Published On: Sat, Aug 1st, 2009


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Scope of study:
In this project report, we have covered the following aspects of REITs:
How REITs earn their profits and their distribution to investors,
Benefits of investing in REITs
Criteria employed to rate REITs before investing
The risks involved in investing in REITs
The general asset mix employed by REITs &
A brief overview of the REIT index in Japan.
We have not incorporated the legal and taxation issues involved in REITs, particularly the treatment of income earned by REITs and dividends at the hands of the investors, by the tax authorities. This is due to reason that taxation & legal laws are different in different countries.
We have also not covered the Indian REIT scenario as much work needs to be done before their launch in India. The work involved includes rationalization of stamp duties across India, computerization of land records etc.
I would like to sincerely thank Prof. Chaturvedi, Faculty Member, NMIMS, for giving us an opportunity to work on this project.
List of tables, graphs and figures
Graph 1 Growth in market capitalization of the Japanese REIT index
Graph 2 Performance of the Japanese REIT index in comparison with Tokyo Stock
Exchange index, TOPIX and its real estate sector index:
Fig 1 Corporate style investment trust
Fig 2 Contract style REITs
Fig 3 Comparison of Contract & Corporate styles of REITs
Fig 4 Earnings of REITs & distribution of dividends:

Concept of REIT:
Real Estate Investment Trusts (REIT) is investment trusts the underlying assets of which are real estate properties. Income is generated by rents collected from those properties , and the proceeds from the sale of properties. This income is then distributed to investors in the form of dividends. Investors receive investment certificates (equivalent to share certificates), which can be traded on the TSE REIT market, just like stocks.
Classification of REIT:
There are two ways of classifying REITs:
Corporate and contract style, &
Equity REITs, Mortgage REITs, Hybrid REITs

Under this type of classification, there are basically two types of REIT, the corporate styles. Contract-style REITs can further be classified into intermediated and direct, depending on whether there is a fund manager acting as intermediary between the investment bank which manages the fund assets.
Corporate Style
Japanese REITs, or J-REITs, are of this type, and it is the corporate style that is expected to be most common.
The basic principal for this type of REIT is that a special corporation, established for the purpose of investing in and managing a real estate assets, uses investors money to buy real estate, in return for which investors receive investment certificates. These certificates can be bought and sold on the TSE market. Although the corporation is technically responsible for owning and managing the real estate properties, in reality this function is sub-contracted out to a third party.

