Asia sees the REIT way ahead
The REIT concept has really become popular in Asia during 2004, with 10 new REITs being launched and most of those trading at a significant premium to net asset value. In December, the HK$30bn(e2.9bn) Link REIT was Iaunched in Hong Kong and in one fell swoop, Hong Kong caught up with Singapore in market capitalisation terms.
Since the Asian market is still at relatively new base, the growth percentages look huge. Actual growth in market capitalisation of existing REITs is 168% in the year to November 2004. This growth has come from three sources: pricing, secondary raisings and, most importantly, new product. Half the growth is made up of new REIT listings.
Japan remains the largest REIT market and arguably the one with the greatest growth potential. The Japanese real estate boom is being fuelled in part by the increasingly large sums invested in REIT. But in spite of the fact that they offer a yield of around 4% compared with 1.5% for 10-year bonds, REITs have not been adopted by pension funds to any great extent.
Currently there are 14 REITs listed in Japan, 13 on the Tokyo Stock Exchange and one on the Osaka exchange. These are classified as investment trusts, not as regular companies. This has implications for investment, primarily because REITs cannot be included in the TOPIX or any other domestic equity index presently. As a consequence, any investment in REITs will be outside the normal equity asset allocation for a Japanese pension fund.
Currently 40-60% of the major investors are financial institutions. According to Eric Perraudin of Tokyo-based Japan Management Consulting: “I would say that non-Japanese investors have also been players from the start, partly because of the classification issue, but also because they have experience of investing in REITs. When you look at the shareholder structure you find the largest shareholders have been non-Japanese investors and most Japanese investment has been from individual investors. Recently it seems that Japanese institutional investors, especially commercial banks, have been more active.”
A drawback of the J-REIT is that it does not have an UPREIT provision. In the US, UPREITs allow companies to contribute assets to a REIT through an umbrella partnership that does not incur tax liability for the contributing organisation. In Japan, a taxable event will be created by the contribution of an asset to a J-REIT. If the property was contributed to a REIT for less than the original purchase price, the transaction would have to be booked as a loss. Companies that are unwilling to face the consequences of booking major losses on properties may be slow to contribute parties into REITs. Despite this drawback, the J-REIT represents a major step forward for Japanese real estate and one that will allow distressed property to be more easily securitised.
Price growth of Asian REITs, particularly in Japan and Singapore, continues to be strong, though there are questions being raised as to how sustainable these prices are. The average premium to NAV in Japan is 55%; in Singapore it is 26%. Low and declining interest rates were the catalyst for growth in the Asian REIT market from 2001 to 2003 and, as J P Morgan’s head of real estate investment banking, Anthony Ryan points out: “While Asian REITs have not been adversely affected by the expectation of a bottoming of the rate cycle, they have yet to be tested in a rapidly rising interest rate environment.”
Ryan suggests the continued price growth is partly attributable to the “legitimisation” of the sector, through the inclusion of REITs within global benchmark indices such as EPRA/NAREIT and MSCI Singapore. New listings are expected to add another ¥1trn to the market cap of J-REITs by 2007-08. According to JMC’s Perraudin: “There are currently estimated to be 30 or so new REITs planning to list.”
There are at least short-term arguments supporting a value premium for REITs. They are offering liquidity benefits and diversification advantages to investors hungry for new and safe alternatives. However, Ryan states that: “The premium demonstrated in Japan and Singapore is of a magnitude not supported by these technical explanations.” The suggestion is that it is excess liquidity that is driving pricing.
This growth is sustainable in the foreseeable future given the infancy of the product in the context of the pool of assets. The large supply of investment grade property across Asia relative to the limited number of REITs offers long-term and sustainable acquisition growth opportunities. J-REITs currently own only 3.6% of an estimated ¥50trn (e0.35trn) of available investment grade property.
Ryan says: “Even if Asian REITs achieve only half the level of market penetration seen in Australia, the total Asian REIT sector has the potential to grow to over ten times its current size.”
In Singapore, robust outperformance by S-REITs in the last 12-18 months has drawn interest from an ever increasing pool of investors. Jones Lang LaSalle calculates that REITs accounted for nearly half of the real estate investment sales in Singapore in the second quarter of 2004.
S-REITs are nearly identical to the Australian Listed Property trust model. The Singapore government continues to support and sponsor the REIT market, giving a further tax break to domestic retail investors as part of their 2004/2005 budget. Not only are Singapore REITs tax transparent at a corporate level, but for individuals, the distribution they receive is now also tax free.
The big news in Asia currently is Hong Kong’s dramatic entry into the market with the Link REIT, the largest REIT so far, worth over HK$30bn. The Link REIT is a privatisation of government assets, with a portfolio comprised 80% retail and 20% car-parking. It actually represents over 9% of total retail space in Hong Kong and almost 14% of commercial car spaces. Demand for yield and abundant liquidity created a strong demand for the Link lPO, which listed in mid-December 2004.
Ryan says: “The Link IPO has shown that divestment of heavy investment assets can deliver profitability gains to property developers, with an increased focus on high margin development operations. And with a booming Asian economy, the opportunities for developers to invest across the region are greater than they have been for many years.”
The downside of this is that despite a seemingly limitless supply of property, the market is tightly held. So the development of the REIT sector is dependent on the actions of a small group of potential issuers. Also, access to cash is not an issue, since there are other equally attractive alternate sources of capital, such as the corporate bond market. Also, in Hong Kong there is no tax transparency or tax advantage, as there is in other REIT markets. Gearing is limited to 35% of total assets and there are restrictions on re-deployment of capital. REITs cannot be used to fund the strategic growth of the developer’s business outside of Hong Kong.
The traditional rivalry between Hong Kong and Singapore extends to the real estate investment market. Singapore has created an attractive environment for REITs and the question remains: will Hong Kong alter its regulations after the successful launch of the Link REIT? Cross border REITs are currently possible in Singapore (eg, the Fortune REIT) while Hong Kong is potentially a superior listing location for China than Singapore.
Morgan Laughlin, managing director of Deutsche Bank Real Estate for Asia is encouraged by development in Singapore and Hong Kong, but is only cautiously optimistic of a market emerging in China any time soon: “In China, the market needs liberalisation of regulations, to allow real estate to be more easily adopted. Increased foreign participation would help raise standards and improve market conditions. Currently, the quality of property management in China leaves much room for improvement. Eventually, there’s going to be such a need, that REITs will grow strongly. And REIT managers will demand international standards.”
The Chinese authorities have made the first steps towards establishing new real estate investment guidelines for institutions. On the 18 October 2004, draft rules were put out by the CBRC, which Laughlin describes as “good stuff” although he added that the list of authorised investments made him nervous, because of the inclusion of certain types of asset that were “way down the risk chain”.
While it may still be too early to be talking about a REITs market in China, the scope for development in the rest of Asia is very encouraging at this point.