REITs - Asset Class for Real Estate Investment
Behind the abbreviation REITs – Real Estate Investment Trusts –
hides a new investment class for German investors, namely companies
listed on the stock exchange and active in the property sector. The
predominant business aim of these companies can be the acquisition
and disposal, renting or leasing, administration or mere financing
But, this alone still does not turn a property company into a REIT. The extraordinary thing about this investment category is the special tax and investment-related features. REITs are, for instance, given special tax relief - independent of the tax regime of the country in which the REIT public company is domiciled. In return, the company must meet a number of conditions set by the state. Most important for the investor at the outset is, namely that the biggest part of the earnings must be distributed to the shareholders. The minimum earnings payout ratio differs from country to country. In the USA it stands, for instance, at 90 percent.
A number of minimum earnings payout ratios:
- USA: 90%
- Australia: 100%
- Japan: 90%
- Belgium: 80% of rent income and 50% of income earned from disposals.
- France: 85% of rent income and 50% of income earned from disposals.
There are three different types of REITs, depending on the business
activities of the companies. REITs owning property and/or selling
property are called Equity REITs in the Anglo-Saxon countries.
These companies obtain their incomes almost exclusively from
renting and leasing of properties. The second group, however,
concentrates on financing. These companies do not invest directly
in properties, but extend loans to property projects or invest in
secured mortgages. Hybrid REITs are mixtures of both activity
REITs are also differentiated per sector. In the meantime, this investment form is available in 19 countries around the world, among others in the USA, Canada, Japan, France or Belgium. In Britain and Germany their introduction is just around the corner. In their basic form REITs are alike. They differentiate themselves, for instance, in the payout ratio, in the minimum requirement for investment in property and are, naturally, adapted to the respective tax laws in effect. The REITs planned for Germany are known as G-REITs, which stand for German Real Estate Investment Trusts.
A REIT share company is exempted from certain taxes. Therefore, companies selling property owned by them to REITs, enjoy tax concessions and can improve their liquidity in the circumstances. But, where are the advantages for investors?
- A transparent, easily tradable investment in real estate - An investment in REITs combines the advantages of the share investment – the share is easily sold again on the stock exchange – with the stability of a property investment. The income of REITs are earned from rent which is agreed for a long period or interest payments. Leaving the personal tax situation of the investor aside, the pay-out profile of the investment is comparable with a direct investment in a property. In this respect REITs are ideal for diversifying a portfolio
- High earnings payout - Compared to conventional shares the earnings pay-out is relatively high, because the company earns a higher income thanks to the tax concessions. In addition, a minimum earnings pay-out is prescribed to REITs.
The essential difference between property companies listed on the
stock exchange and property shares and funds lies in the minimum
earnings pay-out, not present in the case of pure property shares.
The tax dispensation also favours REITs over property funds and
companies, in the sense that property funds and companies are taxed
both on the company and the investor level.
Against open property funds REITs have the advantage that they do not have to sell their property – if necessary, below value - in case of a massive outflow of money. REITs are traded in the same way as shares – when investors sell their shares, it doesn’t impact the portfolio of the company, but merely the share price.
Until now, REITs are treated as shares when it comes to tax. That means, investors must only pay tax on half (after deduction of tax-exempt amounts) of the income earned from REITs investments. Price rises in the shares are even completely tax-free, if the share certificates are held longer than the speculation period of one year.
But, government is already turning the tax screws tighter: The presently still available half-income dispensation for earnings pay-outs and speculative profits will probably be withdrawn. In addition, the capital income tax will also become payable.
One thing investors should definitely keep in mind: Do not allow yourself to be fooled by the alleged secure nature of the indirect property investment. As is the case with a share, the price development of the REIT depends on many factors: the environment, the quality of management or the general stock exchange situation.
REITs have been around in the USA since 1960. They were introduced,
among others, to give small investors access to a secure investment
in real estate. Today about 200 REITs are listed on the New York
The return of an investment in property does not have to be meager. Between 1971 and 2003 the average annual return on Equity REITs amounted to 13 percent in the USA. In the same period the Dow Jones Industrial index rose by about eight percent per year.
The value development of property companies in Europe and the USA can be reproduced by means of a variety of indices. For instance, the EPRA Index, compiled by the European Public Real Estate Association, and calculated on the London Stock Exchange, the performance of the biggest European listed property companies with high earnings pay-outs. The NAREIT – National Association of Real Estate Investment Trust – is the American counterpart of the EPRA.
Around the world there are REITs in 19 countries and another four with REIT-like structures. The oldest are found in the USA (1960), the Netherlands (1969) and Australia (1985). Most REIT structures were introduced in the first years of the 21st century. Germany, Britain, Finland and India plan to implement the legal policies for REITs in 2007.