The reit stuff

New Year’s Day was the one-year anniversary of the launch of UK real estate investment trusts (REITs) – and it has been quite a year. Nine of the UK’s largest real estate companies became real estate investment trusts on the first business day of 2007.

In the months that followed, Germany and Italy adopted REIT structures, giving 75pc of Europe’s economies access to listed real estate securities.

As the year unfolded, the property market and hence REITs encountered some challenges. The sub-prime mortgage crisis surfaced in the US, spread to the UK and culminated in July with the Northern Rock situation. The real estate sector, along with the broader equity markets, continues to struggle with the fallout.

So, the question you have to ask yourself is whether REITs are a wise investment choice in today’s market? In order to answer this you have to take a long view of the fundamentals.

What is a REIT?
Simply stated, a REIT is a company dedicated to owning, and in most cases operating, income-producing real estate such as apartments, shopping centres, office buildings and warehouses.
As they do not pay taxes at the corporate level, REITs are required to pay virtually all taxable income to shareholders. To qualify for REIT tax treatment, the following must apply:
• The company’s assets must be composed primarily of real estate held for the long-term.
• A REIT’s income must be derived mainly from real estate.
• In the UK, the company must pay 90pc of its taxable income to shareholders.

REITs vs direct investment
Why not invest directly? Commercial real estate has historically been a stable and secure investment. Long-term leases provide steady cash flow through up and down markets. Buildings and leases are valuable collateral for lenders and shareholders. And real estate tends to have a low correlation to other asset classes, making it a prime candidate for portfolio diversification.

The caveat, of course is that commercial real estate is expensive. Few investors can afford to buy a hotel or office building, and those who can might think twice about tying up so much capital in one asset. REITs allow investors to diversify their real estate allocation among types – hotels, offices and health care, for example – as well as geographically.

Valuation poses a second obstacle. Buildings are typically valued once or twice a year at most, and often only when they are sold. Because REITs are listed on stock exchanges, the market sets a value each time a share is bought or sold.

Liquidity is REITs’ third advantage. Buildings usually take a long time to sell, especially in down markets. REITs are bought and sold every day. So, an investor with a global portfolio of listed real estate securities can themselves easily manage the allocation and their manager can use the liquidity to add value to the benchmark.

A good investment now?
REITs offer a way for individual investors to own commercial real estate. Combining the best characteristics of equities, bonds and real estate, they offer steady growth and typically have higher yields and lower volatility than many other equities.

The volatility and sell-off that have plagued markets recently has a silver lining for REITs; there are many inefficiently priced assets in the sector that are likely to be very attractive for long-term investors. This is particularly true in the UK; London, for example, has some of the most valuable commercial property in the world, and it is now also among the cheapest.

Secondly, real estate fundamentals, in our view, are sound. The compelling valuations in the UK and Europe are a result not only of the global credit and liquidity crises, but also of interest-rate policies pursued by the Bank of England and European Central Bank. As monetary policy becomes more accommodative, REITs are likely to benefit.

Paul Osborne is head of European marketing at Cohen & Steers