Woolworths (supermarkets) is a leading chain of retail stores in Australia that was established in 1924 at a single basement store in Sydney (Woolworths, 2012). Although the company has been posting positive results, there is a need for management to consider refocusing their strategy by selling a portion of their real estate. Although the company intends to liquidate this portion of real estate, there are benefits to shareholders that are associated with real estate investment trusts:
Increased returns from investment – It is a legal requirement that at least 90% of returns on real estate trust funds be diverted to investors. Meaning that for shareholders of Woolworths, a divestiture strategy will result into attractive returns on their dividend yields. Similarly, REIT dividends are often secured by rents from long-term leases; which are relatively stable. For instance, in the US, the average long-term REIT dividend yield is approximately 8%, a rate that is conspicuously higher than the S&P 500 index (Lee & Stevenson, 2006).
Simple tax treatment – Tax considerations for REIT shareholders are fairly straightforward. As such, dividends are often apportioned to ordinary income, returns on capital and capital gains. Since REITs are not taxed at corporate levels, individuals are taxed at their income level. Also, returns on capital, or distributions in excess of real estate investment trusts earnings and profits are often not taxed as ordinary income, but rather applied in reducing the investor’s cost basis in the stock.
Liquidity of REIT shares – under normal operational environment; it would be much harder for a company to sell its real estate assets so that a shareholder can benefit from the sale at exit. However, placing these assets under an independent real estate investment trust manager will ensure that the shares of the property trades at the stock exchange. With flexible buying and selling of REIT shares on the stock exchange, shareholders can easily liquidate their stocks and convert them into liquid cash for use.
Reduced risk on portfolio – Research has indicated that adding real estate investment trust funds to a diversified investment portfolio reduces risks while increasing returns since REITs are significantly correlated with most benchmark indices. If the shareholder were to invest in real estate by purchasing their own estates, they would have to secure a personal loan for the purchase. With this regard, the failure or success of these singular projects exposes the shareholders to significant levels of personal risks.
By entering the REIT market, Woolworths ensures that individual investors have a share of the trust. This implies that the risk of success or failure is not limited to an individual but rather spread evenly to all shareholders.
Professional management of properties – Although REITs are meant to allow average investor actively participate in the real estate market, there are other inherent benefits accruing from this arrangement, such as professional management of real estates. If the supermarket is involved in the management of these real estate assets, there might vary incidences of conflict of interest and boardroom wrangles. Delegating this responsibility to an independent asset manager would therefore assure the shareholders of efficient management of their stakes (Mueller & Mueller, 2003).
However, there are some cautions that should be exercised with this type of arrangement. Despite the fact that REITs are associated attractive benefits to the shareholders, there are some risks that are associated with the trusts, though. The real estate industry is often characterized by sharp increases and slow decreases in the cost of buying homes. Since individual shareholders are homeowners, they are normally aware of these drastic increases in costs of owning a home, and that real estate bubbles may burst at anytime (Samuelson, 1997). As such, the shareholders may shy away from the idea of entering the real estate investment trusts.
Lee, S. & Stevenson, S. (2006). Real Estate in the Mixed-Asset Portfolio: The Question of Consistency, Journal of Property Investment and Finance. 24(2):123-135.
Mueller, A.G. & Mueller, R.G. (2003). Public and Private Real Estate in a Mixed-Asset Portfolio. Journal of Real Estate Portfolio Management 9(3): 193-203.
Samuelson, P. (1997). "General Proof that Diversification Pays,"Journal of Financial and Quantitative Analysis 2, March 1997, 1-13.
Sullivan, A. & Sheffrin, M.S. (2003). Economics: Principles in action. Upper Saddle River: Pearson Prentice Hall-Woolworths.com, Our story. Retrieved on 16 Oct. 2012 from: http://www.woolworths.com.au/wps/wcm/connect/Website/Woolworths/About+Us/Our-Story/