While real estate investment trusts (Reits) are a new phenomenon in the UK, having been available to investors only since January this year, elsewhere in the world they have a history stretching back decades. There is no doubt they are gaining popularity, however: Reit assets grew from $20bn worldwide in 1990 to $730bn at the end of 2006
What are the particular attractions of Reits?
Jack Foster, manager of the Franklin Global Reit fund, says a high income and simple tax position are among the key benefits. "The Reit structure is unique in real estate: it demands the company must distribute 90-100% of all its net operating income, so you get a higher yield than you would expect from property," he explains. "It also does not generally pay tax at the corporate level: shareholders simply pay tax on the dividends, so it is a very tax-efficient structure for owning real estate."
In jurisdictions without a Reit structure, investors are used to making the choice between direct property and the shares of property companies. But while property companies tend to be volatile because of their often speculative development activities, the safer option of bricks and mortar suffers from illiquidity. Reits can bridge this gap: they are mostly involved in owning property rather than developing it, which makes them less volatile than property shares, yet they are quoted on the capital markets, which makes them more liquid than bricks and mortar investments.
So with Reits sitting between direct property and property shares on the risk/reward curve, although with returns likely to resemble more closely those from direct property, Foster says: "The benefits for investors are tied to two levels. Firstly, investors like income, and Reits distribute a high percentage of their income. Second, and perhaps more importantly, investors in Reit structures get to own office buildings and shopping malls like institutional investors can."
A growing global asset class
Reits are available in 22 jurisdictions, with more expected to follow soon. Most of this growth has been fairly recent.
Says Foster: "Arguably real estate has been the last asset class to be globalised. Most investors have been investing internationally in bonds and shares for years, but it is only in the last 10 years that real estate has become global: traditionally it is a domestic asset class." The strong growth seen in many property markets over the past 15 years has doubtless been a factor in this, he adds.
But while investors may have been looking further afield for their property exposure, it is still fundamentally a local asset.
Foster explains: "The value of a building is what is outside the windows; what is going on economically in your town. The same building would have a different value in Birmingham or New York City or Paris. It is unlike other physical assets like oil and gold, which have global pricing mechanisms. That means it is a great diversifier: property markets internationally have low correlation to one another.
"So with globalisation, strong performance and diversification all coming together, the Reit is a big driver of a significant global trend, which is the securitisation of real estate," he adds. "It has traditionally been owned privately, whether by institutions or individuals, but now we are seeing a trend towards ownership in public structures. The Reit is facilitating that; the capital markets, investors and governments all like Reits."
Do Reits have government support?
Governments are supporting Reits, says Foster, because real estate in a public structure is easier to monitor and tax, whether by taxing dividends or capital gains when the property is traded. "Governments have embraced the Reit structure as the standard for holding property in a public structure," he says.
What skills are necessary to manage a Reits fund?
Foster has been investing in Reits for over 20 years, and he explains that this breadth of experience is vital in spotting the trends in the global property markets. "Probably the most challenging aspect is that public property companies tend to lead trends in private real estate markets by upwards of 24 months, so Reits anticipate trends in the property market," he says. "Any Reit manager should have a sound understanding of the major trends in the property market, and if you can grasp those trends, you will do well."
As a Reit fund manager, what are your main objectives?
Foster says his focus is on maximising income while keeping volatility to a minimum. "Our real belief is because real estate trends tend to be longer and less volatile than other areas, with long leases and relatively transparent new construction (you can usually find out what is being built from public records), we think it is important to look to those trends in terms of finding value around the world," he explains. "We don't believe in tracking a benchmark; we are not worried about owning the largest stocks to achieve a benchmark-like return. So we won't necessarily outperform at the top of the cycle, as we won't own the richly valued, frothy stocks - we are looking for value."
This is not to say the Franklin Global Reit Fund focuses only on heavily undervalued stocks; Foster points to French office and shopping mall operator Unibail as an example of a successful holding. "Unibail is something we have owned for a long time," he says. "Some people think it is expensive but for us it has consistently delivered strong returns. We look for management that can do that: we like good value but we will stick with strong management where we find it."
As property is such a local asset, most global funds have experts on the team who know the various Reit markets, or else have link-ups with local property specialists. Foster is backed up by analysts from Asia, Europe and the US. "It's very important to have people from the local markets on board," he says. "I won't have the cultural perspective on France or China that a local person will."
What about the Reits situation in the States?
Foster is currently underweight the US - though it is still by far the largest geographical weighting in the portfolio, by virtue of the size and maturity of the US Reit market. However, Foster is concerned about valuations, which are difficult to come by, and says the market is "one of the most irrational".
And in the UK?
The UK - where Reits are still in their infancy - is another underweight. "I was in the Tate Modern the other day, looking out over the City, and I counted 50 cranes," says Foster. "Clearly there is a lot of new construction going on in London, and that may be of concern. In a global context, property companies are trading at high valuations - real estate is expensive - but outside the UK, most property markets are not seeing significant development."
Markets he does favour at present include Singapore and Japan. "We are overweight Asia; we like Japan a lot," he says. "We don't see a lot of upside movement in the UK and we are not really bullish on Europe, but we are bullish on Asia."
