REITs are big business in the USA. Now there are moves to bring them to the UK. Karen Lennox looks at the US market and the UK opportunities.
Capital & Regional’s decision to float its US industrial assets into a $212m REIT (real estate investment trust) sets a precedent: it is the first UK company to do so, and one of the few in the US to have done it with industrial property. But hiving off real estate into a separately listed vehicle is nothing new in the US: in fact it is big business, and growing.
REITs are bundles of property put into a trust whose shares are sold to investors. They can be traded like quoted property companies and have the tax advantages of UK property unit trusts, but are widely available to both private investors and institutions.
The tax benefits are particularly important. Investors avoid the double taxation trap by paying tax only on their dividend income: REITs pay no corporation tax.
Some of the most well-established US REITs are well over 20 years old. But, set up in the 1960s and 1970s to finance construction and development, they are often debt-laden.
The new generation of 1990s REITs is a much more highly regarded product: they are investment companies specialising in specific types of property or geographical areas. Average gearing is just 30%. But, most important, they are run by an in-house management team rather than by outside advisers.
As in Capital & Regional’s case, a REIT can release financial resources. The market for debt financing has all but dried up in the US, and a REIT taps into new equity capital.
There are now more than 200 REITs traded on the various US stock exchanges; they account for over $52bn of US real estate. Since the beginning of the year, 27 new REITs have been issued, raising $4.3bn. And, according to one US REIT analyst, another $3bn-$4bn is in the pipeline.
Health & Rehabilitation Properties Trust, Factory Stores of America, National Golf Properties and Real Estate Investment Trust of California are just some of the REITs traded. Specialisation means that institutional investors can make their own portfolio management decisions when buying REIT shares. The retail, health care and residential sectors are still the most popular; there have been few office and industrial issues.
Flush with cash and seeking high returns and growth potential, the US mutual funds have made REITs their new darlings. While REITs performed poorly in the 1980s when the equity market was booming, now that the share market has reached a plateau, the relative performance of REITs is very appealing. According to the National Association of Real Estate Investment Trusts REIT total annual returns are over 26%, while equities show close to 13%.
REITs buy, or manage, property portfolios yielding usually around 10%-11% and financed at 7%-8%. Against equity dividends of some 2%-3% and cash on deposit earning 2%, the positive spread can look very attractive. So much so, that the majority of REITs are now trading well above their net asset values as cash has flooded in.
In the UK stockbroker NatWest Securities is now putting its weight behind bringing REITs to the UK. Analyst Marc Gilbard says: “The nearest thing to a REIT that we have in the UK is the unauthorised property unit trust which is available only to institutional investors. REITs could attract more people into UK property.”
But first there are regulatory hurdles to be overcome. Both the Inland Revenue and the Stock Exchange would need to approve the new vehicles. The Revenue has shown itself to be very reluctant to give tax concessions to property vehicles – such as SPOTs (single property ownership trusts).
In the US, REITs are tightly regulated. To gain a stock market listing they must be managed by a full-time board of directors and at least 75% of the total assets must be invested in property. A minimum of 95% of the income must be paid out in dividends.
The London Stock Exchange says that REITs would not be allowed a listing under its current rules, mainly because they have no track record in the UK. But it may still be open to persuasion: “If anyone came to us with a serious suggestion it would be considered on its own merits,” says a spokeswoman.
So far, the market is untested here. Smith New Court has just raised the first $30m tranche for a new $700m REIT aimed at European investors – the US Property Renaissance Trust. “It is a very difficult product to sell,” says SNC’s Jan Otto von Boetzelaer. “It is a new concept, and a lot of investors have had problems in the US before and are unwilling to add to their portfolios.”
Von Boetzelaer is not sure that the concept can be transplanted to the UK: “In the US REITs take advantage of the fact that the banks and insurance companies are under such great pressure from the regulators to sell their underperforming property. There is not the same pressure on Barclays and NatWest in the UK to shed properties at such low prices and to offer such beneficial financing conditions.”
In addition, UK banks looking to offload underperforming properties may find it harder to conform with some of the REIT provisions: experienced full-time management would have to be bought in. However, REITs could offer a welcome method of recapitalisation for private property companies. Existing staff would have the required management track record and the REIT format would provide an injection of equity capital.
