Property Investment and Finance Lecture : Real Estate Investment Trusts (REITs)

Trust
An equitable obligation

- A sponsor appoints a person to create a trust (Settler) - binding a person (Trustee) - to deal with property (Trust Property) - for the benefit of other persons (Beneficiaries) Any neglect of a trustee not authorised by the terms of the trust : a breach of trust Separation of legal and equitable interests in property between the trustee and beneficiaries

Reasons for the settler creating trusts: to make dispositions of his property to benefit the persons in succession to protect the property from possible dissipation to benefit persons who cannot hold the asset themselves for charitable purpose for retirement purpose for tax planning purposes

Unit Trust (Conventional)

Pools of money invested in a portfolio that is fixed for the life of the fund A sponsor, typically a brokerage firm, buys a portfolio of securities which are deposited into a trustee (usually closedend) They are then repackaged into units of shares in form of redeemable certificates to sell to shareholders All income and payments of principal are paid out About 90% of all unit investment trusts are invested in fixedincome portfolios in the US About 90% invested in tax-exempt debt (for retirement)

Unit Trust (Conventional)

Little active management Invest in relatively uniform types of assets; e.g. in municipal bonds and corporate bonds. Management fee is lower comparing to mutual funds (openend fund) Sponsors earn their profit by selling shares at a premium Investors liquidate holdings by selling the units back to the trustee

Business Trust

An unincorporated business organization created by a legal document, and used in place of a corporation or partnership for the transaction of various kinds of business with limited liability Originated in the US, also called a Massachusetts trust or a common-law trust, to circumvent restrictions imposed upon corporate acquisition and development of real estate while achieving the limited liability aspect of a corporation A business trust differs from a corporation in that it does not receive a charter from the state giving it legal recognition It derives its status from the voluntary action of the individuals who form it

Business Trust

Similar to a traditional trust in that its trustees are given legal title to the trust property to administer it for the advantage of its beneficiaries who hold equitable title to it A written declaration of trust specifying the terms of the trust, its duration, the powers and duties of the trustees, and the interests of the beneficiaries is essential for the creation of a business trust The beneficiaries receive certificates of beneficial interest as evidence of their interest in the trust, which is freely transferable Example, the listing of Hutchison Port Holdings Trust (HPH Trust) aims on the SGX (Singapore Exchange Limited), the trust will operate and develop deep-water container ports in Guangdong, Hong Kong and Macau.

What is REITs?
Established either as a trust or a company Established by financial institutions / corporations, to serve as investment managers to earn a fee Invest in real estate or loans secured by real estate. Similar to a closed-end fund Can be traded on organised exchanges, their prices therefore can differ from net asset value (NAV) Besides issuing shares, they raise capital by borrowing from banks and issuing bonds. Most of them are highly leveraged, with a typical debt ratio of 70%.

Types of REITs

Three broad types of REITs (by business mode): (1) Equity REITs: own and operate real estate (rent) (2) Mortgage REITs: providing loans to mortgage and construction (interest) (3) Hybrid REITs: equity REIT and mortgage REIT.

Types of REITs

By Property Types: Regal REIT : hotels The Link : retail and car park facilities Prosperity : commercial buildings (offices and retails)

REITs Regulatory requirements (US)

Min % of assets invested in real estate or

assets Prohibition from investment in vacant land or development projects Not subject to corporate tax as long as it complies with the minimum payout ratio requirement Subject to public oversight and required to ensure transparency of operations Can be privately held or listed on a stock exchange

related

Management of REITs
In the US, REITs are usually operating companies

that are internally managed by a board of directors The properties are actively managed with a view to maximising rental income This arrangement helps to ensure that the properties are managed in the best interest of REIT investors

Valuation of REITs

Value its underlying assets on a regular basis using: discounting future cash income from its operations (Australia) discounting the funds from operations, inclusive of depreciation charges (US) estimating the net asset value with reference to recent transactions with similar characteristics (Asia) The premium or discount to the net asset value (NAV) of listed REIT influenced by both tangible and intangible factors

Overview of REITs Development

The concept of a REIT originated in the US in 1960 US is the worlds largest REIT market Australia introduced the REIT concept in the 1970s Some countries such as Australia, Netherlands and Belgium, known as Listed Property Trusts (LPTs) In European countries, Netherlands introduced REITs to its market in 1980s, Belgium in 1995 Canada in the 1993 Japan was the first country to introduce this product in Asia 2001. Both Korea and Singapore followed suit by enacting their own REIT legislation.

Trends in REITs
In the past, many REITs were diversified, in that they held properties of many different types.

Now, most REITs are more specialized. Typically, they are specialized by property type or region. Many REITs have gotten larger, either through mergers and acquisitions, or through larger IPOs. REITs are more liquid than they used to be, and are now held by institutional as well as retail investors.

Real Estate Investment Trusts (REITs)

The web site (www.nareit.com) of the National Association of Real Estate Investment Trusts (NAREIT) offers detailed information on REIT markets.

REIT and the Hong Kong Property Market REITs in Hong Kong are likely to: increase liquidity in the secondary property market enlarge the potential pool of property investors reduce the inherent volatility of property market cycle (stabilizing the trading volume) deepen the property market

Legal Structure of REITs in Hong Kong

The

Commission proposes that all REITs shall be structured in the form of a trust REIT shall appoint a trustee that is functionally independent of the management company (sponsor) The trustee must act in the best interest of the unitholders.

The Link REIT

Background to the Divestment
Pursuant to the Governments review of its public

housing policy, it was recommended that HKHA progressively divest its non-core assets. proceed with the Divestment through the initial public offering of units in a REIT, namely The Link REIT

To realise this objective, HKHA has agreed to

Selection of Properties for Divestment

Two types: (i) estates which HKHA owns under Government Leases (ii) public rental estates where the control and management vested in HKHA All retail and carpark facilities of the HKHA should be divested Properties with following considerations are excluded: - age of the properties - redevelopment schedule - size of the housing estates - location of the housing estates - title to the Housing Estates

The portfolio comprises 180 properties of retail and carpark facilities

Valuation

Valued by CB Richard Ellis Ltd, an Independent Property Valuer in accordance with the Hong Kong Guidance Notes on Valuation of Property Assets As at 30 September 2004, the aggregate market value of the Retail Facilities and the Carpark Facilities were HK$24,510 million and HK$6340 million, respectively. The valuations were primarily based on both discounted cash flow and capitalisation of rentals. The Independent Property Valuer has also considered recent sales and leasing transactions of comparable properties

Regulatory structure of The Link REIT

With the aim of providing returns from the rental

income To distribute at least 90% of audited net income after tax To maintain a prudent capital structure with a ratio of aggregate borrowings to total gross assets not exceeding 35% Not to invest in vacant land or, subject to limited exceptions, engage in property development

Organisation Structure of The Link REIT

Investors (1) and Cornerstone Investors Strategic Partner (2)
SP Svc Fees Holds Units Hold Units Fees

Trustee
Custody of the Properties, the Manager, HoldCo, PropCo and FinanceCo on trust for Unitholders

The Link Management Ltd

HoldCo FinanceCo The Link Properties

Rights and Liabilities of Unitholders

To

receive income and other distributions attributable to the Units To receive the audited financial statements To participate in the termination of The Link REIT No right to require the transfer of assets

Tax Issues
Profits tax Stamp duty

- Stamp duty is applicable when acquiring or disposing a new property - For investors, no HK stamp duty is payable in relation to the issue of Units to him or her - However, it is applicable at current rate of 0.2% on the sale and purchase of Units by an investor - In addition, a fixed duty of HK$5 is currently payable on any instrument of transfer of Units