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Real Estate Investment

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The effects of the introduction of Real Estate Investment Trust (REIT) into the UK property/financial market. Executive Summary The review by Kate Barker on the property market UK. Gordon Brown announced in his 2003 Pre-Budget Report that he would consider changing the tax rules to allowUS-style REITs in 2005. (Moneyweek) Property Industry in the UK is welcoming the REIT structure to the UK. Such a vehicle would add value to the industry adding 'liquidity, management efficiency, lower discount to NAV, diversification benefits to investors', (Glascock, 2005). The concerns regarding tax issues have been accepted the industry. With the introduction of REITs the Treasury is concerned about the loss of tax revenue from the industry as well as concerns regarding loss of tax from overseas investors; however there is an overwhelming reaction to such concern because the industry believes that such losses can be obtained when the proposed plans are fully established. Many countries around the world including US, Australia, Japan and France have seen successful results by investment vehicle. The property market is known for its cyclical nature. However, with such a trust the industry is able to penetrate the downturns in the market due to the low debt levels and their ability to manage in such market conditions. For the success of REITs in UK the government should use the structures from established REITs such as US, this has already been stated by the Treasury that the US model will be used, however the legislation should be flexible and not so complex so that investors will turn to UK REITs rather than go to other European REITs. This would go along way to keeping UK investor's money onshore. From the performances of many REITs around the World, it has shown many weaknesses in the introductory stages, however with constant government interaction with the market and REITs have made the structures more successful. Chapter 1 1.1 Introduction Property represents half the world's wealth. Exceeding both bonds and shares. Thus it is unique due to the fact that it is a physical asset, Keng (2004). The direct property investment market which was restructured to introduce REITs has unlocked property in the balance sheet thus improving liquidity and cash flow. REITS are a form of tax efficient fund, where the income and capital gains are not affected by double taxation. They invest in mainly commercial and also residential property, the income and capital gains of the trust are not taxed as long as the Trust pays its shareholders 90% of their taxable income as dividend payout. The investors pay tax on their income. Introduced in the 60's in America, it has now it has expanded to Australia, France and Japan as well as many other European and Asian countries. Introducing REITs into the UK financial markets will create opportunities for average Britons to participate as equity shareholders in the cash flow and value growth of income-producing real estate. (MoneyWeek) REITs were created to give individuals to invest in Real Estate portfolios; the legislation was introduced in 1960 by Congress. It was an incentive for small investors to invest in large scale 'income reproducing commercial real estate and mortgages' Titman et al (2004 p7). The niche of REITs is that, these trusts are exempt from tax at corporate level if they meet the required standards. To qualify to be a REIT, have to distribute at least 90% of its taxable income, excluding net capital gains as dividends. The initial requirement was 95%, but with the passage of REIT modernisation ACT 1999 was changed to 90%. The dividend policy means that management's discretion on free cash is reduced compared to other firms and such payout requirement mitigates agency problems, Hartzell et al (2002). The decrease in free cash and retained earning mean that REITs return to capital market and raises debt. The market for secondary equity offers therefore acts as a monitoring mechanism. The tax code restricts investments on REITs, assets of a REIT must be a minimum of 75% must be real estate related and 75% of gross income must come from Real Estate, through rents or interest on mortgages on real properties. Further restriction on investment include that 30% of income must be through the operation of real estate which has been held less than 4 years, they are not allowed to engage in real estate operation such as 'operating a business, developing or trading properties for sale and selling more than 5 properties a year', Hartzell et al (2002 p8). Such legislations reduce heterogeneity in investment of similar kind. Investment of 2 REITs in similar property type should create similar opportunities, e.g. if 2 trusts invest in multifamily housing, they would both in time have similar opportunities in that market, Titman et al (2004). Then there is that 5-50 rule. This basically means that 5 major shareholders cannot have more than 50% of a REIT's shares, and any REIT should have a minimum of 100 shareholders. Prior to 1993, each institutional investor was considered a single stockholder, however the 1993 tax law institutional investors are not considered as a single investor for the purpose of the 5-50 rules. This meant that ownership is passed through to their beneficiaries. These legislations need to be met in order for REITs to qualify, so that they are not taxed on the income. The income is only taxed at the shareholder level, thus avoiding double taxation. It should also be noted that REITs should not transfer any operating losses to shareholders as a tax credit. These are the main organisation structure conditions that differentiate REITs from an ordinary organisation. The initial legislation was designed so that REITs were not allowed to actively manage themselves; it had to be done by externals, such a legislation created agency problems such as conflicts in interest of managers and owners resulting in REITs being not so popular. This meant that many professional due to lack of ability to utilize their experience and skills in developing and managing their investments, Capozza and Sequin (2003). In an external advised an advisory firm was responsible for managing the daily operations of the REIT including introducing investment opportunities to the Board. They are normally contracted annually and it is seen as an advantage to take the existing operational systems. These external advisors are also experienced in the debt and equity market and have close links with in the market. In the Response by the IPF, APF and RICS, key economic benefits which would flow into the UK economy with the introduction of UK REITs were highlighted. The UK property investment market has a reputation of being very strong, with the addition of the financial services; such assets could result in UK REIT becoming the centre within Europe. UK will be able to regain primacy in Europe as most European REITs will list in London. At present France has a successful REIT structure called the SIIC regime, while the Germans are considering it. If London delay the introduction of REITs, both Paris and Frankfurt could lead the way in Europe leaving London behind, thus resulting in huge opportunity cost for the UK. (RICS Response) REITs has seen a worldwide trend, with established structures in the US, Japan, Korea, Hong Kong and Australia. If UK delays the introduction of REITs, it can be said that investors will look more favourably economies where it is in place, such as France and other countries. Thus leading to capital outflow from UK. Globalisation has taken over investments and capital flows, therefore timescale is very important. This could also result in a decline in tax take from the industry as more offshore vehicles will be established. The RICS and its partners have been lobbying the government for nearly 20 years for the introduction of REITs into the UK, the government however it is quite clear that the Treasury have taken a broad view of REITs. The Treasury's aim is to 'protect all tax payers by ensuring a fair level of tax is paid by the property sector' (Ruth Kelly, RICS). The worry for many is how complex the structure will when it will be introduced, thus making the investment in the UK not so attractive and offshore activities gaining more momentum. 