Transcript Slide 1

Property Companies and REITs:
Real Estate in the Public Markets
Colin Lizieri
Market Types

Public Markets:
- Generally single central market place
- Regulated order processing systems
- Price and deal transparency
- Liquidity
- Market makers / brokers role defined
- Market makers limited impact on prices?
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Private Markets
- Generally no central market place
- Highly restricted transparency and info.
- Asymmetric information?
- Market maker, broker role self-defined
- Market makers may influence prices
Equity Markets
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Generally public markets
Regular price, volume, performance data
Brokers, market makers and orders
For firms:
- Raise capital: initial public offering and seasoned offerings
- Benchmark on market views of firm’s activity
For investors
- Income (dividends) plus capital growth
- Liquidity and portfolio rebalancing
- Ownership of (residual) asset base
- Risk and volatility
Equity Market Pricing
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Homogenous products, supply, demand
Role of Players:
- brokers, analysts, informed investors and noise traders
Pricing principles:
- Investors want capital growth and income
- Investors trade off risk against return
- Pricing: Dividend discount model or Net Asset Value
- Asset values and the Law of One Price
- Risk return trade-off and Betas
Pricing in Public Markets - DDM
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Dividend Discount Model:
- Price represents discounted value of future income stream:
P0 = D1/(1+r) + D2/(1+r)2 + D3/(1+r)3 + … Dn/(1+r)n + …
Assume that dividends grow at g% per annum, then
P0 = D1 / (r-g)
The dividend yield d = (r-g) = D1 / P0
We can observe the dividend yield
If we know or can estimate g then we can find required return r
If we know or can estimate r, then we have market’s view of g
Pricing in Public Markets: NAV
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There are various claims on the value of the firm
The equity holders stand behind:
- The debt holders
- The government
- Preference shareholders etc.
The equity holders own the “residual value of the company”
Take a property company with a simple structure
- The assets are the real estate
- There is debt to be paid
- Property Values – Liabilities = Net Asset Value
- NAV / Number of Shares = NAV per share
- Shouldn’t that be the share price? If not, why not?
Real Estate in Public and Private Markets
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Real Estate in Private Markets
- Direct ownership of portfolios
- Investing in private real estate vehicles and funds
- No central market place
- Information asymmetry, transparency, illiquidity
- High transaction costs, monitoring costs, management costs
Real Estate in Public Markets
- Property companies and REITs
- Exchange traded fund vehicles
- Liquidity, price transparency, transaction costs
- Volatility and correlation
But … Are Public Vehicles Real Estate Investments?
Property Companies vs. REITs
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Property Companies:
- Corporate Entities – Taxable
- Management Control over Activity
o
o
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Gearing, non-core activities, disposal and acquisition
Dividend policy and retained earnings
REITs
- Regulations on Activities and Structure
o
o
o
o
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Core real estate activity
Borrowing restrictions (?)
Distribution policy
Ownership rules
Real Estate Income not taxed within the vehicle
Example: UK Property Companies to 2006
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UK Property Companies:
- Closed End Investment Vehicles
- Taxable corporate entities
- Distinguish between:
o
o
Often relatively low free-float
- Often relatively high management holdings
Sector was shrinking with major players delisting or
restructuring, 1998-2004
Growth potential with arrival of REITs
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Property Investment Companies
Property Developer-Trader Companies
Real Estate in the UK Equity Market
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As at December 2006
43 UK Listed Companies, Market Cap £54.1bn
Represents just 2.86% of total market cap
Major firms:
1.
2.
3.
4.
5.
6.
o
o
Land Securities (34)
British Land (39)
Liberty International (66)
Hammerson (77)
Slough (87)
Brixton (160)
Helical Bar (353)
Development Securities (441)
£10.8bn
£8.9bn
£5.1bn
£4.5bn
£3.7bn
£1.5bn Top Six = 64% market cap
£0.4bn
£0.3bn
A Reminder of Scale:
o
o
o
o
o
Royal Dutch Shell (1)
BP (2)
HSBC (3)
Glaxo (4)
Vodafone (5)
£117.1bn
£110.8bn
£106.8bn
£78.1bn
£74.4bn
Performance 1988-2006
800.0
700.0
600.0
Equities
Bonds
Prop Co
500.0
400.0
300.0
200.0
100.0
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D 01
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D 02
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D 03
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D 04
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D 05
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-0
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Equities
Bonds
Prop Co
Mean
2.96%
2.15%
3.20%
Compound
2.68%
2.12%
2.70%
St Dev
7.48%
2.56%
10.02%
Skew
-0.626
-0.182
-0.378
But Are They Property Investments?
