AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT REDEFINING PROPERTY INVESTMENT, DISTRIBUTED IN THE TIMES

27 SEPTEMBER 2007 REDEFINING PROPERTY INVESTMENTIntelligent property decisions

AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT REDEFINING PROPERTY INVESTMENT, DISTRIBUTED IN THE TIMES2

IntroductionREDEFINING PROPERTY INVESTMENT

CONTENTS

Fifty years of RomeTreaties 4

Who has converted to REITs? 4

Why REITs? 5

Public awareness 5

Property derivatives 7

Case study 9

Beijing Olympics 10

Investing abroad 12

The arrival of REITs 14

Until recently, UK property valueswere increasing year-on-year, creditwas cheap and mortgages easy tocome by. The subsequent propertyboom saw many Britons take on mul-tiple mortgages and build a portfolioof properties designed to bring capitalgains and rental income.

However, the outlook for propertyinvestment has shifted as a result of acombination of market factors. Thecurrent credit crisis began with recordlevels of property owners in the USdefaulting on their mortgage pay-ments, which affected the widerglobal loans market. Banks have be-come far more cautious about whom

REDEFINING PROPERTY INVESTMENTA TITLE FROM MEDIAPLANET

Project manager: Shola AdeniranEditors: Sally Giles, Kelly CrummieProduction Editor: Katherine WoodleyDesign: Sophie WesterbergPrepress: Jez MacBeanPrint: News International

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WelcomeOn the face of it, investing in property at the mo-ment seems like a really bad idea. Headlinesscreaming “credit crunch continues” and “mort-gage woes widespread” certainly do not inspireconfidence and lead investors to suppose that realestate is not the attractive asset class it once was,writes Sally Giles.

they lend money to, and are chargingmore interest, leading to a reductionin affordable credit for companies andindividuals. Sharp interest rate riseshave caused home repossessions inthe UK to surge, as mortgage pay-ments become less affordable.

A survey by the Royal Institutionof Chartered Surveyors has even in-dicated that falling demand hasseen British house prices drop lastmonth for the first time in nearlytwo years. This has whipped upfears over the outlook for globaleconomic growth, with some ana-lysts predicting this is just the tip ofthe iceberg.

take out a mortgage, nor be burdenedwith legal fees and other transactioncosts associated with direct purchase– not to mention the responsibilitiesof being a landlord. And many of thealternatives offer private investors ac-cess to both residential and commer-cial property. There are also attractiveopportunities in emerging overseasproperty markets, which, while spec-ulative, could reward savvy investors.

A glance at the companies listed onthe London Stock Exchange reveals acornucopia of property funds andtrusts in which you can purchaseshares and, at a stroke, invest in therange of properties in their portfolios.Alternatively, if you’re a private in-vestor or institution with significantreal estate assets it’s increasingly pos-sible to swap your exposure in spe-cific sectors using derivatives, therebyhedging your risk. Making gains fromproperty investment will always de-pend on where you put your moneyand how well you manage it. That’swhy wise investors consider thewealth of opportunities available be-fore betting their hard-earned money,and hard-won financial security, onthe future profit potential of a prop-erty investment.

Yet, historically, bricks and mortarhave proven to be a sound long-terminvestment, and that’s likely to re-main the case. Many investors viewdirect property ownership as a viablealternative to pension schemes, sincecapital gains and rental income pro-vide a healthy nest egg for retirement.At the moment, mainstream borrow-ers with good credit ratings are evenfinding some new fixed rate mortgagedeals a bit cheaper, and a short-liveddrop in house prices can present agood time for those people to buy.

However, there are plenty of routesto reaping a return from property in-vestment that do not require you to

The Business of Excellence 2 distributed within The Times (excl Scotland) on 8th November

Contact: 0207 563 8896 shola.adeniran@mediaplanet.com

Property developmentsProperty is all around us, in the formof the buildings in which we live,work, shop and socialise. Property is amajor factor of production for almostall sectors of the economy.

But developments over recent yearshave also confirmed property’s emer-gence as a mainstream global assetclass from an investment perspective.In 2006 capital flows totaled an esti-mated $860bn globally, resulting in aglobal property market of $9.6 trillion.

In recent years, there has been ahuge growth in the number of inter-national property funds, global prop-erty funds of funds, and diverseopportunities in the private and pub-lic capital markets for domestic in-vestors to participate in both local

and foreign property markets. Severalfactors have combined to make globalproperty investment more common,including the widespread pension cri-sis and the fact that real estate is in-creasingly seen as an importantsolution to the ever-growing retire-ment/savings needs of an ageingglobal population.

From my perspective, the most in-teresting aspect of recent years hasbeen the significant developments inthe structural framework of the invest-ment markets. This has been driven byboth the level of demand for propertyand also an element of healthy com-petition between different govern-ments eager to secure a place on thisincreasingly important global stage.

In the UK we have seen the intro-duction of tax-efficient UK REITs andshould shortly see the open-endedequivalent introduced in 2008 – aswell as many other positive develop-ments that are improving access toproperty investment and the effi-ciency and transparency of the mar-ket. Despite the (unconnected) gloomovershadowing the wider marketsthat we have seen in recent months, itshould not be forgotten that thesestructural developments will bringlong lasting benefits.

One thing is certain; we are in themiddle of very interesting times forthe property industry. But for individ-ual investors, these developments canresult in added confusion given the

range of different routes available forinvesting in property. This RedefiningProperty Investment supplement pro-vides an excellent starting point forgetting to grips with some of these re-cent developments.

� Gareth Lewis, Director of Finance andInvestment, British Property Federation

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Defining REITsREDEFINING PROPERTY INVESTMENT

Fifty years of Rome TreatiesThe treaty to establish the European EconomicCommunity (EEC) was signed on 25 March 1957in Rome by Belgium, West Germany, France, Italy,Luxembourg and the Netherlands.

BY DR. MARCUS CIELEBACK, HEAD OF RESEARCH EUROHYPO

After the last ratification documentwas filed it came into force on 1 Jan-uary 1958. The treaty to establish theEuropean Atomic Energy community(Euratom) was also signed by thecountries in Rome at the same time,which is why both treaties are jointlydescribed as the Rome Treaties. To-gether with the European Coal andSteel Community (ECSC) these treatiesand the six signing countries form thecore of the European Community andthe resulting European Union, nowwith 27 member countries, and theEurozone, now with 13 membercountries.

What impact did the process set inmotion by the undersigning of theRome Treaties have on commercialreal estate markets? The performance

of real estate investments is essen-tially influenced by economic trendsand by the development of the realestate market concerned, as both fac-tors determine the value of a property.The Rome Treaties have triggered de-velopments in both areas, whichstrongly influence the behaviour ofmarket participants in real estate mar-kets, and consequently the marketsthemselves. One notable cause of theeconomic convergence in Europe, forexample, are the increasingly syn-chronous prime rent trends in Euro-pean office markets. During theEuropean unification process, the in-troduction of the euro in 1999 had thegreatest impact on European real es-tate markets. With its 13 memberstates, a currency area has emerged in

Europe with approx. USD 4,037 bn orapprox. 2/3 of the European real es-tate portfolio (inc. Turkey and Russia)suitable for investment purposes ofinstitutional investors. The Eurozonetherefore represents the second largestreal estate market with a unitary cur-rency after the USA (with USD 5,167bn). For participants in real estatemarkets, in particular institutional in-vestors, this means that they nolonger have to factor in currencyfluctuations for their investments inthe Eurozone provided that they comefrom the Eurozone themselves. ForBritish and US investors, the need forcurrency safeguards is only focusedon hedging between USD and euro, orbetween GBP and euro. These areboth liquid markets, in which it ispossible to hedge at significantlylower costs than previously in the in-dividual currencies which precededthe euro. This is a major developmentthat among other things has resultedin the rapid boom in cross-border in-vestments in Europe in recent years.

