REIT Resiliency Leads Real Estate Out of Global Financial Downturn
- May 04, 2010
It’s a testament to the resiliency of the real estate investment trust model that REITs are leading the way out of the global economic downturn.
The nature of real estate has typically been that it takes time for investors to identify and select investments, but REITs were created chiefly to provide a market for investors to be able to buy and sell real estate – through securities rather than bricks and mortar – more efficiently. Simply put, bringing liquidity to what has historically been a largely illiquid market was a key driver behind the growth of REITs in the US and, lately, around the world.
We looked at this phenomenon most recently in a global report (“Against All Odds: Global Real Estate Investment Trust Report 2010”) released in March. Our analysis shows that during the recent global downturn, REITs did precisely what they were intended to do. That is, give investors – albeit at a price – an opportunity to quickly adjust their exposure to real estate by selling REIT stocks. Now, REITs are providing investors with a way to capture the market rebound by adding real estate stocks back into their portfolios.
Since March 2009, many REIT markets around the world have seen significant increases in share prices and REITs have raised billions of dollars by going back to the stock market for secondary equity offerings to reduce debt, recapitalize their balance sheets and prepare their businesses for the next wave of growth.
Our report shows that all REIT markets – except Japan — saw double-digit positive returns in 2009. Returns for Japan’s REITs grew just 6.68 percent, with Australia’s REITs performing slightly better at 10.4 percent growth in returns in the same full year period. The largest single REIT market in the world, the United States, witnessed almost 28 percent returns.
It was in Asia where REITs had the most compelling story, though. Asian REITs as a group outperformed all other regions of the world in terms of total returns. Singapore and Hong Kong REITs posted 85.6 percent and 64.5 percent returns respectively in 2009 with Malaysia (38.6 percent) and South Korea (28.4 percent) also showing strongly. South Korea, Malaysia and Hong Kong REIT markets all recorded positive rates of return over the last three years, despite the global downturn.
On the other side of the coin, the United Kingdom and Australian REIT (A-REIT) markets recorded relatively poor performance over the last three years, both exceeding negative 20 percent returns and here’s where some of the weaknesses of the REIT model start to show.
According to Chris Lawton, Leader of Ernst & Young’s Australian Real Estate practice, the poor performance of Australian REITs is on one level surprising, given that the economy ultimately proved to be far more robust through the downturn than the UK economy.
We are left to conclude that the main reason REIT markets in the UK and Australia performed poorly in the last few years is that they moved furthest from the traditional “passive” REIT model – where REITs purchase existing properties and capture revenue by managing those properties – and moved much further up the risk/return curve into high risk development activities. At least in the case of Australian REITs, according to Lawton, this diversification into riskier ventures was a response to market demands for higher returns. Many REITs did diversify and this made some of them much more vulnerable in the downturn. To a great extent, investors need to decide one way or another which role they wish REITs to play in their portfolios. Do they want high returns or stable income? A clear message will help REIT managers run their businesses much more effectively during the future downturns.
Another weakness in the REIT model exposed by the downturn is the requirement that REITs distribute a large percentage (typically 95 percent) of their income to investors. This requirement made it very difficult for REITs to conserve cash at a time when they most needed to. Also, restrictions on REIT debt levels in many countries – designed to prevent REITs from over-leveraging during a period of market growth – had potentially serious tax implications for many REITs during the downturn. So, in addition to investors doing some soul-searching, the onus is also on governments to reassess key elements of the rules regarding REITs in order to make sure they remain attractive vehicles for investors through the next global financial crisis.