REITs – an asset class for real estate

The letter abbreviation REITs - Real Estate Investment Trusts - stands for listed stock corporations active in the real estate sector. Due to the special requirements of profit distribution and special tax treatment, REITs come very close to a direct real estate investment in terms of their opportunity and risk profile. 

REITs are a globally recognised form of indirect real estate investment in many countries. The predominant business purposes of REITs can be the acquisition and sale, letting or leasing, management or pure financing of real estate. But that alone does not make a real estate company a REIT. The extraordinary thing about this type of investment are its tax and investment-related special features. REITs are subject to special tax benefits, depending on the tax legislation of the respective home country of the REIT company. In return, the companies must meet some government requirements. The most important for investors is that the majority of the income must be distributed to the shareholders. The exact minimum payout ratio varies from country to country. In the US, for example, it is 90 percent. 

Some minimum payout ratios:

• USA: 90%
• Australia: 100%.
• Japan: 90%
• Belgium: 80% from rentals and 50% from disposals
• France: 85% from rental and 50% from sale.

There are three different types of REITs, depending on the business activity of the companies. REITs that own and/or sell real estate are called equity REITs in Anglo-Saxon countries. These companies derive their income almost exclusively from the rental and leasing of real estate. The second group, on the other hand, deals with financing. These companies do not invest directly in real estate, but grant loans to real estate projects or invest in secured mortgages. Hybrid REITs are a mixture of the two activities.

REITs can also be broken down by sector. This type of investment now exists in 19 countries worldwide, including the USA, Canada, Japan, France and Belgium. In Great Britain, as in Germany, the introduction is imminent. In their basic form, REITs are similar to each other. They differ, for example, in the amount of the distribution, in the minimum requirements for investments in real estate and, of course, in the applicable tax laws. The planned German design of REITs is referred to as G-REIT - German Real Estate Investment Trust.

What REITs have for investors

A REIT corporation is exempt from certain taxes. Companies that sell their real estate holdings to REITs therefore enjoy tax concessions and can increase their liquidity under these conditions. But what are the advantages for investors?

Transparent, easily tradable real estate investment

Investments in REITs combine the advantages of an equity investment - the share certificate is easy to sell again on the stock exchange - with the stability of a real estate investment. The income from REITs comes from long-term agreed rental income or interest payments. If the investor's personal tax situation is disregarded, the payout profile of the investment is comparable to direct investments in a property. In this respect, REITs serve to diversify portfolios.

High dividend payout

The dividend paid is high in comparison to conventional shares, as the tax benefits result in higher earnings for the company. In addition, a minimum distribution is required for REITs.

Distinction from real estate shares and funds

The main difference to listed real estate companies is the minimum distribution, which does not exist for pure real estate shares. The tax aspect also favours REITs over funds and real estate companies, which are taxed both at company and investor level.

Compared to open-ended real estate funds, REITs have the advantage that companies do not have to sell their real estate - possibly below value - in the event of massive outflows of money. REITs are traded like shares; when investors sell their shares, this does not affect the company's portfolio, but only its share price.

For tax purposes, REITs are still treated like shares. This means that investors only have to tax their income from REITs investments with the final withholding tax (after deduction of tax allowances).

One thing investors should bear in mind when investing in REITs is that they should not be deceived by the supposed security of indirect real estate investments. As with a stock, the performance of a REIT depends on many factors: the market environment, the quality of the management or the general stock market situation.

Performance view

REITs have existed in the USA since 1960 and were introduced, among other things, to give small investors access to a secure real estate investment. Today, around 200 REITs are listed on the New York Stock Exchange. The return on a real estate investment does not have to be meagre. From 1971 to 2003, the average annual return on equity REITs in the USA was 13 percent. Over the same period, the Dow Jones Industrial rose by around eight percent annually.

The performance of real estate companies in Europe and the USA can be tracked using various indices. This is how the EPRA index, which is compiled by the European Public Real Estate Association and calculated on the London Stock Exchange, describes the performance of Europe's largest listed real estate companies with high distributions. The NAREIT – National Association of Real Estate Investment Trust – is the American counterpart to the EPRA.

There are REITs in 19 countries worldwide, four of which have REIT-like structures. The oldest are the USA (1960), the Netherlands (1969) and Australia (1985). Most REITs structures were established in the early years of the 21st century.