Which one of the following is a characteristic of real estate investment trusts REITs )?

1.3.2.4 Real Estate Investment Trusts

Real estate investment trusts (REITs) are entities typically organized as corporations and limited in their investment program to real estate or mortgages. Like other corporations, they are controlled by their shareholders, who elect a board of directors. REITs are unlimited-life, limited-liability entities, and shares issued by a REIT are nonassessable.

To qualify as a REIT, the entity must be widely held with at least 100 shareholders, no five of whom can own more than 50 percent of the equity. The entity must also distribute at least 90 percent of its taxable “earnings and profits.” If the entity meets these and other qualification tests, it may elect to qualify as a REIT. REITs are granted a tax deduction for any dividends that they pay, allowing them to act as pass-through entities for tax purposes. Dividends paid by a REIT are subject to personal income tax.

REIT securities may be issued in public or private offerings. Shares in public REITs are traded on major stock exchanges. The REIT has become a popular form of organization for large publicly held real estate companies in the United States. Many other countries have adopted REIT structures.

6.4.3.2.3.3 REITs

REITs are structured as business trusts or corporations. REITs were created by an act of the US Congress to allow small investors to participate in the ownership of commercial properties. In return for limiting their holdings to real property or mortgages on real property, and for distributing their income in the form of dividends to shareholders, REITs avoid paying tax at the corporate level. REITs may be public companies whose shares are traded on major stock exchanges. They may also be privately held, but all REITs must be widely distributed with more than 100 shareholders. No five shareholders may collectively own more than 50 percent of the outstanding shares of a REIT.

Although the REIT structure has been in place since 1960, this type of investment vehicle did not become popular until the 1990s, when REITs were used to provide liquidity to major development companies that were in need of recapitalization following the real estate recession of the late 1980s.

9.4.1.1 Real Estate Investment Trusts (REITs)

REITs are entities whose primary business is the ownership of debt and equity interests in real property. These entities, typically structured as corporations, agree to limit their investments to real property and to operate within certain parameters in return for favorable treatment under the tax code of their country of origin.

REITs originated in the United States, but similar corporate structures have been adopted by many other countries. In the United States, REITs must be widely held entities investing primarily in equity or mortgage interests in real estate. REITs are not subject to corporate-level tax but are required to distribute substantially all of their annual profits to shareholders. Most U.S. REITs trade on public stock exchanges and are widely held.

3.2.4 Composition of S-REITs

REITs hold different types of properties in their portfolio. These assets consist of shopping malls, office blocks, warehouses, and industrial buildings. Figure 3.2 shows the sector breakdown of assets held by S-REITs in 2012. The following sections describe the characteristics of the different sectors.

The portfolio of retail S-REITs, like CapitaMall Trust and Fraser Centrepoint Trust, comprises shopping malls located across Singapore. Well-located shopping malls provide attractive rental income due to excellent traffic flow supported by strong bargaining power over tenants of such premises. The retail S-REITs have performed well in the year 2012 (see Lee, 2012), delivering positive year-on-year growth driven by strong rentals, along with higher contributions from asset enhancement initiatives to improve occupancy and rental rate. In 2012, the average occupancy rate of retail REITs stood at a high level of 97.2% as leasing activities continued to sustain the sub-sector with “weighted average lease to expiry” at 3.5 years. Some of the S-REITs refinanced their maturing debt in the low interest rate environment. Along with the paucity of new acquisitions this has kept the average aggregate leverage was kept at a healthy level of 34.2%.

Investing in an office REIT is a way to gain exposure to the economic prospects of a country. As office leases tend to be short, REITs can revise rents upward regularly. During an economic upturn, supply of office space tends to lag demand, resulting in bargaining power being on the side of the REITs over the tenants. According to Lee (2012), office S-REITs reported strong results in 2012 with increase in income reflecting strong rental demand for good grade offices despite uncertainty in the macroeconomic environment. Occupancy rates remained stable, while supply of new offices was limited. Borrowing by office S-REITs at the end of 2012 was not excessive with an average leverage ratio of 37.4%.

