funding real estate development: wb/ifc housing finance conference washington, d.c. march 15 – 17,...
TRANSCRIPT
Funding Real Estate Development:Funding Real Estate Development:
WB/IFC Housing Finance ConferenceWB/IFC Housing Finance ConferenceWashington, D.C.Washington, D.C.
March 15 – 17, 2006March 15 – 17, 2006Michael BookstaberMichael Bookstaber
Real Estate Investment Trusts
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What is a REIT What is a REIT (1)(1) ? ? An Investment ClubAn Investment Club
Needing cash in big, irregular increments, not a steady stream of Needing cash in big, irregular increments, not a steady stream of cash flowcash flow
Can be open ended or closed endedCan be open ended or closed ended Vertically integrated: property development, property management, Vertically integrated: property development, property management,
and portfolioand portfolio
Sources of Funds:Sources of Funds: Capital markets, equity subscriptionsCapital markets, equity subscriptions Private investorsPrivate investors Little or no debt (“equity” REITs)Little or no debt (“equity” REITs)
Uses of Funds:Uses of Funds: Buys land and develops projects, rents out unitsBuys land and develops projects, rents out units Expenses in staff costs are minimalExpenses in staff costs are minimal Expenses for property management are incremental costs to the Expenses for property management are incremental costs to the
hard asset.hard asset.
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What is a REIT What is a REIT (2)(2) ? ? The balance sheet consists of The balance sheet consists of
Investment in developed properties on the asset side, and Investment in developed properties on the asset side, and Equity capital on the liability sideEquity capital on the liability side
Profitability, measured by two items:Profitability, measured by two items: Cashflow from operations: equals….Cashflow from operations: equals….rents less: (a) cost of property rents less: (a) cost of property
maintence. (b) payments on any mortgage debt, (c) staff expensemaintence. (b) payments on any mortgage debt, (c) staff expense Gains from sales of (matured) propertiesGains from sales of (matured) properties
Staff costs are minimal because Staff costs are minimal because REITs outsource many key functions: property maintenance, project REITs outsource many key functions: property maintenance, project
management of development of new propertiesmanagement of development of new properties Property management function is highly leveraged, similar to Property management function is highly leveraged, similar to
mortgage loan servicingmortgage loan servicing
As a result, REITs don’t need to retain “earnings”, they do need As a result, REITs don’t need to retain “earnings”, they do need access to large pools of cash on an intermittent basisaccess to large pools of cash on an intermittent basis
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The DisconnectThe Disconnect
Mortgage finance and property development Mortgage finance and property development are out of synch:are out of synch:
Lack of Affordable and Bankable Housing Solutions(supply/demand imbalance)
Mortgage markets are under-developed due to scarcity of housing
stock
Developers not producing due to lack of long term mortgage takeout
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The NeedThe Need Investment in real estate developmentInvestment in real estate development
Needs patient, long-term capitalNeeds patient, long-term capital Can be highly risky, calling for equity-like returnsCan be highly risky, calling for equity-like returns Requires a focus on property type to leverage Requires a focus on property type to leverage
experience and expertise of managementexperience and expertise of management
Capital is needed forCapital is needed for Land acquisitionLand acquisition Land developmentLand development Funding soft costsFunding soft costs In-site infrastructureIn-site infrastructureThese expenses typically comprise 35 to 50 percent of These expenses typically comprise 35 to 50 percent of
total project coststotal project costs
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The ProjectsThe Projects Large scale, expensive to executeLarge scale, expensive to execute Commercial income-producing propertiesCommercial income-producing properties Residential, community formatResidential, community format
1.1. Large scale projects (1,000 housing units or more) delivered in rational production Large scale projects (1,000 housing units or more) delivered in rational production stagesstages
a.a. Achieve economies of scaleAchieve economies of scale
b.b. Utilize mass production techniquesUtilize mass production techniques
c.c. Spread cost of infrastructure over many housing units, financed in the mortgageSpread cost of infrastructure over many housing units, financed in the mortgage
2.2. World class urban design, incorporatingWorld class urban design, incorporating
a.a. mix of housing styles and options, mix of housing styles and options,
b.b. mix of socio-economic groups, mix of socio-economic groups,
c.c. providing for quality of life amenities, green areas, recreation and community facilities, providing for quality of life amenities, green areas, recreation and community facilities,
d.d. retail and commercial spacesretail and commercial spaces
3.3. Ongoing support services will be incorporated into each project:Ongoing support services will be incorporated into each project:
Waste management, Maintenance of common areas, securityWaste management, Maintenance of common areas, security
CONCLUSION:CONCLUSION: Value of housing will be perserved and enhanced by Value of housing will be perserved and enhanced by design and urban planning, ensuring good storehouse of value for design and urban planning, ensuring good storehouse of value for lenders and homeowners (avoiding the creation of future slums)lenders and homeowners (avoiding the creation of future slums)
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The ProblemThe Problem
Investment vehicles to effectively fund and Investment vehicles to effectively fund and manage projects are typically not available manage projects are typically not available in developing markets. in developing markets. WhyWhy??
