FINN 3061

Real Estate Finance

Lecture 15. Real Estate Investment Trusts I (REITs)

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 A Recap….
Last week we considered:
1) the major types of mortgage-backed securities
and their similarities and differences.
2) the main characteristics (and the risk) of the
commercial mortgage-backed securities (CMBS).
3) the role of secondary mortgage market in the
global financial crisis.

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 Exhibit 20-15
Summary of Important Investment Characteristics of Mortgage-
Related Securities

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 Commercial Mortgage-backed Securities (CMBS)

 Commercial Mortgage-Backed Securities

– Similar, in many ways, to residential MBSs (RMBS)
– However, assets in mortgage pool i.e., commercial
mortgage
• Often interest-only (& highly speculative)
• Little or no principal payments until mortgages mature

– Default risk is significantly higher!

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 Mortgage-backed Securities and Financial Crises

“Mortgage-backed securities played a central role in the financial crisis that began in
2007 and wiped out trillions of dollars, bringing down Lehman Brothers and roiling
world financial markets. At the core, an MBS allows a bank to move a mortgage off
its books by turning it into a security and selling it to investors.”
– Investopedia

“The conventional narrative about residential mortgage backed securities and the
agencies that rated them needs to change— the performance of those securities and,
hence, the ratings they held, were not nearly as bad as assumed.”
– BFI Research

https://bfi.uchicago.edu/sites/default/files/file_uploads/BFI_RB_Uhlig_052318_V02.pdf

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Mortgage-backed Securities and Financial Crises

https://www.youtube.com/watch?v=GTfUENx6uR
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 Learning objectives
After studying this topic you should be able to:
 Explain what a Real Estate Investment Trust (REIT) is and
understand the unique characteristics of REITs.
 Describe the principal types of REITs, including both equity
(public or private) real estate trust and mortgage trusts.
 Discuss the advantages and disadvantages of investing in
REITs.
 Outline the various approaches to valuation of REITs

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 Liquid investments in real estate
Publicly traded real estate securities are a popular vehicle
for investors to gain exposure to real estate asset:
• Mortgage-Backed Securities (RMBS and CMBS)
• Real Estate Operating Companies (REOCs)
• Real Estate Investment Trusts (REITs)
 The main difference between REOCs and REITs is that
REITs are exempt from corporate income tax
(However, Companies must conform to legal requirements
to qualify to be REITs).

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 What is REIT? 1/2
• Corporations pay taxes on their earnings and then pay
dividends to shareholders out of the after-tax earnings.
• Shareholders pay (personal) income tax on the dividends.
• Thus, shareholders are ‘taxed twice.’

• REIT is a real estate company that has elected to comply

with certain legal requirements in order to qualify to be
‘REIT’ and pay no corporate tax.  The shareholders in a
REIT are ‘taxed only once.’ They pay only income tax on
the distributions they receive from the REIT.

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What is REIT? 2/2

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 REIT requirements 1/3
• Distribution requirements
 Distribution to shareholders must equal or exceed 90% of
REIT (taxable) income
 “Pass-through” securities!!

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 REIT requirements 2/3
• Asset requirements
 >75% of the value of REITs assets must consist of real estate
assets, cash or government securities
 Of the remaining percentage, no more than 5% may come
from one issuer
 Etc.
• Income requirements
 At least 95% of gross income must be derived from
dividends, interest, rent, or gain from sale of certain assets
 Etc.

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 REIT requirements 3/3
Further restrictions:
• Management activities (requirements for passive
management; typical for trusts)
• Prohibited transactions (own properties for at least
two years prior to sale, etc.)
• Stock and ownership requirements (shares must be
held by a minimum of 100 persons (in the U.S), must
have a board of directors or trustees, etc.)

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 The Growth of REIT industry and
The impact of GFC
Exhibit 21-1 Market Capitalization of Publicly Traded REITs
Subprime
mortgage crisis
and credit
crunch

Tax reform act As of 2021 more

relaxes management than
limitations $1.6 trillion!
Kimco Realty
First REIT
IPO
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IPOs in the US market

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Ownership of Equity REITs

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Largest US REITs in 2020

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 Global developments

REITs in CHINA
Since China's first batch of nine REITs went public in 2020, its REITs market has grown rapidly. By the
end of October 2022, a total of 23 REITs had been approved for issuance and 20 listed on the Shanghai
and Shenzhen bourses -- this within the space of just over two years.

In the secondary market, the 20 listed REITs saw their total market value reach 70.6 billion yuan at the
end of October, with an average increase of 22.93 percent compared to the public offering price.

https://www.chinadaily.com.cn/a/202211/24/WS637f1226a31057c47eba0e26.html

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 History of UK REITs
• UK-REIT regime was introduced on 1 January 2007
(with the 2006 Finance Act and HMRC Guidance)
• Many of the largest listed property companies quicky
converted to UK-REIT status.
• Characteristics of first REITs: Large market cap,
relatively low leverage, high dividends, narrow gap
between NAV and market price.
• First UK-REITs: British Land, Land Securities,
Hammersons, Brixton, Derwent London, etc.
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 Largest UK REITs (Market cap)

• As of end of 2021: more than 50 REITs with market

cap of over $70bn listed on LSE investing across
industrial, office, residential, retail, specialty, hotel,
lodging real estate.
Segro PLC. £15.54 billion
Land Securities Group PLC. £5.09 billion
British Land Co PLC. £4.58 billion
Unite Group PLC. £4.34 billion
Tritax Big Box REIT PLC. £4.2 billion
Source: statista.com

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US vs UK REITs

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 Major Types of REITs

 Equity REITs: ownership in income-producing properties

 Mortgage REITs
– Do not own real property. Invest in mortgages, mortgage
securities (MBSs), or loans that use real estate as collateral.
 Hybrid REITs (combination of equity and mortgage REITs)
 Private REITs
– Not listed on an exchange (or traded over-the-counter)
– 3 typical types
1) Targeted to institutional investors
2) Syndicated to investors (as part of package offered by a consultant)
3) “incubator” REITs (expected to be launching IPO in future)
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 Advantages of REITs

 Exemption from taxation

 High yield
 Earnings predictability
 Liquidity
 Transparency
 Access to premium properties
 Active professional management
 Greater potential for diversification

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 Disadvantages of REITs

´ Limited potential for income growth

´ Forced equity and debt issuance to raise
additional capital for future growth

How to invest in REITs?

- We can invest in publicly traded REITs – as well as REIT exchange-
traded funds (ETFs) – by purchasing shares directly through a broker.

How to value a REIT?

 focus of next week’s lecture!
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 Reading

 Brueggeman, William B. and Fisher, Jeffrey D. Real Estate

Finance and Investments, 14th edition (McGraw-Hill/Irwin,
International Edition 2011). Chapter 21.

 Linneman, Peter and Kirsch, Bruce. Real Estate Finance and

Investments: Risks and Opportunities. Fifth Edition. Linneman
Associates. 2018. Chapter 21.

 See also the module handbook.

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