Industrial REITs consist of industrial buildings like warehouses and factories. Although their rental revisions lag the retail and office sector, the rentals of industrial REITs are more stable due to their longer tenure. Industrial REITs also tend to offer higher yields than other REITs (see Sons, 2007). In 2012, industrial S-REITs benefitted from acquisitions and improved operating performance with robust year-on-year net profit growth that ranged from 8.9% to 16.6% (see Lee, 2012).

The industrial sector occupancy rate was a high 98.1% in 2012, while the “weighted average lease to expiry” remained at 3.4 years. The average aggregate leverage for industrial S-REIT remained at a healthy level of 35.1%. In addition, the average loan tenure of industrial REITs increased to 3.4 years in the same quarter, with more REITs locking in lower interest rate loans. The overall outlook for industrial REITs remains positive with completed asset enhancement initiatives expected to boost growth in the near future. Average dividend yield for 2012 remained the highest among the S-REITs at 7.0–7.2% (see Lee, 2012).

Hospitality REITs allow hoteliers to raise capital for future expansion while allowing owners to retain control of the brand and take on the role of manager. One challenge for the hospitality REIT is the cyclicality of tourist arrivals that affects hotel occupancy levels. Hence, for hospitality REIT, there is a sale-leaseback agreement where the hotel operator pays a stable rent to the trust (Sons, 2007). To attract investors, the trust can sign agreements with the owners to provide for potential income growth. As an example, Singapore’s CDL Hospitality Trust contracted to receive 20% of revenue and 20% of gross operating profit with the hotel owner, Millennium & Copthorne Hotels, with a base guarantee of S$26.4 million in rent per year.

13.2.1.2 Taxable REIT Subsidiaries

Recent changes to the REIT rules allow REITs to own subsidiaries that invest in businesses that do not qualify under the REIT rules. These investments must total less than 25 percent of the REIT’s asset base. The purpose of the REIT taxable subsidiary is to let the company retain control of functions that are integrated with its core business but are not pure investments in real property.

Examples of businesses that are housed in taxable REIT subsidiaries include property management performed for non-REIT assets. This activity leverages the REIT’s operating platform but does not generate rental income and is not a qualified real estate investment for a REIT.

5.4 Data Description

Real estate investment trusts (REITs) have long played an important role in investment portfolios. We analyzed a complete database of worldwide REITs consisting of 300 funds existing since 1973 and we extracted 72 corresponding to Asian countries. This long-term sample was used to understand the statistical features of Asian REITs over the last 40 years. We observed that almost 50% of the dataset consists of Japan REITs while the rest includes funds from Singapore, Malaysia, Hong Kong, Thailand, and Taiwan.

The data are in daily frequency; there are only three REITs in which observations are complete between 1973 and 2013. The rest of the funds were created and disappeared between these two dates constituting a database with no survivorship bias. All the data are given in local currency; thus, we use the historic exchange rates to convert the data to US dollars allowing an analysis of data in a common currency.

This REIT dataset corresponds to the constituents of S&P Global REITs index, thus, we consider this index as the benchmark for the asset pricing model that we estimated. The S&P Global REIT consists of over 250 constituents from 19 developed and emerging countries. In addition, it contains three subsets, the S&P Developed REIT, measuring the performance of more than 250 REITs in 15 developed markets and the S&P Emerging REIT covering over 10 constituents from 4 countries and the S&P US REIT covering the US market. Furthermore, we used a 3-month short-term rate as a proxy of the risk-free rate.