1.2 US REIT US REIT structure had three distinctive phases. The introduction phase from the 1960-1970, the transition and formation until the late 80's and the growth and maturity from the early 90's till present (Glascock and Hall). The introductory periods saw many REITs fail, largely due to the fact that REITs were used as a funding structure. They were intermediaries who borrowed short term and long term. The early periods saw many trusts borrow heavily, thus resulting in high industry debt. Capozza and Sequin, 2000 found in their research about US REITs that the heavy debt was caused by the use of outside advisors, lack of internal property management, small size, lack of key insiders that owned any real share of the firm and the lack of concentration on creating value through property management. However certain REITs did survive who avoided heavy debt and implemented efficient property management (Glascock and Wachter, 1994). Limited Partnerships in real estate received preferential treatment in Tax treatment. Limited Partnership share holders were able to 'deduct their taxes a share of the losses incurred by the partnership' (Capozza and Sequin 2003 p4) such uneven playing field in favour of the limited Partnership mean that even partnerships that were economically not viable surviving purely on the basis of tax benefit that has been provided. This meant that most public investment coming into real estate where diverting to limited partnerships. The transition periods saw a focus on Equity-REIT, as Mortgage REITs were in decline. The change in the tax reform act of 1986 also improved the position of REITs in the US. The US Federal tax policy was amended to facilitate self management of REITs. The amendment of the Act was also through huge pressure on Congress by the market. The Tax Reform Act 1986 removed limited partnership incentives, which made them gain an advantage over REITS, this resulted in owners not being able to take advantage of tax losses. This Reform also introduced self management of REITs, this gave REITs a level playing field with limited partnerships, which resulted in a huge rise in IPO's of Public REITs, Capozza and Sequin (2003). The growth of REITs in started in the early 90s, Glascock and Hughes 1995, in their study found that there has been 245 REITs from the period of 1972 and 1991, however only 16 of them have survived all the way through. Thus showing the volatility of the market during the periods. From 1993, there was immense growth in REIT activity. Before 1993, the industry capitalisation was under $10 billion; however by the end of 1995, it stood at $88 billion. (Glascock and Hall 2004), this was due to the operational efficiency and asset growth, not interest rate risks or intermediation. The government also implemented certain new acts which gave REITS and limited partnerships a level playing field. For example the Umbrella REIT, 'the UPREIT effectively allowed owners of current properties to participate in a REIT by transferring their property into a limited partnership that they and the REIT owned without tax consequences'. The real estate recession in the late 80's and early 90's meant that there property owners found it difficult to raise finance. Or to even sell assets. However REIT was able to raise funding through the market. (Glascock and Hall 2004) The introduction of Umbrella Partnership REIT (UPREIT), also contributed to the transition from private firms to REITs. In such a structure REITs creates an Operating Partnership (OP) with the owner of the existing properties in the market, Capozza and Sequin (2003). To gain shares in the OP, the REIT offers capital raised in public offerings, whereas the owner contributes to the property. In such legislation the property owner avoids tax because the property is transferred into a partnership. Therefore the Operating Partnership can be converted into REITs. Since the introduction of UPREITs, 75% of new REITs have converted into UPREIT's. Coichetti et al states that many institutional investors have taken large stakes in liquid REITS, rather than private real estate. Since the 90's greater number of institutional investors place more of their funds in REITs compared to stocks, this was seen as a major shift in institutional investor behaviour. The late 90s also saw a decline in interest of REITs from investors, especially Equity REITs. One of the major reasons was the dot.com boom, which the world experienced during the period. Thus making real estate less attractive, however it still continues to grow from strength to strength. From the American experience and transition, the UK could learn a lot in order to design its REIT structure to attract investors. One of major factors that contributed to the decline of many REITs were the uneven level playing field between REITs and limited partnerships, if extra incentives are given to limited partnerships then investors would not run towards UK REITS. Therefore there needs to be a level playing field, especially in terms of tax rules. 1.3 Australian REIT, As mentioned before the first REITs were established in the US, such a model was then introduced in Australasia, Europe and Asia. Japan, Korea, Singapore and Hong Kong have floated REITs from 2001 onwards, Taiwan has also passed laws for the introduction in the country. Even though there is a great expansion in Asia, it is still in its infancy, Keng (2004). The popularity has come from the huge success which has been the Australian Listed Property Trust (LPT). The property council of Australia in 1999 stated that 47% of Australians have committed nearly $72.8 billion to invest in property, these include investing in LPT which accounts for 51% of this money. The first LPT was listed in 1971, however the introductory periods like the US was very slow and volatile. It wasn't until the 1990 that the LPT started to grow which resulted in market capitalisation of $10 billion in 1993 to $50 billion in 2003. La'Brooy says that investors gain both value and rental income from LPTS. Their portfolios are professionally managed by fund managers, investors also enjoyed further benefits of the LPT;
  • Stable income stream with reasonable capital growth potential
  • Low volatility, compared to stock and shares
  • Managed by professional fund managers
  • Portfolios of quality properties/diversified
  • Cost-effective exposure to the property market
  • Liquidity provided by listing on the Australian Stock Exchange
  • Tax advantage; pass through of tax concessions, tax differed dividends
  • Lower entry/exit cost, in comparison with direct property investment.