Does this intensified integration ofEuropean real estate markets mean

that there will be further harmoniza-tion of the cyclical trends in thesemarkets? In a few of years, will wejust be speaking of a European realestate cycle instead of German,French or Spanish real estate cycles?Will the diversification effect of Eu-rope wide investment be reduced as aresult of European integration? De-spite the advancing European inte-gration we cannot speak of a generalharmonisation of the real estate cy-cles in Europe or the Eurozone. Agreater synchronisation of the Euro-pean real estate markets can certainlybe expected in the coming years, butthe cycles of the individual marketswill still be influenced by local condi-tions to a considerable extent. Theeconomic trend of the past yearswithin the Eurozone makes it clearthat differences between the cycles ofthe national economies continue toexist. Some studies even concludedthat the euro and the different levelsof flexibility of national markets, inparticular labour markets, may be thecause of recurring long-term eco-nomic assimilation processes, which

will mean that individual countriesshow below-average economicgrowth over several years. Once theassimilation processes are complete,these countries will then have aver-age or even above-average growthagain. The trend in Germany in thepast few years as well as the currentsituation in Portugal are examples ofthese kinds of assimilation processes

DiversificationThis remaining diversification poten-tial is becoming apparent within theEurozone, for example, in the corre-lation coefficients of the prime officerent trends (rolling 10-year periods) inrelation to Frankfurt. With the excep-tion of Munich, the correlation hassharply declined in the last 4 years.The progressive European integrationwill not in future result in real estatemarkets within the EU, and in partic-ular within the Eurozone, becomingsynchronised as the example of theoffice real estate markets shows. Thesuccess of real estate investments willcontinue to be influenced by localconditions to a significant extent ir-respective of how the process of Eu-ropean integration started by theRome Treaties continues to proceed.

UK REITs: Whohas converted?Since the introduction of the regime at the com-mencement of this year sixteen companies havelaunched UK REITs. They are all existing listedcompanies, bar one – Local Shopping REIT, whichjoined the LSE’s (London Stock Exchange) mainmarket at the beginning of May. It is the first spe-cialist REIT, specialising in investing in local shop-ping assets in the UK. The other existing REITsinclude some of the leading names in the sectorlike Land Securities, British Land and Hammerson.

BY KELLY CRUMMIE

The mid-nineties saw the property in-dustry shares rising steadily, over thepast three to four years especially, thishas increased. The property sector as awhole has benefited from a ‘bullish’ ap-petite from investors, which causedshare prices to rise steeply. The positiveincline has been intensified by past lowrates of interest, easy credit and risingasset prices across the board.

This rapid growth accelerated to-wards the final quarter of 2006, inanticipation of the REITs 2007 NewYear start, and saw excitement adding

to the momentum. Over recentmonths an increase in interest rates,fears of an asset bubble, sub primecrisis jitters from the US compoundedwith profit taking has begun to putsome company’s prices under somepressure as illustrated in the figures inthe table (right).

StagnationThis stagnation, and in some declineis merely a combination of the afore-mentioned factors, and could indicatebearish sentiment setting into the

market place. However for others itrepresents a buying opportunity.

The pattern of the UK REITs stillcorrelates with the property market asa whole – REITs and non REITs. Thisis due to continue; it is not expectedthat REITs will phenomenally changethe landscape of the property industryover night, after all the UK REITs as a

regime is still very much in its in-fancy. What is for sure is that over thenext few years we will begin to havea clear idea of exactly how REITshave impacted the property industry,and how much new investment theirintroduction has brought to the mar-ket. Companies will be competing tomarket themselves as the most attrac-

tive for prospective smaller and pri-vate investors, and in particular whenencouraging ‘the man on the street’ toinvest with REITs, companies will be-come more of a ‘brand’. This is some-thing new for a sector which,historically, has had most of its deal-ing with institutional investors.

UK REIT COMPANIESSymbol Quoted price Quoted price Quoted price Conversion date

3 years ago 1 year ago Recent to UK REIT status

Big Yellow Group plc BYG 124 432 � 480 � 15 Jan 2007The British Land Company plc BLND 702.5 1360 � 1129 � 1 Jan 2007Brixton plc BXTN 300 534 � 360 � 1 Jan 2007Derwent London plc DLN 890 1687 � 1625 � 1 July 2007Great Portland Estates GPOR 284 531 � 585 � 1 Jan 2007Hammerson HMSO 695 1240 � 1128 � 1 Jan 2007Land Securities Group plc LAND 1140 1955 � 1634 � 1 Jan 2007Liberty International LII 795 1135 � 1125 � 1 Jan 2007Local Shopping REIT plc LSR n/a 175 � 122 � 27 Apr 2007McKay Securities MCKS 216 395.5 � 326 � 1 Apr 2007Mucklow (A&J) Group plc MKLW 322 471 � 335 � 1 July 2007Primary Health Properties PHP 246.5 414 � 359 � 1 Jan 2007SEGRO– Slough Estates Group SGRO 447 664 � 481 � 1 Jan 2007Shaftesbury SHB 274.5 559 � 519 � 1 Apr 2007Warner Estate Holdings WNER 509 690 � 494 � 1 Apr 2007Workspace Group WKP 205.55 376.80 � 319 � 1 Jan 2007

Sources: Digital Look Solutions / Reita website- ‘Company information’*These figures were taken at midpoint of day trading

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Why REITs? REDEFINING PROPERTY INVESTMENT

REITs are often marketed as a way forthe small investor; ‘the man on thestreet’, to gain access to the commercialproperty sector, as an alternative to di-rect investment in property. So, wewent on the street in a business districtof Newcastle-Upon-Tyne to askwhether anybody had ever heard of aREIT or Real Estate Investment Trust.

Real estate is an American term forproperty, and is rarely used in the UK,so it was unsurprising that few peoplehad ever heard of a Real Estate In-vestment Trust or REIT. Of the 11 percent that had heard of a Real Estate In-vestment Trust, only half knew the ab-breviated term REIT stood for the samething. The individuals that had thisknowledge were also the same half thathad heard of a REIT via their occupa-tion – they are working in the propertyindustry. The others that answered yesto the question had seen the term REITbut could not recollect exactly what itstood for. They said they had seen it ad-vertised in a newspaper or magazine,such as the Financial Times. None ofthose that knew what a REIT was hadinvested in any, yet.

Whatever the future holds for theperformance and popularity of REITs, itwill greatly depend on the general pub-lic, and private investors in particular,understanding more about the benefitsand opportunities REITs afford. “There’sno doubt that there’s still a lack of un-derstanding about REITs in some areasof the financial market and among thewider general public,” says REITA’sDave Butler. “We’re doing all we can toeducate people about this attractivenew investment avenue.”

Research by the Association of In-vestment Trust Companies found thatonly 40 per cent of sophisticated in-vestors consider investing in REITs. Fur-thermore, a survey by REITA found thatless than 20 per cent of financial advis-ers understood REITs prior to theirlaunch, yet nearly 50 per cent envisagedREITs being part of their clients’ invest-ment portfolios. Many experts believethis knowledge gap still exists. As PhilNicklin puts it: “Until the message getsthrough, REITs are destined for a slowburn, not a massive explosion in popu-larity.” Most private investors are likelyto continue participating in REITs

St-REIT aware

Investors have always faced a dilemmaover the most appropriate approach toproperty ownership. The most directroute is simply to buy some buildings,but that can be costly and time con-suming, not just to buy but also tomanage and sell. Two popular alterna-tives, which can bring bountiful re-wards in return for a small investment,are investments in quoted propertyfunds and REITs. They are propertycompanies listed on the stock ex-change that offer investors the chanceto put money into a range of commer-cial and residential real estate insteadof directly purchasing buildings. In-vestors buy shares in a fund, whereone share is ‘one unit portion’ of amanaged pool of property. This pool ofproperty then generates incomethrough renting, leasing and sales, anddistributes that income directly to theshareholder on a regular basis, muchlike dividends from other types oflisted company.

Investors can buy shares by simplycontacting a broker and, because oftheir listed status, funds are highlyregulated and reasonably transparent.In the UK there are many propertyfunds operating as both investmenttrusts and unit trusts. They are not al-lowed to invest in residential propertydirectly and there are restrictions

when purchasing commercial proper-ties – for example, a unit trust musthold at least 20 per cent of its assetsin property shares as opposed to ac-tual bricks and mortar to ensure itmeets liquidity restrictions. REITs area more flexible alternative in thatthey freely invest in both residentialand commercial properties. Launchedin January 2007, REITs are a more taxefficient version of a listed propertycompany. Investment vehicles con-verting to REIT status have to meetstrict criteria and pay a conversioncharge, but in return are no longersubject to corporation tax on capitalgains and rental income, whichmeans they can distribute more profitto investors.