900.0
800.0
Equities
Bonds
700.0
600.0
Prop Co
IPD
500.0
400.0
300.0
200.0
100.0
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cDe 8 9
cDe 9 0
cDe 9 1
cDe 9 2
cDe 9 3
cDe 9 4
cDe 9 5
cDe 9 6
cDe 9 7
cDe 9 8
cDe 9 9
cDe 0 0
cDe 0 1
cDe 0 2
cDe 0 3
cDe 0 4
cDe 0 5
c06
0.0
Equities
Bonds
Prop Co
IPD
Mean
2.96%
2.15%
3.20%
2.75%
Compound
2.68%
2.12%
2.70%
2.72%
St Dev
7.48%
2.56%
10.02%
2.27%
Skew
-0.626
-0.182
-0.378
0.180
But Are They Property Investments?
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Stronger Correlation with Equity than Underlying Property?
Equities
Bonds
Prop Co
Equities
1.000
Bonds
0.051
1.000
Prop Co
0.630
0.018
1.000
IPD
0.058
-0.172
0.227
IPD
1.000
Is This Just a Measurement Issue?
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Property Market Returns are Valuation Based
- May Lag Market Movements – Distorts Correlation
- May Be “Smoothed” – Understates the Volatility
“Desmoothing” Procedures
- Remove the Impact of Valuations in Data
Property Company Returns
- Are Affected by Gearing
- Are Affected by Overall Market Movements and Noise
Desmoothing the Index
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Should be no “memory” in the market
However, valuers actually adjust their prior valuation
Reported return is a blend of “true” and previous return
Rvt = a Rvt-1 + (1-a)Rt
Therefore Rt = {Rvt - a Rvt-1 } / (1-a)
where a is the “smoothing parameter”
Prop Co
IPD
Desmoothed
Mean
3.20%
2.75%
2.65%
Compound
2.70%
2.72%
2.53%
St Dev
10.02%
2.27%
5.06%
Skew
-0.378
0.180
0.724
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Desmoothing in Action
25.00%
20.00%
IPD
Desmoothed
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
Lagging and Correlation
Correlations:
Property Companies with:
Quarte
r
IPD
Desmoothe
d
0
0.227
0.326
1
0.434
0.492
2
0.531
0.359
3
0.460
0.068
4
0.409
0.093
Net Asset Value
Fixed Assets Properties
Other
10,000,000
1,000,000
11,000,000
Current Assets:
Trading Prop 2,000,000
Debtors
600,000
Cash
400,000
3,000,000
Less Creditors due < 1 Yr
TOTAL CURRENT ASSETS
2,000,000
12,000,000
Less Creditors due > 1 Yr
3,000,000
Book Value, Shareholders (+NAV)
9,000,000
3,000,000 ordinary shares issued
NAV per share
300p
Discount to NAV
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Discount / Premium to NAV = (P – NAV) / NAV
NAV = 300 Price = 225 so (225-300)/300 = -0.25 = 25% discount
Why Might Property Companies Trade at a Discount?
- Tax - partic. Capital Gains Tax - liability
- Uncertainty as to true NAV;
- Minority holdings, control, agency issues
- Liquidity and loss on forced sale
- Risk: gearing and volatility; off balance sheet commitments
- Noise traders
- Pricing inefficiency?
In long run, Property Companies behave like underlying market
Double Taxation
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Own Shares in Property Company or Own Real Estate?
Tax Position: Own the Real Estate
- Receive rental income, deduct costs: tax liability
- Trade property at profit, pay capital gains tax
Tax Position: Shares in Property Company
- Company rental income, less costs gives tax liability
- Pays tax, distributes dividend to shareholder
- Dividend taxable for shareholder
- Company sells property, makes capital gain, pays tax
- Investor sells shares, makes capital gain, pays tax
This Tax Leakage Leads to Demand for REITs
Real Estate Investment Trusts
REITs
Tax Efficient Real Estate Vehicles
n.b. some of these are offshore vehicles or pending final approval
Russia: CEMF
Netherlands: FBI
Canada: REIT
Belgium: SICAFI
UK REIT
Germany: OEFs, GREIT
Japan: J-REIT
France: SIIC
US: REIT
Italy: SIIQ
Korea: K-REIT
Mexico: REIT-FI
Malaysia: REIT
Singapore: S-REIT
Brazil, FII
South Africa: PUT
Australia:
LPT
Source: adapted from Emmott (2004), NAREIT (2005)
US Real Estate Investment Trusts
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Created in 1960s to allow smaller investors to participate in
property markets
Tax neutral vehicles provided meet qualification rules:
- Shareholder base: minimum of 100 shareholders
- Limited insider dominance: maximum of 50% shares held by
largest five shareholders
- Asset test: at least 75% of total assets in real estate assets,
cash or government securities
- no more than 25% of assets may be represented by securities
other than government securities
- no more than 20% of assets within Taxable REIT Subsidiaries
- Income test: at least 75% of gross income from rents of real
property, interest on mortgages, gains on sales of property and
dividends from REITs
The Growth of REITs
NAREIT Market Capitalisation
450,000
400,000
350,000
$millions
300,000
Hybrid
250,000
Mortgage
200,000
Equity
150,000
100,000
50,000
0
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
REITs Listed: Growth and Consolidation
NAREIT - REITs Listed
250
All
Equity
200
Mortgage
Hybrid
150
100
50
0
71
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75
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The Growth of REITs
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From <$6bn 1990 to >$400bn end 2006
Based on series of liberalisation measures
- Liberalisation in 1980s to solve real estate debt crisis
- Early 1990s – creation of UPREIT structure
- REIT Simplification Act, 1997
- REIT Modernization Act, 1999
Key probably the UPREIT structure
- Private investors can transfer assets into REIT
- Investors get shares in return
- Does not trigger capital gains tax event until shares sold
- Allows orderly transfer into public markets
Some Myths and REITs:
Diversification but not Real Estate?