Absence of long-term capitalAbsence of long-term capital Governmental investment in urban planning and Governmental investment in urban planning and
in big-ticket infrastructure is often lacking in in big-ticket infrastructure is often lacking in developing marketsdeveloping markets
Nascent equity marketsNascent equity markets Reluctance to use tax policy to foster investmentReluctance to use tax policy to foster investment
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The SolutionThe SolutionReal Estate Investment Trusts (REITs, USA-style)Real Estate Investment Trusts (REITs, USA-style)
Attract long-term, patient capitalAttract long-term, patient capital
Offer specialization by property typeOffer specialization by property type
Offer development and on-going managementOffer development and on-going management
Tax pass-through feature offers dividend-like returns to Tax pass-through feature offers dividend-like returns to investors and equity-like upside of a medium to long-term investors and equity-like upside of a medium to long-term horizonhorizon
Attract investors who need current income and can Attract investors who need current income and can shelter it for tax purposesshelter it for tax purposes
Attract total return investors who benefit from upside Attract total return investors who benefit from upside stemming from turnover of value-enhanced propertiesstemming from turnover of value-enhanced properties
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The REIT WorldThe REIT WorldThe REIT concept is gaining acceptance around the world, in
many developed countries, but also some emerging markets….
CountryCountry Year IntroducedYear Introduced
Asia-Pacific
Australia 1971
Hong Kong 2003
Japan 2000
Korea 2001
Malaysia Late 1980’s
Singapore 2002
Taiwan 2003
Latin America
Mexico 2004
Brazil 1993
CountryCountry Year IntroducedYear Introduced
Europe
Belgium 1995
France 2003
Germany 2006
Italy 1994
Luxembourg 1988
Netherlands 1969
Spain 1994
United Kingdom 2006
North America
Canada 1994
United States 1960
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The RationaleThe Rationale
Why are REITs the right investment Why are REITs the right investment vehicle for real estate development?vehicle for real estate development?
PRINCIPLE ONE: Value enhancement comes from refurbishing old properties or creating new properties, and managing either until cash flow is established.
PRINCIPLE TWO: Dividend yield from REITs is a payout of current cash flow, which does not need to be retained.
• maintenance of properties is an expense item offsetting rental income• cash from creation of new properties is obtained from selling mature properties
in portfolio or raising new equity from investors.
CONCLUSION: Fixed income and medium to long-term upside combine to give investors a unique total return package, WHICH IS A GOOD PROXY FOR DIRECT INVESTMENT IN REAL ESTATE
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The RiskThe RiskReal estate development can be risky, yet Real estate development can be risky, yet
REITs can offer risk mitigating features:REITs can offer risk mitigating features:
Equity REITS use little or no debt, except for construction finance
Focus on property type, leveraging management experience and expertise
Diversification in funding sources stemming from either: pooled investment from a closed group of investors sale of stock to many, diverse individual shareholders
Diversification in multiple property investments
Income is generated from income produced via rents, fees from management of properties, and capital appreciation of properties
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The Tax AngleThe Tax Angle
Under U.S. REIT law:Under U.S. REIT law:
Payment of tax on REIT net earnings occurs Payment of tax on REIT net earnings occurs only once, at the shareholder level, not at only once, at the shareholder level, not at the corporate level…the corporate level…
……provided that the REIT distributes at least 90 provided that the REIT distributes at least 90 percent of its net income in dividends to percent of its net income in dividends to shareholders. shareholders.
How critical is this tax “break” to the successful use of REITs as investment vehicles for real estate development?
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The Tax “Break” ValueThe Tax “Break” Value
WITH THE TAX “BREAK”…WITH THE TAX “BREAK”… Pension funds (not taxable) can boost their investment yields Pension funds (not taxable) can boost their investment yields
using REITs. Real estate development thus draws on a using REITs. Real estate development thus draws on a significant pool of long-term investment fundssignificant pool of long-term investment funds
Listed REITs add additional value of liquidity, thus becoming a Listed REITs add additional value of liquidity, thus becoming a form of securitized real estate. Their trading value is form of securitized real estate. Their trading value is determined by dividend yield.determined by dividend yield.
REITs represent an efficient use of capital REITs represent an efficient use of capital by taxing returns only onceby taxing returns only once earnings from investment in income-producing properties is earnings from investment in income-producing properties is
recycled immediately, not warehoused for new projectsrecycled immediately, not warehoused for new projects..
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The Tax “Break” ValueThe Tax “Break” Value
WITHOUT THE “TAX BREAK”… Encourages short term holdings in long-term assets.
Encourages property development and divestiture before properties have matured, or before they have started to generate income.
Long-term investors are disuaded from participating due to quick property turnover
REITs of this type will undertake more risky investments, stemming from quick turnover.