REIT: Real Estate Investment Trust

by David Harper

A real estate investment trust (REIT) is a real estate company that offers common shares to the public. In this way, an REIT stock is similar to any other stock that represents ownership in an operating business. But an REIT has two unique features: its primary business is managing groups of income-producing properties and it must distribute most of its profits as dividends. Here we take a look at REITs, their characteristics and how they are analyzed.

The REIT Status
To qualify as an REIT with the IRS, a real estate company must agree to pay out in dividends at least 90% of its taxable profit (and fulfill additional but less important requirements). By having REIT status, a company avoids corporate income tax. A regular corporation makes a profit and pays taxes on the entire profits, and then decides how to allocate its after-tax profits between dividends and reinvestment; an REIT simply distributes all or almost all of its profits and gets to skip the taxation.

Types of REITs
Fewer than 10% of REITs fall into a special class called mortgage REITs. These REITs make loans secured by real estate, but they do not generally own or operate real estate. Mortgage REITs require special analysis. They are finance companies that use several hedging instruments to manage their interest rate exposure. We will not consider them here.

While a handful of hybrid REITs run both real estate operations and transact in mortgage loans, most REITs focus on the "hard asset" business of real estate operations. These are called equity REITs. When you read about REITs, you are usually reading about equity REITs. Equity REITs tend to specialize in owning certain building types such as apartments, regional malls, office buildings or lodging facilities. Some are diversified and some are specialized, meaning they defy classification - such as, for example, an REIT that owns golf courses.

What Kind of Asset Is an REIT Stock?
REITs are dividend-paying stocks that focus on real estate. If you seek income, you would consider them along with high-yield bond funds and dividend paying stocks. Consider 20 years of returns for the NAREIT Equity REIT Index (an index of about 150 traded REITs) between 1984 through 2003, shown below. The red bars represent annual returns solely from dividends; they have averaged about 8% and never once fallen below 4.8%. The blue bars add price changes for each year - they represent total return, price change plus income return. You can see that stable dividends combine with price volatility to create a total return that is often promising, but volatile nonetheless.

Analyzing REITs
As dividend-paying stocks, REITs are analyzed much like other stocks. But there are some large differences due to the accounting treatment of property.

Let's illustrate with a simplified example. Suppose that an REIT buys a building for $1 million. Accounting requires that our REIT charge depreciation against the asset. Let's assume that we spread the depreciation over 20 years in a straight line. Each year we will deduct $50,000 in depreciation expense ($50,000 per year x 20 years = $1 million).

Let's look at the simplified balance sheet and income statement above. In year 10, our balance sheet carries the value of the building at $500,000 (a.k.a., the book value): the original historical cost of $1 million minus $500,000 accumulated depreciation (10 years x $50,000 per year). Our income statement deducts $190,000 of expenses from $200,000 in revenues, but $50,000 of the expense is a depreciation charge.

However, our REIT doesn't actually spend this money in year 10; depreciation is a non-cash charge. Therefore, we add back the depreciation charge to net income in order to produce funds from operations (FFO). The idea is that depreciation unfairly reduces our net income because our building probably didn't lose half its value over the last 10 years. FFO fixes this presumed distortion by excluding the depreciation charge. (FFO includes a few other adjustments, too.)

Read more:
Investopedia

NST Property: The allure of Malaysian real estate

The allure of Malaysian real estate

05/09/07

Sharen Kaur

INVESTMENTS by Kuwait Finance House and Macquarie Global Property Advisors in properties purchased in Kuala Lumpur and the landmark value paid for the Four Seasons in Langkawi by Prince Alwaleed of the Kingdom Group have encouraged the flow of foreign direct investments (FDIs) in real estate in Malaysia.

Hall Chadwick Asia (HCA) Sdn Bhd chairman Kumar Tharmalingam said Malaysia's real estate attracted international attention when it removed its shackles from the 1997 regional meltdown.

While there's no fixed rule to what assets are purchased, Middle East investors try to be more syariah-compliant, failing which, they become short-term investors and sell the assets as soon as the project is ready for occupation.

"Other private equity funds will look at the whole range of assets that can give them development profits and income after completion. That provides them with the base returns they are used to in the Gulf, which have been in double-digits," Kumar told Business Times.

He said most investment funds have five-year time frames, where they would look at their real-estate portfolios and sell what they don't need.

He added that tourism has been a great catalyst for the development of real estate in Malaysia.

"Tourists from the Gulf have been arriving here for the last four years in growing numbers. When they return to their home country, they realise that Malaysia is not just a haven for tourists but a good place to invest in," Kumar said.

He said Malaysia's targeted tourist countries like South Korea, Japan and the Middle East have generated positive investments in real estate.

Tharmalingam believes there is also a new wave of investments coming in the food and beverage, and hospitality industries.

"We have investors looking to set up Syariah-compliant five-star hotels in Malaysia, aimed at the Middle East family market. They think there is a market for it here," Kumar said.

He said these hotels will become the centre piece launch pad for similar hotels in Asia, and Malaysia would probably be the hub because of the country's direct air connections within three hours to China and India, and Southeast Asia.

"China, India and Southeast Asia have a total population of three billion people, of which, 800 million are Muslims. Investors believe they can cater to these non-traditional Muslim markets as well through the establishment of the hotels," he added.

Kumar said some of HCA's clients are now looking at buying existing hotels, or building new ones in the Klang valley.

He said the Four Seasons Hotel, currently under construction, will be the magnet for more five-star hotels to be developed in Kuala Lumpur.

Meanwhile, investors from India, Saudi Arabia, South Korea, China and Singapore prefer to buy condominiums, services apartments and luxury houses in Kuala Lumpur, Johor and Penang, worth in excess of RM2 million, representing the premier segment in real estate.

In terms of pricing, Tharmalingam said, Malaysia is still 10 per cent and 20 per cent of Hong Kong's and Singapore's value respectively, in ringgit terms.

"The appetite is always urban. They believe where there is a large urban population, the quality of assets are better and there is also higher rental income returns," Kumar said.

He said Malaysian property buyers would not be affected by foreigners buying homes here. Foreigners buy homes worth in excess of RM2 million, which is not of majority Malaysian interest.

Middle East investment agencies, meanwhile, are looking at providing the large number of investors here with facilities they are comfortable with.

Kumar said there will be more financial institutions, credit card firms and Syariah-compliant tourism facilities like transport and up-market residential accommodation coming up.

"Indian and Chinese government-owned funds are also seeking to invest in Malaysia. They are planning to replicate the success story of Temasek Holdings, which has a good track record of investing outside Singapore," Kumar noted.

Source:
Business Times

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Our Recent Projects: Some Building, Some District

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Our Recent Projects: Some Mall, Some District

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