Dramatic REITs take-off in Asia
Real estate investment trust (REIT) markets are developing rapidly in Asia. Japan was the first REIT market to emerge in Asia in a viable form, with the Nippon Building Fund and Japan Real Estate Investment Trust listing on the day after the World Trade Centre disaster. Despite the inauspicious start the sector caught the attention of investors and rapidly gathered momentum. There are now 17 Japanese REITs (or JREITs) listed on the Tokyo and Osaka exchanges with a total market capitalisation in excess of two trillion Yen, and another three are in the process of listing.
Shortly after their debut in Japan, REIT legislation was enacted in other parts of Asia, paving the way for their emergence elsewhere. In 2002, Capitaland, a major property company in South East Asia successfully established the CapitaMall Trust which listed on the Singapore Stock Exchange in July that year. MGM Macquarie Goodman (an Australian industrial property trust operator) and Ascendas (a subsidiary of Singapore’s largest industrial landlord) teamed up and listed the Ascendas Real Estate Investment Trust (AREIT) in November 2002. Li Ka-shing, Cheung Kong’s billionaire chairman swiftly seized the opportunity to list Hong Kong retail on the Singapore Exchange with Fortune REIT in August 2003, and CapitaCommercial Trust, another trust from the
Capitaland stable followed in May 2004. In Dec 2004 Suntec REIT listed in Singapore, taking the tally to five with a market capitalisation of over nine billion Singapore dollars in total. At least two more REITs are expected to come to the market during 2005.
The success of REITs in Japan and Singapore has been dramatic. Delivering comparatively high yields and underpinned by stable rental streams and historically low interest rates, retail and institutional investors clamoured for stock. Demand has been such that yield compression fuelled double-digit growth in share price every year since launch. Such success hastened REIT legislation in other Asian markets.
The Hong Kong REIT code came into force in summer 2003 but was slightly different to the usual REIT legislation. In its original form the legislation permitted only REITs owning Hong Kong assets to list on the Hong Kong Exchange. Furthermore the tax structure in Hong Kong remains different to elsewhere. Usually, provided REITs distribute most of their taxable income as dividend, they incur no tax on this income. Double taxation is removed as the investor alone becomes liable for tax at the marginal rate. In Hong Kong dividend income carries no tax in any case, so the legislation provided for the trust to pay tax at the usual modest corporate rate. As a result REITs in Hong Kong are not tax efficient in the usual sense, although corporate tax levied is low. Thus, in tax terms, Hong Kong REITs are no different to regular Hong Kong companies although they are likely to be higher yielding.
With a lack of obvious incentives, few property landlords or developers in Hong Kong have transfered their assets into a REIT structure. The Hong Kong Government, however, running a large budget deficit, planned the sale of the Housing Authority’s assets to the Link REIT in an effort to reduce the fiscal imbalance. Had it succeeded the Link REIT issue in Hong Kong would have been the largest global REIT offering in the world. Incorporating some 150 malls covering 18.76m square feet within Hong Kong’s public housing network, it represents nearly 10% of Hong Kong’s retail space. Investors flocked to the issue which was heavily oversubscribed but fate intervened at the 11th hour when a legal challenge from an elderly public housing resident succeeded in postponing the launch. As yet, no REITs have listed in Hong Kong. The Link REIT is expected to re-emerge when all legal issues have been settled.
In the interim the Hong Kong REIT legislation has been fine-tuned and in June 2005 REITs owning overseas assets were granted permission to list on the Hong Kong Exchange. It is widely expected that REITs holding mainland Chinese assets will come forward in due course and that REITs such as Fortune REIT in Singapore will seek a domestic listing in Hong Kong.
There are currently six REITs listed in Korea with a market capitalisation of around US$500m in total. At present the Korean REIT market is domestically focused, with relatively small capitalisation and fairly illiquid. The inability to make secondary offerings in Korea has hindered growth.
In Taiwan, Fubon No 1 REIT listed at a relatively low yield by Asia ex Japan standards. Cathay Financial is expected to launch a competing REIT in Taiwan soon.
In Malaysia, REIT legislation has also been finalised. YTL Corporation and Axis are both planning REIT launches imminently. Thailand also now has REIT legislation and the Central Group has announced intentions to list a retail REIT in July this year.
