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「Using business perspective to understand world changes」

This is the first episode of "Business Detective" 122Videos

Real Estate Investment Trusts, or REITsReal estate funds are definitely a product of the U.S. capital market. At its peak, the scale of U.S. real estate funds reached 4.5 trillion U.S. dollars, making it a capital behemoth in the real estate market!

Speaking of its birth, we have to go back to 1960. At that time, the US real estate market was still the same as what we just talked about. Because the Federal Reserve began to raise interest rates in 1958, the credit market tightened significantly, causing the United States to enter a recession in April 1960. At that time, the performance of real estate was very poor. Some people in Congress proposed that the real estate market was too bad because there were too few players and only big players could enter the market. If you want to revitalize the real estate market, you must attract more money.

So what is stopping the real estate market from sucking money in?One threshold is that the property is not in circulation.I don't need to tell you how troublesome it is to buy and sell a house.Another hurdle is that the average order value is too high.It is estimated that for most people, the most expensive thing they buy in their lifetime is a house, so ordinary investors will not invest in real estate casually.

However,All that changed on September 14, 1960, when President Eisenhower signed the Tobacco Tax Amendment, which added a real estate component that had nothing to do with the tobacco industry and was called the Real Estate Investment Trust Act.

US bills often have this kind of smuggling phenomenon, which is generally the remnant of the game between the two parties. The core content of this real estate investment trust bill is to securitize real estate by establishing so-called REITs, the abbreviation of Real Estate Investment Trust, a real estate investment trust fund.

What does it mean? Let’s start highlighting the key points!

This type of fund will mainly invest in real estate-related assets. Investors do not need to worry about the real estate part. As long as they invest a small amount of money, they can participate in this type of fund. 90% of the fund's profits must be distributed to investors according to law.It is similar to buying a house with a contribution, and the money earned will be shared with you, but you don’t have to worry about the hassles of buying a house, and you can enter and exit freely. Don’t you feel that the two problems that prevent the public from participating in real estate investment are no longer a problem? The introduction of this bill has opened a new chapter in the investment of the US real estate market.

Following the United States, at least 40 countries from Europe to Asia, including China, have introduced similar legal frameworks, laying the foundation for REITs to ride the wave in real estate investment.

Of course, the country that plays the biggest and wildest is still the United States!

Who is the driving force behind this?

With the legislative basis, of course, we still need people to bring REITs to the market. Here we have to talk about the person who established the first REITs fund:Thomas J. Broyhill, we call him Little Thomas. Little Thomas has a cousin, Joel Broyhill, who is an important congressman who promoted the introduction of the Real Estate Investment Trust Act.Through this cousin, Xiao Tang became one of the first people to notice this bill.

At first, no one knew how to play it, but when Xiao Tang heard about it, he felt that this was a once-in-a-lifetime opportunity and he had to do something. He considered many models, such as a model targeting wealthy people who invest in high-end projects, and also thought about targeting the middle class who want to build their own communities to increase their value.Finally, they decided to launch a popular product that had never existed in the real estate industry and in which everyone could participate. So in 1961, Tang established the first REITs fund: American Realty Trust.

Since it was the first, most of the American people didn’t know what it was at first. In order to promote it, Xiaotang started to give lectures everywhere, put up billboards on highways and even Wall Street, and promoted it to young people. He helped REITs enter the investment circle and was the absolute founder of the industry.

After initial exploration and popularization, the real estate fund industry has been developing faster and faster since the 1990s.At its peak in 2022, the overall REITs fund management size in the United States reached US$4.5 trillion, and almost half of the U.S. population invested in REITs or related assets.

This number is really scary. Why? Because according to last year's data, the size of the entire US real estate market was only 3.7 trillion US dollars.

So why are REITs so profitable?

Why are real estate funds so popular?

Real estate funds are very popular,✅One reason is that the investment returns are high and there are tax advantages.As early as the 19th century, British economist David Richardo discovered and proposed the "land rent theory".

