Markets/Global Investing

REITs Ring the Globe

As more nations enact REIT legislation, a transparent global market for commercial real estate investment is emerging.


For many years, only a small group of countries outside the United States provided REITs or REIT-like investment vehicles. Canada, Australia, the Netherlands and Belgium were among the earliest adopters of American-style REIT legislation, but recently a host of new members have joined the club, including Japan (2001), Korea (2001), Singapore (2002), Hong Kong (2003), and France (2003), as well as Turkey, Malaysia and Costa Rica.

Now come two of the biggest pieces needed to complete a global REIT market: Germany and Britain. The U.K. is scheduled to implement REIT legislation on January 1, 2007. “We expect most major U.K. listed property companies to convert to REIT status when that happens,” predicts Chris Morris, a law partner at Freshfields Bruckhaus Deringer in London. Germany, with the largest real estate stock in Europe, will probably follow by the end of 2007.



Different Models

The REIT regimes vary in terms of the rules they must follow. The most significant difference is whether they are structured to employ internal or external managers – jurisdictions like Japan and Singapore require external managers, as the U.S. did before the 1986 Reform Act, which was enacted to reduce management conflicts and align management interests with those of shareholders.

All REITs are required to pay out a substantial portion of earnings in dividend form, but these payouts vary from about 80 to 100 percent. Another variable is the amount of leverage permitted (see attached table for details). And, to complicate matters, all these features remain in flux. “Since many of these regimes are still not very old, they have not yet identified areas where they will need to adapt or make changes,” says Michael Grupe, executive vice president of research and investor outreach at NAREIT.

For example, when REITs were first established in Hong Kong, the companies were not allowed to own assets that were not listed on the Hong Kong stock exchange. Those regulations were revised in June 2005, partly to accommodate investors who wanted to use Hong Kong’s efficient markets to access Chinese properties. Korea, where REITs have gotten off to a slow start, enacted the Revised Indirect Asset Management Business Act in 2005, expanding the types of investments REITS could make.

Investor Benefits

Investors have plenty to gain as REITs expand around the world. U.S. equity investors who used REITs to enhance diversification in their portfolios were rewarded in the past few years as non-correlated real estate assets outperformed most corporate shares. Now, those investors can go a step further, by gaining exposure to real estate on a global basis.
There is little synchronization between real estate returns between regions, or even within regions, producing a range of share performance and, potentially, lower risk: In 2006, the compound annual rate of return for North American real estate has been 13.47%, for Asia 8.22 % and for Europe 22.73% (through June 30), see note 4 according to the EPRA/NAREIT indices. In 2005, North America returned 13.21%, Asia 23.37% and Europe 9.43. Thus, as more nations allow publicly traded REITs, investors can pick up wider exposure, and reduce correlations.

“ Right now, U.S. valuations appear to be approaching a peak, while Japan, at the opposite end of the cycle, is emerging from years of deflation,” points out Scott Crowe, global head of real estate at UBS. Crossing borders with REIT investing also provides a currency play: “Foreign REITs perform as a hedge against a weakening dollar,” says Daniel O’Connor, managing director at San Francisco based GlobalRealAnalytics.

When it comes to demand for the REIT shares, global demographics favor issuers. Asia and Europe, even more than the U.S., have aging populations in which retired investors will seek stable sources of income. Real estate, which also provides protection against inflation offers a useful source.

Important differences remain between the new REITs and those traded in the U.S. and Australia. “Transparency has increased internationally, but it has a ways to go, to reach the level found in the U.S., and further still to that found with Australian listed real estate securities,” says Dionisio Meneses, Jr., senior portfolio manager at GlobalRealAnalytics. Australia, he notes, surpasses U.S. in disclosure rules, requiring REIT issuers to show shareholders third-party appraisals of their holdings.

Scot Sellers, CEO of Archstone Smith, the largest U.S. apartment REIT, says foreign property companies often approach him to learn more about the U.S. model. “Initially, they indicate an instinct not to disclose is correct to disclose much,” he says. “They are even surprised when we explain how added information leads to success. Eventually they think it through, and agree that disclosure works best.”

Greater disclosure and transparency can also lead to greater stability. For instance, office cycles in mature REIT countries like Australia and the U.S. have become less volatile because the publicly-held companies have to tell shareholders—and their competitors—what they’re up to. “REITs produce information, which has helped reduce cyclicality,” Crowe explains.

The spread of REITs may even help global corporations manage their international portfolios of offices, warehouses and factories, Sellers predicts. “As publicly traded real estate becomes more viable, they could spin them off for more money than the carrying value,” he says. In the U.K., Morris foresees companies using the new REITs as a way to get real estate off their balance sheets. Ditto for Germany, where real estate assets are already being revalued (upward) in anticipation of the coming legislation.

Small World

The REIT pie will keep getting bigger. Already, the FTSE EPRA/NAREIT Global Real Estate Index represents $720 billion in market capitalization, with 321 publicly traded companies. Three years ago the index included 227 companies, with a combined market cap of $ 332 billion. But that may be just the start: “Half of the world’s balance sheet is real estate, but only about 8% is listed,” says Crowe.

Grupe of NAREIT expects to see cross-border action by the REITs themselves as more nations adopt the investment structures. A liquid public market in REIT shares will make it easier for them to become global operators, “more like GE or Coke,” he says.

“ We are at the dawn of a huge structural change,” says Crowe. “For the first time, we can invest in liquid and transparent entities across the world.”

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