Figure 5.2 presents the benchmark levels, as well as those of equal-weighted portfolios constructed with funds of the same origin. More precisely, we construct equal-weighted portfolios with REITs from Japan, Singapore, and Hong Kong rebased at a level of 100 for the January 1999–July 2013 period. We observe a high negative impact of the global financial crises on the benchmark and the other constructed portfolios. There were no data available to construct country portfolios for Singapore between 2003 and 2007 and Hong Kong during 2005, and therefore we observe flat curves for those funds in Figure 5.2. For Malaysia and Thailand we only had information available for a few years being impossible to build a country portfolio for this period. According to this regional view, we can observe that before the crisis the best performing REITs were those from Japan but for the most recent years the performance for these three countries is similar. Finally, it is important to emphasize that the number of funds per country is not uniform and that there is a higher number of Japanese and Singaporean funds in this specific dataset we are analyzing. This could also partly explain the really higher performance of Japanese REITs during 1999–2013.

This dataset is quite interesting since it considers a long period which includes several specific events on financial markets. Moreover, during each sub-period the set of REITs is continually changing, which diversifies quite a lot the selection procedure.

The S&P Global REITs index is only available from December 1998, so we focused on a sample starting in January 1999 for our estimations. Finally, with all these restrictions it leads us to a dataset of 34 Asian REITs from January 1999 to December 2012 using daily frequency. More detailed information related to the specific funds considered in this study, the country they belong to, the beginning and ending dates, and some statistics such as the return and volatility are given in Table A.2 in the Appendix.

For the period 1999–2012 we have considered different short-run samples, we analyzed year-by-year subsamples. This analysis gives us a general view of the behavior of Asian REITs over the last 14 years. We took into account only funds with complete yearly data. This type of sampling suggests that the data for Thailand REITs were not fully available for this period and therefore Thailand does not appear in Table 5.1. The number of REITs alive during a subsample of one year length varies from four in 2005 to twelve in 2011, while the average number of Asian REITs available for an entire year is close to nine. The details year per year are available in the second column of Table 5.1. This table also presents several summary statistics for each series transformed into logarithmic returns. We observe that the S&P Global REITs index has average yearly returns of more than 20% for the years 2003, 2006, and 2009 with corresponding volatilities ranging from 10% to almost 40%, for the worst years, not surprisingly, corresponding to the years of the global financial crisis. This index had an average yearly return of −62.5% in 2008 with a volatility of 44% and −15% in 2007 with a volatility of 18%. The figures are similar during the financial crisis for the entire set of Asian REITs available each year, but there are some differences in other years. For example, the year 2002 was a neutral year for Global REITs but a quite good year for Asian REITs with 38.7% of annual return and a volatility of 10.7% producing a Sharpe ratio of almost 3.6. Moreover, 2012 was a better year for Asian REITs than for the global index. We have also estimated these statistics per country conforming equal-weighted portfolios with all the REITs available during a year for each specific country. We observe that during the whole period the Japanese funds represent at least half of the available REITs in Asia; several funds from Singapore are considered from 2007 and on.

Table 5.1. Summary Statistics per Year

Nb—total number of funds alive during that year, Avg—average annualized return for the period, Vol—annualized volatility, Sharpe—Sharpe ratio; calculation by the authors.

Source: Summary statistics per year.

2.1 Introduction

Real estate investment trust (REIT) managers generally prefer to focus on domestic real estate investments (Zhou and Sah, 2009). Clear evidence of home bias exists for the US market, where out-of-state buyers pay a premium for real estate assets due to higher search and transaction costs (Lambson et al., 2004). The Asian REIT industry is quite young—its first REIT was issued in 2001—and is dominated by Japanese and Singapore investment vehicles (J-REITs and S-REITs, respectively) (Ooi et al., 2006). Performance analysis of the Asian REIT industry has focused on the differences among Asian market performances (Tsai et al., 2010) and their role in an international diversified portfolio that considers indirect real estate investments and other types of financial instruments, such as stocks (Yat-Hung et al., 2008). However, no studies provide evidence of the role of home bias in the performance of Asian REITs.