More liquidity and flexibilityShare ownership is a liquid way of in-vesting in property, since investorscan buy and sell shares much moreeasily than they can buy and sellproperty itself. That’s particularly ad-vantageous when investing in over-seas real estate, as buying and sellingon an international scale is im-mensely complex for private individ-uals. Many funds and REITs investinternationally, thereby giving in-vestors access to global property mar-kets via a single share purchase.

Trading shares also incurs muchlower transaction costs compared tobuying property directly. As ChrisLuck from law firm Nabarro explains:“To invest in a property company itgenerally costs you half a per cent instamp duty and brokerage costs. Pur-chasing a property, on the other hand,will incur four per cent stamp dutyand land tax, not to mention the legalfees and other professional costs.”

So, the capital investment withshare purchase is limited to the priceof the unit and the amount of labourinvested is constrained to the amountof research needed to make the rightinvestment. Best of all, funds offersmaller investors a way into the bigmoney commercial property marketthat traditionally has been the pre-serve of bigger institutional investors.

“The best performing property, cer-tainly in the current market, are primeassets such as City of London offices,”says Luck. “Access to those kind oftop-class assets is beyond the pocketsof most private investors, unlessyou’re mega wealthy, whereas invest-ing in REITs and property funds getsyou a stake in a diverse portfolio ofquality property assets.”

So, for a limited sum, investors haveaccess to a range of properties and sec-tors, which spreads their exposure andthereby mitigates the risk of having alltheir eggs in one basket. However, be-cause funds and REITs are listed on thestock market, they are not only subjectto fluctuations in the UK propertymarket but also to turbulence in globalfinance in general. The recent crisis inthe financial markets and its effect onmortgages has made some private in-vestors nervous towards the sector,and some have already begun to drawmoney from property funds.

Risky business“What we’re seeing in the UK now isfallout from poorly underwritten mort-gage lending in the US at a time whenBritain’s property boom is also fading,”explains Kemble-Diaz. “However, thereare some positives to take away: namelythe fact that – for all those cranes on theLondon skyline – there isn’t a huge ex-cess in supply of new buildings. So, areturn to the extended property reces-sion of the early 1990s is unlikely.”

As Robin Priest, lead corporate fi-nance partner at Deloitte elaborates:“Limited supply is one characteristic ofliving on a small island, so propertyprices will stay high as long as demandoutstrips what’s available.”

And although property is subject tomarket cycles, “it remains an attrac-tive long-term investment,” he main-tains. “The historical evidence backsthat up and the risk/reward profilefrom property places it somewherebetween equities and bonds, so it’sideal for a balanced portfolio.”

Get a shareof the actionPurchasing your house or a second home in an exoticlocation is one thing, but if you want to make moneyfrom a portfolio of residential and commercial proper-ties there are attractive alternatives to directly buyingbricks and mortar

BY SALLY GILES

through collective investment vehicles.More direct involvement requires in-creased awareness and understanding ofthe model by investors and their advis-ers, which will take time to develop.

A lack of awareness can result in fail-ure, as Invista Residential REIT, andVector REIT found out to their detri-ment. Invista scrapped their £500 mil-lion float of what was billed to be theUK’s first residential REIT and in AprilLehman Brothers downgraded the UKREIT sector from positive to neutral.

Vector REIT was to be the largestREIT initial public offering (and one ofthe largest floats for the year) in the UK,with an initial valuation of £2.64 bil-lion. The float brought together 70 ho-tels across portfolios owned byAlternative Hotel Group (AHG) andbanks HBOS and Royal Bank of Scot-land in an intricate structure and wasworked upon by several leading lawfirms. Fund managers, who were po-tential investors complained about itshigh management fees and potentialconflict of interests in the manage-ment and ownership structure. Retailinvestors were also offered the oppor-tunity to invest in the ipo throughseveral leading stock brokers, whichled to confidence eroding in the gen-eral marketplace for property securi-ties, once the float was pulled.

Much of the criticism of Vector hasbeen reserved for the underwriters.

Questions have been raised as towhether several key fund managerswere sufficiently briefed regarding Vec-tor’s structure. Others have also blamedwider turbulence in publicly-listedproperty assets that has seen severalreal estate floats pulled in recently(Spain’s Reyal Urbis and Dutch com-pany Uni-Invest shelved high-profileshare offers citing poor demand.)

Lately, though, some smaller firmshave managed to list. Lewis CharlesRomania Property Fund recentlybegan dealings on London’s secondaryAIM exchange, joining a select groupof European property firms goingagainst the trend of cancelled stockfloats. Despite touch market conditionsfor property securities, the Guernsey-domiciled company raised £27.4 mil-lion. This shows that there is still ademand for quality property stocks.

Respondents (55)

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Property derivatives REDEFINING PROPERTY INVESTMENT

Property derivatives come infrom the cold

In basic terms, a derivative is a finan-cial instrument that derives its valuefrom something else. And as ParyaBadie, a senior associate in the realestate department of law firm Allen &Overy, puts it: “Derivatives generallyoffer more flexibility than the under-lying asset and that’s why the deriv-atives market is likely to keepgrowing.

“Property derivatives are excitingbecause real estate is a very importantasset class and derivatives are a veryflexible way of dealing with it. I’mnot suggesting that the popularity ofphysical property investment willfade away, but there are advantagesto using derivatives.”

Lower costs and a chance to manage riskThe advantages are twofold. Firstlyand fundamentally, trading in deriva-tives is cheaper and easier than goingout and buying or selling a property.“For one thing you avoid many of thecosts,” Badie elaborates. “You payneither land tax nor stamp duty andthere are no agent, legal or surveyorfees to worry about. Essentially, aswith property funds and other indi-rect real estate investment vehicles,derivatives offer a chance to invest inproperty synthetically.”

As well as cost savings, perhapsthe greatest benefit to derivativetrading is that it affords an opportu-nity to hedge the risk of property in-vestment. Nick Nabarro from theInvestment Property Databank (IPD),the organisation responsible for thedata that underpins most of theproperty derivative activity in theUK, outlines the principle. “If an in-vestor owns £500 million in retailproperty, for example, they could useproperty derivatives to sell on someof the exposure to the risk of it fluc-tuating in value. On the other hand,if an investor thinks that the valueof office property will increase theycould take on someone else’s expo-sure to that sector.”

Hedging, therefore, allows an in-vestor (either an individual or, morelikely, an institution) to decrease ex-

posure in one area and/or increase itelsewhere, all the while retainingownership of the original asset. Andthat, in theory at least, is immenselyuseful when it comes to overcomingshort-term market trends and long-term investment cycles.

Obstacles to overcomeDespite these unique attractions, prop-erty derivatives are only just begin-ning to catch the market’simagination, even though they’ve beenaround, in one form or another, sincethe early 1990s. There are three mainreasons. Firstly, until very recently, thelegal and tax environment for propertyderivatives was prohibitive for majorinstitutional investors. Secondly, therewere concerns over the presence of asuitable index for derivative values tobe measured against. And thirdly, in-vestors bemoaned a lack of liquidity inthe market.

The two most significant develop-ments for the property derivativesmarket occured in 2002 and 2004,which addressed the legal and tax is-sues. As Peter Sceats of specialistbroking house Tradition FinancialServices (TFS) explains: “There weretwo key legislative changes thatcleared the way for a property deriv-atives market in the UK. To sum-marise, these enabled investmentcompanies to include derivatives intheir solvency calculations and al-lowed them to offset against tax anycapital losses arising on trades.”

Around the same time a solution tothe second stumbling block also pre-sented itself. The existence of a robustindex of property values is essentialfor a successful derivatives marketbecause, as Sceats points out, “a de-rivative is basically a bet on the fu-ture of a chosen property index.”Without such an index there would beno gauge against which an asset’sperformance could be assessed.