  • No direct maintenance cost -Keng 2004
The introductory stage so many diversified LPTs, however during the 90s the LPT was more focused on sector specific. This trend was also seen in the US, where 95% of REITs are sector specific. This move has been influenced by the investors, rather than the LPT managers. During the late 90s and the Asian crisis, many investors turned to the LPT rather the stock market. Such increase in investment meant that managers had to look for larger fund size. However the expansion plans where held back due to the lack of quality real estate locally. Therefore overseas investment had to be made, Calder 2002). It can be said that the LPT has come to maturity stage, and LPT managers had to remain competitive therefore had to be more efficient. Especially at a stage where externally managed trusts where declining in the US. The single responsibility entity concept which was introduced through the Management Investment Act 1998 LPTs began following the American management structure of internal management. The introduction of the internal mgt structure meant that there is a continuous debate regarding the existence of external management structure. The 2004 BDO survey of Australian LPTS concluded that external management expenses where falling and more managers have adopted a performance fee structure, due to increased competition from internal managers. 1.5 Government Proposal Along with the 2004 budget, the government published a consultation paper for the UK property market. The government s objective is to have a healthy and stable property market, through greater productivity in the UK economy, thus resulting in a successful economy. The key objectives set out by the Government were as follows.
  • Improving the quality and quantity of finance for investment in commercial and residential property
  • Expanding access to a wider range saving products on a stable and well regulated basis
  • Protecting all taxpayers by ensuring a fair level of tax is paid by the property sector
  • Supporting structural change in property markets to reduce costs and improve flexibility and quality for tenants.
-UK REITs; a Discussion paper HM Treasury p3 It was clear that the UK property market lacked stability. UK REITs the term favoured by the Industry was considered due to the barriers in the current market.
  • There is limited secondary trading and liquidity in the property sector, thus insufficient information to ensure efficient market pricing and capital allocation.
  • Access to commercial property investment is limited for smaller scale investors without significant capital outlays, potential risk or tax inefficiency.
  • Property companies may be unable to raise optimal amounts of equity and therefore rely more heavily on debt markets, with potential consequences for wider economic and financial stability.
  • High levels of owner-occupied property in the corporate sector in part driven by tax rules may restrict the full potential for efficient asset management
-UK REITs; a Discussion paper HM Treasury p5 The aim of the government is to facilitate the property investment market, however without any cost to the Exchequer. The tax-efficient vehicle crates concerns for the treasury over loss of revenue, which has also created suspicion that the structure would not be suitable to investors. The Governments objectives are that the UK REIT could improve the market through
  • Providing more liquid complement to the current range of property investment vehicles
  • Allowing smaller scale investors the opportunity to access commercial property returns, currently unavailable without significant capital outlays or tax inefficiency.
  • Improving stability in the property investment market by rebalancing some debt with equity among property companies. Providing opportunities for companies to release property assets from corporate balance sheets into professionally managed companies.
  • Potentially improving the housing market through greater professionalism in the private and social rented sectors
  • Alongside wider reforms to the planning system, providing a route into which newly developed rented accommodation can be sold, thereby increasing the willingness of house builders to increase supply.
