Real Estate Investment Trust (REIT)

REAL ESTATE INVESTMENT TRUSTS (REITS)

Are you looking for investment opportunities featuring more attractive returns than savings accounts, tax-free and stable long term returns, and high liquidity? If you are looking for these options Real Estate Investment Trusts (REITs) are a new financial product that might offer the right solution for your investment needs.

WHAT IS THE DIFFERENCE BETWEEN A REIT AND A PROPERTY FUND?

A REIT is not really an investment innovation since it is similar to a property fund. Investors might be surprised to learn that CPNRF, the biggest property fund in Thailand with a market capitalization of more than 30 billion baht, is also the world's biggest property fund. This is true because property funds only exist in Thailand, while other countries have opted for REITs. Property funds were introduced to the market at a time when Thailand's trust laws were not quite ready for REITs. Thailand, therefore, opted to apply mutual fund legislation for property funds for many years.

With the increased readiness of trust laws, REITs will replace property funds in Thailand, and existing property funds will not be allowed to issue new shares or increase capital in 2014. Investment in REITs is another step between property funds and companies operating commercial rental space (e.g. department stores, hotels, factories, or warehouses). The 3 property-related investment categories can be outlined as follows:

 

  Property Fund REIT Companies operating space for rent
Assets Specific property Specific property or shares of property companies Operating space for rent
Foreign investment Not allowed Allowed Allowed
Management Managed by asset management companies Managed by asset management companies or specialized property management companies Managed by specialized property management companies
Financial structure Cannot acquire loans of over 10% of net asset value Cannot acquire loans of over 35% of net asset value or 60% in case of being investment grade No limit.
Dividend payment Not less than 90% of net profit Not less than 90% of net profit Depending on company policy
Tax privilege
  • No tax on fund revenue
  • 10% withholding tax for individuals
  • Special tax rate for legal entities
  • Special transfer rate at 2% of asset value
  • No tax
  • 10% withholding tax for individuals
  • Subject to corporate income tax
  • 10% withholding tax for individuals

Investment in property funds and REITs contains similar features in terms of assets, which are specific to each entity. However, returns, risks, and growth rates will depend on the underlying assets. Because investment is made on completed property projects with satisfactory performance, returns are quite certain and not very vulnerable. Growth mainly originates from increases in rental fee or assets. On the other hand, investment in property companies is like investment in a business. Profits and losses are created from many property items, including those from business expansion and the purchase of new asset items, which can provide higher or more fluctuating returns. However, increased risk could arise from the purchase of empty land plots, project development, and the sale of assets. If one would like to invest in a REIT, what are the factors to consider?

  1. Quality of REIT assets: The first priority is to consider the rate of return. However, it should not be forgotten that the rate of return is a prediction of rates year-by-year, which can fluctuate over the long term. Therefore, investors should also consider the long term growth rate in conjunction with the duration of investment. The most effective indicator should be IRR (Investors who are not familiar with IRR can learn more from text books on asset valuation or corporate finance). In addition, investors must consider the risk of each project in the same manner as those opting for property fund investment. However, with the wider scope of investment allowed by REITs, investors have more investment choices compared to those investing in property funds, which are limited to traditional space rental, such as office buildings, department stores, warehouses, factories, and hotels. Apart from assets, REITs also covers all types of property businesses, such as hospitals (which can be divided into fixed rental rates and variable rental rates based on operating performance of hospital). Accordingly, investors should also study the earning features of each project, which can be used for determining future returns.
  2. REIT Manager and Trustee: REITs operate more to international standards because they allow management by specialized property investment managers, unlike property funds, which must are managed by asset management companies only. REIT management will cover important areas which could directly affect returns on investment, such as the selection of lessees and the negotiation of rental rates, dividend payments, funding structure management, renovation, or new investments. On the other hand, trustees will be responsible for taking care of investor benefits by working with REIT managers to ensure that any investment decision is made for the benefits of investors.
  3. Alignment of the funding structure and investment: REITs allow for fund raising from loans, which is more cost effective compared to raising funds from shareholder equity. Appropriate loan combinations can enhance returns after the loan is paid off. However, too much lending can increase risks, especially if the property is facing unfavorable impacts.
  4. Size of the fund: The size of a fund can directly affect trading after listing. With international formats and diverse scopes of investment, it is likely that the average REIT will be bigger than that of a property fund conducting more trading in secondary markets. Active trading will make it easier for investors to trade and maintain pricing stability.

It can therefore be said that REITs are more or less a new form of property fund. The new instrument is a transformation of mutual funds to trusts, which will be more attractive to foreign investors. REITs can be more expensive for some investors, due to decreased tax privileges for legal entity investors. However, investors should find its features more satisfactory. In the near future we should see the first REIT, and the first active REIT trading.