Examining REITs in Standard and Poor’s Global REIT Index, this chapter compares the home bias of Asian REITs with that of other countries in the index (mainly the United States and Europe). After identifying the differences in home bias among these markets, we evaluate whether more geographically concentrated Asian REITs achieve higher or lower unexpected performance with respect to less concentrated Asian REITs. The results demonstrate that the degree of REIT home bias differs across countries and that Asian REITs are not always the most geographically concentrated. Empirical analysis of the impact of geographical concentration on performance reveals interesting differences between home-biased and non-home-biased Asian REITs.

8.1.10.5 Real estate investment trusts

A real estate investment trust (REIT) is a corporation that owns and manages a portfolio of real estate properties and mortgages on behalf of shareholders. Investors can buy shares in a publicly traded REIT. An investment in REIT provides liquidity and diversity for investors as the investment is in a portfolio of properties and the shares can be easily sold.

REITs are required to distribute at least 90% of their taxable income to investors. REITs have to gain pass-through entity status in order to qualify as an REIT. A pass-through entity status enables the REIT to pass the responsibility of paying taxes onto its shareholders. REITs are managed by a board of directors or trustees. An REIT must hold at least 75% of total investment assets in real estate. REITs are also required to pass the 95% income test in which it is stipulated that at least 95% of an REIT’s gross income must come from financial investments such as rents, dividends, and capital gains. REITs are basically classified in equity, mortgage, and hybrid categories. Equity REITs own and manage real estate properties, such as office buildings, malls, and apartments. These REITs earn dividends from rental income as well as capital gains from the sale of properties. Unlike equity REITs, which invest in properties, mortgage REITs (known as MREITs) provide loans for mortgages to real estate owners or purchase mortgages or mortgage-backed securities. The main source of revenue for MREITs is the interest earned on mortgage loans. REITs are also classified into closed-end and open-ended REITs. Open-ended REITs can issue new shares and redeem shares at any time. Closed-end funds can issue shares to the public only once.

REITs can also be classified as private REITs, publicly traded REITs, and non-exchange-traded REITs. Private REITs are not registered or traded with the SEC and are subject to less regulation.

Publicly traded REITs collect funds via an IPO from investors. Investors own a portion of a managed pool of real estate. The income generated through renting, leasing, or selling the properties is distributed directly to REIT investors. The dividends are also distributed to investors.

10.4.1 Real estate valuation methods

The real estate investment valuation must consider factors like economic and social trends, government regulations. The main value drivers are demand and supply factors, utility, and the scope of transferability. Three basic approaches are used for valuing investment properties.3 The sales comparison or market approach is used for valuation of single family homes and land. This method provides an estimate of value derived by comparing property with currently sold properties with similar characteristics. The differences must be adjusted while making the comparison. The differences are based on property characteristics like location, size of the lot, square footage of the usable building space, and type and quality of construction. Other factors like age, design, land terrain, and interior layout also play a major role in comparative valuation. The cost approach provides separate estimates of value for the buildings and land. Cost analysis starts with simple estimate using current local building costs. The local builders provide a generalized per square foot cost of new construction. Construction cost indexes breakdown costs by material types and region. The building’s current replacement cost has to be adjusted to reflect the actual state (and value) of the subject property. This involves reductions to reflect the property’s physical deterioration, functional obsolescence, and economic depreciation.

Earnings or income capitalization approach estimates the value of income generating assets like apartment complexes, office buildings, and shopping centers. The income approach requires determining the amount, certainty, and length of time of future income from the property and applying an appropriate capitalization rate to find the present value of future cash flows. Choosing a capitalization depends on the property’s type, location, age and quality of tenants. There are three ways in which the capitalization rates are estimated. In the first method, the average capitalization rate of similar properties that have sold recently is used. The second method involves the usage of survey methods to obtain an average capitalization rate used by other real estate investors. The third method involves estimation of the capitalization rate from the discounted cash flow model. The sources of cash flows from a real estate investment is rents and lease income. In the case of leased property, the terms of the lease can affect the projected lease revenues. The expenses included on real estate investments include property taxes, insurance, repairs and maintenance, and advertising. Discounted cash flow valuation is an effective valuation method in real estate business valuation.