Fig 1 Corporate Style Investment Trust
Investment Corporation
As mentioned above, investment corporations are special entities specifically established to own and manage real estate using investors money. Like any other company, these corporations have an executive board and hold share holder (investor) meetings. These functions are necessary for the corporation to own and manage real estate, and are the only permissible activities for such corporations.
Investors entrust funds to the investment corporation in return of investment certificates (equivalent to shares). Investors holding investment certificates at the end of the financial period are entitled to dividend payments, just like shares.
Tokyo Stock Exchange (TSE)
TSE lists and provides a market place for REITs. REIT investment certificates can be freely traded on the TSE market during standard trading hours, and are subject to the same trading regulations as stocks.
Investment trust Contractor
Investment trust contractors are responsible for managing the REIT assets on behalf of the investment corporation, in other words they act as fund managers, and consequently fulfil the most important role. Investment trust contractors are generally involved from the establishment of the investment corporation, and from then on manage real estate assets- buying and selling as necessary to get the best returns.
Asset Custodian/Administrative Contractor
Custody of assets, in reality custody of rights certificates, is carried out by trust banks on behalf of the investment corporation. Assets are held in segregated accounts. Other administrative duties, such as registration of investment certificate holders and issue of new certificates, are carried out by investment trusts and securities companies on behalf of the investment corporation.
Real Estate Management Company
Real estate management companies handle all aspects of the direct management of the real estate assets, including physical management of real estate properties and handling rental contracts and invoices, so as to provide long-term returns.
Contract style 1- Intermediated
Just as for ordinary (stock-based) investment trusts, specific contract style REITs are operated by fund managers/administrators who then select which assets the investment bank should own and manage. It is the investment trusts that fulfil the direct management function. Investors receive tradable beneficiary certificates.
Contract style 2 – Direct
Direct contract style REITs are those which where the investment bank owns and manages the underlying assets. Investors receive tradable beneficiary certificates.
Fig 2 Contract style REITs
Contract Style Corporate
Intermediated Direct Style
Asset holder investment bank corporation
Asset manager fund manager investment bank fund manager
Certificate beneficiary certificate investment certificate
Issue of bonds no corporate bonds
Loan by investment bank by corporation
Fig 3 Comparison of contract & corporate styles of REITs
Under this classification, REITs fall into three broad categories:
Equity REITs: (96.1%)
Equity REITs invest in own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties rents.
Mortgage REITs: (1.6%)
Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or invest in (purchase) existing mortgages or mortgage backed securities. Their avenues are generated primarily by the interest that they earn on the mortgage loans.
Hybrid REITs: (2.3%)
Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.
Earnings of REITs & distribution of dividends:
The following gives a brief overview of the process, right from the financing of a REIT to distribution of dividends by the REIT to its investors.
REIT A raises 30 yen billion by selling 100000 units (net asset per unit of 300000 yen) and raises a loan of 20 yen billion. This 50 billion is then used to purchase real estate.
Annual Income
The annual real estate rental income is 5 yen billion.
Costs & Profits
The initial loan of 20 yen billion is subject to the interest of 2%, which works out at 400 yen billion. The real estate properties incur management costs of 3 yen billion, 1.6 yen billion remains as profit.
Unlike ordinary corporations, which are liable for corporation taxation on profits, REITs are exempt from taxation if they distribute over 90% of profits as dividends. Thus in example given above, 1.5 billion yen (or 93.75% of 1.6 yen billion) is available for dividends. This works out at 15000 yen per unit (1.5 billion yen 100000 units), or a return of 3% on a REIT valued at 500000 yen (15000 yen 500000 yen).
Fig 4 Earnings of REITs & distribution of dividends:
Benefits of investing in REIT:
Up until now, the real estate market has been an unrealistic option for individual investors because of the huge costs involved and the relative lack of liquidity. Equally, existing real estate based products have been aimed at institutional investors and have again lacked the necessary liquidity to attracts individuals.
However, now REITs offer individuals the opportunity to invest in real estate at affordable prices, and in form that can be readily trade on the exchange market, while leaving the management of the properties themselves to professionals. Dividends are paid to investors on the basis of income arising from the properties (rents, etc). This stable source of dividends and relatively high rate of interest, along with their inflation hedging ability is the key distinguishing features of REITs. Investment in REITs allows investors to diversify their financial assets, with all the attendant benefits.
The other benefits vis-a- vis stocks & fixed income products include:
Stable Dividends
Derived as they are from the regular rental income from underlying real estate properties, REIT dividends are generally stable and not subject to volatility.
Relatively High Returns
Unlike ordinary corporations, which devote most of their profits to future business development, investment corporations usually assign over 90% of their profits to dividends. This is because their only purpose is to hold real estate assets and they are not subject to corporation tax, so they only need to reinvest for future development.
However, although REITs generally offer relatively high returns compared to ordinary stocks, it goes without saying that rental incomes, dividends and REIT prices can be negatively affected by real estate and economic conditions.
Relatively Stable Prices
Unlike stocks, which are traded on the basis of estimated future corporate performance, REITs are traded on the basis of relatively stable incomes, which can readily be forecast and not generally subject to violent swings. Thus, prices do not generally fluctuate a great deal in either direction. However, this does not mean that REITs are not subject to market forces, and that it is impossible for REITs to suffer price volatility.
Inflation Resistant
Unlike bonds with pre-determined rates of interest, which lose relative value in times of high inflation, REITs are generally considered to be highly resistant to inflation. This is because rental incomes, which are the basis of dividend payments, adjust themselves in line with the cost of living, so are less vulnerable to inflation related devaluation. However, this is not to say that REIT dividends are totally immune to external influences. In times of economic depression rental fees may decline, and the relative cost efficiency of asset management may also have a negative impact on dividends.
Portfolio Diversity
It goes without saying that by investing in only one type of financial products, investors risk large losses if that particular product performs badly. Thus it is advisable to choose a range of different products, which dilutes risks and provides greater opportunity for consistent returns. (In other words, don’t pull all your eggs in one basket!) For example, government bonds offer security for the principal, but are vulnerable to devaluation in times of inflation. In contrast, REITs, whilst a higher risk product, offer higher rates of return and are relatively resistant to inflation. Equally, the performance of REITs generally bears little correlation to stock and bond performance, so unlike these products risk is diversified at times of market volatility rather than exacerbated.
Criteria to rate REITs:
Unlike stocks, which are an investment in a particular company, REITs are an investment in real estate via a token investment corporation. There are of course a variety of specialist analytical and evaluation tools and methods. However, the following are some simple guidelines as to what to look when choosing a REIT. ( it goes without saying that due attention should also be paid to disclosure documents, market and interest conditions).
Net Asset Value (NAV) per Unit
NAV is an important indicator, particular when the market is first established as it is difficult to compare with other products. As for stocks, it is always a good idea to compare the NAV and the market price. Thus foe example we might find that the NAV for a particular REIT is 500000 yen while the market price is 600000 yen. This indicates that there is the NAV is expected to rise, or that the market values the REIT above the current NAV. The PBR (price to book value), calculated by dividing the market price by the NAV, is also a good guide.
Rate of Return
REITs offer a relatively high rate of return as dividends are source from rentals and other income from the properties. Thus, the rate of return is another factor to be considered when selecting REITs. Investors should consider past and forecasted future dividends, as well as comparing with returns from other products. However, it is important to bear in the mind the different character of each individual product, rather than just making a simple comparison on the basis of rate of return.
The more profitable the investment corporation, the higher the dividends. Just like when comparing stocks, it is a good idea to consider the PER. (For example, REIT A priced at 5,00,000 yen earns 4 billion yen on 200000 listed units, and REIT B priced at 700000 yen earns 3 billion yen on 100000 listed units. If we compare them we see that the PER for REIT A is 25.0 (500000 yen/ 200000 yen (4 billion yen/ 200000 units)) and for REIT B is 23.3 (700000 yen/ 30000 yen (3 billion/ 100000 units)). Thus REIT B offers higher returns per unit at lower price (lower PER).
The REIT market is already well established in US, so there are variety of sources of analysis available to investors since analysts offer independently calculation and analysis of NAV. We can expect the same to happen in Japan once the market establishes itself.
Risks while investing in REITs:
As publicly traded securities based on real estate, REITs are vulnerable to real estate market and macro-economic factors, which may adversely affect dividends and prices. For detailed explanation of the risks involved, please study prospectuses carefully. A brief outline of risk factors is given below.
Unsecured Principal & Dividends
REITs are subject to real estate and market forces, which may effect prices and dividends, so there is always a risk that investors will lose money when selling a REIT at a lower price than when they bought it. also, there is no guarantee that dividends will continue to be paid at the same levels as in the past. In other words, REITs are completely different from government bonds, which are secure investments with a pre-determined rate of interest and redemption of the principal is possible.
Prices affected by property values and management strategies
Real estate related valuations and rental incomes are subject to real estate market conditions, macro-economic and other external factors. Additionally, REITs may raise funds not only by issuing shares, but also by taking out loans on which interest must be paid. All these factors can cause REIT prices to fluctuate.
Dividends affected by rental incomes
REIT dividends are paid on the basis of income earned from rentals of real estate properties. This generally means stability, but also means that in times of adverse real estate market conditions the values of these rental fees may decrease. Alternatively, there may be times when the properties are left empty, thus producing no income. All of these factors can adversely affect dividend payments.
Risk of Natural Damage, Wear and Tear
Real estate properties are exposed to a variety of structural risks, arising from natural, environmental and man-made causes. All which can adversely affect the value of these assets and REITs based on them. In this respect, REITs differ widely from ordinary financial products, which are not based on physical/tangible assets.
Devaluation due to changes to regulatory/Tax frame work
There is always the possibility that laws and taxes may change, or be introduced, which adversely affect real estate property prices.
Market conditions
Unlike ordinary investment trust, REITs are traded in the same way as stocks, and are thus subject to the same factors (supply / demand, interest rates, real estate market conditions), all of which can adversely affect prices.
(G)Asset mix of REITs:
Individual REITs are able to distinguish themselves by specialization. REITs may focus their investments geographically (by region, state, or metropolitan area), or in the property types (such as retail properties, industrial facilities, office buildings, apartments or healthcare facilities). Certain REITs choose broader focus, investing in a variety of types of property and mortgage assets across a wider spectrum of locations.
The current REIT industry’s investment choices can be broken down by property type as follows:
Retail 20.1%
Residential 21.0%
Industrial/office 33.1%
Specialty 2.3%
Health care 3.8%
Self storage 3.6%
Diversified 8.5%
Mortgage backed 1.5%
Lodging/backed 6.1%