UK REITs; a Discussion paper HM Treasury p6 The British Property Federation (BPF), investment Property Forum (IPF) and the Royal Institute of Chartered Surveyors (RICS) has shown great support for this forward movement by the government. They have also shown their delight at the certain features such as
  • Internal v external management would be left to the market
  • Broad range of property types will be eligible for inclusion,
-Response by BPF, IPF, RICS However they have also shown their concern over the outstanding issues to be resolved which could trigger a delay in the project timetable. The treasuries and the industries intensions may differ, thus resulting in adoption of over complex, or commercially unviable or unattractive solutions, which could as a result limit the take up of UK REITs. Chapter 2 Literature Review The UK already has a very popular property market in Europe, and a structure such as REIT will a very natural step forward, more straightforward than the US market. (Glascock and Hall 2004). Property companies have an objective to maximise shareholders value, through 'trading in land and buildings, acquiring standing investments and holding them for long term capital growth (Barkham 1997). Therefore they are categorised as Property Trading Companies or Property Investment Companies. PICS tend to have a substantial portfolio of commercial property, thus have assets backing, therefore are valued by the market. Supply and demand determines the stock determine quoted share prices. However property companies in addition trade at a discount to Net Asset Value. Sahi and Lee, defines NAV as the companies NAV less its market capitalisation expressed as a percentage of NAV. Adams and Venmore-Rowland 1989, made certain suggestions in order to explain the discount to NAV, such as the 'uncertainty as to true market NAV, the unrealised capital gains liability on disposal of the companies assets and the increased risk in holding property indirectly as a result of high gearing. (Sahi and Lee) The biggest downfall in the UK property market is the discount to Net Asset Value. The average is currently 29%, but not long ago, it was 40%. (MoneyWeek) When a company trading on a 40% discount buys a property, 40% of the value of the building is immediately wiped out. This makes capital raising nearly impossible. Therefore a REIT structure will help reduce the NAV thus encouraging more firms to become REITs. The Australian Listed Property Trust (LPTs) is an example of a very successful property investment fund structure. It has become one of the most popular investments in Australia. Certain benefits investing in LPT includes;
  • Low volatility, with stable income and reasonable capital growth
  • Investing in a diversified portfolio of quality of properties managed by professionals
  • Lower entry and exit costs, compared to direct property investment and a cost-effective means to gain exposure to the property sector.
  • Taxation advantages via tax concessions passed through and tax deferred dividend from property rental
  • No maintenance costs
  • Liquidity by listing on ASX (La'Brooy, 2001)
These features are very similar to ones found in US REITs, however one of the major differences is the form of management. In US firms at present use mainly internal management, the Australians used mainly external, however recently they have also followed this structure. Capozzza and Sequin says that external management causes higher agency costs, higher debt levels and also higher debt rates. In the US the Discount to NAV is around 8% for an externally managed firm, which could be further reduced if the alternative approach is implemented. Even in the US the market as I have mentioned before that even the US REIT started of with an external management scheme (Glascock and Hall 2004), however the market demanded changes from Congress to introduce internal management. There are other markets which have also used internal management structures such as Korea and the new REIT structures such as china and Hong Kong. The Australian property market have made their views clear on the which type of management structure to follow, they find that external management is still an effective model, however there is a need for management fees which leak outside, thus decreasing the returns for investors. It has also been highlighted that external managers and investors often have conflicting views (Keng 2004). Glascock and Ghosh 2000 ask 'are there problems associated with this change?' The internal models have shown signs of stronger returns compared to external. In Australia the original structure of the Listed Property Trust uses external management, this has some advantages, external managers can be easily replaced if underperforming, compared to internal managers. There is a great battle between external managers, therefore trust are able to choose from lower management fees. An external management structure does not gain income from other business activities, other than property rental income from the trust. Therefore the investor or the unit holders are not under risk from further risks associated with the market apart from the real estate investments. Sagalyn 1996 says that the inherent conflict between external managers and unit holders were one of the reasons why many REITs failed in the early days of its introduction in the US. This is also supported by Ambrose and Linneman 2001, that the conflict has hindered the market. This has also resulted in many property developers not to convert into a REIT model due to the lack of control one has to mange assets, thus risk loosing control. These studies were of the US REITs during the introductory and transitory periods. As mentioned before the US REIT structure was naturally designed to have an external management. However the 1986 tax policy, which introduced self management, gave REITs the authority to select investment properties and managing assets, thus allowing them to have an internally managed status (Keng 2004). Prior to this time, REITS were only allowed to be managed eternally (Sagalyn 1996). Similar steps were also seen in Australia, where the Managed Investment Act 1998 was incorporated into the corporation law. Sagalyn 1996 says that even with internal management model, all potential conflicts cannot be avoided, thus suggested 5 key strategies to minimise such occurrences.
  • Governance structure
  • Policies
  • Laws and covenants
  • Economic incentives
  • Disclosure
It is clear that even with such strategies all conflicts cannot be avoided. However Glascock and Hall 2004 say that to mitigate conflicts of interest, there need to be an integrated approach. 'dedicated governance structure through a truly independent board of directors, explicit policies and covenants , full disclosure, economic incentives that create mutual interest between internal managers and unit holders'( Keng 2004) It is quite clear that UK property firms have seen the discount NAV decrease since the government's consultation paper on introducing Property Investment Fund. Such decline as from 40% at one stage to an average of 29%. REITs tend to have a lower NAV through lower agency costs, this is a clear indication that the market is expecting better things to come for the UK property market. For example many more property companies to convert into a REIT. The fact is traditional listed property firms have done well in Europe, however REITs in well established countries such as US and Australia have done better (Glascock and Hall). REITs seem to also have less debt than traditional property firms, Feng et al (2005), says that debt is issued for three main reasons;