Today, the role is largely filled bythe aforementioned IPD, which pro-duces a range of indices highlightingthe performance of commercial prop-erty assets both as a whole and di-vided into three sub-sectors: retail,office and industrial. In many respectsthe UK leads the way in terms ofproperty derivatives trading, a factmany attribute to market confidencein the IPD’s data. As Charles Weeks,co-founder of real estate investmentbusiness Protego, states: “IPD is now

Continued on page 8

� Parya Badie, senior associate at Allen &Overy

LIFFE LAUNCHES FUTURES CONTRACT BASED ONPROPCO EQUITIES BASKETS

Liffe announced on 6th Septemberthat it will launch on the Paris de-rivatives market two futures con-tracts on indices that track theperformance of European real es-tate companies.

The two new futures contractsare based on the FTSE EPRA/NAREITEurope Index (EPRA) and the FTSE

EPRA/NAREIT Euro Zone Index (EPEU) which are seen as benchmarks in Europe forinvestments in listed real estate companies.

The FTSE EPRA/NAREIT Europe Index covers approximately 100 listed real es-tate companies based in 15 European countries with the largest weighting beingthe UK (45 per cent).

The FTSE EPRA/NAREIT Euro Zone Index covers approximately 50 real-estatecompanies based in nine Euro Zone countries, with the largest weighting beingFrance (40 per cent).

The futures contracts are the first of their kind in Europe and complementLiffe’s existing range of derivatives on national and pan-European equity indices.

Financial derivatives have been around for many years and established markets already exist for almost every class of asset you could careto mention, be it currency, equity or natural resources. Yet, property derivatives have not taken off, even though real estate readily lends it-self to being traded in this way, so why should investors be interested?

BY SALLY GILES

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Property derivativesREDEFINING PROPERTY INVESTMENT

one of the most credible property in-dices in the world, if not the most.”

While IPD’s research underpins thecommercial property market in the UK,the residential sector operates slightlydifferently. “There are some indices outthere but they don’t have the samereputation as those provided by IPD,”says Allen & Overy’s Parya Badie.“That said, HBOS’ house price index(HPI) in the UK and the Schiller indexin the US are two residential indiceswith rapidly growing reputations.”

The move to a more favourable leg-islative framework combined with theemergence of robust central indiceshas worked to boost liquidity in theproperty derivatives market. The likesof Barclays, Goldman Sachs, MerrillLynch, Prudential and Santander arejust a few of those now taking a keeninterest. The impact on the market hasbeen staggering, as a glance at IPD’sstatistics reveals.

During the first half of 2007, IPDsaw trades with a total notional valueof £3.9 billion take place against itsindices. This represents a marked in-crease on the figure of £1.4 billionseen in the first half of 2006 anddwarfs the £550 million seen in 2005.

A note of cautionWhile the property derivatives marketis benefiting from increased attentionfrom investment banks, insurers andfund managers, who all have the po-tential to inflate it exponentially, it isworth remembering that liquidity stillremains a concern. Over-arching eco-nomic trends will play an importantpart in the attractiveness and futuresuccess of property derivatives.

The current sub-prime mortgagecrisis in the US – and subsequentglobal credit crunch – provides atimely reminder of the power of thisinfluence. As William Kemble-Diaz,editor of ReutersRealEstate.com,points out: “August’s data from IPDshowed UK commercial property fail-ing to generate a positive monthly re-turn for the first time since December1992, in the wake of a global creditsqueeze that has curtailed propertyinvestment.” Moreover, a lack of liq-

uidity has meant that sizeable fundmanagers have not yet been able to“hedge exposure effectively using de-rivatives.” There’s a dearth of fellowinvestors willing to trade with them.

But, according to Paul McNamaraof Prudential Property InvestmentManagement (PruPIM), the marketdownturn may actually representsomething of an opportunity for in-vestors. “At the moment property de-rivative pricing actually looks veryinteresting and there could be specu-lative gains to be had,” he ventures.“If investors come forward and arewilling to trade at current valuationsin the current climate it will be ahugely promising sign for the indus-try. If not, I don’t know what that willsay about the market.”

You pays your money…Whether commercial or residential,property derivative deals can be struc-tured in a number of different ways.In their purest form they consist of“total return swaps”. An investor sellsexposure to an IPD index in exchangefor exposure to Libor (a benchmarkfor short-term interest rates), plus orminus a negotiated number of basispoints. These basis points are key asthey allow an investor to state howthey expect the property index to per-form in comparison to interest rates.The return on the underlying asset’svalue is then determined by the per-formance of these two markers over aset period of time.

“At the moment,property derivative pric-

ing actually looks very in-teresting and there couldbe speculative gains to be

had”But variations on this theme exist.

“Some investors believe that propertytotal return swaps are simply not forthem,” explains TFS’ Peter Sceats. “Asan instrument, total return swaps aresomewhat complex, they may notspecifically hedge enough propertyand have interest rates imbedded inthem, which can be unattractive.”

For these reasons many transac-tions now take place in the form ofcontracts for difference (CFDs).

“Effectively a CFD represents anindex,” states Andrew Fenlon, head ofproperty derivatives at SantanderGlobal Banking & Markets (formerlyAbbey), a major player in the resi-dential derivatives market. “When theswap deal takes place it effectivelystarts at 100. The seller can statewhere they expect the market to beafter a set period of time, say threeyears. If they think the index’s valuewill increase to 110, the buyer will

then have the option to either ‘golong’ or ‘short’. If they ‘go long’ andthe index value rises to 112 theirprofit is two. But if it falls to 108 theyloose two. Transactions are cash freeat the start and settled at the end.”

CFDs have one major intrinsic at-traction, although it is also a signifi-cant risk, namely that they enable abuyer to bet against – or “short” – themarket. Thus it is still possible tomake a profit if a market falls, some-thing of an attraction given the cur-rent market turbulence. The danger isthat, in theory at least, the losses arepotentially limitless.

“Property derivativesare exciting because realestate is a very importantasset class and derivativesare a very flexible way of

dealing with it”Given this risk, others favour an al-

together different approach to deriv-atives trading. Protego, for instance,works with Barclays to provide expo-sure to the UK property market via theissue of property index certificates(PICs). “These are essentially Eu-robonds listed on the London StockExchange, which are issued by Bar-clays. They pay both capital and in-come returns, with the former being

based on the IPD benchmark,” ex-plains Protego’s Charles Weeks.

PICs differ from total return swapsand CFDs in that they offer a morestructured product. You have to pro-vide the cash up front to buy a bondand you can’t bet against the index,but you can trade them in a second-ary market, which affords some addi-tional security.

The path aheadOn the whole property derivatives re-main the reserve of large corporateentities and it is easy to see why. AsSantander’s Andrew Fenlon com-ments: “The problem with CFDs andtotal return swaps is that they haven’treached a size where private investorscan trade in them directly.” After all,few individuals have multimillion-pound property portfolios at their dis-posal, or the equivalent cash, andeven fewer have the expertise to ne-gotiate appropriate contracts.

But while most private investorscan’t play directly in the property de-rivatives market, there are structuredproducts through which they can gainaccess.

Fenlon, for instance, notes that “or-ganisations such as building societiesand the post office can buy exposurewholesale from us and then hedgethis by selling it on piecemeal to theirclients.” Likewise Protego, GoldmanSachs and others are starting to pro-

vide products with denominations aslow as £1,000.

“Although there’s not much evi-dence of a retail investor market inderivatives at the moment there seemsto be a lot of interest,” says Allen &Overy’s Parya Badie. “In a way, deriv-atives could even offer some retail in-vestors a first foot onto the propertyladder.”

Assuming the property derivativesmarket successfully weathers the cur-rent sub-prime storm there could besome interesting opportunities aheadon an international basis, too.

“IPD produces data in Germany andFrance,” continues Badie. “In recenttimes there have also been propertyderivative trades in Hong Kong,Japan and Australia. And there’s theUS market to consider. The hope forthe future is that you’ll be able to buyoffice exposure in Japan in exchangefor retail exposure in the UK. Onceyou start viewing derivatives on aninternational level these things be-come possible.