Property value=Operating income after taxes/Capitalization rate

The value of an asset can be standardized using its income. The gross income multiplier method is used to appraise properties which are not purchased as income properties but could be rented such as one and two family homes. The gross income multiplier method relates the sales price of a property to its expected rental income.

Real estate investments can also be valued using standardized value measures and comparable assets. The major relative value ratios are P/E ratio and book value per share.

4.1 Introduction

Over the last decade, Real Estate Investment Trusts (REITs) have become prevalent all over the world. In Asia, the REIT regime plays a very important role in accompanying the growth of the domestic real estate industry. First introduced in Singapore and Japan in 2001, REITs are now traded in nine Asia-Pacific countries, with the notable exceptions of India and China which are said to be actively considering the introduction of such a regime. As of August 2013, according to the Asia Pacific Real Estate Association (APREA), there are 213 Asian REITs (or REIT-like structures) listed on public markets. Ex Australia and New Zealand, Asian REITs accounted for 12% of the global REIT market with a market capitalization of over $118 billion as of year-end 2012.

Although each regime has its own idiosyncrasies, the core rationale underpinning the initial US regime has been preserved, i.e., to offer investors access to property returns that would be otherwise unreachable and to foster transparency and tax efficiency. The success of Australian listed property trusts since the early 1970s undoubtedly played an important role in influencing the widespread adoption of REITs in Asia (Brounen and De Koning, 2012). Benefits of REITs in Asian economies are numerous. In particular, sponsored REITs enable developers to recycle capital while benefiting from the advantages of a strong shareholder basis. Having a well-established sponsor can be highly beneficial for a REIT considering that in many Asian countries (e.g., Singapore, Hong Kong), property markets which operate within relatively small space markets for grade A properties tend to be oligopolistic and difficult to access. Asian REITs come in many shapes and forms: from retail REITS to hospitality REITs, from industrial REITS to medical REITs. One of Asian REITs’ important characteristics is their ability to be transnational, e.g., a Singapore sponsored and listed REIT investing in Chinese office properties, or an Indonesian sponsored Singapore listed REIT focusing on Indonesian retail properties.

Owing to these unique features, international investors have been attracted to Asian REITs as a vehicle of choice for capitalizing on fast-paced Asian economies. However, beyond Asia’s seemingly compelling growth story, investors should be aware that not all Asian REIT markets are similar, all the more so as Asian property markets have matured fast (JLL, 2012). As the REIT regime is becoming more established in these countries with almost 10 years of trading history, notable differences have started to emerge in the pricing and market behavior of Asian REITs as an asset class. Interestingly, one of the Asian casualties of the US sub-prime crisis was a Japanese REIT which filed for bankruptcy in 2008 due to excessive leverage. Hence, what is actually priced in REITs across Asia? Are investors properly rewarded for the risks they face? How did Asian REIT markets compare during and after the GFC? More specifically, what risk-adjusted performance measures should investors rely on for selecting Asian REITs offering the best opportunities?

The chapter addresses these issues by applying risk-adjusted performance measures based on multifactor models to nine existing REIT markets in the Asia-Pacific region (Australia, Hong Kong, Japan, Malaysia, New Zealand, Singapore, South Korea, Taiwan, and Thailand). In Section 4.1, it reviews past research pertaining to Asian REITs’ performances. In Section 4.2, it introduces methodologies. Data and the asset pricing model used in the study are described in Section 4.3. In Section 4.4, it analyzes the findings and explains how the Global Financial Crisis (GFC) impacted Asian REITs’ risk/return trade-offs. In conclusion, it summarizes the study and proposes a series of recommendations as to how best evaluate Asian REITs’ performances after the Global Financial Crisis.