From this theory, we can see that one of the main features of real estate is that it can continuously create cash flow. And as I just said, the law stipulates that 90% of REITs' income must be distributed directly to investors. This is the standard Cash Cow!

You should know that not all stocks will have dividends, and futures and so on have no dividends at all. The bonds () does have stable interest income, but if you wait until maturity, the principal will not have much room for appreciation. However, the properties held by REITs will still appreciate in value.

Let's talk about the tax benefits of REITs. The core is that you don't have to pay corporate tax. You should know that most stock dividends are taken out of the company's after-tax income, which is absolutely incomparable to REITs. Someone has calculated that the average annual return of active REITs can reach 10.6%.

What’s more, the cash income received by investors can also enjoy some tax deductions, which makes them earn a lot of money!

The second reason why real estate funds are so popular is that there are many ways to play, covering all aspects of the real estate market.As U.S. regulations continue to relax, the types of properties that REITs can invest in have become increasingly diverse. For example, the U.S. enacted the REITs Modernization Act in 1999, which further liberalized the areas in which REITs can enter.

So over the past 60 years, more than 20 real estate REITs have been developed, from shopping malls to cinemas, hospitals, data centers, agriculture, etc. Basically, whatever industry is popular, real estate REITs related to that industry will be launched.After all, which industry can be completely without land?

This provides a relatively stable and flexible investment opportunity for many investors who want to participate in new industries. For example, when the epidemic first started, e-commerce was very popular, so REITs related to e-commerce warehouses also became popular. In the past two years, AI has been popular, so REITs related to data center real estate have immediately taken the limelight. In addition, the United States enacted the Tax Reform Act in 1986, which also gave real estate funds the right to bypass third parties and operate directly, which gave REITs more room to make money.

The third reason why real estate funds are becoming more and more popular is that the threshold is getting lower and lower.Previously, it was necessary to go through specialized brokerages, and settlement and pricing took some time. However, starting in the 1990s, REITs began to be listed one after another, making participation in REITs as convenient as buying and selling stocks. Naturally, more investors, whether small retail investors or big money sponsors such as pension funds, were willing to enter the market.

The pros and cons of real estate funds?

Looking at the world's largest funds today, from Blackstone to KKR, almost no one has not touched on real estate funds. weLet’s talk about Blackstone, which is not only the “King of Global Private Equity” but also the “King of Real Estate”.

As the world's first trillion-dollar alternative asset fund, Blackstone has four business segments including real estate, private equity, hedge funds, and credit and insurance, among which real estate accounts for the largest proportion.

Including in China, they have also acquired real estate such as Changtai Plaza in Shanghai and participated in many projects.

You may have a question here, what are alternative assets? This is the so-called traditional assets that are easy to trade, such as stocks and bonds.

Alternative assets generally have poor liquidity, including private equity, real estate, raw materials, and even sports cars, artworks, and red wine.

So what can real estate funds like REITs bring to the real estate market?

Let’s talk about this benefit first.First of all, real estate is no longer exclusive to large companies and wealthy people. Small investors can also get a piece of the pie from real estate development.In this process, it also helped the real estate industry expand its sources of funds.

Secondly, it can help stabilize the market during a crisis.For example, Starwood, one of the protagonists of this wave of real estate fund crisis, started out by taking over a group of apartment buildings of "bankrupt" banks in the US savings and loan crisis in the 1980s and 1990s at low prices. Another example is Blackstone. Blackstone was founded in 1985 and initially focused on private equity. It only started to touch real estate in 1991. The financial crisis became an important turning point for Blackstone. At that time, Blackstone bought a large number of defaulted houses at low prices. Because they took over, the housing prices in the crisis were stabilized, and of course they also made a lot of money. Since then, real estate has become Blackstone's largest business.

Third, it is to accelerate the growth of emerging industries and regions.We have said before that whatever industry is hot, there will be REITs in that industry waiting to be hot, which actually attracts social capital to help these industries quickly build relevant infrastructure and accelerate development. In addition, because such capital parties are willing to participate and take over, more developers are willing to invest in new projects.

