Causa Finita advices on how to diversify your REIT property portfolio.
– the final version of Polish law on REIT is still unknown, yet, there is no doubt that Polish REITS will be able to function in various property sectors. Thus, portfolio diversification will become a crucial question here as well.
During our last interview you mentioned a need for a reasonable property portfolio diversification regarding a given REIT. What should be diversified then?
REITS worldwide operate in a variety of property sectors and geographical regions. The cradle of REITS – the United States of America- companies of such profile deal with almost every type of property we can imagine. Besides malls, offices, housing estates REITS let properties for prisons, casinos, warehouses, forests, archives, wind and solar farms, railways, roads, transmission networks, mobile network masts, plants and farms. Mortgage REITS purchase whole mortgage packages. One of the USA REITS attempted to set up a cemetery. Eventually it turned out that in New Jersey state cemeteries can be run only by non-profit organisations…
The final version of Polish law on REIT is still unknown, yet, there is no doubt that Polish REITS will be able to function in various property sectors. Thus, portfolio diversification will become a crucial question here as well.
Would diversification bring any precise results?
Each sector is different and reacts depending on various conditions and business environment of tenants. Long term let of factory in Poznań is something totally different than short term let of hotel rooms in Wisła.
Are diversified portfolio REITS managed some different way than these of more specialized profile?
Yes, of course. Let’s take two different examples. One of them, so-called ‘Multi REIT ‘ comprises of three retail malls, two hotels and a couple of properties let for healthcare services. The other, so-called ‘Single REIT’ is in possession of malls only. American market experiences teach us that in a current market situation which is oversupply we can expect investors evaluating Multi REIT shares as a safer investment. Profit from hotel and warehouse lets will balance the decrease in profits from retail lets. We can assume this will be soon reflected in shares rate. It will be more stable as the results of Multi REIT are easier to forecast. On the example of Single REIT we can notice that the results will be more variable. Stock investors will perceive their shares as fraught with risk, thus, will expect higher profits.
Is it your suggestion then to diversify?
It is a very complex issue to answer. We cannot forget about such an important factor as overall REITS costs and their credibility in the eyes of the investors. Coming back to our example Multi REIT would need to possess considerably more resources to manage retail malls, hotels or healthcare centres. Taking into account the profits from letting its costs will be higher than these that competition needs to cover. The risk of failure steps and business decisions will be higher. We need to remember that stock investors will focus on a REIT team qualification and experience to manage a given property sector. Single REIT will do better due to its specialization in single, specified area. Research carried out by American organization NAREIT show that investors in order to disperse risk choose to do so on the level of their portfolios by purchasing a lot of specialized REITS instead of one of diversified portfolio.
Are there any negative diversification aspects?
The above described situation will be even better seen when REIT decides on personal selling or city malls development. Investors may start to worry about Multi REIT directors fail in reading the market conditions, underestimating potential of future projects or seeking new clients. Such threats will not be that influential when taking into account Single REIT. In such cases highly specialized team will have a chance to boast of many similar projects to have been executed in the past. Most likely Multi REIT will be forced to bear higher costs of personal selling and development (agents, due diligence, legal or technical service.) Specialized REITS using economies of scales are able to reasonably minimize such costs.
Which REITS should aim at portfolio diversification?
The crux of this issue is REIT transparency. The more coherent REIT the easier it is for the investors to grasp its business idea and evaluate its potential. Higher transparency of a REIT property portfolio means higher liquidation of its shares and finally results in lower capital costs and higher stock capitalisation.
To answer a question whether and how to diversify our REIT portfolio we need to emphasise that the structure of REIT properties we possess must ensure our progress in business development strategy. If we aim at dynamic REIT development we will need money to finance new projects. Money can be achieved from less risk averse investors who seek REITS of high development potential. In such conditions it is much better our REIT has a uniform property portfolio. It will be more transparent for investors and cheaper to manage. It will be easier to encourage potential investors that our REIT team are highly skilled and experienced professionals who can face any challenge regarding development.
However, if we prefer organic development ( that is stable revenue increase from the properties we already have), than we must rely on the fact our REIT will attract capital based on stable, though moderate, increase in share prices and regularly paid dividends. It is a case where well—balanced portfolio diversification is advised.
autor: Robert Szczepanek, Attorney at law, founder of CAUSA FINITA Law Firm