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

Financial Mirror (Cyprus) - - FRONT PAGE -

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.

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