It wasn’t part of their original brief, but real estate investment trusts travel well.
About a dozen years after U.S. REITs caught fire, creating a vibrant public property market for investors, more and more countries are allowing their own variations. In addition to Australian listed property trusts, or LPTs, which took off in the early 1990s, Japan’s J-REIT arrived on the scene in 2000. Korea’s K-REIT and Singapore’s S-REIT debuted in 2001 and 2002, respectively, and last year the French société d’investissement immobiliers cotées, or SIICs, along with REIT structures in Taiwan, Hong Kong and Mexico joined the crowd. In the U.K. the government is expected to approve a similar vehicle, tentatively known as a property investment fund, or PIF, within the next 12 months."The world has taken a look at the U.S. REIT market and said, ‘That’s a very interesting way of owning real estate,’” says Charles Lowrey, CEO of Parsippany, New Jerseybased Prudential Real Estate Investors, which manages about $22.5 billion of real estate around the world.
For real estate owners, the emergence of European and Asian REITs provides another capital markets financing option and increases liquidity. They can now either convert their companies to REIT status or sell properties to the new trusts. For shareholders, REITs offer the chance to own a tax-efficient stake in real estate properties in a publicly traded security. Other capital markets options for real estate companies include raising private equity and, on the debt side, issuing bonds or tapping the markets for commercial-mortgage-backed securities. CMBSs are well established in the U.S., but they’ve only recently begun to catch on in Europe and Asia.
“I think we’re witnessing a potentially fundamental change in how global real estate is held,” says Steven Carroll, global securities portfolio manager for LaSalle Investment Management, a real estate investment firm headquartered in Chicago and London. “The public market is going to become increasingly important.”
What happens to the global proliferation of REITs if interest rates continue to rise? “Higher interest rates in and of themselves will not kill the real estate investment trust model,” says Richard Saltzman, New Yorkbased president of private international real estate investment firm Colony Capital. “But it may slow down the trajectory of how quickly these models are embraced outside the U.S. It’s a two-edged sword. On one hand, rising rates are for the most part evidence of an improving economy, which generally means real estate fundamentals are going to improve. On the other hand, rising rates may make other investments more attractive relative to real estate and to REITs in particular.”
Like their American counterparts, non-U.S. REITs have one all-important characteristic: Tax codes allow the trusts to avoid paying corporate taxes on profits so long as the lion’s share of income (90 percent in the U.S. and Japan, 85 percent in France, for example) is passed along to shareholders as dividends. Other publicly traded real estate companies do not share this tax break. The advantages of trust status are clear: Real estate companies gain greater access to capital, and REIT shareholders enjoy relatively stable -- and usually high -- yields.
While many of these REITs confine their real estate investments to their home countries, some have international portfolios. The Australian LPTs Macquarie DDR Trust and Westfield America Trust, for example, are major owners of U.S. shopping centers, and French SIIC Klépierre owns and manages shopping centers in the Czech Republic, France, Greece, Italy, Slovakia and Spain. The cross-border trend requires shareholders to pay close attention. “We’ve got global investors who have chosen to include Australia in their allocation, and now they see the Australian LPTs going offshore to make investments, and they’re saying: ‘Wait a minute, that’s not what we bought into. We bought you thinking you were the Australian market,” says Will McIntosh, global head of research and strategy for ING Real Estate in New York.
A number of U.S. REITs have gone global as well. In addition to industrial REITs like Aurora, Coloradobased ProLogis, which owns distribution facilities in China, Europe, Japan and Mexico, a few retail REITs have expanded to overseas markets. New Hyde Park, New Yorkbased Kimco Realty Corp. owns shopping centers in Canada and Mexico, and Indianapolis shopping mall REIT Simon Property Group owns stakes in properties in France, Italy, Poland and Portugal.
According to McIntosh, there are about 310 publicly traded real estate companies around the world with a total equity market cap of about $421 billion. Roughly half are U.S. companies -- predominantly REITs -- with a combined equity market cap of about $220 billion. The rest are scattered around the globe. There are about $48 billion worth of publicly owned real estate companies in Hong Kong and $41 billion in the U.K. Japan’s market includes roughly $33 billion of publicly owned real estate companies, of which more than $12.6 billion is in 13 J-REITs. Australia’s public real estate companies, virtually all LPTs, are valued at $31.4 billion. France has a public real estate market of about $17 billion, virtually all of which represents companies that have converted to SIIC status.
Outside the U.S. and Australia, REIT markets are still quite immature. Says ING’s McIntosh: “REIT shareholders have to be careful. A lot of the markets are very small and thin.”
The availability and transparency of information about corporate governance vary greatly from country to country. REIT structures also differ on issues ranging from the rules governing share ownership to income distribution to the use of leverage and the ability to amass land for future development. In the U.S., for example, REITs face no legal limits on the amount of debt financing they can use and enjoy unrestricted development options. Australian LPTs are limited to a debt-to-equity ratio of 3-to-1 if they don’t exceed certain capitalization minimums or if they are substantially controlled by foreign entities. French SIICs are required to distribute at least 50 percent of capital gains on the sale of properties to shareholders within two years. J-REITs have no debt restrictions, but their loans must be extended by “qualified” institutional investors, and to be listed on an exchange, at least 50 percent of their total assets must be income-producing.
