Alphabet Soup of REITs satisfies world’s thirst for liquid real estate

Liquidity begets efficient markets.  Ergo, the growth of efficient markets relies on previously private assets, such as real estate, becoming part of the publicly tradable universe of securities. This helps to “complete” markets.  But promoters of these alternative investments, it turns out, also have an aptitude for another thing: corny neologisms.

Thanks to them, you can now add a few more names to your real estate vocabulary. There’s “P-REITs”, for example, which have nothing to do with a very popular Johnny Depp movie series set in the Caribbean at a time when alternative investing meant Spanish galleons.  The Philippines approved real estate investment trusts over the summer. Yes, the real estate industry actually calls them ‘P-REITs”.

Hopefully they get more traction than prematurely geriatric “G-REITs”. That’s right, Germany has REITs too. But only since 2007. It’s been a gritty experience to find a footing since their long-standing competitor, open-ended funds called SIFs, are “not listed on the stock market and not subject to free float and maximum participation requirement … it is more exclusive and less volatile. Without notable developments in the field of G-REITS, the SIF could prove to be more suitable for institutional investors.” says Dirk-Reiner Voß and Daniel Barth, Berlin-based lawyers at Salans LLP, a global legal firm.

In a mark-to-annual-value regime, of course SIFs will be less volatile. And that may affect “F-REITs” (I’ll have steak with that, please) in France and in Belgium. European REITs haven’t found regulators very friendly – Gosh, they’re almost like hedge funds the Euro-types say. (On the theory that anything with leverage is like a hedge fund.  Message to the masses: pay off your mortgages, now.)

“Europe’s commercial real estate owners, saddled with 1.9 trillion euros ($2.5 trillion) of debt, may be forced to make billions of euros in cash payments under planned laws that would treat them like hedge funds,” Bloomberg reports.

“Currently, real estate borrowers aren’t required to post collateral on interest-rate swaps that have moved the wrong way unless they break the contract. While the liabilities are reported on company accounts, they aren’t usually paid if the swap is held to its maturity date.”

If E-REITs seem unwelcoming, how about  “J-REITs”? (They’re tanking.)

“The government may revise the regulation to allow the trusts, known as J-REITs, to retain more than 10 percent of their earnings to finance operations, said Sumio Mabuchi, vice minister of the Ministry of Land, Infrastructure, Transport and Tourism. Currently, J-REITs must pay out more than 90 percent of their profit to investors as dividends to receive tax breaks,” Bloomberg reports.

But that’s par for the course in REITland: REITs pay out almost all of their profit to shareholders.It perplexes Japanese officials that J-REITs are eating more of their cash flows than they earn back.

While some investors welcome REITs for expanding the investable universe, others find them a “PITA”. Not an especially edible one. Especially if they are involuntary REITs. That’s the situation in REO property in the U.S. REO? It’s not a speedwagon. It means real-estate owned. In other words, properties in foreclosure.

That’s what happens when the chickens come home to roost. You end up with a lot of assets worth less than when they’d flown the coop. And now you have to manage them, says a recent Fortune magazine article:

“Chris Whalen, co-founder of Institutional Risk Analytics, told a packed room at the American Enterprise Institute … “They are not designed to be REITs, but that’s what our banks are becoming,” he said. “We are turning all of our banks, [Fannie Mae] and [Freddie Mac] into owners and operators of real estate, and this stress is going to overwhelm them.”

Pity that, they might actually learn something about ground-level real estate investing. Still, that opens the question, what are expected rates of return on property?

Jonathan Thompson, chairman of the building, construction & real estate at KPMG notes that “global commercial real estate (CRE) investment has been recovering since the second half of 2009 and is expected to reach US$300 billion by the end of 2010, a 40 – 50 % year-on-year (y-o-y) increase. (see chart from report below – click to enlarge)

Geographically, Americas outpaced Europe Middle East and Africa (EMEA) and Asia-Pacific in terms of improvement in CRE investment; however, its base was the lowest among the other regions. The recovery is driven by improved global liquidity and credit conditions, coupled with investor confidence, which has provided an impetus to cross-border investments. However, the risks associated with the scale of maturing debt in the US and the UK over the coming years loom ominously beside the tight credit for non-trophy (Class B/C) assets and the lack of quality investments for a sustained recovery.”

In other words, the taps are mostly dry, it seems, since “stable opportunities are elusive.” As they should be given the proposition, “if property fundamentals in the US and Europe do not continue to improve, the optimistic CRE investment outlook may fall short of reality.”

Blame it on deleveraging. Blame it on refunding past debts now coming due. As for well-capitalized REITs, there may be a B-REIT opportunity. As the Belgian waffle shop in my neighbourhood says, “Goed Eten!”

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