WEBVTT 00:00:00.000 --> 00:00:01.860 OK, I want you to picture something for a moment. 00:00:02.000 --> 00:00:05.080 Picture the financial district of, well, any 00:00:05.080 --> 00:00:07.400 major city. Right. Doesn't matter where. New 00:00:07.400 --> 00:00:10.839 York, London, Singapore. You're standing there 00:00:10.839 --> 00:00:13.279 on the pavement just looking up. And you see 00:00:13.279 --> 00:00:18.179 these colossal buildings, glass, steel, just... 00:00:18.519 --> 00:00:21.359 Pure capital. Exactly. The physical manifestation 00:00:21.359 --> 00:00:25.039 of capital. You see these huge towers, sprawling 00:00:25.039 --> 00:00:29.600 shopping complexes, maybe even one of those windowless 00:00:29.600 --> 00:00:32.759 fortresses we call data centers. It is the ultimate 00:00:32.759 --> 00:00:35.579 asset class, really. It's tangible. You can touch 00:00:35.579 --> 00:00:37.700 it. You can see it. But it's also incredibly 00:00:37.700 --> 00:00:39.700 expensive. And that's the thing. It feels so 00:00:39.700 --> 00:00:42.520 exclusive. The natural assumption when we look 00:00:42.520 --> 00:00:45.020 at that skyline is that ownership is just. It's 00:00:45.020 --> 00:00:47.100 reserved for billionaire. Or institutions. Yeah. 00:00:47.399 --> 00:00:49.520 Sovereign wealth funds, huge insurance companies. 00:00:49.679 --> 00:00:51.880 Right. It feels completely out of reach for the 00:00:51.880 --> 00:00:53.880 average person with a brokerage account. And 00:00:53.880 --> 00:00:56.039 for most of history, that was the reality. Yeah. 00:00:56.119 --> 00:00:57.960 I mean, real estate is lumpy. It's illiquid. 00:00:57.960 --> 00:01:00.780 It requires massive upfront capital. If you had 00:01:00.780 --> 00:01:03.640 $5 ,000 to invest, you couldn't buy a fraction 00:01:03.640 --> 00:01:05.560 of an office building. You could maybe buy a 00:01:05.560 --> 00:01:09.140 shed. Maybe. A very small one. But, and this 00:01:09.140 --> 00:01:12.219 is where a deep dive begins today, that is not 00:01:12.219 --> 00:01:15.840 entirely true anymore. There is a legal structure, 00:01:16.019 --> 00:01:18.500 a fascinating mechanism that was actually born 00:01:18.500 --> 00:01:22.180 from a cigar tax bill in the 1960s, of all things, 00:01:22.319 --> 00:01:25.780 that allows anyone to own a piece of that skyline. 00:01:25.939 --> 00:01:27.640 You are talking about the Real Estate Investment 00:01:27.640 --> 00:01:31.400 Trust. The REIT. The REIT. That is our mission 00:01:31.400 --> 00:01:34.359 today. We are going to unpack this beast. We're 00:01:34.359 --> 00:01:37.260 going to look at how a... Really, a tax loophole 00:01:37.260 --> 00:01:40.159 turned into a global phenomenon that now exists 00:01:40.159 --> 00:01:43.620 in over 39 countries holding trillions of dollars 00:01:43.620 --> 00:01:45.840 in assets. And we're going to get into how these 00:01:45.840 --> 00:01:48.159 massive entities work, why they're legally required 00:01:48.159 --> 00:01:50.280 to give you almost all of their money, and the 00:01:50.280 --> 00:01:52.219 specific mechanics that make them so different 00:01:52.219 --> 00:01:54.980 from buying a normal stock like Apple or Tesla. 00:01:55.159 --> 00:01:57.420 It's a subject that really rewards a closer look. 00:01:57.579 --> 00:01:59.459 I mean, on the surface, it sounds incredibly 00:01:59.459 --> 00:02:01.920 dry, real estate investment trust. It does. It 00:02:01.920 --> 00:02:03.500 sounds like something out of an accounting textbook. 00:02:03.900 --> 00:02:06.239 But it really sits. at this fascinating intersection 00:02:06.239 --> 00:02:09.520 of tax law, urban development, and what people 00:02:09.520 --> 00:02:11.340 love to call the democratization of finance. 00:02:11.939 --> 00:02:13.840 Democratization of real estate is the marketing 00:02:13.840 --> 00:02:16.960 slogan for sure. It sounds noble. But looking 00:02:16.960 --> 00:02:19.080 at the research we have today, I have a feeling 00:02:19.080 --> 00:02:21.419 you're going to ground that enthusiasm in some 00:02:21.419 --> 00:02:23.639 pretty harsh realities. Oh, I think we have to. 00:02:23.819 --> 00:02:27.060 Realities of tax codes, interest rate sensitivities, 00:02:27.400 --> 00:02:31.520 leverage profiles. It's not all sunshine and 00:02:31.520 --> 00:02:34.759 dividends. It isn't. While the concept is absolutely 00:02:34.759 --> 00:02:37.780 about access, the machinery that makes it run 00:02:37.780 --> 00:02:41.080 is all about tax efficiency and capital structure. 00:02:41.560 --> 00:02:44.180 It's not just about owning a building. It's about 00:02:44.180 --> 00:02:46.479 how money moves through that building, how it 00:02:46.479 --> 00:02:49.419 avoids the tax man, and how it lands in an investor's 00:02:49.419 --> 00:02:52.020 pocket. So let's start right there with the definition, 00:02:52.120 --> 00:02:54.500 but let's go beyond the dictionary version. We 00:02:54.500 --> 00:02:57.080 know a REIT is a company that owns income -producing 00:02:57.080 --> 00:02:59.389 real estate. But how is this different from, 00:02:59.449 --> 00:03:02.189 say, McDonald's? McDonald's owns billions in 00:03:02.189 --> 00:03:03.889 real estate. That is the crucial distinction. 00:03:04.669 --> 00:03:06.789 McDonald's uses its real estate to sell burgers. 00:03:07.349 --> 00:03:10.430 Walmart uses its real estate to sell goods. For 00:03:10.430 --> 00:03:12.990 them, the building is a cost center, a means 00:03:12.990 --> 00:03:15.409 to an end. A REIT's sole business is the real 00:03:15.409 --> 00:03:18.530 estate itself. It owns, operates, and sometimes 00:03:18.530 --> 00:03:21.960 finances income -producing property. The key 00:03:21.960 --> 00:03:24.479 is that the revenue must come primarily from 00:03:24.479 --> 00:03:27.500 passive rent or mortgage interest, not from an 00:03:27.500 --> 00:03:29.439 active business operation like slipping burgers 00:03:29.439 --> 00:03:32.639 or selling clothes. So it's a pure landlord model. 00:03:32.900 --> 00:03:35.159 Essentially, yes. Think of it like a mutual fund 00:03:35.159 --> 00:03:37.699 for bricks and mortar. You know, a mutual fund 00:03:37.699 --> 00:03:41.840 pools money from thousands of people to buy a 00:03:41.840 --> 00:03:44.080 basket of stocks. Right. You get diversification 00:03:44.080 --> 00:03:46.240 without having to buy every single stock in the 00:03:46.240 --> 00:03:49.150 S &P 500 yourself. Exactly. A REIT does the same 00:03:49.150 --> 00:03:51.969 thing, but it pools money to buy a portfolio 00:03:51.969 --> 00:03:54.830 of physical buildings. So instead of you buying 00:03:54.830 --> 00:03:57.050 one rental property and having to deal with that 00:03:57.050 --> 00:03:59.370 3 a .m. phone call about a broken toilet. Which 00:03:59.370 --> 00:04:02.210 is everyone's nightmare. It is. Instead, you 00:04:02.210 --> 00:04:03.930 buy a share of a company that owns a thousand 00:04:03.930 --> 00:04:05.990 apartments and it has a professional management 00:04:05.990 --> 00:04:08.550 team to handle all the toilets. And the asset 00:04:08.550 --> 00:04:11.289 classes here are just wildly diverse now. We're 00:04:11.289 --> 00:04:13.189 not just talking about office blocks and shopping 00:04:13.189 --> 00:04:15.710 malls anymore. Oh, far from it. That was the 00:04:15.710 --> 00:04:18.879 industry 40 years ago. Today. The REIT universe 00:04:18.879 --> 00:04:21.800 covers almost every single sector of the economy. 