The Market for REITs

Real Estate Investment Trusts (REITs) offer individuals the opportunity to invest in income-producing real estate assets without directly owning or managing properties. REITs effectively enable individuals to invest in portfolios of real estate assets through stock purchases or investment in mutual funds or exchange-traded funds (ETFs).

Shareholders of REITs earn a portion of the income generated by the real estate holdings without the need for property management or financing. Collectively, REITs in the U.S. own over $4 trillion in gross assets, with public REITs accounting for around $2.5 trillion.

REITs invest in diverse real estate property types such as offices, apartments, warehouses, retail centres, medical facilities, data centres, and hotels. While most REITs focus on specific property types, some maintain diverse portfolios.

REITs primarily generate income by leasing space and collecting rent on their real estate holdings, which is then distributed to shareholders as dividends. They are required to distribute at least 90% of their taxable income to shareholders, often reaching 100%.

REITs historically offer competitive total returns, including steady dividend income and long-term capital appreciation, making them an attractive portfolio diversifier. Their low correlation with other assets helps reduce overall portfolio risk and increase returns.

Over the past 45 years, REITs have demonstrated reliable dividend growth and long-term capital appreciation compared to the broader stock market, bonds, and other assets. Managed by professionals, listed REITs focus on maximising shareholder value by attracting tenants, generating rental income, and strategically managing property portfolios to create value throughout real estate cycles.

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Varieties of REITs and Their Asset Focus

REITs come in different forms, including:

• Publicly Traded REITs: Regulated and listed on stock exchanges, accessible to anyone with a brokerage account.

• Public Non-Traded REITs: Regulated but not traded on stock exchanges, thereby only accessible through financial advisors or online platforms.

• Private Non-Traded REITs: Limited to high-income or high-net-worth individuals, and exempt from registration.

And typically, REITs focus on different asset types:

• Equity REITs: Own and manage income-producing properties like apartments, offices, and warehouses.

• Mortgage REITs (mREITs): Provide real estate financing by acquiring mortgages and mortgage-backed securities, earning income from interest.

• Hybrid REITs: Invest in both income-producing properties and real estate-backed loans.

While investing in Real Estate Investment Trusts (REITs) offers numerous advantages, there are also drawbacks to consider. On the downside, REITs can lead to higher tax liabilities due to nonqualified dividends, making them best suited for tax-advantaged accounts like IRAs. They are also sensitive to changes in interest rates, often experiencing stock price declines as rates rise, and carry property-specific risks such as tenant turnover, industry challenges and technological disruptions, as well as the risk of overleveraging through debt.

However, on the positive side, investing in REITs provides several benefits. For instance, REITs typically provide above-average dividend yields, offering passive income, and contributing to portfolio diversification due to their lower volatility compared to stocks. They also present potential for attractive total returns through stock price appreciation and dividends, and publicly traded REITs offer liquidity and transparency with audited financial statements, all at a lower cost than buying commercial real estate outright.

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Rise of REITs in the UAE Real Estate Sector

In the UAE's real estate sector, REITs emerge as key investment instruments driving growth amidst a backdrop of global economic and political uncertainties.

Despite challenges stemming from geopolitical tensions, recession fears and inflationary pressures, the UAE's economy has shown resilience, with a growth trajectory projected at 4.0% in 2024 by the International Monetary Fund. This growth narrative is supported by the UAE government's efforts to diversify the economy away from oil dependency. Notably, real estate projects and associated sectors including hotels, logistics and manufacturing serve as cornerstones in this diversification strategy.

REITs in particular stand to benefit from the UAE's commitment to economic diversification. Assessments by CBRE, a real estate advisory firm, projected a positive outlook for the UAE's real estate sector, whereas S&P Global's projections indicate a substantial increase in property deliveries, reflecting a burgeoning market. According to CBRE, “the total number of transactions in Abu Dhabi rose by 94.1 per cent year-on-year (YoY) in H1 2023, underpinned by a 160.4 per cent increase in off-plan transactions while Dubai smashed records to post a 43.3 per cent YoY jump in transactions volumes.”

Yet, investors eyeing the UAE's thriving real estate market increasingly turn to REITs, attracted by their potential for high yields and portfolio diversification benefits.

UAE REITs, structured to adapt to regional dynamics, have showcased resilience amidst global economic fluctuations, with investor preferences shifting towards sustainable and socially responsible real estate projects. These REITs play a pivotal role in driving the UAE's real estate and construction sectors, offering investors exposure to property markets and potential value appreciation without the burden of physical property management.

The growth of the GCC REIT market, notably since the listing of Emirates REIT in 2014, underscores the region's embrace of this asset class with more than 18 of them listed across the region, including in Abu Dhabi, Dubai, Saudi Arabia, Bahrain, and Oman. While uncertainties arise, driven by global economic factors, the future outlook for REITs remains the same, with a shift towards specialised asset classes within the GCC region anticipated.

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Challenges Facing European REITs

While REITs flourish in the GCC, Europe's publicly traded REITs are grappling with an unstable landscape marked by fallout from Brexit and the Covid-19 pandemic as well as aggressive interest rate hikes. According to Bloomberg Intelligence analyst Sue Munden, these factors have rendered European REITs unappealing to investors. The sector, representing just 1.37% of the Stoxx Europe 600, faces declining investment and discounted shares.

The discrepancy between the illiquid nature of real estate and the daily trading of public companies also poses challenges, with share prices often diverging from asset values. UK landlords, in particular, experience significant discounts to their reported asset values, leading to diminished confidence and investor interest. According to Jack Sidders of Bloomberg, “the combined €160 billion ($174 billion) market capitalisation of property companies currently in the Stoxx 600 index represents an average 24% discount to the value of their assets.”

Weak returns and a series of take-private deals further underscore the sector's struggles, with total returns below 7%-8% required for meaningful investor attention. While recent discussions of rate cuts have provided temporary relief, analysts remain cautious, with price targets hovering just 10% above current shares.

Mergers and acquisitions emerge as strategies for landlords to achieve scale and mitigate costs, with recent examples including LondonMetric Property Plc's acquisition of LXI REIT Plc and Custodian Property Income REIT Plc's agreement to purchase Abrdn Property Income Trust Ltd.

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REIT Strategies and Lessons Learned

In light of European challenges, the property sector in the GCC, and REITs in particular, should import the learnings of prioritising the delivery of robust dividends and asset value growth to ensure that regional investor enthusiasm remains high and overall portfolio performance remains attractive.