  • A less costly source of fund
  • Interest payments are tax deductible so that the tax shield adds value to the firm
  • The mandatory interest payment on debt mitigates the agency cost of managerial proclivity to waste cash on poor investment (Feng et al 2005)
However it also be seen to expose the companies bankruptcy cost, thus deter managers from making profitable investments. In a REIT environment induces investments and rather than prevent neglect of fiduciary responsibility. It is common worldwide that if REITs pay 90% of earnings as dividend to its shareholders then they don't have to pay any tax, thus resulting in lower budgets for managers to invest in low yielding acquisitions. In order to monitor the performance of a REIT manager, there need to be special skills and knowledge. Hans (2004), states that skills and knowledge to monitor a REIT manager will include 'general and local economic trends, conditions of comparable properties, complex financing arrangements, other specialised skills and even insider information'. REITs by nature are included in real property transactions which can be heterogeneous and illiquid assets, thus resulting in shareholders finding it difficult to determine the fair market value of such investments. When UK eventually does introduce REITs, property companies who wish to convert in to a REIT will need to qualify to be a REIT. Such as the firm should have a diversified ownership with 100 shareholders, with the five biggest not owning more than 50% of the total. Cambell et all (2001) states that such unique ownership structure contribute to a lack of hostile takeovers amongst REITs. And also monitoring through the market for corporate control is diminished. Zietz et al (2003) states that there is an inverse relationship between the REIT management and stock market performance. The stock market performance is triggered by management performance. Studies have been carried out in this area by McIntosh et al (1994) and Eichholtz, Op't Veld and Schweitzer (2000) who states that managerial specialisation could explain the performance of property companies. The stock market reacts to management decisions, and there is a positive relation between director ownership and market to book ratios, similar relation can also be seen in the board of directors where out-side directors and market to book ratios have positive relations. However too much outside influence results in the market to discount the REIT shares, Ambrose and Linneman (2001) states that externally advised REITs respond to market pressure, in order to confirm to the performance standards benchmarked by internally advised REITs. US REITs after the transition period has seen a change in the management style. Brounen, Eichholtz and Ling stated that prior to 1993; REITs were 'passive investment vehicles that owned diverse portfolios of properties', Brounen et al (2005 p3). External advisors arranged REITs for portfolio and property management, and considered static and known as 'diversification plays'. However post 1992 REITs have differed from the earlier days. Now they are more integrated operating companies. The portfolios are more focused by the type of property and geographic market. The focus on specialised portfolios allows investors to benefit from the expertise of the management team. Such active management has resulted in REITs selling at premiums to NAV, in anticipation of growth. However such active management and private real estate funds and the superior management targeting ability, there is limited evidence of real estate managers enhancing operational or stock return performance'. Agency costs have been a major focus of REIT, Zietz et al (2003) reveals that on average REITs make a bigger payment to executives than public real estate companies. Issues such as compensation packages are resultant of the executive's shareholding in the company. Longer term incentives are used to motivate senior executives as well as bonuses and share options. The literature also talks about agency cost and the involvement of employee. In a survey of employees, Ferguson (2001) indicated that employees desire better communication with management, more training, carer development, recognition programmes and additional compensation. Such a survey showed the importance of hiring the right people in terms of their vision and performance. Feng et al (2005) states that in average REITs have a debt ratio of 65%, 10 years after the IPO. The main reasons why mangers opt for debt in the short term is to minimize the adverse selection cost of equity, however the long term objective to avoid debt issues in order to preserve future debt capacity will be difficult, as REITs have a very high dividend payout of 90% of taxable earnings. Thus causing lower ratio of free cash and retained earnings. This legislation nullifies debt financing incentives. The tax deductibility of interest payment and tax shield is non-existent, and as 90 of earning are distributed through dividend payouts, therefore in terms of agency cost debt servicing has limited value, Feng et al (2005 p8). The pecking order theory Myers and Majluf (1984), states that investors suspects managers asserting that managers have privileged information regarding the firm, therefore investors suspects shares being overvalued by opportunistic managers resulting in share price reacting negatively to equity shares. Therefore in pecking order theory, it is expected by investors for managers to sell the shares when overvalued, thus investors discount the value of the newly issued shares. The market timing theory by Barker and Wurgler (2002), states that companies issue stock when it is favourable to the firms market, and also issue debt when the market is not so favourable. Market timing theory is behavioural in nature, thus firms with high growth and high market values tend to issue equity more often, however with low leverage ratios. With reference to US REITs, the literature states that REIT IPO's have been overpriced, under priced and correctly priced Zietz et al (2003). Ling and Ryngaret (1997), studied REIT IPO's from the introductory period, it was clear from their research that REITs were overpriced thus underperformed. However after the Transition period in the 90's REIT IPO's were actually under priced and later performed better. REITs are naturally tax exempt, this means that they are less incline to use debt as it has no tax advantage. Studies into non-REIT firms shows that they are heavily leveraged and paying lower dividends than REITs. Non-REIT firms also have greater amount of free cash even after dividend payouts Moordian and Yang (2001). REITs are able to influence their market risk, this can be done through minimizing financial leverage, thus reducing the sensitivity of REITs the market fluctuations; however they can be sensitive to interest rate changes. Myers and Majluf (1984) say that the dividend policy of any property company will have an impact on the retained