Online Financial Tips

Archive for the ‘Real Estate Investment Trusts’ Category

According to a latest report of FCCI and Ernst and Young in the list of top nine attractive destinations for property investments, India is ranked as the fifth most attractive destination for future property investments. In this list China is on top spot, USA is on second followed by England and Singapore. Because of good economy development and improved real estate market index, India gain fifth spot as most attractive destination. On the other hand China remains attractive as an investment destination primarily due to its impressive economic growth record and favorable demographics.

If government of India allows real estate investment trust (REIT) and real estate mutual funds (REMF), India can overtake the Chinese attractiveness in property investment. Lack of source of finance in India is also one of the reason for making Indian property investment less attractive than other. So that government should promote some alternative source of funding this will be helpful in getting good response.

This is all about the Indian real estate position in the world and now I am going to explain you why Indian property can be more profitable in future.

In India the price of houses are going to rise high because India will face shortage of over 26 million houses by 2012 and that’s why demand of houses will be more as compare to the supply.

“With India back on a high growth trajectory, demand for commercial and residential space is likely to witness an upward trend,” consultancy firm Ernst and Young said in a report.

Because of growing young working population, increasing urbanization, declining household size and improved availability of loans demand for residential property going to rise more high in future.

In India $1.2 trillion investment was needed to meet the rising demand for urban development said Co-chairman of FICCI Real Estate Committee Pranay Vakil.

He said that the urban population in India would nearly double to 600 million in the next 15 years from nearly 350 million now, and this would put massive pressure on urban infrastructure, including roads, power and water supply.

Dean Hodcroft, partner-head of real estate for Europe, Middle East, India and Africa at Ernst and Young, said India needed institutional reforms to attract more investments in infrastructure development projects.

Many investors in British Columbia who have chosen RRSPs and mutual funds over the past decade have been disappointed by investments that either have underperformed, or have been affected by the turmoil of the stock market in recent years. However, savvy real estate investment participants who have invested in REITs have learned to expect a regular distribution deposited in their bank account each month.

When choosing a REIT, look for an experienced manager with a strong track record. It’s also important to make sure the management team has experience with the property type that is part of the portfolio, be it commercial space or residential real estate. REITs should produce strong net operating incomes on a regular basis, and cash flow should also be demonstrably strong and sustainable. Ensuring that the REIT has limited debt is also critical. While a real estate investment trust can typically leverage investor funds with external capital in order to compete in the real estate market and generate sustainable returns, debt can still introduce risk to the equation. At the very least, debt possessed by the Trust should feature a fixed interest rate in the short term.

Management should also demonstrate faith in the Trust itself, so it’s always wise to look for management investment in the REIT; this can help keep management interests aligned with those of the investor. The larger the portfolio the better. REITs with larger assets sizes benefit from economies of scale in the face of fixed overhead costs. It’s also wise to shop around to compare management fees, degrees of tax deferral, lease rollover rates, and the operating plan of the REIT.

Finally, communication is key. Investors should seek out managers that provide regular updates on not only the performance of the portfolio, but also changes to the business operation, and how these changes are streamlining the operation to provide even more profits.

You’ve undoubtedly heard about the three million homeowners who have gone into foreclosure this year. There are pundits that say the commercial real estate market is the next segment of the market to experience a huge downturn. If you’re a value investor, you might consider now the right time to enter into the real estate market. Real estate has certainly experienced a significant downturn, thus you think you’re buying a property on sale at a severely discounted price. You have also determined that the economy may be on its way to turning around and moving toward recovery. However, you may not be cut out to be a landlord. You do not want the responsibility of collecting rent or being woken up at 2am when your renter’s pipes have burst. Real Estate Investment Trust or “REIT” may be a great investment alternative to purchasing a rental or investment property.

What is a REIT?
REITS stands for Real Estate Investment Trust. A REIT is a company that invests and manages real estate projects. As with stocks, there are several types of REITs you can invest in. Some REITs will specialize in commercial projects such as shopping mall or office buildings; other trusts will invest in apartment complexes or residential developments.REITS are publicly traded companies. They are highly liquid and are traded just like any other stock. Like most other asset classes, you can choose to invest in a mutual fund or ETF to mitigate your investment risk.

Spreading your risk
There are hundreds of different REITs and mutual funds which specialize in REITS. As always, you must choose which section within the REIT universe that suits your needs.An ETF REIT may invest in 20 or more different REITS, thus spread default risk.

Diversification
REITS can be considered non corrolated verses equities. The 20 year historical return for a REIT is 10.57%, slightly higher than the S&P 500. In most markets, REITS and real estate can be considered a hedge against equities (stocks). The FTSE NAREIT All REITs Index, which represents the full universe of U.S. publicly traded real estate investment trust (REIT) stocks, had returned 19.73% year to date, as of November 30, 2009.