00:04:22.000 --> 00:04:24.740 Like what? Give me some examples. Okay. You have 00:04:24.740 --> 00:04:27.680 data center REITs, which are basically the physical 00:04:27.680 --> 00:04:30.379 backbone of the internet. They own the buildings 00:04:30.379 --> 00:04:33.139 that house all the servers for cloud computing. 00:04:33.480 --> 00:04:36.819 So they're renting space to Google and Amazon. 00:04:37.120 --> 00:04:39.860 Precisely. You have cell tower REITs, which are 00:04:39.860 --> 00:04:43.040 really more of a infrastructure play. They own 00:04:43.040 --> 00:04:45.899 the towers and lease space on them to AT &T, 00:04:45.939 --> 00:04:48.089 Verizon, and so on. That feels less like real 00:04:48.089 --> 00:04:50.649 estate and more like a utility. It has that characteristic, 00:04:50.889 --> 00:04:53.329 for sure. Then you have health care REITs, owning 00:04:53.329 --> 00:04:56.449 hospitals, medical office buildings, senior living 00:04:56.449 --> 00:04:58.470 facilities. And I saw in the notes we even have 00:04:58.470 --> 00:05:00.850 timber REITs. Weyerhaeuser is the big one that 00:05:00.850 --> 00:05:03.170 comes to mind, which has always fascinated me 00:05:03.170 --> 00:05:04.970 because it really blurs the line between real 00:05:04.970 --> 00:05:08.850 estate and agriculture. But the IRS is okay with 00:05:08.850 --> 00:05:11.250 this. They treat the timber as the asset and 00:05:11.250 --> 00:05:14.180 the harvest as the income. Exactly. As long as 00:05:14.180 --> 00:05:16.319 the land produces the income, it can fit the 00:05:16.319 --> 00:05:18.959 structure. They even have REITs that own outdoor 00:05:18.959 --> 00:05:22.000 advertising billboards. If you can charge rent 00:05:22.000 --> 00:05:24.279 on it, someone has probably tried to turn it 00:05:24.279 --> 00:05:26.480 into a REIT. Okay, so we've got a company. It 00:05:26.480 --> 00:05:28.579 owns a diverse set of rent -generating assets. 00:05:28.939 --> 00:05:31.800 But let's get to the magic sauce. The reason 00:05:31.800 --> 00:05:33.920 these things exist isn't just because people 00:05:33.920 --> 00:05:36.259 wanted to pool their money. It's because the 00:05:36.259 --> 00:05:39.000 government gave them a golden ticket. Let's talk 00:05:39.000 --> 00:05:42.300 about the golden rule of REITs. The golden rule. 00:05:42.699 --> 00:05:46.120 Or as it's often called, the 90 % rule. This 00:05:46.120 --> 00:05:48.439 is the core of the whole structure. In the United 00:05:48.439 --> 00:05:51.000 States, and this template has been copied pretty 00:05:51.000 --> 00:05:53.720 much globally, to qualify as a REIT and keep 00:05:53.720 --> 00:05:56.360 that special status, a company must distribute 00:05:56.360 --> 00:05:58.860 at least 90 % of its taxable income to shareholders 00:05:58.860 --> 00:06:02.000 as dividends. 90%. Let's just sit with that for 00:06:02.000 --> 00:06:03.759 a second. When you say that to a tech investor, 00:06:03.980 --> 00:06:07.170 their head explodes. Right. Amazon, Google. They 00:06:07.170 --> 00:06:09.269 pay zero dividends. They reinvest everything 00:06:09.269 --> 00:06:11.730 back into the business to grow. Why on earth 00:06:11.730 --> 00:06:13.769 would a company agree to this kind of financial 00:06:13.769 --> 00:06:16.329 street jacket that forces them to give away 90 00:06:16.329 --> 00:06:18.829 % of their profit every single year? Because 00:06:18.829 --> 00:06:21.370 the carrot is absolutely worth the stick. And 00:06:21.370 --> 00:06:24.410 the carrot is tax avoidance on a massive scale. 00:06:24.629 --> 00:06:28.089 The universal motivator. Always. Here's the math. 00:06:28.470 --> 00:06:31.569 In a normal corporation, what we call a C corporation, 00:06:32.009 --> 00:06:34.569 you have the problem of double taxation. Okay, 00:06:34.610 --> 00:06:37.069 walk me through that. So a normal company earns 00:06:37.069 --> 00:06:39.790 a dollar of profit. First, the government takes 00:06:39.790 --> 00:06:41.810 a bite at the corporate level. Let's say the 00:06:41.810 --> 00:06:44.709 corporate tax rate is 21%, so Uncle Sam takes 00:06:44.709 --> 00:06:48.250 21 cents. Right. Then the company distributes 00:06:48.250 --> 00:06:50.910 the remaining 79 cents to you, the shareholder, 00:06:51.069 --> 00:06:54.029 as a dividend. But it doesn't end there. The 00:06:54.029 --> 00:06:56.370 government then taxes you on that dividend income 00:06:56.370 --> 00:06:59.129 you just received. So that same dollar gets taxed 00:06:59.129 --> 00:07:02.329 twice, once inside the company and again when 00:07:02.329 --> 00:07:04.800 it hits my brokerage account. Exactly. The government 00:07:04.800 --> 00:07:06.500 takes a bite at the corporate level and another 00:07:06.500 --> 00:07:09.000 bite at the personal level. A REIT, however, 00:07:09.160 --> 00:07:11.560 strikes a deal with the IRS. The government says, 00:07:11.660 --> 00:07:14.600 look, if you agree to pass at least 90 % of that 00:07:14.600 --> 00:07:16.660 profit directly to the shareholders, we will 00:07:16.660 --> 00:07:18.759 not tax you at the corporate level. So the first 00:07:18.759 --> 00:07:21.600 layer of tax just disappears. It vanishes. The 00:07:21.600 --> 00:07:25.800 REIT pays zero corporate income tax. Zero. As 00:07:25.800 --> 00:07:28.879 long as they follow the distribution rules. So 00:07:28.879 --> 00:07:31.639 the taxation only happens once. At the shareholder 00:07:31.639 --> 00:07:34.339 level, when you receive your dividend, it makes 00:07:34.339 --> 00:07:36.699 the REIT an incredibly efficient pass -through 00:07:36.699 --> 00:07:39.079 vehicle for income. And that explains why the 00:07:39.079 --> 00:07:41.139 dividend yields on REITs are usually so much 00:07:41.139 --> 00:07:43.160 higher than the broader market like the S &P 00:07:43.160 --> 00:07:46.350 500. They're structurally designed to be income 00:07:46.350 --> 00:07:49.329 hoses. They have no choice. Now, we need to make 00:07:49.329 --> 00:07:51.029 one important distinction before we move on. 00:07:51.110 --> 00:07:53.689 We've been talking mostly about equity REITs, 00:07:53.689 --> 00:07:55.569 the ones that own the actual physical buildings. 00:07:55.930 --> 00:07:59.370 But there's a second, smaller, and much riskier 00:07:59.370 --> 00:08:04.110 category. Ah, yes. The mortgage REITs or MANSAs. 00:08:04.209 --> 00:08:06.589 Right. I wanted to touch on this. Errants don't 00:08:06.589 --> 00:08:09.129 own the building. They own the paper, the debt. 00:08:09.310 --> 00:08:11.310 Correct. They don't own property. They finance 00:08:11.310 --> 00:08:13.579 it. They'll buy mortgages or mortgage -backed 00:08:13.579 --> 00:08:15.839 securities. Their business model is much more 00:08:15.839 --> 00:08:18.259 like a bank or a hedge fund. How so? They borrow 00:08:18.259 --> 00:08:20.519 money at short -term interest rates, lend it 00:08:20.519 --> 00:08:22.660 out at long -term rates in the form of mortgages, 00:08:22.839 --> 00:08:25.040 and then they pocket the difference. It's called 00:08:25.040 --> 00:08:27.720 the net interest spread. Which sounds great until 00:08:27.720 --> 00:08:30.439 the yield curve inverts or credit markets seize 00:08:30.439 --> 00:08:34.080 up. Exactly. They are far more sensitive to interest 00:08:34.080 --> 00:08:36.539 rate volatility and credit risk. For the purpose 00:08:36.539 --> 00:08:38.360 of our discussion today about owning the skyline, 00:08:38.519 --> 00:08:41.740 we're really focusing on equity REITs. And the 00:08:41.740 --> 00:08:43.860 financial world has kind of formally separated 00:08:43.860 --> 00:08:46.340 them, right? It has. It was a huge validation 00:08:46.340 --> 00:08:50.000 for the industry. Back in 2014, S &P Dow Jones 00:08:50.000 --> 00:08:53.679 and MSCI, the big index providers, actually moved 00:08:53.679 --> 00:08:56.240 equity REITs out of the generic financial sector 00:08:56.240 --> 00:08:59.000 and gave them their very own headline sector. 