The REIT Footprint Expands Globally
Key Regions to Watch: United States, Europe, and Asia
REIT markets around the globe have seen immense growth recently. The cumulative market capitalization of REITs globally is approaching $2 trillion, and 35 countries now have active REIT legislation, including 25 nations with at least one actively traded REIT. With the growing momentum for REITs, the United States, the U.K. and Continental Europe, and Asia are particularly key regions to watch.
In the United States, one trend to monitor is the disconnect in pricing between the public and private real estate markets. As of Nov. 1, the major sector REITs traded at a 13% discount relative to the private market value of their underlying assets, and that discount has averaged over 10% for three years. This valuation disconnect in traditional sectors has suppressed capital markets activity, resulting in fewer IPOs and secondary equity offerings. In contrast, there has been activity in non-traditional sectors, including net lease, data centers, and temperature-controlled warehouses. For example, Green Street’s Advisory Group served as an independent advisor on an IPO earlier this year for Americold, a company focused on cold storage and refrigerated warehousing solutions. Non-traditional REITs continue to attract capital, continue to perform well relative to traditional sectors, and are becoming a bigger piece of the pie in the U.S. REIT market. See Green Street’s report on recent Commercial Property Price Index enhancements for more information about the tremendous growth in non-traditional sectors over the past decade.
U.S. Equity Market Cap ($ million)
Emerging non-traditional sectors represent an opportunity in the U.K. and Continental Europe, where the listed market has been dominated by traditional sectors. In October 2018, Public Storage (PSA), the owner of a $36 billion U.S. self-storage portfolio, filed an IPO for its European platform under the name Shurgard Self Storage (SHUR (EBR)), creating the first self-storage REIT in the European market. Green Street expects more non-traditional IPOs to emerge over the next few years.
In Asia, several markets are poised for growth. India recently finalized legislation for REITs, and although the first REIT has yet to be established, there has been significant buy-in from market participants. Green Street’s Advisory Group spent time in India this year and witnessed the palpable excitement for the coming REIT market. Singapore, with its REIT market cap approaching $70 billion, also merits attention. Interestingly, most Singapore-listed companies actually own assets outside of the country. That makes Singapore’s REIT market a unique avenue for real estate owners around the globe to list and access public market investors including retail and institutional investors in Asia.
Opportunity Grows in India
India’s nascent REIT regime is expected to offer both domestic and international investors the opportunity to invest in stabilized institutional-quality real estate for the first time. The current real estate companies listed on the Indian stock exchange are primarily condominium developers who have seen boom-and-bust cycles and offer a very different risk profile than the stabilized real estate of REITs. The quickly growing supply of institutional-quality real estate in India, particularly in the office sector, has attracted the top private equity firms and top sovereign wealth funds to the private market over the past five to seven years. The hope is that the REIT market will further expand this investment opportunity to a broader base of public market investors. From a global perspective, it will offer international investors, whether real-estate focused or generalists, to get direct exposure to real estate in the fastest-growing large economy in the world.
Cross-Border Valuation Challenges
Properly assessing relative value between companies and property sectors across borders is challenging. It is wise for global investors to keep several key considerations top-of-mind.
The first is corporate level taxation. REITs in the United States are pass-through entities, meaning they do not pay corporate-level tax. That structure has been widely adopted globally, but it is not universal. There is some level of corporate taxation in certain markets, especially when REITs own assets outside of the country in which they are listed.
The second consideration is capital expenditures (cap-ex). When evaluating companies in the United States and within the same sector, there is usually a tight range of cap-ex spend for those companies. Once investors cross international borders, those ranges widen materially. The best example of this is in the office space. In the U.S. office sector, Green Street estimates that cap-ex eats up about 30% of net operating income (NOI), and a majority of that is leasing costs such as tenant improvements and leasing conditions. In some Asian markets, including India, the tenant is responsible for improvements, not the landlord. This arrangement leads to a very different and more attractive cap-ex profile for office assets in those markets.
The third area to consider is sovereign risk. How much additional return should REIT investors require to invest in an identical asset in India versus one in the United States? To answer this question, Green Street looks to sovereign debt yields as a guide; more specifically, the spread between the unlevered return expected from the REITs at their current pricing and the sovereign debt yield in that market. All things being equal, a wider spread indicates more attractively priced REITs on a relative basis.
Recommendations for Emerging Market REITs
While investors evaluating cross-border opportunities face challenges, the emerging market REITs seeking global capital also experience unique difficulties. Green Street’s Advisory Group works with active REITs trying to broaden their investor bases, private companies looking to enter the REIT market via IPOs, and C Corps seeking to enter the market through conversions. These types of clients benefit from independent and expert support in messaging, disclosure, and corporate governance in order to be best received by the REIT-dedicated investment community. In emerging markets, those challenges can be magnified.
In terms of corporate governance, many markets in Asia have adopted an externally-managed structure, which is not the preference of Green Street or REIT-dedicated investors in the United States. U.S. investors believe an internal structure creates a better alignment of shareholder and management interest. Because of this, emerging market REITs that are externally advised should go above and beyond the norm when designing external management contracts. In particular, it’s important to contractually align the interests of the external manager and the public market shareholders wherever possible, and to ensure the total management fee is comparable to the general and administrative expenses (G&A) load at a comparable internally managed company.
Emerging market REITs should also place a strong emphasis on financial disclosure when preparing to attract global investors. It can be difficult for investors to make apples-to-apples comparisons across borders because of the different accounting standards and different free cash flow metric definitions. It is critical for emerging market REITs to translate their performance metrics to those that global REIT investors know well.
Green Street believes the securitization of real estate is a powerful trend that will continue, and the growing REIT market around the world offers exciting new opportunities and challenges. With dedicated advisory professionals in the U.S. and Europe serving clients spanning five continents, Green Street's Advisory Group is uniquely positioned to translate real estate best practices across global markets.
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