Please consult with a financial planner to see if REITS fit in your investment strategy.

In 1980, Congress enacted the Foreign Investment in Real Property Tax Act (FIRPTA), 26 U.S.C.S. 1445. The law provides that if a seller of real property is a “foreign person,” the buyer must withhold a tax equal to 10% of the gross purchase price, unless an exemption applies under the law.

A “foreign person” is a non-resident alien individual, a foreign corporation not treated as a domestic corporation, or a foreign partnership, trust or estate. A resident alien is not considered a foreign person under the law.

Exemptions to FIRPTA

There are a number of exemptions to FIRPTA. A transaction is exempt if:

the seller of real property furnishes a non-foreign affidavit stating under penalty of perjury that the seller is not a foreign person the transaction involves the transfer of a property acquired for use as the buyer’s residence and the amount realized is not greater than $300,000 the seller obtains a “qualifying statement” from the Internal Revenue Service stating that no withholding will be required
Obtaining Legal Counsel

In connection with any real estate sale involving a foreign investor the buyer and the seller should consider making a specific agreement with regard to FIRPTA compliance. The expertise of a real estate attorney may be helpful to avoid complications that may otherwise arise at the last minute and delay the closing.

One of the first things people looking to start investing in real estate generally ask about is how to find investors, or how to generate the capital to do their deals. While a traditional bank or mortgage lender can be of some help, most real estate investment companies today use other options for funding. Two of these options are known in the business as “hard money” and “private money.”

Hard Money

In real estate investment, the term “hard money” refers to a short-term loan which is used to finance a property. Hard money gets its name from the fact that these type of loans are very expensive for the borrower and yet also very advantageous for the lender. For real estate investment transactions, hard money lenders will generally only loan on properties up to 65% loan-to-value and will charge an interest rate well above the current standard mortgage rates. The reason for the high cost of obtaining hard money is that it is much easier to borrow, and because of this the lender is placed in a position with much more risk of default. Hard money can be good for very short-term needs or if a situation comes up without any readily available alternatives.

Private Money

Private money, just as it sounds, is money you can obtain from private individuals for real estate investment funding purposes. Private money can be obtained in a variety of ways, and can be a much better deal than using hard money. The biggest advantage of private money is the lower cost than hard money, and the added flexibility of working with investors who come to know you and understand your business.

Finding private money lenders requires prospecting for investors. When you enter the arena of real estate investing, prospecting for investors needs to be something you do on a regular basis in order to insure that you always have the capital readily available to fund your deals. Finding the right real estate investors means that you can make the best deals possible, and you can make them on your own terms rather than the terms of a bank or a hard money lender.

Depreciation is a difficult subject in the area of cost accounting for commercial real estate.

Accountants do strive to make their financial statements accurate, and so they must recognize a fundamental principle of the universe that has troubled philosophers for tens of thousands of years. As George Harrison sang years ago, “All Things Must Pass.”

There is nothing permanent in this three-dimensional world of space, time, matter and energy. Just as any Buddhist.

No building will last forever. Even the pyramids of Egypt will someday erode into dust.

Therefore, real estate property owners are allowed to deduct an expense from their gross income, called depreciation, on the theory that every year, the building is being worn down somewhat by the wear and tear of the universe. What physicists call entropy, according to The Third Law of Thermodynamics.

This depreciation expense is often calculated by dividing the total cost of the building by the number of years it’s expected to have a useful life.

If you pay one million dollars for a building, and it’s expected to last 10 years, that’s a straight-line depreciation expense of $100,000 per year.

Notice that $100,000 in cash is not actually paid out of your pocket. Depreciation simply reflects the reality that sooner or later, that building won’t be useful, and so the $1,000,000 you paid will be gone.

Although this is not practical, the ideal would be for you to pay someone $100,000 a year for ten years to build you a new, replacement building.

And when you take the depreciation expense, that is also deducted from the building’s cost basis. So after 10 years, in the above example, that building is officially worth nothing, even though it may still be in great condition in a prosperous neighborhood. If it’s well-maintained and in a good area, it can be useful for an indefinite period.

So one of the big problems is deciding what the useful life span of a commercial building is.

Of course, when we’re talking about shopping malls, we’re assuming their function is to lease space out to retail stores and restaurants, not to act as tourist attractions. So we can rule out multi-thousand year old spans such as represented by the Coliseum of Rome and the ruins of Angkor Wat — which attract tourist money even though they’ve fallen down.