00:08:59.320 --> 00:09:01.519 Which was the market saying, this isn't just 00:09:01.519 --> 00:09:03.940 a niche financial product anymore. It was the 00:09:03.940 --> 00:09:06.519 market saying, this is a fundamental pillar of 00:09:06.519 --> 00:09:09.720 the economy. It signaled that real estate is 00:09:09.720 --> 00:09:12.519 a distinct asset class, with its own drivers 00:09:12.519 --> 00:09:15.100 completely separate from banks or insurance companies. 00:09:15.259 --> 00:09:17.860 So we have this vehicle. It avoids corporate 00:09:17.860 --> 00:09:20.559 tax, it pays high dividends, and it owns everything 00:09:20.559 --> 00:09:23.139 from malls to cell towers. But how did we get 00:09:23.139 --> 00:09:25.179 here? You mentioned a cigar tax bill earlier. 00:09:25.360 --> 00:09:27.519 I need the full story on that because it sounds 00:09:27.519 --> 00:09:30.100 like typical legislative sausage making. It is 00:09:30.100 --> 00:09:32.279 the absolute definition of legislative sausage 00:09:32.279 --> 00:09:34.600 making. We have to go back to the United States 00:09:34.600 --> 00:09:38.360 in 1960. The Eisenhower administration is in 00:09:38.360 --> 00:09:42.409 its final year. Okay. 1960, the Cold War is on, 00:09:42.549 --> 00:09:45.210 Mad Men era. What's the context? The context 00:09:45.210 --> 00:09:47.490 is important. At the time, if you were a small 00:09:47.490 --> 00:09:49.789 investor, you were completely locked out of commercial 00:09:49.789 --> 00:09:52.710 real estate. You could buy a home, maybe, but 00:09:52.710 --> 00:09:54.370 you couldn't buy a shopping center. The only 00:09:54.370 --> 00:09:56.529 people who could were the ultra wealthy through 00:09:56.529 --> 00:09:58.970 private syndicates. So the intent of the law 00:09:58.970 --> 00:10:02.889 was genuinely populist. It was at its core. Congress 00:10:02.889 --> 00:10:05.850 wanted to create a way for the little guy to 00:10:05.850 --> 00:10:08.129 invest in large scale, diversified commercial 00:10:08.129 --> 00:10:10.690 real estate portfolios, much like mutual funds 00:10:10.690 --> 00:10:12.490 had recently allowed them to invest in stocks. 00:10:12.690 --> 00:10:14.830 It's about access. It's about access. But the 00:10:14.830 --> 00:10:16.950 legislative vehicle for passing this revolutionary 00:10:16.950 --> 00:10:21.429 idea was a rather mundane revenue bill. 86779. 00:10:21.590 --> 00:10:24.169 And in the halls of Congress, it was known informally 00:10:24.169 --> 00:10:27.590 as the Cigar Excise Tax Extension of 1960. So 00:10:27.590 --> 00:10:29.690 they tacked a revolution in real estate finance 00:10:29.690 --> 00:10:32.389 onto a bill about tobacco taxes. That is often 00:10:32.389 --> 00:10:35.169 how Washington works. You attach your pet project 00:10:35.169 --> 00:10:38.809 to a must -pass bill. Eisenhower signed it, and 00:10:38.809 --> 00:10:40.889 the REIT was born. And who was the first one 00:10:40.889 --> 00:10:43.070 out of the gate? The first one was called American 00:10:43.070 --> 00:10:46.830 Realty Trust, founded in 1961 by a man named 00:10:46.830 --> 00:10:49.990 Thomas J. Broyhill. And it's probably no coincidence 00:10:49.990 --> 00:10:52.889 that he was the cousin of Joel Broyhill, a Virginia 00:10:52.889 --> 00:10:55.289 congressman who was a major champion of the legislation. 00:10:55.570 --> 00:10:57.730 Of course. History is always about who you know. 00:10:58.129 --> 00:11:00.769 But here's the thing. Looking at the chart of 00:11:00.769 --> 00:11:03.070 the industry's growth, it didn't just explode 00:11:03.070 --> 00:11:05.789 in the 60s. It sort of plotted along for decades. 00:11:05.970 --> 00:11:09.210 It wasn't until the 1990s that we see what they 00:11:09.210 --> 00:11:12.669 call the modern REIT era. What changed? The tax 00:11:12.669 --> 00:11:15.159 law again. But this time it was about solving 00:11:15.159 --> 00:11:17.379 a very specific problem for the big real estate 00:11:17.379 --> 00:11:19.639 developers. We need to talk about the UPRATE. 00:11:19.720 --> 00:11:23.059 The UPRATE, Umbrella Partnership REIT. Now, the 00:11:23.059 --> 00:11:25.220 notes explain this as a way to defer taxes, but 00:11:25.220 --> 00:11:27.259 walk me through the mechanics. Why was this the 00:11:27.259 --> 00:11:31.399 aha moment? Okay, let's create a scenario. Imagine 00:11:31.399 --> 00:11:35.200 you're a real estate tycoon in 1990, a big developer. 00:11:35.620 --> 00:11:38.480 You own 10 shopping malls. You built them years 00:11:38.480 --> 00:11:42.159 ago for a total of, say, $10 million. And now, 00:11:42.240 --> 00:11:44.679 after years of appreciation, they're worth $100 00:11:44.679 --> 00:11:47.580 million. A nice problem to have. A very nice 00:11:47.580 --> 00:11:51.580 problem. But you are asset rich and cash poor. 00:11:52.360 --> 00:11:54.279 Your wealth is all tied up in these buildings 00:11:54.279 --> 00:11:55.779 you want to cash out or maybe you just want to 00:11:55.779 --> 00:11:58.840 diversify. But if you sell those malls to a newly 00:11:58.840 --> 00:12:01.679 formed public REIT, what happens? You trigger 00:12:01.679 --> 00:12:04.500 a massive tax bill. A massive capital gains tax 00:12:04.500 --> 00:12:06.659 event. You have to pay tax on that $90 million 00:12:06.659 --> 00:12:09.179 gain immediately. It's a huge financial hit. 00:12:09.299 --> 00:12:11.799 That's the friction cost. You lose a huge chunk 00:12:11.799 --> 00:12:14.399 of your wealth just to get liquid. Exactly. So 00:12:14.399 --> 00:12:16.799 for 30 years, the big developers refused to sell 00:12:16.799 --> 00:12:19.419 their portfolios to REITs. The best assets stayed 00:12:19.419 --> 00:12:22.659 private. The UPRUT, which was invented in 1992 00:12:22.659 --> 00:12:25.340 by a mall company called Taubman Centers, created 00:12:25.340 --> 00:12:27.779 a sort of currency swap mechanism to get around 00:12:27.779 --> 00:12:29.600 this. How does that work? Instead of selling 00:12:29.600 --> 00:12:32.519 the malls to the REIT for cash, The tycoon contributes 00:12:32.519 --> 00:12:35.500 the malls into a new entity called an operating 00:12:35.500 --> 00:12:39.019 partnership. The REIT itself is the general partner 00:12:39.019 --> 00:12:41.919 of this new entity, but the tycoon gets special 00:12:41.919 --> 00:12:44.480 units in exchange for his properties. Let's call 00:12:44.480 --> 00:12:46.860 them op -units. And these units are worth money. 00:12:47.159 --> 00:12:49.519 They are economically equivalent to the REIT's 00:12:49.519 --> 00:12:51.940 publicly traded shares. They get the same dividend. 00:12:52.320 --> 00:12:55.000 But technically, legally, they are not stock. 