Chapter 1: Introduction

1.1 Introduction

A Real Estate Investment Trust (REIT) is a mode of indirect investment which buys, sells, develops and manages property investments. REITs have an advantage in that they experience gains from certain taxation rules. Before REITs were introduced in the UK in 2007 listed property companies suffered from double taxation, with corporation and investors tax being paid on their dividends. With direct property investment there was only one taxation charge on rental income. In order to alleviate this problem the REIT structure was adopted in the UK, by making companies exempt if they met certain requirements.

The birth of the REIT structure came from the United States and dates back as far as the 1880’s. Originally they were simple modes of investment were it enabled investors to avoid double taxation by distributing their income to beneficiaries. In this essence they have not changed however are more heavily regulated than these early days. Although this tax advantage was ended in the US for a period they quickly re-emerged in 1960’s, were their structure has been developed since. Certain changes such as allowing pension funds investment access has saw the mode of investment sore.

Although REITs offer advantages of taxation it also has numerous benefits over direct property investment vehicles. The heterogeneity of property can lead to uncertainty about its market value which can be compounded by thin trading in some locations with a lack of transparent data on transaction prices also. Thin trading can lead to delays in the sale and slow legal transfer process. These disadvantages of direct property create the potential for illiquidity and prevent fund managers from actively managing their portfolios. Property also has higher management and transaction costs than the paper asset quality of REITs which can be sold in smaller divisible units. Direct property is lumpy in that only the largest financial institutions can afford to buy in any large volume. REITs have the benefit of being a paper asset tradable on major exchanges with their dividend linked to the income from property. Information for REITs are freely available and regulated by accounting policies. REITs also have the benefit of the opportunity for investors to diversify risk in their portfolio. This has the benefits of property but without the difficulties linked to direct property investments.

In the REIT structure there are 3 different types of REITs generally on offer. Equity REITs offer investment trusts where greater than 75% of assets are in the form of direct ownership of income producing properties. These are the most popular form of REIT. Mortgage REITs however deal in the ownership and investment of property mortgages, they loan money to owners of property or invest in existing mortgages or mortgage securities. These are debt instruments were income is generated from the interest they earn on the mortgage loans. A Hybrid REITs combine both equity and debt instrument.

Although REITs appear to offer many advantages in comparison to direct property investment their history in UK since their instigation in the UK has been greatly chequered with the global economic downturn having effected fund values greatly.

Source- REITa.org

1.2 Proposition

The proposition for this paper is;

Investor confidence in the UK-REIT has been permanently affected by the timing of their introduction to the UK during the recession.

1.3 Aims and Objectives

Indirect investment in property has been a steadily growing mode of investment in the UK over the previous years. With Real Estate Investment Trusts being introduced to the UK in 2007 my overall research aims to establish the effects recent years have had on investor confidence in UK-REITs performance as an indirect investment mode in portfolios. In order to meet this aim a number of objectives are assembled. These are:

1. To look at how the recession has affected investment in property as a whole.

2. To compare how direct and indirect investment in property have performed in the UK during the recession.
3. To establish whether there is an inherent problem with the structure of UKREITs or has the recession been the main driver for their underperformance.
4. To interview a mixture of fund managers, property investors and general property professionals in order to support theoretical findings of the poor performance of UK-REITs since their introduction and establish any other underlying factors in the UK-REIT system.

1.4 Scope of Study

This research initially involves an overview of the structure of the UK-REIT and its performance history since January 2007. The scope of the study is then further narrowed down, with emphasis on why the UK-REIT has performed poorly supported by interviews to indicate investor’s views of the future performance of UK-REITs.

1.5 Structure of Study

Chapter one: Introduction

Introduces the field of this study and states the hypothesis that will be investigated. The chapter also sets out the aims and objectives of the dissertation to understand the history of REIT performance within the UK and ascertain if investor confidence has been permanently affected by the recession and concludes with a brief discussion of the methods used.

Chapter two: Research Methodology

States the research methodology utilised to carry out this study. It looks at the various types of research and data that will be employed and how these findings will be analysed.

Chapter 3: Literature Review

This shall look at the generic fundamentals of the UK structure of the REIT in order to establish that the UK-REIT structure is not flawed. It will look at the theoretical determinants of the performance the UK-REIT.