0.800
0.600
0.400
0.200
0.000
-0.200
Sources: NAREIT, NCREIT, DataStream
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REITs with Property
D
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99
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REITs with Equity
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-0.400
REIT Performance in Context
40.00%
NAREIT(R)
NCREIF(R)
30.00%
USEquity(R)
20.00%
10.00%
0.00%
-10.00%
-20.00%
19
78
19 Q1
79
Q
19 3
81
Q
19 1
82
19 Q3
84
Q
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1
85
19 Q3
87
Q
19 1
88
Q
19 3
90
19 Q1
91
Q
19 3
93
19 Q1
94
Q
19 3
96
Q
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1
97
19 Q3
99
Q
20 1
00
20 Q3
02
Q
20 1
03
Q
20
3
05
Q
1
-30.00%
Source: NAREIT, NCREIF, Universty of Reading
REITs
Direct
REITs
1.000
Direct
0.058
1.000
Equities
0.473
0.016
Equities
1.000
Some Myths and REITs:
Discount to Net Asset Value
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Traded Property Companies trade at discount to NAV
Alleged that REITs do not (e.g. by EPRA)
- SIICs had very low discounts to NAV post-conversion
- But UK REITs now trade at sharp discount to NAV
But:
- How much is a tax effect?
- US REITs DO NOT publish NAV
- Analysts estimate NAV from income
- May use discount rates higher than market cap rates.
May thus be an overstating of the benefits
REITs – Discount/Premium to NAV
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Source: Green Street Advisors, 2005
Green Street estimate NAV from cashflow and cap rate figures.
REITs trade at times at substantial discounts to estimated NAV
However, they also trade at a premium at times.
Some Myths and REITs:
Liquidity
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REITs are supposed to remove illiquidity as a negative factor
damping investment
Listed vehicles are more liquid than private vehicles
- Turnover: IPD 15%, Property Co. 61% (IPF Liquidity Report)
- Tradable transparent public market
- Low transaction costs, lower information costs
But … REITs may be less Liquid than Property Companies
- Property Companies
61%
- REITs
22%
- LPTs
21%
(IPF Liquidity Report, data for 1993-2002)
Australian Listed Property Trusts
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A Tax-Transparent Trust Vehicle for Commercial Real Estate
LPTs take off in the 1990s, retail and institutional sales
Major market players (Lend Lease, AMP, ING, MacQuarie,
DeutscheBank)
Come to dominate market: low cost of capital gives buying power
Now expanding outside Australia
- Asian markets
- USA
- UK – e.g. Westfield, Lend Lease & UK shopping centres
- Mainland Europe
LPT Performance
Australian Property and Equity Returns
Direct Property
30.00%
Listed Property Trusts
20.00%
Equities
10.00%
0.00%
-10.00%
-20.00%
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-30.00%
S ource: PCA, University of Reading
Direct
LPTs
Direct
1.000
LPTs
-0.221
1.000
Equities
-0.101
0.618
Equities
1.000
SIICs
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Sociétés d’Investissements Immobiliers Cotées - French REIT
Note legislative process and speed:
- Process begins 2001 with Industry working party
- Opportunity with 2002 Presidential & General elections
- Ministerial and political lobbying 2002
- Placed in draft Finance Bill for 2003
- Accounting and enabling legislation summer 2003
- Passes into law end 2003
- Many property companies transfer status early 2004
- Further liberalisation 2004, 2006: UPREIT status?