(H) Case Study: The Japanese REIT index
In November 2000, amendments made to the investment Trust & Investment Corporation law expanded the allowable use of capital by investment to include real estate, thereby making funds composed on real estate investment trust schematic possible. In March 2001, TSE created a listing system for REITs to be traded on its market, and the first two REITs were listed on September 10, 2001.
Tokyo Stock exchange, Inc. (TSE) has calculated and published the Tokyo Stock exchange REIT index from April 1, 2003, reflecting both further reinforcement of investment infrastructure for the J-REIT market, established in September 2001 on the TSE, and strong demands by users to introduce a benchmark for the market.
The Tokyo Stock Exchange REIT index is a capitalization weight index based on all REITs listed on the TSE and is calculated with the same methodology used for the calculation of TOPIX (Tokyo stock price index)
As of end June 2004, 13 REITs were listed. Twelve of these are listed on the Tokyo Stock Exchange (TSE) and one of the Osaka Stock Exchange (OSE). The REITs listed on TSE are:
Nippon building fund management
Japan real estate investment corporation
Japan retail fund investment corporation
Japan prime realty investment corporation
Premier investment corporation
Tokyo REIT Inc.
Global one real estate investment corporation
Nomura real estate office fund Inc.
United urban investment Corp.
Mori trust Sogo REIT Inc.
Nippon residential investment Corp.