earnings, thus affecting the investment potential. Firms need financial support for make profitable investment opportunities. Such policies are also needed for portfolio considerations due to the risk-return characteristics of stocks. REITs are considered low risk and also pay a healthy dividend yield and have always attracted investors. At present REITs are not in the UK, and the real estate market is in 2 categories PTC's and PIC's. Property Trading Corporations are firms who have a short term goal in which they vision is to develop real estate and sell them. Where Property Investment Corporations objectives are long term therefore they develop real estate seeking rental income and capital growth, L. Ooi (2001). The risk return characteristic and price of stocks are affected by the dividend policy, therefore investors need to consider dividend payout policy when making investment sin real estate corporations in UK at present. The question here is how would the introduction of REIT determine the dividend policy? Studies have been carried out in order to see affects of REIT status dividend policy by Mooradian and Yang (2001). They found that non-REITs have higher income and market to book ratios. They were also highly leveraged and had more free cash and had a lower dividend payout. However they incurred higher expenses for acquisitions. Having to make a 90% payout on dividends in order to avoid double taxation, this means that REITs have limited liability to finance growth, therefore REITs have to use external financing for growth. During the late 90's and the period of the dot.com boom meant that the REITs were not so attractive for investors, this resulted in a significant rise in debt commitments by REITs. Oppenheimer (2000) study showed that debt offering by REITs in mid 1998 was $7.2 billion, compared to $2.2 billion a year earlier. Such increase in debt offering meant that the Federal Reserve issued caution to banks for unsecured lending to REITs, L. Ooi (2001). The frequent search for funding in the capital market provides outsiders with to collect information about the Trust and therefore they are able to scrutinize the firm, its prospectus and performance, Titman et al (2004). During the Transition period of US REITs, it was becoming clear that Equity REITs were gaining popularity, this was due to the significant higher proportion of income as dividends than mortgage REITs. Wang, Erickson Gau (1993), found that REITs made a higher payout than legally required, this meant that dividend policy was influenced by imperfect information from the market and the agency cost. Such free flow of cash should raise eyebrows of EREIT investor about the REIT mangers, especially when in real estate it is difficult to estimate changes in the market value. L Ooi (2001) in such circumstances agency costs can be lowered through dividend payments. In this scenario the agency costs include management discretion. As mentioned before, high dividend payout results in lower retained earnings, thus a need for managers to search for funds from the capital market. Capozza and Sequin (1998) found that there was a negative relationship between dividend payout and cash flow volatility. Firms with high cash-flow volatility would be trying to reduce the penalty of cutting dividend payouts. Better dividends are paid out by E-REITs who have a low debt to assets ration and large well diversified real estate portfolio, L. Ooi (2001).volatile cash flows results in difficulties when trying to raise funds. Therefore firms need internal sources of finance such rained earnings which will reduce dividend payouts, Bradley et al (1998). Over the last 4 decades of the existence of REITs in the US, has increased from 46 in 1972 to 176 in 2002 (NAREIT) during the time period there has been a increase in Equity REIT from being 17 out of 46 in 1972, to 149 out of 176 in 2002, basically making up 85% of total REITs. The dividend yield however has remained very similar, the lowest has been both in 1972 and 2002 7.3% and the maximum has been 9.0% in 1982. It can be said that an increase in trust values due t capital gains are minimal. An average REIT grew around 11% every year and has also grew to just under $1billion, Capozza and Sequin (2003) Capozza and Sequin says that growth has not generally come from internal, however more to do with the revaluation of assets, mergers, IPO's and growth in the asset base fuelled by external financing. The catastrophic events of the 9/11 will be remembered worldwide for many years to come, the effects of such volatility can be seen in the economic determinants which trigger the stock market such as expected earnings. Interest rates, real growth and inflation, Lee and Gheno (2005). This can also increase in uncertainty in the financial market as its natural for investors risk aversion to increase, however the market responded positively and gained much of what is lost with a very short time. Miller et al (2003) stated that in his findings the US didn't show any significant vacancy rates in Real Estate, with the exception of New York and tall buildings. Miller et al (2003) study also showed tall building and especially famous buildings have shown a higher vacancy due to the increased risk and terrorist attacks still looming around the Western World. It can be said that the 'psychological and economic effects the attacks on tenants of high rise buildings and their immediate areas are significant, Miller et al (2003 p3) The expectation was that after 9/11 there would have been a serious impact on the economy. However the US economy was already suffering prior to the attacks and didn't make such substantial impact. The Real Estate market was expected to have an immense impact due to the uncertainty, and could be long lasting. However certain studies have shown that even in Real Estate markets, such volatile incidents increases investor risk aversion for only short periods and the effects are sort lived. Lee and Gheno (2005 p.7) concluded in their research into 9/11 and REITs and stated that the 'impact of 9/11 on US Real Estate Securities was financial and transitory, rather than fundamental and persistent'. It was argued by Baen, that the attacks increased property investment risk in US and therefore will have significant impact on the capital value and Net Operating Income to both institutional and investment grade real estate. Both Baen (2003) and Kelly (2001) predicted that tourism cities, high tech localities will face immediate effect and could last for some time. They also found that in tall buildings, so called 'trophy buildings' were facing insurance premiums increasing to more than 300%. The performance of REITs is directly linked to the private market, and the asset values of companies dependent on the capital value of the real estate, Lee and Gheno (2005 p4). The dividend payout from the net operating income from the property and the profitability depends upon the capital value which is derived from rental market and expected future growth. Lee and Gheno concluded from their result that 9/11 had significant impact on REIT, through uncertainty however it is expected that the uncertainty is short lived and should not create long term impacts. However this statement is only valid if further attacks are avoided in the US. The attack sin London on the 