There are other important distinctions among the world’s REITs. Many non-U.S. REITs are externally managed by outside companies and not by the REITs’ executives or trustees. These outside managers oversee assets, make deals and set strategy. Since 1986, U.S. REITs have been allowed to manage their properties directly, and virtually all now do. Typically, that structure serves to better align REIT management interests with those of their shareholders. For example, an outside management firm could stand to gain a fee on the purchase or sale of a property and advise the REIT to undertake such a transaction, even if the timing, price or quality of the deal were not in the best interests of the REIT and its shareholders.
“In Japan’s externally managed structures, the people managing the REITs don’t necessarily have a direct alignment with the holders of the REIT stock,” says Christopher O’Brien, managing director and co-head of Asian operations for Greenwich, Connecticutbased Starwood Capital Group Global. “But,” he adds, “the market has accepted this structure. Investors accept that there is potential for conflict, but I don’t think they’ve felt abused.”
Certainly, Japan’s REIT market has come a long way since it debuted three years ago. When TGR Investment, a Tokyo-based REIT investing in office and apartment properties, went public on the Osaka Stock Exchange in May, it brought the total number of J-REITs to 13. The other 12, with a combined market cap of nearly $13 billion, trade on the Tokyo Exchange. “I think it’s a good pace in terms of the market cap,” says Yuichi Hiromoto, executive director of Tokyo-based J-REIT Japan Retail Fund Investment Corp. and president and CEO of its asset manager, Mitsubishi Corp.UBS Realty. “But there is much room to grow. We should be able to catch up with the traditional real estate segment very soon.”
In Japan some J-REITs were sponsored by private companies looking to access public capital. The Nomura Real Estate Office Fund, for example, was seeded with properties from Nomura Real Estate Development Co., including a 253,200-square-foot building in Osaka, and other private sellers. But many of the trusts were sponsored by large Japanese public corporations, either real estate companies like Mitsubishi Estate Co. and Mitsui Fudosan Co. or conglomerates and financial institutions with significant property portfolios, such as Mitsubishi Corp., Marubeni Corp. and Orix Corp. In contributing their real estate holdings to the new REITs, the companies were able to secure an exit for their real estate investments, raise capital to clean up their balance sheets and, in many cases, expand their businesses by establishing companies that manage the REITs and thus earn fee income.
Because the Japanese REIT market has created a new group of potential property buyers, owners of existing properties -- the ranks include U.S.-based opportunity funds Colony Capital, Morgan Stanley Real Estate Funds and Starwood Capital as well as Japanese corporations, financial institutions and real estate investors -- hope to benefit from the upside of a public market-exit strategy. That’s especially relevant now that Japanese real estate values have begun to recover in the past six months.
In the resurgent Tokyo office market, some real estate owners are beginning to find flush buyers among so-called pre-REITs -- investors who are amassing portfolios of properties to eventually take public.
“The REIT market has established itself so firmly in Japan that the trusts have become the benchmark for pricing stabilized assets,” says Starwood’s O’Brien. In January, Starwood closed on the purchase of two distribution/warehouse buildings in Kawaguchi, a far suburb of Tokyo with numerous distribution centers that serve points north. The purchase was made “with the expectation that industrial J-REITs will start coming out later this year and next year,” says O’Brien. He won’t reveal the price but says Starwood expects a 20 percent rate of return -- typical for opportunity funds -- when it sells.
For funds that invest in global real estate stocks, the emergence of a worldwide REIT market has added an interesting new option. Amsterdam-based Kempen & Co.'s Orange European Property Fund, devoted to European real estate stocks, has delivered an annualized return of 11.9 percent since its October 2000 inception. ABN Amro, also headquartered in Amsterdam, launched its High Income Property Fund, which invests globally, in May 2002 and has since delivered an annualized performance of 14.3 percent.
In February the ING Clarion Global Real Estate Income Fund raised some $1.4 billion in its IPO. And in May, Nikko Asset Management Co. launched a global public real estate fund for individual Japanese investors. Two more U.S.-based global real estate securities funds have been registered with the Securities and Exchange Commission, by LaSalle Investment and Deutsche Bank affiliates Scudder and Rreef. They plan to invest primarily in stocks of public real estate companies, including REITs, around the world to produce high current income and, secondarily, capital appreciation, once they are approved by the SEC.
Real estate stocks everywhere have delivered strong performances in the past year. The global real estate index produced jointly by the European Public Real Estate Association and National Association of Real Estate Investment Trusts in the U.S. showed a total return of 40.7 percent in 2003.
Assuming prices don’t collapse amid rising global interest rates and REIT markets continue to grow around the world, some investors may start to buy private real estate companies with the idea of taking them public, possibly utilizing the REIT structure. Another future possibility: buying troubled or undervalued public real estate companies, turning them around and then tapping the REIT market. “These are the kinds of things you can pursue when you have a public market with depth,” notes ING’s McIntosh. “The more markets develop, the more you can do.”