“Banks are now trading propertyderivatives and there are funds beingset up to include them, so I think thisis laying the foundations for the mar-ket to take off,” Badie adds. “Andonce you factor international tradeinto the equation, I think the propertyderivatives market could experiencethe sort of growth that everyone ishoping to see.”

� Paul McNamara of Prudential PropertyInvestment Management (PruPIM)

On behalf of

We are urgently seeking either individual properties or a portfolio of trading/industrial estates comprising:

Mills/Factories/Industrial/Commercial buildings

Multi-occupiers (40+)

Short-term leases/licences

Anywhere in the UK

Up to £200m available for immediate purchases

Full details to:

Paul Adams (paul@paf-london.co.uk) or Owen Flaherty (owen@paf-london.co.uk)

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Case study REDEFINING PROPERTY INVESTMENT

Safeland ‘flexes’ its muscleswith £200 million fundWith the majority property fund raisings on holddue to the credit market turmoil, Safeland, theproperty management business, has a lot to smileabout. Having recently closed a fundraising, whichgives them £200m of funds at its disposal, Safe-land is now firmly on the acquisition trail.

Over the last 21 years Safeland plchas moved from being a businesssolely focused on trading property,mainly in Greater London, to a com-pany firmly focused on its growingproperty fund management arm. Thislatest development for the companyculminated in the recent news thatthe Safeland Active ManagementFund, the Jersey unit trust to whichSafeland is UK property manager,had increased its leveraged invest-ment capability to around £200 mil-lion.

The establishment of the SafelandFund in October 2006 marked Safe-land’s first move into property fund

management. With an initial £15minvestment from Electra Partners andan investment by Safeland of £1 mil-lion, the Safeland Fund aim was toinvest in income producing UK prop-erty investments where value can beadded by active management. Todate, £47 million has already been in-vested in properties, all of which tradeunder the brand name “Flexspace” of-fering space, typically to small busi-nesses, on short term renewablelicences for use as offices, studios,workshops and other light industrialworkspace.

In September Safeland’s ability toidentify and manage investment

properties was given a firm endorse-ment with the news that it had raisedfurther equity with Babcock & Brown,the Australian investment group,agreeing to invest an initial sum of upto £50 million. At the same time Elec-tra Partners agreed to increase theirinvestment in the Safeland Fund from£15 million to £20 million and Bar-clays Bank plc to increase its facilitiesfrom £35 million to £170million, ef-fectively quadrupling the resources atSafeland’s disposal to expand theFlexspace portfolio.

Larry Lipman (pictured left), Man-aging Director, sees benefits of thisdeal for the growth of Flexspace aswell as delivering significant valuefor Safeland shareholders, “it obvi-ously brings increased revenue to thebusiness, through our managementfee and the potential to earn morethrough profit share, but it alsofirmly establishes our fund manage-ment business and gives us far morepredictable revenue streams. It is ouraim to repeat the success that weachieved through Bizspace”.

Of course Larry and his colleaguesare no strangers to the world of man-aged workspace as they establishedflexible managed workspace providerBizspace in 2000 by demerging thebusiness from Safeland plc and listingit on AIM. Within six years the busi-ness had grown from 3 sites to 64 sitesnationwide before being sold to High-cross (Bugatti) Ltd in 2006 for £81.2m.

It is this past success through “atried and tested model” that attracts

investors to Safeland but the man-agement also have a very strongreputation as directors of propertybusinesses listed on the LondonStock Exchange, a number of whichwere demerged from the originalSafeland business. As well as Biz-space, Hercules Property Services, aresidential management businessand commercial property auction-eer, was demerged and listed onAIM eventually being sold Erina-ceous in 2004 with an enterprisevalue of £110m. Similarly self-stor-age company Safestore followed theSafeland demerger and AIM listingroute in 1998 growig from threecentres to 20 and was subject to a£44m management buyout. Safe-store returned to AIM in March thisyear valued at £450m.

Given the recent expansion of theSafeland Fund Larry Lipman is natu-rally bullish about the prospects forthe company he founded in 1986:“The team at Safeland has an im-mense knowledge of the managedworkspace sector and we have the fi-nancial support to expand the fundeven further. We have a lot of workahead of us to ensure that the fund isfully invested in quality managedworkspace properties but we are verywell placed to deliver again.”

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Beijing 2008REDEFINING PROPERTY INVESTMENT

SPAIN & IRELAND ON THE TURN?

Two of Europe’s hot property markets that may find themselves under the spot-light over the coming months are Ireland and Spain. Ireland for example havingexperienced a decade of phenomenal growth has seen five consecutive monthlydrops in house prices, the last in July, leading to the first annualised fall in 11years. In many cases house prices have near quadrupled as the benefits of a lowinterest rate environment have fed into both demand for and construction of,new housing. It is hoped a soft landing can be achieved as new house construc-tion is now seen slowing coupled with hopes that the interest rate cycle may bereaching its current peak. House price growth is expected to be fairly flat thisyear and next against growth around 12 per cent for 2006.

Spain is also a ‘Euroland’ economy which has flourished seeing impressivehouse price growth whilst encouraging huge construction over the last few years.There are still a number of factors which may provide support to the housingmarket going forward not least a strong economy with good levels of employ-ment and relatively low levels of interest rates. Some Spaniards are however look-ing to cash in on their property investment returns made during the boom years.

Where the real estate meets the capital markets

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Christoph HommerichHead of Property BusinessFraport

Herman AukampCIO Real EstateNordrheinische Aerzteversorgung

Simon Hedger Global Property Securities Principal Global Investors

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Olympic RealEstate: BeijingWhat will happen to local house prices after Bei-jing 2008,? Will the frenetic Chinese dragon slowfor breath or simply collapse? Questions such asthese should be on the minds of senior directorsacross property related companies.A huge amount of resources are beingutilised to build a world class infra-structure capable of hosting what willbe the world’s most spectacularOlympic games ever. China’s need forresources as a whole, not just Bei-jing’s, has driven commodity pricesup worldwide to the benefit of indus-tries such as mining and oil, with over$36 billion dollars spent already, andmore being budgeted.

When an Olympic event is under-taken by a host country, the local realestate industry benefits greatly. Largescale public construction projects actas spurs for the local real estate mar-

ket. Public Infrastructure of all kindsimprove and areas become more de-sirable to live and work in due to im-proved facilities. Prior to theirrespective Olympic games, Barcelona,Sydney and Athens house prices allrose more than 50 per cent. After thegames though, these cities declined inprice and attractiveness to residents.

Different Olympic games have useddifferent strategies for development tocope with the games, and what fre-quently occurs after events is a down-turn in property values. This occursdue to a location’s social services in-frastructure not being updated as well

as public fixed infrastructure, leadingto a rational choice by people to liveelsewhere. There are three main mod-els of development for the games interms of real estate and its associateddisciplines.

For the Los Angeles 1984 Gamesthe city board decided to upgrade ex-isting facilities rather than investheavily in new hosting facilities, amodel that proved prudent long term,as the city wasn’t saddled with exces-sive levels of debt, and didn’t experi-ence volatility in the residentialproperty marketplace.

The model used in Sydney, and cur-rently being used for the London 2012is to regenerate certain areas. In Syd-ney, property prices leapt 60 per cent(subsequently retreating signifi-cantly). In areas of London like Strat-ford, which is a major area ofregeneration for the games, prices

2007 seems a long time ago now! The recent 2012 Olympics remind me ofthe great feat that REITs have achieved.

This time five years ago, 16 property companies holding around £60 billion of property had converted toREITs. On the face of it, it seemed a great success, but for most of those companies conversion was aneasy decision. Their shareholders instantly enjoyed a considerably improved after tax return (10% to 15%better for individuals and over 40% better for gross funds) and yet it was business as usual for the REIT.Where were the newly formed REITs? The only newly formed REIT was The Local Shopping REIT thataccounted for a mere £200 million of that £60 billion, but that was then.