7/7, was a very small scale compared to 9/11. However the market in the UK reacted positively so did the people of London. The impact of 7/7 may be short lived, however further attacks are not out of contention. Would this effect the Real estate market of London and in particular the introduction of REITs? In the REIT sector there seems to be very limited hostile takeover bid. Campbell et all (2001), in their study did not find any evidence of such activity, this can be seen as a disciplining mechanism, Titman et al (2004). This area has also been studied by Chan, Erickson and Wang, who came to a conclusion that many REITs use the so-called excess share holder provision. Thus making it difficult to acquire large equity stake in REITs. Such limited activity could affect the value of REITs through the boards and large shareholders monitoring and the managerial ownership role. Much research has been carried out in the relationship between inflation and stock returns. Much of the analysis have shown that there is a negative relationship between stock prices and inflation and many have concluded that it is a result of the proxy effect, Adrangi, chatrath and Raffiee (2004). The proxy effects hypothesis, the negative relation between stock and the inflation reflects the adverse effects of inflation on real economic activity. (p97). There is also a macroeconomic link, based on the quantity theory of money. However the REITs study has shown that there is limited hedge against unexpected inflation. The fact that REITs own large equity means that there is weak or negative relationship between REITS and inflation. Even in the case of REITs, the relationship has the proxy effect and other macroeconomic effects. Real estate market is cyclical in nature, this mean that the investment opportunities in REITs exhibit time-series variation and the variety in the types of property into which REITs can invest means that there is cross sectional variation opportunity. The 1988 Housing Act introduced a new era of Buy-to-Let market in the UK. Prior to the Act there were only a few BTL owners,, it was mainly council housing and provision by landlords, however in 2004 there has been huge jump to over 500,000 owners and also more BTL properties says Glascock (2005). The Council and Mortgage Lenders survey carried out in 2004 showed that majority of BTL properties are owned by investors who have around 6 properties. The introduction of REITs into the UK may affect the BTL market. John Glascock says that the UK REITs will not affect the BTL market in a significant way, Glascock (2005). From the US and French markets REITs are large scale operators, for example REITs who specialise in apartments will invest in large scale developments such as 200-400 units. However BT: investors are generally 21-50, 11-20 or 6-10 units, and are not large scale operators. A REITs investor is attracted to passive investment, with high cash flow and small scale risk. Such returns on investments have been seen in both US and Australia. The US REITS in the last decade have at lower risk outperformed the S&P 500 and has shown that how REITs can have high cash flow payouts, from safe and low risk investments in quality real estate, Glascock (2005) REITs investors and BTL investors are different in many ways, especially when it comes to management of the portfolio. BTL investors want strong cash flow and capital appreciation; therefore they carry out much of the management such as renovation which adds capital value to the property, such investments mean that they are not insulated from personal liability. Such hand on management cannot be carried out by REIT investors, because the shareholders are insulated from personal liability. London is preparing to host the 2012 Olympics, and is a huge regeneration project. The lower Lea Valley of East London is considered one of the most deprived areas of London and also the UK. The area is a huge brown filed site, contaminated land, underused and the community suffers from poor housing to poor schooling, hospitals and transport links, (Mayor of London). The London Development agency have made an estimate of 9000 new homes in the area through this huge regeneration project, and many of the houses will be affordable housing for the local people. Affordable housing will mean that there would be priority given to key workers such as Teachers, police officers, nurses etc. Regeneration programmes are occurring though out the UK, especially as there is shortage of homes in the country. John Prescott the Deputy Prime Minister had pledged an increase in housing supply specially using up the vast amount of Brownfield site as well as Greenfield site. Under Section 106 Planning obligation agreement and subsidies related to the policy are used only for affordable housing. In the US affordable housing investment by REITs is only 0.2%. Therefore if REITs are to play a major role in affordable housing and regeneration in the UK. There would be a need to changes in regulation which will enable more rental housing and regeneration programmes to go through REITs, Glascock and Hall (2005). the advantage of an Investment property fund structure such as REITs, is that it can offer competitive management opportunities, economies of scale and efficient financing to the market. (p25). If the government provide incentives for REITs then there would be appropriate private rental housing. In the US, the legislation allows a tax credits for affordable housing. The UK government is currently providing subsidies for local authorities and registered social landlords. Therefore affordable housing REITs could be set up by these social landlords or even private landlords. Such an incentive programme was introduced in Belgium, where the government provided funds and expertise to the countries social housing stock with clear goals set to modernise. Chapter 3 Research Methodology In the literature review the relevant literature related to the subject of research was reviewed to provide the different views and opinions of research that have done research previously in the same subject. The introduction of REITs will result in a change process in the UK property market. Much of the literature that that reviewed where from Research carried out in US and Australia. As REIT vehicle hasn't been introduced in the UK as yet. However, undertaking the literature review provided a clear idea of the kind of research focus that had to be carried out. This chapter incorporates the details of how the research was done, why the particular method was chosen, the details of the research undertaken and finally tries to identify the limitations. The UK property market has been waiting for REITs for many years; however the success depends largely on the details set out by the Chancellor Gordon Brown in the government legislation. The effectiveness of every research is heavily dependant on the way the researcher approached the research and the method adopted to undertake the research (i.e. the philosophy and the method of research). A clear aim and the effective filtering of information from the data are of no lesser importance. The collection of data for the research is very important; to get an overall picture it is essential to collect both the qualitative and quantitative data (Saunders et al, 2003). 