The benefit of investing in real estate, as Italians love to do (80% of families owns a home, and 13% at least two) is easy to spot: full control of asset, personalized management, and low correlation with financial markets. Also, one avoids investing in costly and sometimes opaque financial instruments.
However, buying a home has specific risks and costs that are not always adequately taken into account: the direct management of an asset requires time; risk is concentrated on one or two lease-holders; it could be hard to fill a vacancy; diversification of risk is very limited. Also, with the increase in the average cost of homes and offices, the minimum threshold for investment has gotten high. Finally, the investment is illiquid in the short-term and could be a constraint in legal succession. Will SIIQs (Italian acronym for listed real estate investment companies) be as successful as Real Estate Investment Trusts on which they have been modeled?
In 2003-2006, European institutional investors have allocated increasing portions of their portfolios in real estate finance assets (from 8.3% to 10%), making real estate a prime asset class. Recent Italian experience with real estate investment trusts offers a mixed record: while some have returns above target comprised between 5% and 7%, others are listed at a strong discount (20-30% on Net Asset Value), discouraging investors and lowering returns.
For the search for value to be pursued there needs to be a strong alignment between the interests of investment managers and those of investors. Generally, increasing Net Asset Value (NAV) is the main objective of managers, rather than market value. NAV and market price should converge over the long run, but not all investors have a time-horizon of 10-15 years.
Thus investment managers stay focused on NAV and neglect financial communication, while intermediaries show little interest for thin assets with reduced exchanges, professional investors show scarce propensity for illiquid assets, and investment funds focus on extracting fees. Underwriters are then left with an unenviable choice of strong discounts on NAV and little opportunity to increase the value of their shares.
SIIQs will have to favor governance mechanisms that realign managers' and investors' interests, including stock grants or incentive stocks, according to the risk profile associated with this asset class. In evaluating SIIQs, business plans and expected cash flows are important, keeping NAV as a control parameter. Competent management and efficient management structures are necessary but not sufficient conditions to create value. A listed company must pursue prospects for growth: leaving managers without the development leverage, and obliging them to distribute profits without opening opportunities for new investment puts undue burden on a financial instrument potentially able to satisfy the needs of small and big investors alike.
by Massimo Spisni,
Business Administration, Finance, Real Estate, and Management Control Division, SDA Bocconi School of Management, and Full Professor of Corporate Finance, Università degli Studi di Bologna