Yet even when we come down the level of commonplace apartment building and shopping strip centers, we just don’t know for sure how long they’ll last. Sure, there’re castles in Europe hundreds of years old — but also stone farm houses where farming families still live.

So it’s entirely possible for a building in a good area to be bought or built, to have the depreciation expense taken on them . . . and 20 or 30 years later they’re now worth far more than you originally paid.

So, in a long-term sense, depreciation reflects something real, but it’s difficult to know just how much of an expense to take every year — without a crystal ball.

For example New York City’s Empire State Building is nearly 80 years old, but would be worth many millions if sold. The World Trade Center’s useful life ended prematurely in a way that couldn’t be predicted.

So when a Real Estate Investment Trust calculates its net income, it is required to apply Generally Accepted Accounting Principles. It will figure out its gross revenues, then subtract its operating expenses, then subtract a substantial figure representing depreciation on the buildings it owns — even though they may in fact have appreciated in value.

Let’s say XYZ REIT had gross revenues of $1,000,000 and operating expenses of $$700,000. That leaves $300,000. Then they deduct another $100,000 for depreciation. That leaves $200,000 as their net operating income.

The law requires them to pay at least 90% of this to their shareholders in the form of dividends. So they must mail out $200,000 X .90 = $180,000 to their investors.

But wait — the $100,000 depreciation expense is a “book entry” only. That is, it’s only on paper.

The $700,000 operating expenses represent cash that left the REIT’s bank account to pay for salaries, repairs, and other necessary expenditures.

Depreciation does not represent a cash payment to anybody. That $100,000 is still sitting in their bank account.

So why not pay it out to their shareholders also?

That’d be $180,000 plus $100,000 = $280,000 available for dividends for shareholders, making them even happier.

Why not, indeed? That’s what many of these companies do — pay out more in dividends that the law requires.

And receiving some dividend payments that represent depreciation should make the shareholders even happier than usual. Here’s why.

The percentage of the dividend checks they receive from real estate investment trusts that represents depreciation is not immediately taxable to shareholders.

Because it represents money that’s available only because the company took a depreciation expense, according to the IRS it’s officially a “return of capital,” not income.

A return of capital is not taxable because it’s not income. But it does reduce the cost basis of your REIT shares.

When is the only time you care about the cost basis of your shares of stock?

When you sell them.

If you don’t sell them . . . you don’t have to ever care.

Let’s say you bought 100 shares of XYZ REIT for $10 each. Your cost basis is $1000.

In the first year got a dollar back for each share, of which 25 cents per share was for depreciation. Which means your cost basis is reduced by .25 X 100 = $25.00.

So your cost basis in those 100 shares is now $975 instead of $1000.

You do have to pay taxes on the dividends, but only on $75, not the full $100.

If next year you decide to sell the shares of stock for $11 each, you’d get a total of $1100. You’d owe capital gains taxes on $125 instead of $100.

In effect, you’re now paying the taxes on that 25 cents per share depreciation in dividend checks you received the year before.

But let’s say you’re smarter than that. You don’t sell your shares of XYZ. You just keep collecting the dividends for as long as you live.

When do you pay taxes on the depreciation percentage? Never.

The implications of this aren’t widely known or understood. Even the best known REIT book writer, Ralph L. Block, doesn’t mention this in his book INVESTING IN REITS until the first Appendix.

The percentage of dividend checks that represent return of capital because of depreciation varies from company to company, and can of course vary over time. Historically, it runs 25% to 30%.

The bottom line for real estate trust shareholders is that — if they never sell their shares — their effective, net after-tax yields are significantly higher than they think. The exact amount depends on their marginal tax rate.

Let’s say that in the above example, your marginal tax rate is 35%.

You’ll owe ordinary taxes of .35 X $75 = $26.25.

You received $100, and paid $26.25 in taxes, leaving you with an after-tax net of $73.75.

Your after-tax net yield on your shares is 7.375%.

If this was an ordinary dividend-paying company in some business besides real estate, you’d have to pay taxes on the entire $100 in dividends, for a total tax owed of $35. For a net of $65. For a net after-tax yield of 6.5%.

Therefore, to figure out the true net, after-tax yield of a REIT, you must multiply its stated yield by (one plus the depreciation percentage X your marginal tax rate).

Thus, in the above example, the apparently yield is 10%. (One dollar in dividends for ten dollars worth of stock).

.10 X (1 + ((.25 X .35)) =

.10 X 1.0875 = 10.875% net after tax yield

Purists would argue that you should use the new cost basis, but my argument is that it’s irrelevant so long as you never sell the stock. In that case, your “practical” cost basis is what you originally paid for it.

So never sell it.