00:12:55.240 --> 00:12:57.639 And because they aren't stock, the IRS views 00:12:57.639 --> 00:13:00.240 this whole transaction as a contribution to a 00:13:00.240 --> 00:13:04.179 partnership. not a sale so no tax event no tax 00:13:04.179 --> 00:13:07.100 event that is incredibly clever so the tycoon 00:13:07.100 --> 00:13:09.940 gets a currency these op units that's basically 00:13:09.940 --> 00:13:12.840 as good as stock and he keeps his gross wealth 00:13:12.840 --> 00:13:16.259 intact he only pays the tax years later if and 00:13:16.259 --> 00:13:18.600 when he decides to convert those units into actual 00:13:18.600 --> 00:13:20.799 shares and sell them on the open market precisely 00:13:20.799 --> 00:13:23.620 it's a tax deferral machine And once this structure 00:13:23.620 --> 00:13:25.720 was approved by the IRS, it opened the floodgates. 00:13:25.879 --> 00:13:28.639 All these massive private real estate empires, 00:13:28.659 --> 00:13:31.539 the Simons, the Zells, the Taubmans, suddenly 00:13:31.539 --> 00:13:33.600 had a tax efficient way to take their empires 00:13:33.600 --> 00:13:36.039 public. So that's why the market cap of the industry 00:13:36.039 --> 00:13:38.399 just exploded in the 90s. It wasn't just new 00:13:38.399 --> 00:13:40.519 buildings being built. It was all these private 00:13:40.519 --> 00:13:42.899 assets finally moving into the public sphere. 00:13:43.120 --> 00:13:45.500 That's it. It was a transfer of existing wealth 00:13:45.500 --> 00:13:48.179 from private hands to the public market. OK, 00:13:48.279 --> 00:13:50.720 that brings us to the next major stress test 00:13:50.720 --> 00:13:54.559 for the industry. 2008, the global financial 00:13:54.559 --> 00:13:58.559 crisis. Real estate was ground zero. logic would 00:13:58.559 --> 00:14:00.179 dictate that REITs should have been completely 00:14:00.179 --> 00:14:02.100 wiped out. And they were certainly hammered. 00:14:02.100 --> 00:14:04.220 I mean, share prices collapsed 70, 80 percent 00:14:04.220 --> 00:14:07.340 in some cases. But the aftermath is what's really 00:14:07.340 --> 00:14:09.519 interesting. It actually proved the resilience 00:14:09.519 --> 00:14:12.299 of the public model versus the private model. 00:14:12.480 --> 00:14:15.460 How so? If I was a private landlord in 2009, 00:14:15.840 --> 00:14:18.120 I was in deep, deep trouble. If you were a private 00:14:18.120 --> 00:14:20.879 landlord with a big mortgage coming due in 2009, 00:14:21.100 --> 00:14:23.960 you were basically dead. The banks were not lending. 00:14:24.649 --> 00:14:27.210 To anyone. You couldn't refinance. You had to 00:14:27.210 --> 00:14:29.350 hand the keys back to the bank. But the public 00:14:29.350 --> 00:14:32.269 REITs had a superpower. The stock market. The 00:14:32.269 --> 00:14:33.970 stock market. They could print new shares. Right. 00:14:34.029 --> 00:14:36.710 They could raise equity. Exactly. They re -equitized. 00:14:37.049 --> 00:14:39.070 Even though their stock prices were in the tank, 00:14:39.289 --> 00:14:41.450 they could still go to the market and issue new 00:14:41.450 --> 00:14:44.929 shares to raise cash. And investors were willing 00:14:44.929 --> 00:14:47.450 to buy those shares at those depressed prices 00:14:47.450 --> 00:14:49.830 because they knew the underlying assets were 00:14:49.830 --> 00:14:52.450 good. The companies were just over leveraged. 00:14:52.799 --> 00:14:55.519 So they raised tens of billions of dollars. Tens 00:14:55.519 --> 00:14:59.100 of billions in 2009 and 2010. They used that 00:14:59.100 --> 00:15:02.360 cash to pay down debt to clean up their balance 00:15:02.360 --> 00:15:04.960 sheets. So they diluted the existing shareholders, 00:15:05.139 --> 00:15:07.500 which is painful. Very painful. But they saved 00:15:07.500 --> 00:15:10.179 the company. They survived. And that ability 00:15:10.179 --> 00:15:12.559 to access capital when the debt markets are completely 00:15:12.559 --> 00:15:15.059 frozen is probably the single biggest advantage 00:15:15.059 --> 00:15:17.559 of being a publicly traded REIT. Which transitions 00:15:17.559 --> 00:15:19.960 us perfectly into the mechanics of investing 00:15:19.960 --> 00:15:22.320 today. We know they survived. We know they pay 00:15:22.320 --> 00:15:24.639 high dividends. But I want to play devil's advocate 00:15:24.639 --> 00:15:26.980 here for a second. We talked about that 90 % 00:15:26.980 --> 00:15:29.080 payout rule, like it's a great thing for investors. 00:15:29.279 --> 00:15:31.779 But isn't it also a massive operational risk? 00:15:31.940 --> 00:15:33.860 Well, if I'm running Google, I keep my profits. 00:15:34.159 --> 00:15:37.460 I have billions in retained earnings. If a recession 00:15:37.460 --> 00:15:40.440 hits, I have a war chest of cash to ride it out. 00:15:40.809 --> 00:15:43.490 But if I'm running a REIT, I've legally sent 00:15:43.490 --> 00:15:46.009 90 % of my cash out the door every single year. 00:15:46.169 --> 00:15:48.929 I have no retained earnings. If the credit markets 00:15:48.929 --> 00:15:51.210 freeze up again, aren't I just fundamentally 00:15:51.210 --> 00:15:54.009 fragile? You have just hit on what the industry 00:15:54.009 --> 00:15:56.750 calls the payout trap. It is the existential 00:15:56.750 --> 00:15:59.649 risk of the entire sector. So it's a real thing. 00:15:59.870 --> 00:16:02.509 Oh, absolutely. Because they cannot retain earnings 00:16:02.509 --> 00:16:04.870 in any meaningful way, they are structurally 00:16:04.870 --> 00:16:08.440 addicted to external capital. To grow or even 00:16:08.440 --> 00:16:11.460 just to refinance existing debt, they constantly 00:16:11.460 --> 00:16:13.720 need to go back to the well -issuing new shares 00:16:13.720 --> 00:16:16.200 or selling new bonds. So they are completely 00:16:16.200 --> 00:16:18.480 at the mercy of market sentiment. Completely. 00:16:18.539 --> 00:16:20.919 If the stock market crashes, their cost of equity 00:16:20.919 --> 00:16:23.059 goes through the roof. It becomes too expensive 00:16:23.059 --> 00:16:25.299 to raise money by selling stock. If interest 00:16:25.299 --> 00:16:27.500 rates spike, their cost of debt goes up. They 00:16:27.500 --> 00:16:30.419 can become paralyzed, unable to grow or refinance. 00:16:30.559 --> 00:16:32.419 So what do they do when those capital market 00:16:32.419 --> 00:16:34.659 windows slam shut? They have to turn to something 00:16:34.659 --> 00:16:37.799 called capital recycling. This is a buzzword 00:16:37.799 --> 00:16:40.279 you will hear on every single REIT earnings call. 00:16:40.399 --> 00:16:42.720 Okay, what does that mean? It means selling your 00:16:42.720 --> 00:16:45.879 mature or lower quality assets to generate the 00:16:45.879 --> 00:16:48.940 cash to buy new higher growth assets or just 00:16:48.940 --> 00:16:52.519 to pay down debt. You have to cannibalize parts 00:16:52.519 --> 00:16:54.679 of your own portfolio to keep the machine running 00:16:54.679 --> 00:16:57.019 because you can't just save money from your rental 00:16:57.019 --> 00:17:00.179 income. That sounds incredibly stressful. Speaking 00:17:00.179 --> 00:17:02.100 of stress, let's talk about interest rates. This 00:17:02.100 --> 00:17:04.819 is the classic textbook correlation. Rates go 00:17:04.819 --> 00:17:07.720 up, REITs go down. Why is that relationship so 00:17:07.720 --> 00:17:10.039 consistently strong? It's strong for two main 00:17:10.039 --> 00:17:12.960 reasons. The first one is mechanical and pretty 00:17:12.960 --> 00:17:16.220 obvious. REITs, by their nature, carry a lot 00:17:16.220 --> 00:17:18.859 of debt to buy these big buildings. Higher rates 00:17:18.859 --> 00:17:21.079 mean higher interest expense, which means less 00:17:21.079 --> 00:17:24.019 cash left over for dividends. Simple math. Simple 00:17:24.019 --> 00:17:27.000 math. But the second reason is more psychological, 00:17:27.160 --> 00:17:29.460 and it's about competition for your investment 00:17:29.460 --> 00:17:32.480 dollar. The bond substitute argument. Exactly. 