Neither Government nor the property industry wanted things to stop there. Both were keen to see abroad, deep and expanding REITs sector, which attracted further capital into UK property and facilitatedwider investor choice. Conversion of existing listed property companies into listed REITs did not instantlyachieve this end; the only difference being that they had elected to be taxed under the beneficial REITsregime. What everybody wanted to see was more assets encouraged into the REITs sector to provide ahome for new capital and to give investors a wider choice.

This was particularly the case in relation to residential property, which was one of the initial catalysts forthe Government introducing the REITs regime. The residential property sector needed new capital to helpimprove the quantity and quality of housing. It was also hoped that having large scale REIT landlords,rather than buy-to-let ones owning residential property, would improve the way the rental sector wasrun.

There was also a vast amount of property, other than residential, that was inaccessible to REIT investors.Much of this was in the hands of the major corporate owner-occupiers such as retailers, or was ownedby life funds or the Government. How were these organisations encouraged to release this property intothe REIT arena? There were many obstacles to seeding a new REIT, including tax costs. Thankfully theGovernment gave new entrants REITs a real kick-start by introducing a seeding relief which enabled theseorganisations to contribute their properties to a REIT in exchange for shares, only paying tax when theydisposed of the shares.

Another great step forward for REITs happened when the Government introduced unlisted REITs andallowed for REITs traded on AIM. At last new REITs didn’t need to suffer the cost of obtaining a stockexchange listing.

Hats off to the Government for not resting on its laurels. It deserves a goldmedal for its leap of faith, removing the hurdles for new entrants, producing a world-beating REITs regime that everyone is proud of.

Phil Nicklin, real estate tax partner at Deloitte, leads the Treasury-appointed technical group on REITs.Audit.Tax.Consulting.Corporate Finance.

REITs for time travellers

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Beijing 2008 REDEFINING PROPERTY INVESTMENT

have already increased in anticipationof the Olympics effect. It remains tobe seen what will occur, but a tellingpoint might be house price futures for2012 showing prices going down to£208,601 from a current price of£220,009, a potential loss of £6,814,adjusted for inflation*.

In Beijing, the focus is on creativedestruction, a long term plan to pro-mote overall development. This is aprocess of old areas being removedand new areas being built, rather thanproperty built to cope with an eventthat will last a month.

Prior to the games, there was al-ready a significant natural demand forproperty in Beijing at all levels of the

residential marketplace, rather thanartificial, games induced stimulus.This contrasts to other Olympic Gameshosts cities, where new accommoda-tion was not needed by citizens, in-evitably leading to a downturn in theproperty marketplace post games.

RegenerationBeijing is currently undergoing alarge scale urban regeneration pro-gram, meaning a substantial demandfor residential property due totranslocation. As with all major sport-ing events, the Olympics is makingthe path for regeneration smoother toimplement. Public facilities (trans-portation, sanitation etc) are always

upgraded to cope with major events,and the main beneficiaries will bethose living in suburbs.

Prior to the games Beijing was un-dergoing a process of renewal, whichmeans that rather than starting froma location flat or only appreciatingslightly in growth, Beijing was al-ready at a significant phase of neededreal estate redevelopment, an impor-tant point to consider when analysinglikely occurrences post-Games.

In all likelihood Beijing post games,house prices will remain on an up-ward trajectory, much like the rest ofthe country.

*average price, whole of England,TFS Brokers data

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Investing abroadREDEFINING PROPERTY INVESTMENT

A place, and a profit, in the sunMore and more of us are hoping to make a mint by investing in emerging real estate markets, so whereare the future property hotspots in the world? We ask the experts for their top tips

BY SALLY GILES

Current mortgage market turbu-lence aside, there is little doubtthat the British property markethas enjoyed an unprecedented runof good fortune over the last fewyears. A recent survey from theNational Housing Federation fore-cast that, by 2012, the average UKhome is likely to cost in excess of£300,000. In London, this figure isexpected to be closer to £500,000.Other surveys have hinted at a po-tential slowdown, but for as longas domestic house prices remaincomparatively expensive andcheap international travel prevails,

increasing numbers of Britons willhead overseas in search of secondhomes and sound investments.

The evolving market“For some time, investors based herehave been looking at overseas prop-erty markets because they’ve beenunable to find value in the UK,” saysRobin Priest, lead corporate financepartner at Deloitte. “Real estate in-vestors are global animals, roamingfrom country to country, hunting forthe next big target.”

Throughout the 1980s and 1990s,for example, Brits flocked to the

Mediterranean to seek out their veryown “place in the sun”. But as theSpanish and French markets matured,attentions turned to Central and East-ern Europe. Investors snared hand-some rewards as widening economicand political stability in these regionssent prices racing. For those inter-ested in securing sound capital re-turns on property investment,therefore, the challenge is to sort theBalearics from the Balkans.

Following two years of heavy over-seas investment, these Central andEastern Europe markets are graduallylooking less appealing to ambitious

investors. “If you consider Bulgaria,for example, I think the market haspeaked,” ventures Caroline Holling-worth managing director of overseasproperty investment consultancyHollingworth & Associates. “Investorspilled in but I don’t think there’s theunderlying demand to sustainthings.”

Other industry commentators maytake issue with Hollingworth’s assess-ment. However, there is little doubtthat investors are hungry for the nextunexplored territory with affordableproperties that have the potential torapidly rise in value. And they are

ISA’S OFFER REIT WRAPPER

On July 25th this year, The Treasuryrevealed they had laid Regulations im-plementing a reform package for Indi-vidual Savings Accounts (ISAs) that,the then Chancellor, Gordon Brownhad promised in his Pre-Budget Re-port. ISAs and their tax-free benefitshad been due to end in 2010, but nowafter concluding that ISAs had realisedtheir goals to promote saving and inensuring tax relief on savings wasmore fairly distributed, ISAs have beenmade indefinite, with no set end date.

Good newsThis is good news for investors. ISAsare a tax efficient wrapper designedfor long-term growth and they repre-sent a perfect home for REIT invest-ment as any dividends earned fromfunds or shares held in them are taxfree. This thus eliminates the only taxa retail investor has to pay on a REITinvestment.

With the newly announced reformpackage it will become easier forsavers to invest into stocks and sharesISAs as they will be able to transfersaved money from their cash ISAstraight into it. Every adult will havean annual ISA investment allowanceof £7,200, of which £3,600 of can besaved into a cash ISA, the rest into astocks and shares ISA. Alternativelythe full balance can be invested in astocks and shares ISA.

NEW PROPERTY FUNDPROMISES BEST OF BOTHWORLDS

Scottish Widows has launched a newfund, which aims to offer investorsexposure to a diverse range of prop-erty investment types.

The pensions and investments com-pany says its new Dynamic PropertyFund will “bridge the divide betweendirect property investment and theglobal REITs market.” Through thefund a series of direct and indirectproperty investments will be madeacross a plethora of geographic re-gions. By combining these direct andindirect approaches, Scottish Widowshopes to adjust the asset mix of itsportfolio in order to suit the preveil-ing market conditions.

Balanced“We believe that property continuesto be an important part of a properlybalanced investment portfolio,” com-ments Alasdair Fraser, head of invest-ment services at Scottish Widows.“The Dynamic Property fund offersour customers exposure to a diversi-fied property fund managed by aproperty team with an average ofover 15 years industry experience.”

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Investing abroad REDEFINING PROPERTY INVESTMENT

looking ever further afield to find it.Of course, there are inherent dangersto this approach. “People are alwayskeen to tap into the potential of de-veloping economies,” cautions RobinPriest of Deloitte, “but many of theseareas have yet to be proven as soundinvestment markets, so decisions toinvest there should depend on yourappetite for risk.”

Ripe for risktakersFor example, the Cape Verde Islands,which lie off the West Coast of Africa,have received a considerable amountof press attention in recent times. Asthe closest tropical islands to WesternEurope, Cape Verde’s appeal is obvi-ous.

“It’s an exotic location, which isboth politically and economically sta-ble,” explains Adrian Lillywhite ofCape Verde Property. “It’s not thecheapest place in the world, but theislands aren’t affected by hurricanesand you don’t get jet lag travellingthere. The absence of palm trees aside,it’s just like visiting the Caribbean.”

