re known as unit trusts), Japan, Singapore, France and Germany. In the latter case, the enabling legislation has been in place only since 2007 but German stock exchanges now have more publicly-traded REITs than any country other than the United States, many of them being secondary listings – in Frankfurt or Berlin typically – of REITs domiciled in another country.
Multiple Listings Are Common
A useful collection of the world’s REITs can be found at Bloomberg, at the page www.bloomberg.com/markets/companies. Under the heading ‘Financial’, a click on the tab ‘REITs’ produces a sub-series by sector, with each showing country of listing and exchange symbol for each entrant. Far and away the largest category is ‘diversified’, with some 308 listings, of which 80 are German, 78 are American and 25 each are French and Australian. It’s possible here to discover, for example, that the New Zealand property company Kiwi Income Property Trust (NZX:KIP) – a long-time resident of the New Zealand Stock Exchange – is also listed on the Berlin exchange (GR:KN5) and traded over the counter in the United States (OTC US:KWIPF). And that the above-mentioned Intu Properties, listed on the LSE, has a secondary listing in Johannesburg, South Africa (SJ:ITU). And we learn that the UK’s second-largest REIT, British Land plc (LON:BLND), is listed in Frankfurt (GR:BLD) and is also available on the American OTC market (OTC US:BRLAF).
Buying Into A REIT – At Home
Whether the REIT investment is to be at home or abroad, the practical question arises – how does one actually go about it? The answer in almost every case is – through a broker. The fact is that stockbrokers long ago cornered the market on securities dealing: it would be a rarity for a listed company to facilitate the direct purchase and sale of its shares and of course stock exchanges accept – and are geared to accept – transactions only from accredited members, meaning brokers of one kind or another.
For the purchase of units in a UK-REIT, all of the mainstream stockbrokers will be able to oblige, there being no difference between those securities and the shares of other listed companies. There’s a fee of course – typically around £10-12 for a single buy or sell transaction, with most brokers offering discounted fees for repeat or volume business. For example, one prominent broker – Hargreaves Lansdown – promotes a fee of £5.95 for 20 or more deals per month.
For REIT securities listed outside the UK, it will be possible for a British broker to handle the transaction if the foreign REIT has issued DRs – depositary receipts – which are listed on a UK exchange. Originally an American invention – way back in the 1920s – DRs are negotiable securities issued by banks in country A in exchange for shares of a company incorporated in country B, allowing investors in country A to buy and sell the equivalent in all respects of the foreign company’s securities as if it was a local company. DRs denominated in US dollars (ADRs) remain the most widespread but nowadays depository receipts are also issued in euro (EDRs) and other currencies.
The alternative to DRs is for the investor to open a trading account with a broker directly in the country where the foreign REIT is listed. There will be exchange rate risks of course and also the prospect of repatriation of either earnings or sale funds being impacted by local laws, so investors going this direct route need to have done their homework.
Finally, a word or two on the alternative to investment in a specific REIT, or selected REITs, and whether domestic or offshore, which is to take a position in a REIT-indexed ETF (exchange-traded fund). The in-principle advantage is that the investment is tied to the performance of a number of real estate market participants – those which make up the index – so avoiding the risk that a given REIT will perform badly during the investment period.
A consequence of the relatively small size of the UK-REIT market is that there is only a small choice of indexed funds – the most prominent of which is the iShares FTSE EPRA/NAREIT UK Property Fund (iShares is an offshoot of Blackrock Capital of the US and claims to be ‘the dominant force in global exchange-traded funds’). This fund tracks the performance of the 10 largest (by market cap) listed UK property companies, nine of which are REITs, with the top three – Land Securities Group (LON:LAND), the previously mentioned British Land and Hammerson (LON:HMSO) – making up 46 percent of the index weighting.
Beyond the UK market, there is a large selection of REIT-indexed funds to choose from. Investors seeking a global exposure to REIT performance, but with a strong US bias, could consider, for example, the Vanguard Global ex-US Real Estate ETF (NASDAQ:VNQI) but there are many others.
Brokers – A Necessary Evil
Whichever way you think to go, there’s a wealth of information to be had on real estate investment trusts both in the UK and globally, much of which is freely available to anyone with the time and motivation to look for it. When it comes to actually buying REIT securities though, as already observed it’s virtually impossible to proceed without the services – and attendant charges – of a stockbroker. In which case, it will make sense to select a broker offering the widest possible range of services – and expertise – in relation to both domestic and offshore real estate investment trusts.