SIICs - Structure
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Primary objective:
- Construction or acquisition of income-producing property; or
- Ownership of shares in companies with that objective
Must be traded on French exchange, minimum cap. €15million
Tax Exempt, provided:
- Distribute 85% of net income to shareholders
- Pay out 50% of cap gains within 2 years of realisation
Firms subject to an “exit” tax of 16.5% on unrealised capital
gains, payable within four years of conversion
SIICs - Drivers
• Other competitor countries have REIT structures;
• Much property investment going “offshore”;
• Government needs cash – windfall €1.5 bn "exit" tax;
• Expectation of tax from secondary trading;
• Persistent discount to NAV for listed companies
• Concern about pensions in France:
• Switch to private from public system
• Need for diversified portfolio / access to asset class
• Capital issues:
• Capital markets determine capital flows
• Under Basel II, bank lending may be constrained
SIICs - Drivers
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Other competitor countries have REIT structures;
Much property investment going “offshore”;
Government needs cash – windfall €1.5 bn "exit" tax;
Expectation of tax from secondary trading;
Persistent discount to NAV for listed companies
Concern about pensions in France:
- Switch to private from public system
- Need for diversified portfolio / access to asset class
Capital issues:
- Capital markets determine capital flows
- Under Basel II, bank lending may be constrained
SIICs: Developments and Problems
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SIIC II: an attempt to increase market size
- UPREIT-like structure to permit inflow of assets
- Relaxation of some of regulatory constraints
Corporate Float-Offs of Real Estate into SIICs
Tax and Ownership Problems
- Tax issues for non-French investors
- Limited control and ownership constraints
Metrovacesa – Gécina Deal
- Metrovacesa (Spanish firm) buys controlling interest in
French SIIC Gécina (€5.5bn deal, creating 2nd largest listed
real estate fund in Europe)
- Borrows money in Spain to finance the acquisition
- Pays no tax on dividend payments from Gécina
- Interest payments offset against profits to reduce tax bill
The UK REIT
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Industry has been seeking a REIT vehicle for many years
Pressure on Government and Treasury for change:
- External – SIICs etc.
- Capital Flow Offshore
- Pensions issues – poor performance of equities etc.
- Clear appetite for real estate: buy-to-let
- Urban Task Force / Barker Report
Pre-budget announcement and Treasury Consultation Paper
Industry / interest group response
Positive noises but delays and the election cycle
The UK REIT, January 2007
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Company and Listing Rules
- Must be a closed ended company
- Must be listed on main stock exchange (LSE not AIM)
- Must have one class of (voting) shares
- Must be resident in UK for tax purposes
- Restrictions on large share-holdings (10% rule)
Activity Rules
- Define a Tax Exempt Business (ring-fenced)
- 75% of firm’s profit from real estate (rents)
- 75% of firm’s assets = real estate
- Must have three properties (not owner occupied)
- Development activity OK for portfolio building (3 year rule)
The UK REIT, January 2007
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Other Constraints and Rules
- Gearing rule: Profit/Finance Costs  1.25
- Conversion charge 2% of GAV – may be phased
Tax and Distribution
- TEB not subject to corporation tax
- 90% of profit must be distributed as Property Investment
Dividend (PID)
- PID subject to withholding tax and treated as property income
for shareholders
- Capital allowances set against income in profits calculation
- Cannot offset losses inside/outside TEB
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UK REITs – Market Reaction
250.0
Land Sec
Brit Land
Brixton
200.0
Slough
150.0
100.0
50.0
0.0
The UK REIT – Issues and Problems
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Establishing a Critical Mass
- Conversions of Property Companies
- New entrants and listing requirements
- The offshore industry and REITs
Specialist or Diversified Vehicles?
- Professional versus retail investors
- Investor interests versus management interests
Returns and Market Expectations
- REITs as an income vehicle
- Property values, yields and distributions
- Growth, retained earnings and distributions
- The state of the market and investor confidence
The G-REIT …
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Must be public (German/EU) stock corporation, based in Germany
Minimum free float of 25%, 10% shareholder maximum
75% assets, 75% profits from real estate (residential restricted)
Must distribute 90% of distributable profits
Maximum 60% debt to asset value
Restrictions on trading
G-REIT exempt from corporation taxes
Investors fully taxable, withholding tax for non-domestic investors
Retroactive to January 2007?
Summing Up
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Listed Real Estate Offers Benefits:
- Liquidity and Low Transaction Costs
- Relatively Small Capital Requirement to Invest
- Ability to Diversify Within and Across Countries
Listed Real Estate Has Disadvantages:
- High Volatility Compared to Underlying
- Higher Correlation with Equity than Real Estate market
- Part of This is Measurement Issue
REITs Offer Advantages over Property Companies
- Elimination of Double Taxation
- Reduction of Discount to NAV Problem
- Linked to Real Estate Market in Long-Run
- Linked to Equity Market in Short-Run