00:17:32.859 --> 00:17:35.900 Think about the mindset of a typical REIT investor. 00:17:36.180 --> 00:17:38.859 They're often retirees or people looking for 00:17:38.859 --> 00:17:43.930 yield. Safe, steady income. If a REIT pays a 00:17:43.930 --> 00:17:46.450 4 % dividend and a risk -free U .S. Treasury 00:17:46.450 --> 00:17:49.509 bond pays only 1%, the REIT looks fantastic. 00:17:49.849 --> 00:17:52.069 You're willing to take the extra risk for that 00:17:52.069 --> 00:17:54.710 extra 3 % of yield. But if the Federal Reserve 00:17:54.710 --> 00:17:57.329 raises rates and that Treasury bond suddenly 00:17:57.329 --> 00:18:00.089 moves to 5%. Then why on earth would you buy 00:18:00.089 --> 00:18:02.549 a risky real estate stock that only pays 4 %? 00:18:02.670 --> 00:18:04.750 You wouldn't. Money flows out of REITs and into 00:18:04.750 --> 00:18:08.180 the safety of bonds. So, to compete. REIT stock 00:18:08.180 --> 00:18:10.500 prices have to fall until their dividend yield 00:18:10.500 --> 00:18:13.220 rises high enough to be attractive again relative 00:18:13.220 --> 00:18:15.960 to that new higher bond yield. So it's a repricing 00:18:15.960 --> 00:18:18.119 mechanism. The market is forcing the yield up 00:18:18.119 --> 00:18:20.099 by pushing the price down. That's it. Now, it's 00:18:20.099 --> 00:18:21.779 not always that simple. There's a counter argument. 00:18:21.920 --> 00:18:24.099 Which is? Which is that why rates are rising 00:18:24.099 --> 00:18:26.319 matters. If rates are rising because the economy 00:18:26.319 --> 00:18:29.200 is booming and inflation is high, REITs can actually 00:18:29.200 --> 00:18:30.900 be a pretty good hedge. Because they can raise 00:18:30.900 --> 00:18:33.250 rents. Because they can raise rents to keep up 00:18:33.250 --> 00:18:35.490 with inflation. So their income stream is growing, 00:18:35.609 --> 00:18:38.009 which can offset the negative impact of higher 00:18:38.009 --> 00:18:40.890 rates. But in the short term, a sudden spike 00:18:40.890 --> 00:18:43.529 in rates is almost always painful for the sector. 00:18:43.710 --> 00:18:45.869 OK, let's get into the weeds of the numbers. 00:18:46.190 --> 00:18:48.690 If I'm a new investor, I pull up a REIT ticker 00:18:48.690 --> 00:18:51.670 on my screen and I look at the P .E. ratio price 00:18:51.670 --> 00:18:54.569 to earnings. It often looks broken. I might see 00:18:54.569 --> 00:18:58.220 a P .E. of 80 or 100. For a normal stock, that 00:18:58.220 --> 00:19:00.900 means it's insanely expensive. But you're telling 00:19:00.900 --> 00:19:03.720 me to just ignore that. Ignore completely. In 00:19:03.720 --> 00:19:05.839 fact, if you invest in REITs using P .E. ratios, 00:19:06.259 --> 00:19:08.220 you will almost certainly make bad decisions. 00:19:08.279 --> 00:19:11.039 The entire problem is with the E in P .E., the 00:19:11.039 --> 00:19:13.400 net earnings. And this goes back to depreciation. 00:19:13.420 --> 00:19:15.359 It's all about depreciation. Let's do an explained 00:19:15.359 --> 00:19:17.920 apartment like five. Imagine you buy an apartment 00:19:17.920 --> 00:19:21.049 building for $10 million. For tax and accounting 00:19:21.049 --> 00:19:24.029 purposes, the IRS rules say the building has 00:19:24.029 --> 00:19:28.630 a useful life of roughly 27 .5 years. Okay. So 00:19:28.630 --> 00:19:30.930 every year you get to tell the taxman, my building 00:19:30.930 --> 00:19:33.930 lost about $360 ,000 in value this year due to 00:19:33.930 --> 00:19:36.009 wear and tear. You deduct that from your rental 00:19:36.009 --> 00:19:38.589 income. Even if, in the real world, the building 00:19:38.589 --> 00:19:40.349 actually went up in value because the neighborhood 00:19:40.349 --> 00:19:43.349 got trendy. Exactly. That's the key. In reality, 00:19:43.509 --> 00:19:45.930 well -maintained buildings usually appreciate. 00:19:46.549 --> 00:19:50.250 But on paper, for accounting... They depreciate. 00:19:50.589 --> 00:19:53.869 It is a non -cash charge. It's a phantom expense 00:19:53.869 --> 00:19:56.410 that reduces your reported profit. So your net 00:19:56.410 --> 00:19:58.769 income on the financial statements might show 00:19:58.769 --> 00:20:02.549 zero or even a loss. But in reality, your bank 00:20:02.549 --> 00:20:05.390 account is full of rent checks. Your bank account 00:20:05.390 --> 00:20:09.490 is full of cash. Net income, for a REIT, is an 00:20:09.490 --> 00:20:12.109 accounting fiction. It creates a massive distortion, 00:20:12.349 --> 00:20:14.890 and that is why the industry invented its own 00:20:14.890 --> 00:20:18.319 metric. FFO. Funds from operations. Funds from 00:20:18.319 --> 00:20:20.819 operations. And the math there is pretty simple, 00:20:20.880 --> 00:20:22.440 right? You just take the net income and you add 00:20:22.440 --> 00:20:24.440 the depreciation back in. That's the main part 00:20:24.440 --> 00:20:26.880 of it, yes. You take net income, you add back 00:20:26.880 --> 00:20:29.380 the depreciation and amortization, and you also 00:20:29.380 --> 00:20:31.680 subtract any one -time gains you might have made 00:20:31.680 --> 00:20:34.059 from selling property because that's not recurring 00:20:34.059 --> 00:20:37.839 income. That gives you the FFO. That is the industry's 00:20:37.839 --> 00:20:40.299 baseline for cash flow. But it doesn't stop there. 00:20:40.680 --> 00:20:43.099 Then there's AFO -adjusted funds from operations. 00:20:43.519 --> 00:20:46.960 Why do we need yet another acronym? Because FFO 00:20:46.960 --> 00:20:49.460 is, frankly, a little too optimistic. It adds 00:20:49.460 --> 00:20:51.779 back all the depreciation. But in the real world, 00:20:51.900 --> 00:20:55.339 buildings actually do wear out. Roofs leak. Parking 00:20:55.339 --> 00:20:57.720 lots need to be repaved. The carpets in the hallways 00:20:57.720 --> 00:20:59.759 need to be replaced every few years. These are 00:20:59.759 --> 00:21:02.880 recurring capital expenditures, capex. Exactly. 00:21:02.880 --> 00:21:05.339 These are real cash costs you have to spend just 00:21:05.339 --> 00:21:07.900 to maintain the quality of your property. AFO 00:21:07.900 --> 00:21:10.299 is a more honest metric because it subtracts 00:21:10.299 --> 00:21:13.420 that necessary recurring maintenance capex from 00:21:13.420 --> 00:21:16.140 the FFO. So AFFO tells you the true cash flow 00:21:16.140 --> 00:21:18.039 that's available to be paid out as a dividend. 00:21:18.299 --> 00:21:21.079 It's the safe number. If a REIT's dividend is 00:21:21.079 --> 00:21:23.740 higher than its AFFO, you should be very worried. 00:21:23.880 --> 00:21:26.019 It means they are borrowing money or selling 00:21:26.019 --> 00:21:28.799 assets just to pay you. That is a dividend cut 00:21:28.799 --> 00:21:32.259 waiting to happen. Okay, so AFO is the key. One 00:21:32.259 --> 00:21:35.180 last metric before we start our world tour. NAV. 00:21:35.950 --> 00:21:39.170 net asset value. This seems critical for knowing 00:21:39.170 --> 00:21:41.509 if you're getting a deal or not. It is the anchor 00:21:41.509 --> 00:21:45.690 for valuation. NAV is simply the estimated market 00:21:45.690 --> 00:21:48.289 value of all the properties the REIT owns, minus 00:21:48.289 --> 00:21:51.750 all of its debt. It's the breakup value. If they 00:21:51.750 --> 00:21:54.250 sold everything tomorrow and paid off all their 00:21:54.250 --> 00:21:56.119 loans, What would be left for the shareholders? 