Funding Real Estate Development:

1
Funding Real Estate Development
Real Estate Investment Trusts

• WB/IFC Housing Finance Conference
• Washington, D.C.
• March 15 17, 2006
• Michael Bookstaber

2
What is a REIT (1) ?

• An Investment Club
• Needing cash in big, irregular increments, not a
  steady stream of cash flow
• Can be open ended or closed ended
• Vertically integrated property development,
  property management, and portfolio
• Sources of Funds
• Capital markets, equity subscriptions
• Private investors
• Little or no debt (equity REITs)
• Uses of Funds
• Buys land and develops projects, rents out units
• Expenses in staff costs are minimal
• Expenses for property management are incremental
  costs to the hard asset.

3
What is a REIT (2) ?

• The balance sheet consists of
• Investment in developed properties on the asset
  side, and
• Equity capital on the liability side
• Profitability, measured by two items
• Cashflow from operations equals.rents less (a)
  cost of property maintence. (b) payments on any
  mortgage debt, (c) staff expense
• Gains from sales of (matured) properties
• Staff costs are minimal because
• REITs outsource many key functions property
  maintenance, project management of development of
  new properties
• Property management function is highly leveraged,
  similar to mortgage loan servicing
• As a result, REITs dont need to retain
  earnings, they do need access to large pools of
  cash on an intermittent basis

4
The Disconnect

• Mortgage finance and property development are out
  of synch

Lack of Affordable and Bankable Housing
Solutions (supply/demand imbalance)
Developers not producing due to lack of long term
mortgage takeout
Mortgage markets are under-developed due to
scarcity of housing stock
5
The Need

• Investment in real estate development
• Needs patient, long-term capital
• Can be highly risky, calling for equity-like
  returns
• Requires a focus on property type to leverage
  experience and expertise of management
• Capital is needed for
• Land acquisition
• Land development
• Funding soft costs
• In-site infrastructure
• These expenses typically comprise 35 to 50
  percent of total project costs

6
The Projects

• Large scale, expensive to execute
• Commercial income-producing properties
• Residential, community format

• Large scale projects (1,000 housing units or
  more) delivered in rational production stages
• Achieve economies of scale
• Utilize mass production techniques
• Spread cost of infrastructure over many housing
  units, financed in the mortgage
• World class urban design, incorporating
• mix of housing styles and options,
• mix of socio-economic groups,
• providing for quality of life amenities, green
  areas, recreation and community facilities,
• retail and commercial spaces
• Ongoing support services will be incorporated
  into each project
• Waste management, Maintenance of common areas,
  security

CONCLUSION Value of housing will be perserved
and enhanced by design and urban planning,
ensuring good storehouse of value for lenders and
homeowners (avoiding the creation of future
slums)
7
The Problem

• Investment vehicles to effectively fund and
  manage projects are typically not available in
  developing markets. Why?
• Absence of long-term capital
• Governmental investment in urban planning and in
  big-ticket infrastructure is often lacking in
  developing markets
• Nascent equity markets
• Reluctance to use tax policy to foster investment

8
The Solution

• Real Estate Investment Trusts (REITs, USA-style)
• Attract long-term, patient capital
• Offer specialization by property type
• Offer development and on-going management
• Tax pass-through feature offers dividend-like
  returns to investors and equity-like upside of a
  medium to long-term horizon
• Attract investors who need current income and can
  shelter it for tax purposes
• Attract total return investors who benefit from
  upside stemming from turnover of value-enhanced
  properties

9
The REIT World

• The REIT concept is gaining acceptance around the
  world, in many developed countries, but also some
  emerging markets.

Country Year Introduced
Europe Europe
Belgium 1995
France 2003
Germany 2006
Italy 1994
Luxembourg 1988
Netherlands 1969
Spain 1994
United Kingdom 2006
North America North America
Canada 1994
United States 1960
Country Year Introduced
Asia-Pacific Asia-Pacific
Australia 1971
Hong Kong 2003
Japan 2000
Korea 2001
Malaysia Late 1980s
Singapore 2002
Taiwan 2003
Latin America Latin America
Mexico 2004
Brazil 1993
10
The Rationale

• Why are REITs the right investment vehicle for
  real estate development?

PRINCIPLE ONE Value enhancement comes from
refurbishing old properties or creating new
properties, and managing either until cash flow
is established.

• PRINCIPLE TWO Dividend yield from REITs is a
  payout of current cash flow, which does not need
  to be retained.
• maintenance of properties is an expense item
  offsetting rental income
• cash from creation of new properties is obtained
  from selling mature properties in portfolio or
  raising new equity from investors.

CONCLUSION Fixed income and medium to long-term
upside combine to give investors a unique total
return package, WHICH IS A GOOD PROXY FOR DIRECT
INVESTMENT IN REAL ESTATE
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The Risk

• Real estate development can be risky, yet REITs
  can offer risk mitigating features

• Equity REITS use little or no debt, except for
  construction finance
• Focus on property type, leveraging management
  experience and expertise
• Diversification in funding sources stemming from
  either
• pooled investment from a closed group of
  investors
• sale of stock to many, diverse individual
  shareholders
• Diversification in multiple property investments
• Income is generated from income produced via
  rents, fees from management of properties, and
  capital appreciation of properties

12
The Tax Angle

• Under U.S. REIT law
• Payment of tax on REIT net earnings occurs only
  once, at the shareholder level, not at the
  corporate level
• provided that the REIT distributes at least 90
  percent of its net income in dividends to
  shareholders.

How critical is this tax break to the
successful use of REITs as investment vehicles
for real estate development?
13
The Tax Break Value

• WITH THE TAX BREAK
• Pension funds (not taxable) can boost their
  investment yields using REITs. Real estate
  development thus draws on a significant pool of
  long-term investment funds
• Listed REITs add additional value of liquidity,
  thus becoming a form of securitized real estate.
  Their trading value is determined by dividend
  yield.
• REITs represent an efficient use of capital
• by taxing returns only once
• earnings from investment in income-producing
  properties is recycled immediately, not
  warehoused for new projects.

14
The Tax Break Value

• WITHOUT THE TAX BREAK
• Encourages short term holdings in long-term
  assets.
• Encourages property development and divestiture
  before properties have matured, or before they
  have started to generate income.
• Long-term investors are disuaded from
  participating due to quick property turnover
• REITs of this type will undertake more risky
  investments, stemming from quick turnover.