The introduction of direct flightsfrom Gatwick and Manchester latelast year has already started to boostthe local tourist industry, althoughthe islands’ infrastructure remains

very basic. However, with an averagetwo-bedroom apartment costing be-tween £70,000 and £130,000 and themarket still in its infancy, there’senormous potential for investors tomake massive gains. Clearly, it’s diffi-cult to predict how the economy andreal estate market will perform overthe coming years, but investors will-ing to manage the risks could seegreat rewards.

Situated off the coast of China and,like Cape Verde, a former Portuguesecolony, Macau is also currently beingtipped as an emerging market of im-mense potential – albeit for very dif-ferent reasons.

As Floris Van Dijkum, chief invest-ment officer of property investmentgroup Speymill, points out: “Macau’seconomy is on fire at the moment.GDP is rising rapidly, there is almostno unemployment and the populationis growing by five per cent a year.”

The gambling industry has under-pinned this economic advance. Infact, Macau recently overtook theVegas strip in terms of its gaming rev-enue.

To Van Dijkum, however, the casefor investing in property in Macauisn’t based on gambling alone. “If youlook at the neighbouring island of

Hong Kong, prices are up to five orsix times more expensive than Macauand it is 45-50 minutes away byferry,” he elaborates.

Van Dijkum also acknowledges theinherent risks. “The lack of invest-ment in infrastructure could createfuture bottlenecks for growth,” hewarns. “In particular, poor roads, pub-lic transport and airport links coulddent the number of people who canaccess the island.”

Beware of BRICsWhen identify emerging propertymarkets it is impossible to overlookthe BRIC nations. Back in 2003, in-vestment bank Goldman Sachs pre-dicted that Brazil, Russia, India andChina would emerge as a new waveof economic giants by 2050. Withrapid growth predicted in each ofthese markets the opportunities forbrave investors should be immense.

However, the situation isn’t neces-sarily that simple. Investing in Macau,for example, is one way of gainingexposure to the Chinese market, butthings are far more complex on themainland. In India, meanwhile, a raftof laws makes it difficult for foreignnationals of non-Indian descent tobuy property. Perhaps most signifi-cant among these is a requirementthat foreign nationals must havespent at least 183 days during a pre-vious financial year in the countrybefore they can buy.

“Essentially, there are two differentcategories of emerging markets,” saysKevin Prior of overseas property in-vestment specialist Obelisk Interna-tional. “You have the pure emergingmarkets such as China, in which thepolitical climate makes things com-plicated, and then there are the moreaccessible emerging markets that arealready seeing a huge influx of in-vestors. India is particularly difficultto invest in. We would love to be in-volved there but for now it’s just tootricky.”

The main exception to the rule isBrazil. As Prior states: “Foreign in-vestment in real estate is actively en-couraged in Brazil and foreigners canown 100 per cent of land and prop-erty within the country. This is rareamong the emerging markets.” As aresult, Brazil, the most westernised ofthe BRIC nations, appears to offer thegreatest investment opportunities.

“Northeast Brazil is a very promis-ing market at the moment,” concursSteve Worboys managing director ofoverseas real estate firm ExperienceInternational “And Natal, in particu-lar, is receiving lots of attention in in-vestment circles. The climate is hot allyear round and it is the closest regionof Brazil to Europe. A two-bedroomapartment will cost between £40,000and £50,000 and a villa with a sea

view from £100,000 to £300,000.”One other reason Northeast Brazilstands out as an intriguing locationfor property investors at the momentis that the region is currently receiv-ing considerable investment in infra-structure. Most significantly, a majornew airport is due to be completed in2010. Expected to be the largest air-port in South America (and the eighthlargest in the world), its opening iswidely tipped to spark a dramatic risein tourism.

Closer to home, Turkey is anothercountry expected to experience aboom in its market over the comingyears, thanks to major infrastructuredevelopment. Indeed, many industryanalysts reckon it has the potential tochallenge Spain as the most populardestination for UK tourists.

“Turkey offers outstanding valuefor money when compared with Por-tugal and Spain,” comments DominicWhitney, editor of investor guideBuying in Turkey. And the Govern-ment has ambitious plans to doublethe number of visiting tourists to 30million by 2010. A new airport is setto open at Alanya next year and spe-cial tourism development zones arebeing set up by the Government.There’s also an encouraging mix ofinterest from both local and overseasinvestors.”

Strong secondary market is vitalFor those looking to invest in, andmake a profit from, overseas property,the importance of a strong domesticafter-market cannot be overstated. “InTurkey, for example, the market isn’tjust being driven by overseas in-vestors but by local residents,” ex-plains Caroline Hollingworth ofHollingworth & Associates. “Thismeans you don’t see the false infla-tion of property prices that you do inother places, which brings more sta-ble growth.”

Obelisk’s Kevin Prior agrees withthis assessment. “The safest strategicapproach is to ask yourself before youinvest, ‘Is there a local demand forproperty?’. When it comes to brand-new developments, buyers tend to befrom overseas, but when you want tosell on your property, locals will dom-inate the secondary market. That’syour exit route, so you need to knowthe demand is there before you invest.”

Careful selection of the type ofproperty you chose to buy is essen-tial, too. “If we’re going to recom-mend a property to someone it has tohave unique selling points that willsee its value increase over time,” con-firms Caroline Hollingworth. “Youmust always assume that there isgoing to be a downturn in the marketat some point, so your best insurancepolicy to counter that is having aproperty that will be the first to sell.”

Closer to homeDespite the lure of distant lands anduntapped new economies, one of themost promising emerging markets ofall may actually be lurking on ourdoorstep.

The German economy is the biggestin Europe and is doing much betterthan it has been for a long time,” De-loitte’s Robin Priest states. “After tenyears in the doldrums, there are signsthat unemployment is going down,productivity is up and GDP is growingfaster than planned.

“There have been jitters lately aboutthe residential sector because there’s afeeling it’s perhaps a little overcooked,but broadly speaking a lot of moneyis still flowing into the country be-cause there are sound investments tobe had. You can buy some real estatefor less than the cost of building itnew. Yes, it’s Germany, stereotypicallynot an Englishman’s cup of tea, butit’s a pretty safe bet compared withother expanding markets.”

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REITs: the new In January 2007, the Government introduced UK REITs,a new type of property investment vehicle designed toattract more private investors to the market. So, ninemonths on, are REITs a bundle of joy or are they giv-ing investors sleepless nights?

BY SALLY GILES

The UK is one of the last of the G8 coun-tries to introduce REITs as they havebeen around for more than a decade inat least 11 developed economies, includ-ing America and Australia and Japan.Across the world, REITs have success-fully attracted new investors interestedin making money from the propertymarkets because they offer a number ofunique benefits. The main advantageREITs offer over other listed investmentvehicles is that they avoid so-called“double taxation”, which has previouslyleft many property funds unable to passon maximum revenue to investors.

As Chris Luck, an expert on REITsfrom law firm Nabarro, explains:“Property funds have been around inthe UK for years in the listed arenaand have built up significant capitalgains on the rental properties in theirportfolios. Corporation tax is incurredon these capital gains and on rentalincome, which is a significant costand means less revenue for the com-pany and less passed on to investors.

“And, of course, investors then haveto pay further tax on what they do re-ceive. It’s a painful double-whammythat’s put people off investing in listedproperty vehicles altogether.”

Historically, many investors avoidedthis double taxation by putting moneyinto unlisted property vehicles or in-vesting in property held offshore byinstitutional funds. They were not sub-ject to the same tax liabilities and,therefore, had an advantage over UK-listed investment vehicles.

Since January, UK funds can nowconvert to REIT status, which removesthis tax inequality and levels the play-ing field. In exchange for a one-offconversion charge, which equates to 2per cent of the market value of grossassets, quoted companies can becomea REIT and be exempt from corporationtax on rental income and capital gainson their rental property businesses. Ofcourse, income from the company’ssubsidiaries and other areas of businessmay not be tax exempt. REITs must beclose-ended investment trusts, be resi-dent in the UK and publicly listed on astock exchange recognised by the Fi-nancial Services Authority.

