At the beginning of 2006, we were reporting that investors were indulging in a feeding frenzy over Hong Kong's belated entry into the Asian real estate investment trust (REIT) market. There were half a dozen new REITs in the pipeline and, despite warnings that these investments were not meant to shoot out the lights, local investors were enthused by the early success.
Fund managers were not so keen though, and the market euphoria was rudely curtailed when professional investors took a dim view of the financial engineering employed first by Prosperity and then the Champion REIT. In the case of Champion, a single property REIT launched by Great Eagle Holdings in May, analysts complained that its interest rate swaps and a waiver of dividends by sponsor Great Eagle artificially inflated the original yield at the expense of future income growth.
Shares slumped and Hong Kong's REIT boom was sadly short-lived. In recent weeks though the market has been reinvigorated. Michael Smith of Goldman Sachs predicted that in 2006, the story would be cross-border REITs. At the tail end of the year, China in particular was grabbing the headlines in the market.
According to Simon Lo, director of research at Colliers in Hong Kong: "The future of REITs in Asia is compelling. The majority of the REITs that have been established in Asia so far have largely been formed to enable government-backed entities to privatise some of their assets or for developers to dispose of non-core assets. All the assets have one key characteristic: they are high yielding income-producing properties with potential for further upside. The assets are not always prime as they are being offered in markets where prime assets are tightly held and are generally low yielding. But they are in good locations and are capable of generating a sustainable income stream."
The REITs market in Asia has sprung up in the last five years - from nothing to a market capitalisation of over $50bn (€37.9bn) for the main six markets - Japan, Singapore, Hong, South Korea, Taiwan and Malaysia. If we include Australia and New Zealand, the number of REITs almost doubles from 83 to 150, and the market capitalisation swells to $130bn. Peter Mitchell, chief executive of APREA, the association for the listed real estate industry in Asia, says because the Asian REITs market is still so new, the growth potential is enormous.
The advantage the Australians have is that their listed property trusts (LPTs) market is probably the most developed in the world, certainly outside the US. Property as a percentage of stock market capitalisation is over 10% in Australia, way ahead of Hong Kong and the Netherlands at 3.7% and the US at 3%. Hong Kong's figures represent listed property companies as well as REITs.
Approximately 43% of the property held by Australian LPTs is located outside Australia. John Welch, head of research at Melbourne's Property Investment Research, points out that: "Looking at the graph (see Global Potential for Securitisation) and concentrating on the ‘percentage of the global investable universe' bar, we see that Australia is actually a minnow in terms of size of the property market, being just under 2% of the world total. The size of the market is not a factor of the size of the country, it is a factor of the size of the economy. While Hong Kong and China are just under 10%, if the Chinese economy continues to grow at its phenomenal rate, then so too should its percentage of the world's real estate market."
Although advisers are working to put the framework in place, China does not yet have REIT guidelines or regulations, so the mainland China developers are looking to Hong Kong and Singapore for listings. Henderson Land, Sun Hung Kai Properties, Lai Sun Development, Sino Land, New World Development, Nan Fung Development and Hang Lung Properties have all been rumoured to be in throes of listing REITs, but they have all been put off by the market's mid-year reaction to the Champion REIT. Lo says: "Although local property firms are of great interest, the market is eagerly awaiting more China issuers."
The GZI REIT was the first REIT in Hong Kong to invest in Chinese mainland properties, with a portfolio comprising four office/retail properties in Guangzhou. Simon Lo says GZI is an interesting test case because the portfolio consists of mainland real estate and the company is Chinese itself. That fact that GZI is the most popular REIT that has been listed so far in Hong Kong - the retail portion was 495 times oversubscribed during the IPO - bodes well for the new batch of China REITs being launched in Hong Kong and Singapore.
Lo believes the China property market presents a full variety of choices to foreign investors, including residential developments, office and retail, industrial developments, logistics facilities, serviced apartments, hotels and non-performing loan portfolios. The risks associated with China's private property market, less than two decades old, include inaccurate land titles, unpredictable laws and policy shifts, lack of transparency, complex tax issues and rapid construction that can suddenly make an area unfavourable. "The low percentage of invested stock in China implies the majority of real estate is still concentrated in the private sector with a low degree of investor participation. Real estate assets held in private hands or within companies that do not specialise in property are typically inefficient in terms of management and taxes."
China lacks a framework for REITs, and has introduced rules this year requiring investors to hold property in local companies rather than in offshore firms - making it harder to list trusts in Hong Kong or Singapore. These restrictions are not likely to dampen investors' enthusiasm. Hong Kong is looking to China as the key to its future as a major REITs player. According to an estimate by UBS, the size of the investment grade real estate market in Hong Kong and China is about $334bn, of which 77% is yet to be listed. The fact that China does not have regulations in place governing REITs, combined with the recent austerity measures introduced by China to take the heat out of the market, puts the advantage with Hong Kong.
The Hong Kong REITs market seems to have recovered. Whether the market has learned this lesson will be seen in the next few weeks as reaction to the new wave of IPOs sinks in. Henderson Land, having shelved a proposed HK$3.8bn (€371m) REIT in June, repackaged the Sunlight REIT, consisting of about 25 office and retail properties in Hong Kong, and raised $348m at its IPO in December 2006. Also in December, the Regal Hotels group plans to bundle its five hotels worth HK$16bn into a REIT, raising HK$6bn in the process. Wharf Holdings is also expected to launch the HK$5bn Diamond REIT, consisting of Lane Crawford House, a retail-office building in Central, Plaza Hollywood, a shopping mall in Diamond Hill and other commercial properties.
Singapore is also playing the China card. Local developer CapitaLand has been massively oversubscribed on its CapitaRetail China Trust, raising US$150m in a Singapore IPO in December 2006. The deal packages seven shopping malls in five Chinese cities into the REIT. The malls, valued at $690m, have a total gross rentable area of around 413,000m2. JP Morgan was the adviser and underwriter of the issue, together with UBS and China International Capital Corp. This move from CapitaLand is part of its strategic development in China, where the developer has a fund building 19 malls, and another revamping existing buildings. CapitaLand bought the trust's malls at a cap rate of 8%. The prospective yield is between 5.42% and 6.45%.
Singapore remains the most developed and attractive of the REIT markets in south Asia. Among its other new REIT IPOs is one from Jakarta-based Lippo Karawaci, the real-estate arm of Indonesian conglomerate Lippo Group. Lippo is listing a property trust in December in Singapore, known as First REIT. The portfolio will consist of three hospitals and a hotel resort worth US$257m (€127m) in total, and would be the first Singapore-listed REIT to be based on Indonesian assets. Lippo, which is controlled by Indonesia's Riady family, said the trust would eventually own and invest in healthcare assets in Singapore, China, Malaysia, Thailand and Hong Kong. Merrill Lynch and Overseas-Chinese Banking Corp were joint lead managers for the deal.
The situation in Australia is unusual in that, even now, there is a sizeable yield differential compared with other developed markets. Gearing is another key point of difference: there is no legislative restriction on gearing for Australian LPTs, where managers use gearing to arbitrage the yield spread and thus enhance return, especially with overseas property and far more than most overseas REIT managers.
If there are liquid and well-regulated REITs markets developing overseas, what does this mean for the Australian LPT market? PIR's John Welch says: "We are effectively running out of investment grade property in Australia and the bulk of the new supply comes from overseas. Meanwhile, we still have a large amount of superannuation money coming in, some of which needs to find a home in property."
So once again, it seems that Asia is the focus for investors looking for greater international exposure.
Richard Newell is Asia correspondent for IPE Real Estate