00:21:56.480 --> 00:21:58.380 And the fascinating thing about the stock market 00:21:58.380 --> 00:22:00.940 is that the share price can drift wildly away 00:22:00.940 --> 00:22:03.019 from that NAV. That's where the opportunity is. 00:22:03.099 --> 00:22:05.980 Sometimes the market is pessimistic and a REIT 00:22:05.980 --> 00:22:09.680 might trade at a 20 % discount to its NAV. That 00:22:09.680 --> 00:22:12.240 means you are literally buying a dollar of prime 00:22:12.240 --> 00:22:15.339 real estate for 80 cents. And the big private 00:22:15.339 --> 00:22:17.839 equity firms like Blackstone, they live for this. 00:22:18.019 --> 00:22:19.799 They love this. They look for REITs trading at 00:22:19.799 --> 00:22:22.200 deep discounts. buy the whole company and take 00:22:22.200 --> 00:22:24.640 it private, arbitraging that gap. And conversely, 00:22:24.640 --> 00:22:26.819 if it trades at a premium to NAV, that's a signal 00:22:26.819 --> 00:22:28.539 to management that they should be issuing shares 00:22:28.539 --> 00:22:30.940 like crazy to buy more stuff. Exactly. It's their 00:22:30.940 --> 00:22:33.400 cost of capital advantage. Okay. We have the 00:22:33.400 --> 00:22:35.680 definition, the history, and the investor's toolkit. 00:22:36.200 --> 00:22:38.599 Now let's look at the map. This is not just a 00:22:38.599 --> 00:22:41.119 U .S. story anymore. You mentioned 39 countries 00:22:41.119 --> 00:22:43.839 have adopted this model. Let's do a rapid -fire 00:22:43.839 --> 00:22:47.059 global tour starting here in the Americas. Well, 00:22:47.099 --> 00:22:49.529 the U .S. is the heavyweight, obviously. Over 00:22:49.529 --> 00:22:52.210 190 public REITs. It's the most mature market. 00:22:52.470 --> 00:22:55.630 Let's look south to Mexico. They have FIBRAS. 00:22:55.750 --> 00:22:58.750 FIBRAS. Fideicomiso de Infraestructura y Bienes 00:22:58.750 --> 00:23:01.650 Raíces. You've been practicing. I try. But looking 00:23:01.650 --> 00:23:03.769 at the structure, they seem, I don't know, more 00:23:03.769 --> 00:23:06.569 rigid than the U .S. model. They are. They were 00:23:06.569 --> 00:23:09.789 introduced in 2011, modeled on the U .S., but 00:23:09.789 --> 00:23:12.269 with much tighter guardrails. For example, the 00:23:12.269 --> 00:23:14.269 payout requirement isn't 90 percent, it's 95 00:23:14.269 --> 00:23:17.259 percent. Wow. Even less margin for error. And 00:23:17.259 --> 00:23:19.259 they have very strict rules about holding periods. 00:23:19.420 --> 00:23:21.599 A fibra generally must hold its assets for at 00:23:21.599 --> 00:23:24.059 least four years. The Mexican regulators wanted 00:23:24.059 --> 00:23:26.299 to prevent speculation and flipping. They wanted 00:23:26.299 --> 00:23:28.640 these to be long -term, stable infrastructure 00:23:28.640 --> 00:23:31.099 players, not traders. And the first one was Fibra 00:23:31.099 --> 00:23:34.019 Uno. Yes. And it became this massive conglomerate 00:23:34.019 --> 00:23:36.680 of industrial retail and office assets all across 00:23:36.680 --> 00:23:39.799 the country. And then Brazil. Brazil has a feature 00:23:39.799 --> 00:23:42.259 that makes U .S. investors incredibly jealous. 00:23:42.640 --> 00:23:46.720 The FIIs, or Fundos de Investimento Inmobiliario. 00:23:47.039 --> 00:23:49.519 And yes, the killer feature there is tax -free 00:23:49.519 --> 00:23:51.839 dividends for individual investors. Completely 00:23:51.839 --> 00:23:54.279 tax -free, no strings attached. There are a few 00:23:54.279 --> 00:23:55.839 strings. You have to be a personal investor, 00:23:55.960 --> 00:23:58.299 not a corporation. And the fund has to have at 00:23:58.299 --> 00:24:00.240 least 50 shareholders and be publicly traded. 00:24:00.500 --> 00:24:03.880 But if it meets those criteria, the income is 00:24:03.880 --> 00:24:06.599 tax -exempt. In a high inflation, high interest 00:24:06.599 --> 00:24:09.039 rate environment like Brazil, that tax shield 00:24:09.039 --> 00:24:11.779 must be incredibly powerful. It's created a massive 00:24:11.779 --> 00:24:14.420 retail investor culture around FIIs. You have 00:24:14.420 --> 00:24:17.619 regular people on YouTube in Brazil who are basically 00:24:17.619 --> 00:24:19.559 day trading these things because that tax free 00:24:19.559 --> 00:24:22.200 income stream is so attractive. OK, let's move 00:24:22.200 --> 00:24:24.720 north to our neighbor, Canada. They had a bit 00:24:24.720 --> 00:24:26.759 of a drama with something called the SIFT tax. 00:24:27.119 --> 00:24:29.880 This feels like a real lesson in regulatory risk. 00:24:30.119 --> 00:24:33.779 It is a textbook case. In the mid -2000s, Canada 00:24:33.779 --> 00:24:36.440 had a broader structure called income trusts, 00:24:36.680 --> 00:24:39.259 and they became too popular for their own good. 00:24:39.539 --> 00:24:42.299 Regular operating companies, telecoms, energy 00:24:42.299 --> 00:24:44.700 companies, even restaurants started converting 00:24:44.700 --> 00:24:47.660 into trusts just to avoid corporate tax. So the 00:24:47.660 --> 00:24:49.859 government realized it was losing its entire 00:24:49.859 --> 00:24:52.539 corporate tax base. The Ministry of Finance woke 00:24:52.539 --> 00:24:54.980 up one day and saw a giant hole in its budget. 00:24:55.079 --> 00:24:58.099 So they cracked down hard in 2006 with these 00:24:58.099 --> 00:25:00.839 new SIFT rules specified investment flow through. 00:25:01.039 --> 00:25:03.380 They slapped a new tax on these trusts that effectively 00:25:03.380 --> 00:25:05.519 killed the advantage of converting. But REITs 00:25:05.519 --> 00:25:08.119 were spared. This is the key. They carved out 00:25:08.119 --> 00:25:10.440 a specific exemption for trusts that held real 00:25:10.440 --> 00:25:13.299 property. So the real estate trusts were saved, 00:25:13.380 --> 00:25:15.640 but the energy trusts and business trusts got 00:25:15.640 --> 00:25:18.559 hammered. It's a stark reminder that these tax 00:25:18.559 --> 00:25:20.859 loopholes exist entirely at the pleasure of the 00:25:20.859 --> 00:25:23.440 government. They can be closed at any time. Let's 00:25:23.440 --> 00:25:25.440 jump across the ocean. Let's talk about the Asia 00:25:25.440 --> 00:25:27.519 -Pacific region. Who are the big players here? 00:25:27.859 --> 00:25:30.039 Well, the real pioneer outside the U .S. was 00:25:30.039 --> 00:25:32.400 Australia. They launched what were called listed 00:25:32.400 --> 00:25:36.579 property trusts, or LPTs, way back in 1971. They're 00:25:36.579 --> 00:25:38.500 a massive part of the Australian stock market, 00:25:38.539 --> 00:25:41.099 the ASX. But I think the most interesting strategic 00:25:41.099 --> 00:25:43.720 player in the region today is Singapore. The 00:25:43.720 --> 00:25:45.950 SREITs. I was reading that they're increasingly 00:25:45.950 --> 00:25:48.309 becoming global landlords. What does that mean? 00:25:48.509 --> 00:25:51.049 It means that because Singapore is a tiny island, 00:25:51.269 --> 00:25:53.990 there's a physical limit to how much real estate 00:25:53.990 --> 00:25:57.430 you can buy there. So to grow, the S -rate regime 00:25:57.430 --> 00:25:59.670 has always encouraged cross -border ownership. 