The collapse in values means that property is a potentially attractive option for investors, particularly on the commercial side

For some investors, the mere mention of a real estate investment is enough to set off a panic attack. For others, however, the collapse in values over the past five or six years means that property is now looking potentially attractive once more, particularly on the commercial side.

So if you’re looking to satisfy your appetite for property – be it for a shopping centre, office block or hospital – a new structure introduced in the Finance Act might be for you. But what are real estate investment trusts (REITs), how do they work and how big might the Irish market actually be?

What is a REIT?

In simple terms, REITs provide a similar structure for investment in real estate as funds provide for investment in shares. REITs are quoted companies that own or operate property, such as office blocks and shopping centres, and are now the primary way of listing commercial property around the globe. They enable investors to indirectly access the residential and commercial property markets, by buying shares in property companies, which are either listed on a stock exchange or sold privately. These companies invest in a variety of types of property, which may include shopping centres, office buildings, apartments, warehouses and hotels.

Are they a completely new invention?

While the Finance Act may introduce REITs into Ireland for the first time later this year, they can actually be traced back to the 1960s in the US, when the government introduced the products to enable the investing public to benefit from investments in large-scale real estate enterprises.

In 2001, REITs were included in the Standard & Poor’s 500 Index, and since then the market has grown substantially. REITs have been introduced in more than 20 other countries worldwide, including Australia, France and Japan, while in January 2007 the UK introduced its own REIT product. Today, the global REIT market is valued at about €500 billion, with the typical REIT having a market capitalisation of about €1 billion.

How do they compare with bonds and equities?

A REIT sits somewhere between a high- growth stock and a bond. In a recent commentary, Barclays described REITs as being like “a total return vehicle”, in that they combine both attractive income and solid growth/appreciation potential.

REITs typically offer above-average dividend growth as they have to distribute a certain proportion of the rental income they receive – 85 per cent in the case of Irish REITs. In 2012, for example, US REITs had an average dividend yield of about 3 per cent, compared with 1.7 per cent on 10-year Treasury bonds and an average 2.2 per cent for the SP 500. In the UK, dividend yields are running at about 3.5-4 per cent on REITs.

“A REIT should be a dividend machine,” says Alan Carter, property analyst with Investec in London, with rents, and therefore dividends, growing in line with inflation.

Investors can also benefit from a surge in capital values which will push the price of units in a REIT upwards, while the structure also offers an opportunity for retail investors to access types of property such as shopping centres and office blocks, that may previously have been out of their reach.

REITs are bought and sold, like shares, via a stockbroker, with dividend income subject to tax at your marginal rate. Any gains made on a REIT will be subject to capital gains tax at 33 per cent.

“Buying a REIT will be exactly the same as buying shares in Ryanair or Diageo,” says Bill Nowlan, managing partner of property asset managers WK Nowlan Associates, adding that just as shareholders own a public company, so too will investors in a REIT own the properties it manages.

What are the other beneficial attributes of REITs?

REITs are often used as a tool to diversify a portfolio, as they tend to have a low correlation with other asset classes, and some would see them as a defensive investment. Opting to invest in a REIT, rather than an individual property, also helps diversify an investment in property, as a REIT will typically hold investments in a number of properties.

In addition, REITs can offer property investors some much needed liquidity. Unlike property funds, where encashment penalties might apply should you wish to cash in your investment early, shares in REITs can be bought or sold on stock exchanges. However, the smaller the REIT the lower the liquidity might be.

As they are publicly quoted, REITs also offer investors transparency on how their money is invested.

As with other investment products, when evaluating REITs investors should consider the management team behind the REIT, and its external funding source.

“It depends on the quality of the property and the quality of the management. You will be looking at the location, the bricks and mortar, and the leases,” says Nowlan.

Globally, REITs are performing strongly at present. For example, the MSCI US REIT, which represents approximately 85 per cent of the US REIT universe, is up an average of 19 per cent per year for the past three years when dividends are included, while the Dow Jones Equity All REIT Index, which tracks 136 REITs, delivered a total return of nearly 20 per cent for 2012, more than double the 7.5 per cent gains in 2011 and the fourth consecutive year that REITs outperformed the Standard Poor’s 500 stock index.

How will an Irish REIT work?

EPRA, the European Public Real Estate Association, has put the potential for an Irish REIT market at about €5 billion, and experts have suggested that a minimum market capitalisation of about €250 million per REIT will be needed.

However, the difficulty in getting an Irish REIT off the ground remains the lack of property managers of sufficient scale. In the UK, companies such as British Land transferred to a REIT structure once legislation was introduced in 2007, but the collapse of the Irish property market has also meant the collapse of many property companies.

As a result, there is only a handful – at best – of property businesses that could put together a portfolio of sufficient scale to sell as a REIT.

Nama is one candidate, with other contenders including IPUT, which has a portfolio of 56 primarily freehold properties in Dublin and Cork.

So far, Nama has been pursuing another option for selling off some of its properties via a qualifying investor fund or QIF. However, this structure is targeted at sophisticated investors, and opting for a REIT might broaden the range of investors it can target.

Why such a push to facilitate property investment? Have we not learned any lessons?

It’s all about bringing international money into the market. According to members of the REITs Forum, which has been lobbying for the introduction of such a structure in Ireland, the main advantage of REITs is that it will allow international investors easily access the Irish market.

As Nowlan points out, prior to the boom years there was “virtually no international investment into Ireland”, apart from the “occasional foray from an English pension fund”. But to sustain the property market, investors with deeper pockets are needed.

What are the risks in launching Irish REITs?

Investors could look to the experience of the UK market, which was launched with great aplomb in January 2007. However, the market quickly plummeted following the onset of the global financial crisis.

“Consequently the first two years of REITs’ existence was one of significant share price decline which prevented any further IPOs and the sector went through a significant refinancing requirement,” notes Carter, adding that “since then we’ve not seen much in terms of new REITs coming to the market”.

Indeed, there are currently about 18 UK REITs on the market, with a market capitalisation of about £25 billion – far off the peak of about double that when they were first launched. One of the most dramatic declines has been the example of the Invista European Real Estate Trust, which invests in properties across Europe. It has plummeted by 70 per cent in the year to February 18th.

While there has been a recovery of sorts since, Carter bemoans the lack of support from investors for new REIT IPOs.

“It could be because of the sort of things that have been brought to market or priced incorrectly,” he says, adding that it can also be difficult to find the required scale needed to get a REIT off the ground.

This should send out some warning bells, given that the Irish market is so much more concentrated and smaller than the UK.

Another potential issue is that in other countries, REITs have been structured along specialist lines, by investing in particular assets, such as retail warehouses, office properties or apartments.

“Fund managers like the idea of REITs being specialised,” says Carter, noting that this might, to an extent, “inhibit” international fund managers from moving to Ireland

“The Irish market will struggle to identify anything beyond a Dublin office portfolio, but possibly will through time,” says Carter, while Nowlan adds that one potential big opportunity for Ireland is healthcare REITs.

However, with values now near the bottom, the growth potential might be just too good for some.

“You should never lose sight of the fact that if there’s money to be made people will invest,” says Carter.