LE 6.1

Posted: August 26th, 2021

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LE 6.1

Question 1

Real estate investment trusts(REITs) refers to firms owning and operating real estate businesses with the sole purpose of generating income. Most of these companies specialize in a particular sector of the real estate, often concentrating their resources on a given segment of the whole real estate. In some cases, however, a section of real estate companies practice diversification and those with specialty hold different properties in portfolios. Some of the properties in a portfolio may include data centers, apartment complexes, hotels, health care properties and infrastructure such as cables, energy pipelines and fiber cables, among others.  

Structure of REITs

Usually, REITs operates based on the trust structure to help safeguard the interests of an investor. Trusts refer to legal agreements that are established and managed based on a Trust Deed. In a Trust Deed, an investor’s asset is placed or entrusted to a group called trustees who manage the property in the interest of the unitholders or shareholders. The duties of the manager and the Trustee are further segregated. As a result, beneficial and legal ownership of the assets are also separated. In this structure, the legal owner of the estate is the Trustee, while the property is placed under the management of a professional. However, the two parties are bound by fiduciary duty to ensure often that the interests of Beneficiary are above their own. The chart below summarizes the structure of REITs.

Figure 1: Structure of REITs

As revealed in figure 1, the REIT manager is involved in the appointment of a property manager who manages the REIT at an agreed fee. The separation of duty and power in the REIT structure is achieved by separating management and ownership roles REIT assets between the REIT Manager and Trustee. Hence, this reduces conflicts in the organization setting.

Also, there are different types of REITs, namely; equity, mortgage and hybrid. Equity REITs are the most common. They are involved in the purchase, owning, and managing income-producing real estate. Their primary source of revenue is rented. Mortgage REITs are involved in money lending targeting real estate developers while hybrid REITS are engaged in both lending and holding of physical property. Thus, a hybrid portfolio assetis apportioned based on the performance of each REIT.

Besides, REITs have some tax advantages. For instance, they do not suffer from double taxation that C-Corporations face. In most C-Corporations, both the business and the investor are taxed separately according to distributions they have earned from the business.However, this benefit is countered when it comes to taxing dividends. Usually, the dividends are taxed at ordinary income rates instead of dividend rates. Hence, it is always appropriate to have REITs held under tax-protected accounts to avoid high taxation costs.

Question 2

Compared to other financial intermediaries, the performance of REITs has been increasing over the past twenty (20) years. REITs are increasing, attracting most retail investors, which depicts a significant shift in retirement assets. Currently, investments in REITs account for the most significant financial share concerning retirement assets. The trend has seen the volume of REIT increase from 25.9% in 2005 to 49.2% in the last quarter of 2018. As most retail investors continue seeking to place their investments in REIT, the trend is poised to increase gradually. Moreover, real estate complements strategically to a portfolio of bonds and stocks. The reason is that it establishes an additional diversification to the overall investment portfolio hence reducing the risks of a loss.

More so, the REITs are moving into the retail investment mainstream for both non-retirement and retirement accounts. The sector is recognizing the opportunity to capture themost significant share of investment in the properties market. For instance, by the year 2017, retail investors accounted for about 16% of the direct investments made in REIT. The REIT market has become highly attractive particularly after the introduction of tax cuts. The tax cuts allow the dividends accrued from ordinary REITs to forfeit 20% tax deduction irrespective of the exclusion of corporate entities’ tax rules. Therefore, the reduction in costs incurred on REITs has seen the industry grow overtime and the trend is expected in the 2020 period.

Question 3

Descriptive Statistics

The descriptive statistics show the characteristics of the dataset throughoutthe analysis from January 2015 to December 2018. The value-weighted return, including dividends for the seven REITs, was 0.00523 units. The standard deviation for the value-weighted return was 0.0332 within a range of -0.0888 (minimum) and 0.0740 (minimum) returns over the period. VTR, SPG and FRT exhibited the best performance in the portfolio by contributing 0.0046, 0.0029 and 0.00101 units respectively to the overall portfolio. The weighted return is negatively skewed at -0.6843 from the mean. The summary descriptive statistics are presented under Table 1 below:

Table 1: Descriptive Statistics Summary

	Mean	Median	Standard Deviation	Sample Variance	Skewness	Minimum	Maximum
BRX	-0.0050	-0.0031	0.0629	0.0040	0.0270	-0.1198	0.1102
VNO	-0.0027	0.0090	0.0580	0.0034	-0.2620	-0.1380	0.1120
WY	-0.0048	-0.0046	0.0674	0.0045	-0.0382	-0.1748	0.2044
FRT	0.0010	-0.0001	0.0492	0.0024	-0.0337	-0.0986	0.0970
VTR	0.0046	-0.0085	0.0613	0.0038	0.0854	-0.1367	0.1441
CBL	-0.0311	-0.0297	0.1173	0.0137	0.4667	-0.2819	0.3201
SPG	0.0029	0.0066	0.0523	0.0027	0.0447	-0.1017	0.0975
Value-Weighted Return-incl. dividends	0.0053	0.0094	0.0332	0.0011	-0.6843	-0.0898	0.0740

Table 1 above is a summary descriptive statistics for the monthly portfolio returns over the past four (4) years in the REITs investment.

Correlation – Variance/Covariance Matrix Analysis

Analysis ofthe correlation coefficient reveals a positive relationshipwithin theREIT portfolio. It, therefore, implies that a unit increase in individual REIT returns positively impacts the unit change in the whole portfolio.The correlation coefficients are as expected. It is expected that the leverage of the traded REITs is below 50% or 0.5. Hence, the results conform to these expectations as summarized in Table 2 below. The score is related to the market proxy, which conforms to the expectations.

Table 2: Correlation-Variance/Co-Variance Matrix

Correlation-Variance/Co-variance Matrix
	BRX	VNO	WY	FRT	VTR	CBL	SPG
BRX	0.0040	0.0027	0.0011	0.0026	0.0018	0.0031	0.0024
VNO	0.0027	0.0034	0.0023	0.0022	0.0019	0.0029	0.0023
WY	0.0011	0.0023	0.0046	0.0009	0.0009	0.0035	0.0011
FRT	0.0026	0.0022	0.0009	0.0025	0.0020	0.0011	0.0020
VTR	0.0018	0.0019	0.0009	0.0020	0.0038	0.0007	0.0021
CBL	0.0031	0.0029	0.0035	0.0011	0.0007	0.0140	0.0023
SPG	0.0024	0.0023	0.0011	0.0020	0.0021	0.0023	0.0028

            Table 2 summarizes the variance-covariance output following the analysis of portfolio returns. Besides exhibiting less risk, the REITs portfolio is also stable and it is not easily subjected to price fluctuations in the market. Examining the standard deviation and returns while assuming a uniform distribution of portfolio weights, the results exhibit a 0.5% annualized probability of loss on returns with an estimated deviation of 0.24%, which is still within a stable range (See Excel Chart).

Beta Analysis (See Excel)

Subsequently, the portfolio beta results show that when exposed to the market, prices are likely to fluctuate at 10.5%. This represents the risks of exposure, which is less than 1 or below 100%. Thus, it implies that the REITs portfolio investment has lower volatility than the market. As such, going into the year 2020 based on the current projections, the REITs market is likely to report a continuously stable growth due to its ability to withstand fluctuations in the property market prices. This is especially in VTR, SPG and FRT REITs. However, the case may be different in BRX, VNO and WY since they have exhibited wide fluctuations throughout the analysis period.