00:26:00.490 --> 00:26:03.410 Today, you can buy a Singapore -listed REIT that 00:26:03.410 --> 00:26:06.109 owns data centers in Ireland, logistics parks 00:26:06.109 --> 00:26:08.670 in Japan, or shopping malls in mainland China. 00:26:09.180 --> 00:26:11.900 So Singapore acts as the financial hub, but the 00:26:11.900 --> 00:26:14.180 actual assets are scattered all over the globe. 00:26:14.380 --> 00:26:16.779 Correct. And investors, particularly international 00:26:16.779 --> 00:26:19.160 ones, really favor them because of the strict 00:26:19.160 --> 00:26:21.680 regulatory oversight from the Monetary Authority 00:26:21.680 --> 00:26:24.500 of Singapore. They impose a hard cap on leverage, 00:26:24.720 --> 00:26:27.700 the gearing ratio. It used to be a firm 35%, 00:26:27.700 --> 00:26:29.740 it's varied a bit since then, but it prevents 00:26:29.740 --> 00:26:31.619 the kind of cowboy leverage you sometimes see 00:26:31.619 --> 00:26:34.119 in other markets. Now, we have to talk about 00:26:34.119 --> 00:26:36.420 China, the second largest economy in the world. 00:26:37.049 --> 00:26:39.869 massive construction, but they were surprisingly 00:26:39.869 --> 00:26:43.130 late to the REIT party. Very late. They only 00:26:43.130 --> 00:26:45.609 launched the public pilot program in 2020 and 00:26:45.609 --> 00:26:49.309 2021. But the flavor of the Chinese REIT, the 00:26:49.309 --> 00:26:51.390 sea reit, is totally different from what you 00:26:51.390 --> 00:26:54.220 see in the U .S. How so? In the U .S., REITs 00:26:54.220 --> 00:26:56.559 are primarily about commercial real estate malls, 00:26:56.559 --> 00:26:59.579 offices, apartments. In China, the government 00:26:59.579 --> 00:27:02.420 is pushing REITs specifically for infrastructure. 00:27:02.519 --> 00:27:06.000 So not apartment buildings, but toll roads and 00:27:06.000 --> 00:27:08.740 sewage plants. Exactly. toll roads, industrial 00:27:08.740 --> 00:27:11.339 parks, logistics warehouses, energy pipelines, 00:27:11.700 --> 00:27:14.319 waste treatment facilities. Why that specific 00:27:14.319 --> 00:27:16.900 focus? Why not open it up to the residential 00:27:16.900 --> 00:27:18.819 or office market? You have to think about the 00:27:18.819 --> 00:27:21.460 macroeconomics. For the last 30 years, the Chinese 00:27:21.460 --> 00:27:23.380 state and local governments have been on the 00:27:23.380 --> 00:27:25.539 world's biggest infrastructure building spree. 00:27:26.480 --> 00:27:28.680 Trillions and trillions of dollars are now trapped 00:27:28.680 --> 00:27:31.400 in that concrete. By launching REITs, they can 00:27:31.400 --> 00:27:34.519 securitize a toll road, sell it to public investors, 00:27:34.680 --> 00:27:36.940 and get their cash back. So it's a deleveraging 00:27:36.940 --> 00:27:39.339 tool for the state. They're cashing out. Precisely. 00:27:39.599 --> 00:27:41.920 It recycles capital so they can either build 00:27:41.920 --> 00:27:44.819 more infrastructure or, more likely, pay down 00:27:44.819 --> 00:27:46.819 the massive debts that local governments have 00:27:46.819 --> 00:27:49.079 accumulated. It's not really about helping you 00:27:49.079 --> 00:27:52.079 own a condo in Shanghai. It's about fixing the 00:27:52.079 --> 00:27:55.000 state's balance sheet. That is a critical distinction 00:27:55.000 --> 00:27:58.369 for an investor. If I buy a sea reed, I'm buying 00:27:58.369 --> 00:28:02.049 a stable utility -like cash flow, not a bet on 00:28:02.049 --> 00:28:04.609 rising rents in a booming city. It's a very different 00:28:04.609 --> 00:28:06.730 risk profile. Correct. What about some of the 00:28:06.730 --> 00:28:08.650 other countries in the region? I saw some notes 00:28:08.650 --> 00:28:11.329 about friction costs in places like India and 00:28:11.329 --> 00:28:13.430 the Philippines. The Philippines is a classic 00:28:13.430 --> 00:28:16.170 case of a zombie law. They passed a reed law 00:28:16.170 --> 00:28:19.640 way back in 2009. But the regulators got greedy. 00:28:19.700 --> 00:28:21.700 They put in all these restrictive tax policies 00:28:21.700 --> 00:28:24.299 like requiring that if a developer put land into 00:28:24.299 --> 00:28:26.680 a REIT, they had to pay a huge value added tax 00:28:26.680 --> 00:28:28.700 and other taxes immediately. So the friction 00:28:28.700 --> 00:28:30.740 cost was just too high to make it worthwhile. 00:28:31.059 --> 00:28:34.799 Exactly. Nobody used it. For 10 years, the law 00:28:34.799 --> 00:28:37.579 existed on the books and there were zero REITs 00:28:37.579 --> 00:28:40.519 listed. It was a complete failure until 2020 00:28:40.519 --> 00:28:43.259 when the government finally said, OK, OK, we'll 00:28:43.259 --> 00:28:45.579 relax the tax friction. And only then did the 00:28:45.579 --> 00:28:48.079 first one, a REIT from Ayala Land, finally launch. 00:28:48.279 --> 00:28:51.319 A clear lesson for policymakers. If you want 00:28:51.319 --> 00:28:53.380 a market to develop, you have to lower the toll 00:28:53.380 --> 00:28:56.359 at the gate. Indeed. India had similar issues 00:28:56.359 --> 00:28:59.180 where the initial rules were skewed so heavily 00:28:59.180 --> 00:29:02.140 toward institutional investors that retail investors 00:29:02.140 --> 00:29:04.740 were largely shut out. They've been slowly fixing 00:29:04.740 --> 00:29:07.019 that over time. OK, let's head back west, Europe 00:29:07.019 --> 00:29:09.460 and the Middle East. The UK feels like a country 00:29:09.460 --> 00:29:11.200 that should have been an early adopter, but they 00:29:11.200 --> 00:29:14.980 weren't. No, surprisingly late, 2007. And they 00:29:14.980 --> 00:29:17.539 had a strange quirk. To convert your existing 00:29:17.539 --> 00:29:20.279 property company into a REIT, you had to pay 00:29:20.279 --> 00:29:22.859 the government an entry fee of 2 % of the gross 00:29:22.859 --> 00:29:25.819 value of your assets. A 2 % cover charge just 00:29:25.819 --> 00:29:29.170 to get into the club? That's hefty. It was. But 00:29:29.170 --> 00:29:31.589 the big established players like British Land 00:29:31.589 --> 00:29:34.549 and Landsec paid it because they calculated that 00:29:34.549 --> 00:29:37.190 the long -term tax savings of being a REIT were 00:29:37.190 --> 00:29:39.750 worth more than the one -time entry fee. That 00:29:39.750 --> 00:29:42.509 charge was eventually abolished in 2012 to make 00:29:42.509 --> 00:29:44.710 the market more attractive. And what about Germany? 00:29:44.849 --> 00:29:47.089 I know the German housing market is very unique, 00:29:47.170 --> 00:29:49.529 a very high percentage of renters, strong tenant 00:29:49.529 --> 00:29:52.109 protections. How did that shape their version 00:29:52.109 --> 00:29:54.450 of the REIT? Germany is the great skeptic of 00:29:54.450 --> 00:29:56.910 the REIT model. There was huge political resistance, 00:29:57.230 --> 00:29:58.809 especially from the Social Democratic Party. 00:29:59.049 --> 00:30:02.269 They were terrified that locust investors, their 00:30:02.269 --> 00:30:04.349 term for private equity and rights, would buy 00:30:04.349 --> 00:30:06.289 up all the apartment buildings and jack up rents 00:30:06.289 --> 00:30:08.869 on German families. The fear of financialization. 