3.1 Qualitative data Qualitative data is referred to as a non numerical data which generally arise as words, phrases or statements (Kent, 1999). It is an important form of data for marketing research. The qualitative data generally arises from interviews and group discussions. However the data collected through this method can be in the form of writing or can be taped. However it can also emerge from the surveys and experiments when the respondents are asked to provide some of their answers in response to open ended questions. Qualitative data can also include observations. Qualitative data can provide an in-depth understanding of the interviewee's knowledge beliefs and attitudes (Kent, 1999. Saunders et al, 2003). In this research I have opted to use an interview method, which would be semi structured. The interviews will be semi-structured as it will give the opportunity to explore the outcomes in greater depth. This would give a greater insight in to individuals experience in the market and the roles of the government. 3.2 Quantitative data Quantitative data is referred to as data whose values can be measured numerically. The quantitative data generally arises from surveys, records of organizations, Statistical reports of government etc. (Creswell, 1994. Kent, 1999. Saunders et al, 2003.). 3.3 Data Collection Data for the research project is usually collected either by using primary data, secondary data or a combination of both. 3.4 Primary Data Saunders et al states that Primary data is collected for the study in hand, and obtained through observing the research area or using direct/indirect communication with the subject. Direct communication techniques include qualitative research techniques as in-depth interview, focus group and projective techniques, and quantitative research techniques such as telephone, self-administered and interview surveys (Saunders et al, 2003). In this report I will be collecting primary data through questionnaires and a semi structures interview. . An interview is a purposeful discussion between two or more people (Kahn). The use of interviews helps to gather valid and reliable data that are relevant to the research and its objective (Saunders et al, 2003). In semi-structured interviews the researcher will have a list of themes and questions to be covered, although these may vary from interview to interview (Saunders et al, 2003). This means that the interviewer may omit some questions or include additional questions in particular interviews, depending upon the specific organisational context that is encountered in relation to the research topic. The order of questions may also be varied depending on the flow of the conversation. On the other hand, additional questions may be required to explore the research question and objectives given the nature of events within particular organisations (Saunders et al, 2003). The design of questionnaires are time consuming, however I managed to design a small questionnaire and also include a semi structured interview. The questionnaires where initially handed out, a total of 30 questionnaires where sent by e-mail, with 10 responses. The respondents were carefully selected as it was important for the individual to have knowledge about REITs. All the selected respondents were members of the Royal Institute of Charted Surveyors. This meant that my population sample was the same all the way through. The semi structured interview was a follow on procedure, and from the 10 respondents I managed to interview 3 over the phone. 3.4.1 Advantage of Semi-Structured Interviews The advantages of semi-structured and in-depth interviews are as follows (Saunders et al, 2003): Conducting an interview gave an added incentive, that unstructured views could be covered. Semi-structured gives rise to 'probe answers, where we want the interviewees to explain, build on their responses. The interviewees where all Surveyors and had different levels of experience in the property industry. This approach is most advantageous where there are a large number of questions to be answered, where questions are either complex or open ended and where the order or logic of questioning may need to be varied depending on the interviewee. However my questions were open ended, however there wasn't large number of questions. I restricted questions to a maximum of 6. Apart from the difficulty of trying to design a viable questionnaire schedule to cope with questions that are complex, or open-ended, or large in number, the time needed to obtain the required data may mean that an interview is in any case the best or only option especially considering that the interviewees are from a wide range of backgrounds and experiences 3.4.2 Limitations of Semi-Structured and The limitations of this technique for collecting primary data are as follows: There may be interviewer bias. It is human nature to interpret tone and non-verbal behaviour, thus affecting the nature of comments. In such an environment the interviewer may create a bias view to the interviews response, Saunders et al, (2003) There may be interviewee or response bias. This may be caused by perceptions about the interviewer, as referred to above, or in relation to perceived interviewer bias. (Saunders et al, 2003) The issue of reliability of the findings derived by using non- standardised research methods are not necessarily intended to be repeatable since they reflect reality at the time they were collected, in situation which may be subject to change (Marshall and Rossman, 1999) 3.5 Secondary Data Secondary data includes both quantitative and qualitative data and they can be used in both descriptive and explanatory research (Saunders et al, 2003). The data being used may be raw data where there has been little if any processing, or compiled data that have received some form of selection or summarising (Kervin, 1999) The three main subgroups into which secondary data can be classified are documentary data, survey based data, and those compiled from multiple sources. 1. Documentary 2. Multiple Sources 3. Survey The documentary type of secondary data consists of both written as well as non-written materials. The written materials consist of organization's records such as personnel or production, organization's communications records such as letters, emails and notes, organization's website, report of committees, books, journals, newspapers, diaries etc (Saunders et al, 2003). The documentary data both written and non-written will be used extensively within this report. Data based on surveys done by various government agencies and data collected from internet, newspapers, journals etc are also used in this report. In my research I will be using secondary data, especially for quantitative data. Much of the research on REITs has been carried in US, as REITS are an established vehicle. Secondary data will be a significant part of my research even though I have primary research. 3.6 Research Limitations. One of the major concerns were to get enough respondents in order to find the views of individuals in the property market in the UK, with regards to REITs in the UK, there is also a shortage of literature. Therefore much of the secondary research that I have obtained is from America and Australia. Time is also a major constraint.  
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