REITs for the (Property) Czars

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Recently the rating agency Fitch highlighted the massive connection between shadow banking and mortgage REITs, a property investment vehicle that has increased hugely on the back of the collapse in the US property market. While REITs have been around for a while (first legislated for in 1960 by President Eisenhower ) they didn’t make much of an impact, as other forms of investment through asset speculation dominated the stock market.

With a financial crisis on the back of a bursting property bubble however, REITs finally came into its own as it seemed that the financial collapse deflated values in property sufficiently to make them a worthwhile investment given that prices in certain markets (mostly major capital cities) would likely rise again. As one of the requirements of REIT is to disperse up to 80% of its profits to shareholders, it is considered to be ‘safe’ from a regulatory point of view.

However, the Fitch report was written to highlight the considerable risk that mortgage REITs might pose, as they are being financed through the shadow banking system.

“Agency mREITs rely on repo funding from dealer banks, who in turn borrow through the triparty repo market. U.S. money market funds, known for being short-term risk-averse investors, are major repo lenders to dealer banks within the triparty market. *Therefore, risk aversion by either dealer banks or money funds could negatively affect mREITs’ repo funding terms and availability.

If, as a result, mREITs were compelled to deleverage and liquidate some of their MBS holdings, this incremental selling pressure could affect MBS pricing*. Recent research by the Federal Reserve Bank of New York, for example, indicated that a one-day liquidation of more than $4 billion in agency MBS could drive price declines.”

See diagram below.


Shadow banking (for which the IFSC is now a hub as – according to Hedge Funds Ireland – it accounts for over 40% of alternatives investments worldwide) is a form of finance that remains outside of regulatory oversight. Any proposed plans to change that will no doubt be watered down to nothing by the time they are published and are likely to remain as ‘guidelines’ for the industry if they are enacted in legislation. Of course, the over-reach of shadow banking, and the ability of private finance to created credit money without any oversight from central bank was one of the causes of the collapse in 2008.

Now, REITs are coming to Ireland – or rather Dublin – and it’s noteworthy that the first company to set up in the Irish stock exchange since 2007 is based on property speculation.

The Irish Times editorial this morning makes a point that should have given it pause for thought, but didn’t:

“A stock exchange exists to enable companies raise money, by selling their shares to the public, in order to develop their businesses. But with so many companies leaving and – until this week – none choosing to list in Dublin and raise capital for investment, the exchange seemed set in terminal decline.”

That itself is an indication why the Irish economy remains on the floor – the complete lack of private investment. This is the fundamental cause of the Irish recession. Those Irish companies that are large enough to have weathered the storm and remain in business have left, seeking investors (and opportunities) elsewhere. Irish private capital has absolutely no interest in investing in Ireland, yet the country and its tax regime remain the ‘flag of convenience’ for tax avoiding corporations that keep a couple of call centres open here to cover the fact that Ireland is a safe conduit to route their profits elsewhere (usually in bank accounts situated and managed from the US).

But, again, the only thing that Irish capitalists are able to try and gain from is property speculation. But there are still considerable problems in the property market – a workforce and citizenry that is weighed down with massive debt because the previous private-bank-developer fuelled-and-tax-incentivised bout of property speculation increased the amount they had to pay for houses to several times more than their actual earning potential. A draconian arrears resolution mechanism is set to flush out those whose earning potential has been decimated by the cost of refunding the banks for their losses in an effort to make the balance sheets of those banks look healthy for vulture fund investors. The additional advantage of this is that this will suddenly make available a tranche of cheap buy-to-rent as well as family owned residential property.

The main advantage of course, goes to those who are getting into the REITs business, which is one that depends on having a large enough portfolio to attract investors (mainly foreign but with a nominal Irish contingent). With prices only likely to rise in Dublin in the short to medium term it is not surprising that this is where REITs interest lies. The first Irish REITs company Green REITs said recently:

“…that its objective was to assemble a portfolio of freehold and long leasehold commercial properties in Dublin ahead of an expected upturn in the commercial property market.

Green Reit said it would target property in the range of €10m-€50m in the Dublin area.”

It is also looking to benefit from NAMA’s fire sales. NAMA’s original plan of using Qualified Investor Funds or QIFs – a funding pot for investors with more than €100,000 to put in which NAMA would then sell property to – has been quietly dropped in favour of REITs, the development of which it has actively supported.

And who are these scions of Irish investment that are such a good indication of a future improvement in our collective fortunes?

“Stephen Vernon and Pat Gunne, directors of the Irish property company Green Property, will manage the Reit.

Stephen Vernon was managing director of Green Property from 1993 until its buyout in 2002, a period when the company’s market capitalisation increased from €24m to about €1bn.

Green Reit is to be chaired by Gary Kennedy, current chairman of Greencore Group and a director at the drugmaker Elan. Other directors include Jerome Kennedy, a director at Independent News & Media, and Thom Wernink, a non-executive director at Atrium European Real Estate.”

But these guys are only estate agents. As the Fitch report indicates, mortgage REITs are mainly vehicles for shadow banking entities – that is the US money markets – seeking a good return, and once again it’s seeking gains from property speculation to do so. REITs is widely seen as currently the most tax efficient means of investment.

“A REIT is a tax efficient way to enjoy the benefits of owning investment properties without the hassles of being a landlord.”

Or supply-side, tax-incentivized property speculation to you and me. REITs do not have to pay corporation tax. They enjoy a 7 year capital gains tax holiday. Stamp Duty has been reduced from 6% to 2%. The small number of Irish investors will be taxed at 33% on shares.

However, for investors who not tax resident, well…

“Non-resident investors will not be liable to capital gains tax in Ireland because the REIT is a public listed company. However, such investors will be liable to such taxes in their home jurisdictions.”

So they can talk about how essential labour market reform is and the need for improved competitiveness, and reducing costs to attract this and that. But at the end of the day, there is only one way that that those with power in Ireland know how to make money for themselves – speculation on the commodity that caused all the problems in the first place and which many are still struggling to deal with.

Before it was AIB, Bank of Ireland, Irish Nationwide and Anglo Irish Bank that wanted to keep on playing in the US money markets and got an unlimited guarantee to continue to do so even though it made the state liable for their massive losses.

Now its the REITs boys and girls asking the state to let them carve up the Irish property market so that they too can go and play in the money market sandpit.

Sure with a significant chunk of shadow banking covered by Irish law, what could possibly go wrong?

REITs may be a first step in the development of Ireland as a hub for
the financing and management of international property investment.
This would build on the success of the International Financial Services
Centre (IFSC), REITs have the potential to complement the significant existing international funds industry located in Ireland, and to become part of the IFSC strategy for the further development of the sector.

Real Estate Investment Trusts (REITs), The International Standard for Property Investment. Presentation given by the Dept of Finance to explain changes announced in Budget 2013.