00:30:09.029 --> 00:30:11.250 That's the heart of it. So when they finally 00:30:11.250 --> 00:30:14.349 passed the Guy Wright law, also in 2007, they 00:30:14.349 --> 00:30:17.069 included a poison pill to protect tenants. Guy 00:30:17.069 --> 00:30:19.130 Wrights are legally forbidden from owning any 00:30:19.130 --> 00:30:20.950 residential properties that were built before 00:30:20.950 --> 00:30:24.289 January 1st, 2007. Wait, say that again. They 00:30:24.289 --> 00:30:27.230 can't buy the existing housing stock. No, they 00:30:27.230 --> 00:30:29.430 can only buy newly built apartment buildings 00:30:29.430 --> 00:30:32.589 or commercial properties. The vast majority of 00:30:32.589 --> 00:30:34.630 German apartments, the entire existing stock, 00:30:34.930 --> 00:30:39.390 is off limits to G -rights by law. It was a political 00:30:39.390 --> 00:30:41.970 compromise to protect tenants from the perceived 00:30:41.970 --> 00:30:44.849 evils of the capital markets. That is absolutely 00:30:44.849 --> 00:30:46.970 fascinating. You can play in our sandbox, but 00:30:46.970 --> 00:30:49.210 don't touch the old stuff. It's a very German 00:30:49.210 --> 00:30:52.210 solution. And as a result, the G -right market 00:30:52.210 --> 00:30:54.769 has remained very, very small and niche. OK, 00:30:54.809 --> 00:30:57.309 finally, let's go to Dubai, a city literally 00:30:57.309 --> 00:31:00.049 built on real estate speculation. But a city 00:31:00.049 --> 00:31:02.730 with a very complex legal map. The REITs there, 00:31:02.829 --> 00:31:05.849 like Emirates REIT, are domiciled in the DIFC, 00:31:06.009 --> 00:31:08.410 the Dubai International Financial Center. That's 00:31:08.410 --> 00:31:10.809 a free zone, right, with English -style common 00:31:10.809 --> 00:31:12.930 law. Exactly. But the rest of Dubai, where all 00:31:12.930 --> 00:31:15.650 the buildings are, operates under local UAE civil 00:31:15.650 --> 00:31:18.309 law. And this created huge headaches initially. 00:31:18.730 --> 00:31:22.170 A DIFC -based REIT couldn't legally own properties 00:31:22.170 --> 00:31:24.769 outside the zone unless it had majority local 00:31:24.769 --> 00:31:27.470 ownership. A classic jurisdiction mismatch. How 00:31:27.470 --> 00:31:30.059 did they solve it? Emirates REIT, which was run 00:31:30.059 --> 00:31:33.359 by a dot -com entrepreneur, had to engineer this 00:31:33.359 --> 00:31:36.039 very complex platform structure with local partners 00:31:36.039 --> 00:31:39.019 to satisfy those ownership rules, which finally 00:31:39.019 --> 00:31:40.839 allowed them to actually buy buildings in the 00:31:40.839 --> 00:31:42.839 rest of the city. And on top of all that, they 00:31:42.839 --> 00:31:46.119 are Sharia -compliant. Yes. That adds a whole 00:31:46.119 --> 00:31:48.660 other layer of complexity. They cannot use conventional 00:31:48.660 --> 00:31:50.519 interest -based debt. They have to use as long 00:31:50.519 --> 00:31:54.660 bonds or sukuk. And they cannot lease their properties 00:31:54.660 --> 00:31:57.859 to tenants that engage in haram or forbidding. 00:31:57.869 --> 00:32:00.710 in activities. So no banks that charge interest, 00:32:00.809 --> 00:32:04.190 no alcohol sales, no gambling. Right. So a hotel 00:32:04.190 --> 00:32:07.069 REIT in a Sharia structure might have a problem 00:32:07.069 --> 00:32:08.869 with the lobby bar. They would likely have to 00:32:08.869 --> 00:32:10.750 structure it so that a third party operates the 00:32:10.750 --> 00:32:13.789 bar and the REIT itself doesn't touch that specific 00:32:13.789 --> 00:32:16.670 revenue stream. It's complicated. So we've gone 00:32:16.670 --> 00:32:19.970 from the U .S. to Mexico, Brazil, China, Germany, 00:32:20.190 --> 00:32:22.549 Dubai. We have a global market now where it's 00:32:22.549 --> 00:32:25.289 something like $1 .7 trillion. At least. It's 00:32:25.289 --> 00:32:27.700 a huge asset class. And we have all these different 00:32:27.700 --> 00:32:30.519 flavors, infrastructure focused in China, strict 00:32:30.519 --> 00:32:33.660 tenant laws in Germany, tax free income in Brazil. 00:32:33.880 --> 00:32:36.880 But it all comes back to that same simple idea 00:32:36.880 --> 00:32:40.240 from that 1960s cigar tax bill. The chassis is 00:32:40.240 --> 00:32:42.680 the same, a tax efficient pass through vehicle. 00:32:43.259 --> 00:32:46.279 The bodywork just differs by local culture and 00:32:46.279 --> 00:32:48.980 politics. Yeah. It really shows how a country's 00:32:48.980 --> 00:32:51.500 legal and social priorities shake its financial 00:32:51.500 --> 00:32:53.680 markets. So let's bring this all home for the 00:32:53.680 --> 00:32:55.359 listener. We've talked about the mechanics, the 00:32:55.359 --> 00:32:57.079 pros and cons. We've talked about the risks, 00:32:57.180 --> 00:32:59.279 the payout trap, the sensitivity to interest 00:32:59.279 --> 00:33:01.980 rates. But I want to end on a more philosophical 00:33:01.980 --> 00:33:04.650 note if we can. Just hear it. We started this 00:33:04.650 --> 00:33:06.849 conversation by saying this democratizes real 00:33:06.849 --> 00:33:09.490 estate. It lets me, the little guy, own a piece 00:33:09.490 --> 00:33:11.869 of the mall or the data center. And that sounds 00:33:11.869 --> 00:33:14.890 great. But as this model expands, especially 00:33:14.890 --> 00:33:17.309 into single family housing, which is a booming 00:33:17.309 --> 00:33:20.150 REIT sector in the U .S. now, are we crossing 00:33:20.150 --> 00:33:22.609 some kind of line? You're talking about the financialization 00:33:22.609 --> 00:33:26.099 of home debate? Exactly. If a company like Invitation 00:33:26.099 --> 00:33:28.420 Homes has a fiduciary duty to maximize dividends 00:33:28.420 --> 00:33:30.640 for me, the shareholder, that means they have 00:33:30.640 --> 00:33:33.339 a legal duty to raise rents as much as the market 00:33:33.339 --> 00:33:35.480 will bear. And when that asset is a shopping 00:33:35.480 --> 00:33:38.660 mall, nobody really cries for the tenants. But 00:33:38.660 --> 00:33:40.440 when that asset is a starter home in Atlanta 00:33:40.440 --> 00:33:42.799 where a family lives... It changes the social 00:33:42.799 --> 00:33:46.460 dynamic completely. You have the... cold, hard 00:33:46.460 --> 00:33:49.299 efficiency of Wall Street applied to what many 00:33:49.299 --> 00:33:51.839 people consider a basic human need or even a 00:33:51.839 --> 00:33:53.940 human right. Right. So the provocative thought 00:33:53.940 --> 00:33:56.000 I want to leave with the listener is this. When 00:33:56.000 --> 00:33:58.299 you buy a residential REIT, you are celebrating 00:33:58.299 --> 00:34:00.740 that efficiency. You are cheering for the 90 00:34:00.740 --> 00:34:03.640 percent payout. But you also have to ask yourself. 00:34:04.250 --> 00:34:06.569 Are we turning our cities and our homes into 00:34:06.569 --> 00:34:09.349 pure financial instruments? Is the skyline just 00:34:09.349 --> 00:34:11.650 a ledger of tickers on an exchange? It's the 00:34:11.650 --> 00:34:13.889 ultimate tradeoff, isn't it? The benefits of 00:34:13.889 --> 00:34:16.170 liquidity and access for investors versus the 00:34:16.170 --> 00:34:18.610 potential social cost of the commodification 00:34:18.610 --> 00:34:21.510 of community. There's no easy answer. It's something 00:34:21.510 --> 00:34:23.389 to chew on the next time you see a for -rent 00:34:23.389 --> 00:34:25.789 sign managed by one of these massive corporate 00:34:25.789 --> 00:34:28.989 landlords. You might actually own a tiny piece 00:34:28.989 --> 00:34:30.869 of it. Thanks for diving deep with us on this. 00:34:30.929 --> 00:34:33.030 It was fascinating. We'll see you on the next 00:34:33.030 --> 00:34:34.150 one. And stay curious.