Real estate investment is an important part of a portfolio for many investors. The arguments for allocating to real estate are clear: they can produce a stable and steady income; have a low correlation to equity and fixed income investment to support portfolio diversification; and low price volatility.
However, another key characteristic of real estate investments is illiquidity. The investment horizon usually has to be long-term in nature. This fact was widely accepted and partly neglected by investors until it proved critical in the recent financial crisis. With falls in property prices in 2008 and 2009, many investors hit their risk limits and were forced to sell assets to prevent future losses. Real estate investments often could not be liquidated because of the difficulty in selling the underlying asset in a depressed market. Many property funds have lock-up periods, preventing investors from selling their fund units, and some others had to temporarily close as too many investors wanted to withdraw their money at the same time. Investors had to sell equities instead, which had the effect of stabilising or even increasing the weighting of real estate in their portfolios.
This experience has left many investors looking for more liquid ways of accessing the market as their confidence has returned, which has been particularly true in the GCC. Real Estate Investment Trusts (Reits) are being seen as an attractive alternative to direct investment in real estate, combining the benefits of real estate investments with liquidity, and Reit exchange- traded Funds (ETFs) have become popular as a cost effective and diversified way to access a broad range of Reit vehicles.
Reits are publicly traded real estate companies that own, manage and sometimes finance real estate and can be traded like stocks. As such, Reits offer returns from real estate investments and regular income streams – Reits are required to distribute the majority of their income to investors – but also offer liquidity because they are traded on stock exchanges like equities. In addition, in many countries Reits have beneficial tax treatments, meaning that no corporate tax has to be paid on profits on a company level. Taxes are typically paid on an investor or fund level only.
Many Gulf-based investors prefer to invest in the European-listed Reit ETFs, which may offer tax advantages over US-based funds. There are now Reit ETFs listed on the London Stock Exchange that invest in Asian, European, UK and US-based Reits. As with any ETF, the liquidity of Reit-based ETFs is primarily driven by the liquidity in the underlying securities, not the volumes on exchange.
Investors can buy Reits directly, invest via mutual funds or as mentioned earlier, invest in ETFs which track Reit-based indices. Interest in ETFs has seen rapid growth globally over the past 10 years, and the key reason for their popularity is that ETFs offer investors efficient, cost-effective and diversified access to markets or asset classes that can be difficult to achieve by other means. Reit ETFs are no different to this.
A Reit ETF will typically invest in a range of Reits, offering investors the benefits of instant diversification through one single trade. Investors only need to make one transaction and track one price, but still gain exposure to the entire index at once. This reduces their trading costs and the cost of monitoring investments, and as ETFs typically trade on several stock exchanges, in a number of currencies, they enable easy and efficient investment in foreign Reits.
Reit ETFs can make small investments in real estate possible – if an investor wishes to allocate only a small proportion of their portfolio to the asset class, it is possible to do so efficiently with ETFs, where it would be very challenging – and costly – to affect this through direct investment. Using ETFs to access the Reit market can also enhance liquidity for investors. Although Reits are traded on-exchange, some Reits liquidity may be insufficient to satisfy investor demand. The Average Daily Volume (ADV) of Reits varies greatly, so investors could be exposed to the spread if a Reit is not heavily traded. As ETFs invest in a portfolio of Reits, the sum of liquidity of the constituents forms the source of liquidity of the ETF.
ETFs offer intraday pricing, so that at any point, investors can see the value of their holdings and take investment decisions based on this ongoing information. This is a particularly useful feature when markets are volatile, such as we have seen recently, as investors can buy and sell based on up-to-the-minute data should they wish.
Reit ETFs can also offer investors flexibility, and the choice between broad exposure to the Reit market, regional or single country exposure. The key, as with any ETF, is that investors and advisers should look at which Reit index the ETF is tracking to fully understand what they are investing in, and that it is suitable for their needs.
For example, the index provider FTSE calculates the FTSE EPRA/NAREIT index series, which is designed to represent general trends in eligible listed real estate stocks worldwide. It includes 335 Reits from countries around the world with a total market capitalisation of $373 billion (Dh1.37 trillion), making it a representative example for worldwide Reit markets. Its largest region is Asia Pacific, measured by market capitalisation, while its largest single country is the US, so buying an ETF based on this broad index will give investors this exact exposure.
Dow Jones Stoxx also offers a Real Estate index family, which includes tailored Asia and Asia ex-Japan exposure, with each component in the index accounting for no more than 20 per cent of the whole to ensure sufficient diversification.
Reit ETFs offer investors the chance to gain exposure to real estate with the added benefit of increased liquidity and diversification, attributes which are especially attractive after the spell of illiquidity experienced in 2008. But as with any investment vehicle, it is important to take time to understand what you are investing in and to come to an active investment decision based on the requirements of the portfolio and the investor.
- The author is Regional Business Director of GCC iShares