Diversification, liquidity and transparency in global-listed real estate
The FTSE EPRA/NAREIT Global Real Estate Index Series
Listed real estate securities offer investors the opportunity to access the commercial real estate market with the added liquidity, transparency and regulation associated with publicly traded stocks.
The FTSE EPRA/NAREIT Global Real Estate Index Series is designed to represent the performance of eligible listed real estate stocks worldwide, including real estate investment trusts (REITs) and other property-focused securities. The index series includes companies involved in the ownership and development of income-producing real estate.
The series provides comprehensive coverage of the liquid, listed real estate universe by covering global, developed and emerging markets, and includes a range of regional and country, capped, dividend-focused, sector, REIT and non-REIT indexes. At the same time, by requiring index constituents to derive at least 75% of their earnings before interest, tax, depreciation and amortization (EBITDA) from real estate-related activities to qualify for index inclusion, the series provides purer real estate exposure than other index series with less stringent eligibility criteria.
The indexes are administered by FTSE International in partnership with the European Public Real Estate Association (EPRA), a non-profit organization responsible for promoting and developing the European real estate sector, and the National Association of Real Estate Investment Trusts (NAREIT), the US-based association for REITs and publicly traded real estate companies.
Characteristics of real estate as an asset class
As an asset class, real estate has several distinct characteristics:
- It is a tangible asset, offering a predictable income stream, derived from rents
- It provides the potential for long-term positive real returns as a result of the linkage to inflation indexes embedded in many rental contracts
- Direct investments are subject to liquidity limitations, high transaction costs and high lot size
- Property performance data is often based on valuations, rather than transactional data
The combination of an inflation-linked income stream, relative illiquidity and high transaction costs mean that, traditionally, real estate investments have been made with a long-term time horizon.
Accessing the asset class–direct, unlisted and listed real estate
Direct investment in real estate has generally been more accessible to large institutions, who are able to transact in large lot sizes and who may be relatively indifferent to short-term liquidity risks. An investor making a direct investment in property gains direct access to the income streams from the properties owned, but is also responsible for property management and is reliant on in-house expertise or specialist advice in the management of its property portfolio.
For many investors, an indirect investment in real estate is the only feasible route of accessing this asset class with adequate levels of diversification. This means gaining access to real estate via a collective investment vehicle such as a partnership, corporation, mutual fund or trust, which may be unlisted or listed.
An unlisted real estate investment vehicle has to manage its liquidity carefully. If it allows investors to invest or divest daily it is likely to hold a significant buffer of cash or listed property securities alongside its direct property holdings, enabling it to meet redemption requests from the investors in the fund at short notice.
In stressed market conditions even such a cash or securities buffer may be insufficient to meet investors’ demands for liquidity and the vehicle’s managers may be forced to suspend redemptions. For example, this happened to a number of pooled UK commercial property funds in June/July 2016 in the aftermath of the Brexit vote.
By design, a listed real estate investment vehicle offers investors an extra buffer of liquidity in the form of its stock exchange listing, which permits market participants to buy and sell on demand.
The most popular form of listed real estate investment company is the real estate investment trust (REIT). REITs were introduced in the US in the 1960s and have the legal obligation to distribute a high proportion (usually 90%) of their net income to investors each year. According to EPRA, legislation allowing for the listing of REITs existed in 34 countries around the world in 2016.
In Exhibit 1, we show the proportion of the property markets represented by listed property vehicles in Europe, North America, Asia-Pacific and Africa/Middle East.
While the overall property markets of the US and Europe are similar in value (around US$8 trillion), a smaller percentage of the market is accessible via listed property vehicles in Europe (5.9%) than in the US (11.5%). However, with the growth of listed property vehicles and the popularization of the REIT structure, this figure is steadily on the rise.
Why listed real estate?
Institutional investors’ allocations to real estate continue to rise. According to a recent survey by Cornell University and Hodes Weill and Associates, covering 228 institutional investors in 28 countries with over US$10.3 trillion under management, the average target allocation to real estate within institutional portfolios now stands at 9.9%, up 1% since 2013. The institutions surveyed indicated their intention to increase their target allocation by a further 0.4% by 2017.
Within the real estate asset class, listed real estate securities offer a combination of features that are important for investors unable to consider direct investments or who may be concerned about the illiquidity and high transaction costs traditionally associated with the asset class.
Shares of listed real estate are readily converted into cash because they are traded on the major stock exchanges. And listed real estate companies offer an extra layer of governance to investors: they operate under company law, as well as having to meet accounting standards and stock exchange rules and reporting requirements.
The FTSE EPRA/NAREIT Global Real Estate Index Series
The FTSE EPRA/NAREIT Global Real Estate Index Series is designed as a set of relevant, focused and investable real estate benchmarks, suitable for use either in performance measurement or as the underlying performance target for index-replicating financial products.
The principal characteristics of the index series are summarized in Exhibit 2.
The index series is designed to reflect the equity market performance of companies engaged in the major real estate markets of the world. As well as including a global index, the series covers the major geographical regions (the Americas, the UK, Europe and the Eurozone, Asia-Pacific and Japan).
The series also includes a number of indexes with a specific focus, such as developed and emerging market indexes, REIT and non-REIT indexes, dividend plus indexes, capped indexes and super liquid indexes.
The principal indexes within the series are the following:
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