The growth in the market capitalization of the REIT index since its inception is depicted in the graph below:

Source : Tokyo Stock exchange, Jones Lang LaSalle
Graph 1 Growth in the market capitalization of the Japanese REIT index
The listing criteria for REITs on the TSE-REIT index are as follows:
Given that investors investing in REITs are doing so as a substitute for direct investment in real estate, the main focus of TSE’s REIT listing criteria is on the nature and proportion of real estate assets held within the fund, more specific details are set out below.
Assets under management
Real estate must make up at least 75% of total assets under management
Assets must be real estate related, cash or highly liquid cash equivalents
At least 50% of total assets must be income producing, and not likely to be sold within a year
Real estate must make up atleast 75% of total assets under management
Total assets of at least 5 billion yen
Net assets per unit of at least 50000 yen
Atleast 4000 units listed
Atleast 1000 unit/shareholders/investors
Major unit/shareholders may hold no more than 75% of listed units
Graph 2 performance of the Japanese REIT index in comparison with Tokyo stock exchange index, TOPIX and its real estate sector index:
Real estate investment trusts (REITs) are an efficient way for many investors to invest in commercial and residential real estate businesses. As an investment, REITs combine the best features of real estate and stocks. They give an investor a practical and effective means to include professionally manage real estate in a diversified investment portfolio.

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