Is it time for Real Estate Investment Trusts (REIT)?

In the aftermath of the economic crisis, the sector that has been suffering for some time now is the real estate and construction industry. One could argue though that a major reason for the crisis is the overexpansion of this market (in the years between 2004-2010), the creation of a bubble in real estate prices, and when the bubble finally burst, the problems have transferred via the banking sector to the rest of the Cyprus economy. Banking was unfortunately heavily exposed to this market, and that was one of the reasons for the collapse of the banking system in March 2013. Since that time, we have seen an exponential increase in the nonperforming loans (NPLs) in the system, as loan holders are either unable or not willing to repay their obligations.

The latest data by the European Banking Authority (EBA) in 21 countries and across 105 banks in Europe shows the magnitude of the problem. Cyprus has the highest NPL portfolio (almost 50%), well above the second country (Slovenia at 28%) while the average is only at 10%.

Furthermore, the provisions made by our banks (at 32%) is the third lowest among all countries and well below the average (at 43%). In the past, I argued that the passage of securitisation for the selling of loans, or the introduction of an asset management company (AMC) that would handle the problematic situation.

Here, I suggest that the establishment of a Real Estate Investment Trust (REIT) might be another proposed solution for this problem.

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This is an investment vehicle that is comparable to a mutual fund, i.e. pools money from investors and invests in real estate (apartment complexes, hotels, shopping malls, etc.), and can be traded on an organised exchange as an exchange-traded fund (ETF). It is basically an indirect way of investing in real estate.

REITs can be divided into two types: (1) equity REITs where investors taking part in this vehicle receive ownership of the property under the fund; and (2) mortgage REITs where the investment is in property mortgages (i.e. debt securities).

To induce participation in this investment vehicle, REITs offer special tax advantages and provide a high dividend yield – earnings from rent payments or from capital gains from selling property holdings in the case of equity REITs, and gains from the net interest margin, i.e. the difference between the interest received from mortgage loans and the cost of funding these loans.

It’s also important to note that both small and large investors are encouraged to participate in such a vehicle, with a minimum of at least 100 shareholders. be set up either by the property developers who are finding it difficult nowadays to repay their loans, or by the bank themselves (if they end up taking ownership of some of the assets of problematic loan holders). This can help the economy in several ways:

1. It can bring much-needed liquidity to the real estate market, and the increased demand can halt the downward path of real estate prices. One of the characteristics (disadvantages) of real estate as an asset class is the lack of liquidity.

This problem is exacerbated in recessionary periods. Trading of such a vehicle in an organised exchange can bring liquidity to the market as participants will be able to liquidate their investment quickly and at a price close to the fair market value, if needed.

2. The increased liquidity will then help the property owners to recover some of the lost value of their assets, or if those assets had already passed into the hand of the banks, can help the banking sector recover a bigger portion of the problematic loans.

3. Overall, there will be a positive impact for the economy as a whole – for the real estate market, for the banking sector, but also for the rest of the market participants as the problems of the banking sector are felt inevitably by all sectors of the economy.