Investors reap rewardsTo qualify for tax exemption, REITcompanies must pass on the majority

of rents received directly to sharehold-ers. Therefore, in theory, REITs offerinvestors more income than traditionalproperty shares and more closely repli-cate investing in direct property. Thedistributions to investors are calledproperty income distributions (PIDs)and must be equal to 90 per cent of thenet profits of the property rental busi-ness. In the 2006 Budget, GordonBrown, Chancellor at the time, relaxedthe distribution requirement from 95per cent to 90 and there is a taxpenalty imposed on those companiesnot meeting this criterion.

REITs are subject to the usual stampduty and land tax rules, and investorsare subject to stamp duty at 0.5 percent on their dealings in shares, butthat compares favourably with themaximum 4 per cent charge applica-ble to real estate purchased directlyby investors.

There is also a limit on how much aUK REIT is able to borrow, which isintended to provide stability for in-vestors and reduce the company’s ex-posure to the risks associated withinterest rates. Capping the amount ofdebt finance also prevents a REITfrom diverting a substantial part of itsprofits towards repaying interest,which would reduce the amount dis-tributed to shareholders.

Dave Butler, programme co-ordina-tor at REITA, the REITs and quotedproperty group, has been instrumen-tal in educating the wider investmentcommunity about REITs. He high-lights another key benefit: “REITs en-able property investment to be liquidbecause investors are able to quicklyand easily buy and sell shares – aquick phone call to your broker is allit takes,” he says. “That’s a major ad-vantage over direct property owner-ship, where hefty transaction costs,time and effort are involved if youwant to buy or sell up.”

Asset managementThe ease with which investors cantrade in and out of REITs makes theman attractive proposition not just forprivate investors but also for propertycompanies themselves. Funds invest-ing in REITs can take on more of anasset management role, spreadingtheir investments across a number ofREITs, which in turn each have a port-

AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT REDEFINING PROPERTY INVESTMENT, DISTRIBUTED IN THE TIMES 15

Arrival of REITs REDEFINING PROPERTY INVESTMENT

arrival

folio of properties. This means in-vestors in listed funds have exposureto the benefits of REITs but are onestep removed because the fund han-dles the asset management on in-vestors’ behalf.

It’s also been predicted by some an-alysts that well-known investmentbanks and financial services compa-nies may become REIT managers,using the financial adviser network tobuild property portfolios funded byprivate investors.

Many private investors have moneyin property funds via pensions and

personal investment plans. The clearwinners from the new tax efficientstructure of REITs are pension fundsand tax sheltered personal financewrappers such as ISAs and SIPPs. “Be-cause of their tax exempt status, theydon’t pay tax on the dividends REITsdistribute, which is already exemptfrom corporation tax, so they receivethe full payout,” explains HowardFreedman, head of Baker Tilly’s prop-erty and construction group.

Performance anxietyFor all their attractions, UK REITshaven’t yet made the impact on the na-tional property market that was beingpredicted prior to their launch. Someanalysts believed REITs would encour-age investors to turn away from directproperty purchase towards indirect in-vestment. “But we haven't really seenthat to a great extent in Britain, despitethe best tub-thumping efforts of theREIT industry,” says William Kemble-Diaz, editor of ReutersRealEstate.com.

In fact, share prices in propertyfunds have taken a turn for the worsethis year, because, like other listedproperty companies, REITs have beenaffected by fluctuations in the finan-cial markets, which is one of their in-herent disadvantages.

According to Phil Nicklin, seniorpartner in Deloitte’s real estate taxgroup, “It’s unfortunate timing that thelaunch of REITs coincided with a cool-

ing off in the stock market. There werehigh expectations prior to the REITs,with some saying that they would rev-olutionise the property market, butthat’s not yet proved the case andthere’s currently more market negativ-ity towards real estate assets in generalthan there was this time last year.”

"UK REITs are a classic example ofit being ‘better to travel than to ar-rive’,” muses Kemble-Diaz. “Propertyfunds put on about 50 per cent lastyear in anticipation of the REIT legis-

lation, but it’s the worst performingsector so far this year.

“Some of the biggest names, suchas Land Securities and British Land,are trading at deep discounts to theirnet asset value. However, greatervolatility is the flipside to being farmore liquid than the lagging directproperty market. So, essentially, whatwe've seen this year is REITs correctlyforecasting a downward turn in theunderlying property market."

REITs can also contain other busi-ness activities, such as constructionand investment in equities, which canaffect the company’s overall shareprice. And some property companiescan’t convert to REIT status becauseof the diverse nature or configurationof their business.

Come one, come allNine months since their launch, REITshave yet to realise their full potential.However, “The arrival of REITs has re-moved tax inefficiencies in property in-vestment and we now have a globallyrecognised and standardised investmentvehicle,” says Nabarro’s Chris Luck.“We can look to the performance ofREITs in other countries as an exampleof how REITs might develop in the UK.”

One likelihood is that more special-ist REITs will emerge, as they have inhuge numbers in the US and Australia,for instance. “REITs can specialise in aspecific geographical location or acertain area of the residential or com-mercial property market,” says OliverGilmartin, senior economist at theRoyal Institution of Chartered Survey-ors. “So, you can tailor your invest-ment to suit your risk appetite. Forexample, you could have £10,000 in-vested in residential housing in Liver-pool while another £5,000 could be inindustrial property around the M25.”=Specialist REITs focusing on one typeof property asset have also emerged,

one example being Primary HealthProperties, which specialises in newand refurbished GP practices and pur-pose-built healthcare facilities. Spe-cialist REITs such as this have furtherempowered shareholders, enabling in-dividuals to pick and choose whichtypes of property they wish to investin. As Gilmartin puts it: “Private in-vestors have become their own assetmanagers, buying and selling sharesin different specialist REITs depend-ing on how certain sectors of theproperty market are performing.”

“So, it’s likely REITs will emergethat specialise in golf resorts or hotelsor shopping malls – the possibilitiesare numerous,” adds Deloitte’s PhilNicklin.

Some experts are also trumpetingthe possible arrival of REITs investingpurely in residential property.Gilmartin says: “The Government iskeen to attract more money into theresidential property market in order todeal with the current shortage of hous-ing and REITs could add more profes-sionalism to the residential lettingsector and stimulate building activity.”

PAIF PROPOSALS ANNOUNCED

The Government has just issued a discussion paper on Prop-erty Authorised Investment Funds (PAIFs). These will be theopen-ended equivalent of UK REITs, in that they will be af-forded beneficial tax treatment provided they meet broadlysimilar conditions to UK REITs, including investing primarily inproperty and shares in property companies.

The Government's intention to introduce such a vehiclewas announced in the last budget following lobbying andconsultation from a wide range of organisations includingthe BPF, IMA and AREF (read the discussion paper).

The Treasury's discussion paper on PAIFs includes draft reg-ulations and suggested solutions to specific problem areas.This includes the issue of protecting the Treasury's tax receiptsby preventing larger shareholders (holding more than 10 percent of the PAIF shares) from making excessive reclaims ofwithholding tax under the international tax treaties.

The new PAIF will take the form of an Open-ended Invest-ment Company (OEIC) and will therefore require existingproperty authorised unit trusts to convert to OEICs to take

advantage of the new regime. However, the government haveincluded a proposal to relieve these unit trusts from StampDuty Land Tax on such a conversion. The new tax regime is ex-pected to be implemented by April 2008.

Gareth Lewis, Director of Finance and Investment at theBPF, said the proposals are a very positive development forthe property industry:

"It is encouraging to see that the Treasury has now gonepublic with its proposals for an open-ended vehicle that willhave equivalent tax benefits to those of UK REITs. We lookforward to continuing to work with the Treasury and the in-dustry to take these proposals forward. The introduction ofPAIFs form part of the Government’s objectives to open upthe opportunities to invest in real estate to a much widerrange of investors. It also allows investors to make decisionsabout how to invest in property via either a (UK based) closed-ended or open-ended vehicle, or directly in property, withouttaxation being a major distorting factor in the making of thatdecision"

� Oliver Gilmartin, senior economist atthe Royal Institution of Chartered Sur-veyors (RICS)

� Robin Priest, lead corporate financepartner at Deloitte

The smart move in the property market

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