Why did REITs fail?

I just talked about the benefits of REITs, but if you play too big, there will be trouble, including the current crisis of US real estate funds.Let’s first talk about how these REITs traders, or sponsors, make money. They rely on collecting various management fees and handling fees.Some fees are charged based on the volume of real estate under management, while others are charged based on the returns. There are definitely many reasons for this. Data shows that all together, it is about 6% to 9% of the fund's returns.

So for these funds, if they want to make more money, they just need to attract as much money as possible and buy good properties.

When excessive REITs pour into real estate with a lot of money, the most direct result is a rush to buy houses and artificially push up housing prices.Just look at this chart, which is the price index of commercial housing. Can you imagine that after the outbreak of the epidemic, when no one went to the office anymore, the price index of commercial housing was still soaring? Don’t you think it’s unreasonable?

This is closely related to the influx of funds from a large number of REITs. At the same time, as large landlords, real estate funds are definitely stronger than small tenants, which will cause the market to increasingly fail to utilize ordinary tenants.The United Nations published a report in 2019 pointing out that after Blackstone bought a large number of defaulted houses after the financial crisis, it raised rents sharply, driving away many tenants.

How does a crisis brew?

Let's focus on the current crisis.The first protagonist is Blackstone. After the financial crisis, Blackstone, which benefited from the real estate era, established a real estate fund BREIT in 2017.，At that time, the U.S. real estate market was experiencing a bull market, and interest rates were still at historical lows.

Many people want to get involved in real estate.Blackstone's positioning of BREIT is to allow ordinary people to participate in commercial real estate. Its advantages are low thresholds, and people can enter with $2,500.Although it is not listed, it has the strong support of Blackstone and its distribution is done by securities firms of all sizes at all levels. Compared with other REITs, its various fees are relatively low. At the same time, BREIT promises high dividends and claims that its annual return on performance in recent years can exceed 10%.So BREIT became popular as soon as it was listed. In just five years, it reached a scale of 116 billion US dollars. At its peak, it could receive US$3 billion in capital inflows every month.

It became the largest real estate buyer in the United States, bringing Blackstone up to $1.8 billion in management fees in 2021.

But I didn't expect that the faster I climbed, the harder I fell.In 2022, the United States began to raise interest rates, everyone's capital costs increased, and commercial real estate began to perform poorly. At this time, investors wanted to take out their money, and Blackstone panicked.As a new fund, the main source of its cash flow for the generous dividend distribution was actually the continuous inflow of funds from new investors, rather than real money earned from real estate. So what made Blackstone anxious was not only that everyone wanted to withdraw money, but also that the new investment funds were beginning to dry up.

Moreover, the properties managed by BREIT not only have poor liquidity but are also shrinking in value. At the same time, Blackstone has added leverage during the investment process and is under pressure to pay interest. Therefore, Blackstone's entire cash flow is in crisis. In November 2022, it announced that it would begin to restrict redemptions. Monthly redemptions can only be 2% of investors' assets and no more than 5% per quarter. Even with such restrictions, $15 billion still flowed out of BREIT in 15 months.

Afterwards, fund companies such as KKR, which benefited from the previous wave of real estate dividends, also experienced capital outflows and restricted cash withdrawals. Although Blackstone ended the restrictions in March this year, Starwood proposed redemption restrictions in May.The outflow of funds from the entire real estate fund has begun to accelerate again, and the overall scale is expected to reach US$16.5 billion this year.

The U.S. real estate market, mainly the commercial real estate market, shows no signs of improvement, and investors are unlikely to return to the madness of the past, so the blood will continue to flow.

Buffett said that only when the tide recedes can we tell who is swimming naked. After experiencing the crazy tide, the entire real estate fund market may begin to find a true balance.

Relaxed regulation and legislative stimulus have brought about rapid development and huge capital in the U.S. real estate market, leading to an imbalance with real industry demand.The crisis may be inevitable, just as capital can never escape greed. What do you think of this real estate fund crisis? Leave a message to tell me.

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