Opportunities and type of exposure
REIT investing is open to small and large investors alike and is no different to buying property company shares on the stock exchange. For the larger REITs in Japan and Singapore liquidity is high, with millions of shares traded daily. Pricing of the trust units needs to be assessed, however. This requires an understanding of the trust’s business and the likely dividends it can distribute.
The opportunities are mainly for commercial real estate in the form of office buildings, retail and industrial space. More recently, residential and distribution REITs have emerged in Japan.
At Henderson Global Investors we prefer single sector REITs for two reasons. Firstly the ability to generate growth in a REIT requires skilled management who are expert in their field, be that office leasing or retail centre management abd so on. In our opinion, success is more likely if management are focused on a specific sector. Secondly, we like to make the asset allocation decision between sectors ourselves and so we do not need the REIT manager to do this on our behalf.
Picking sectors is relevant because retail, office, industrial and residential property is affected and led by different aspects of the economic cycle. However, it remains only one aspect of the decision in choosing between competing REITs.
In the final analysis the strength of the income stream, the quality of the assets, the quality of the tenants and the management team are all important issues to be considered. Valuation is also key, and requires looking at a range of metrics. Most commonplace in this respect are the prospective yield and spread above long-term bonds, the price relative to net asset value and the price/earnings multiple.
How about returns?
The returns generated by Asian REITs to date have been extraordinarily good. For Japan and Singapore which have an observable performance record REITs have generated spectacular double-digit local currency returns every year. More impressive is the fact that these returns have been generated at very low levels of volatility which, in layman’s terms, means they have been less risky than equities generally.
The chart at below shows the price performance (excluding dividend return) of the TOPIX REIT index, plus Singapore’s two longest running REITs, CapitaMall Trust and Ascendas REIT over the last two years. On an annualised basis Japanese REITs have delivered 19% capital growth, while CapitaMall has seen its price rise by 42%pa on average and Ascendas by 62% pa on average.
Investors should question whether such returns
are sustainable over the long term. REITs are by
their nature relatively low-growth, high-yield
vehicles which under normal market conditions
could be expected to return between 10-12% per annum. About half of this return comes from yield and half from modestly leveraged capital gains. In Asia, the lack of REIT products coupled with a
high demand for low-risk stable returns have
created an unusual scenario where the yield on
existing REITs compressed sharply, generating above-average capital growth. Such yield com
pression is a one-time event and cannot be easily repeated. In time, REIT returns in Asia will normalise in line with other more mature markets. At Henderson Global Investors we believe the sweet spot for
REITs will continue for a considerable time, however, as demand will continue to outstrip REIT supply. Going forward, demographic changes and the huge pension burden created, will add further fuel to the REIT market.
Growth prospects for REITS
The future for REITs in Asia is extremely bright. The case is compelling from both the supply and demand side. Bear in mind a large percentage of global real estate assets is in Asia. A vast amount of these assets are held in private hands, or within companies that do not specialise in property, and are thus inefficient from a management and tax perspective. REITs provide a more efficient alternative for leased assets, and over time ownership will shift from the private to the public sector.
REITs also create liquidity in the property market which allows companies in other industries to lighten their balance sheet and improve return on equity by selling their property assets to REITs. On the demand side, investors want more of these products. The attractive returns delivered with low risk makes them extremely competitive from an asset allocation
perspective. The risk and return characteristics also make them suitable to generate the kind of inflation-hedged income streams required by pensioners and thus they will increasingly be used to match pension liabilities. As pension liabilities are expected to grow exponentially it seems fair to assume that REITs are going to be increasingly in demand.
Singapore is keen to develop as a REIT hub in Asia, and has also fine-tuned the REIT legislation since it was first introduced, to encourage growth in the market. In its most recent budget, Singapore withdrew stamp duty for newly created REITs and eliminated tax on REIT dividends for domestic investors, making REIT investing tax-free for the domestic holder. Withholding taxes were also reduced, sweetening the tax position of overseas investors. Other adjustments currently under consideration include changes to permitted debt levels, part ownership of assets and improvements in disclosure requirements and corporate governance practices.
Since writing this article/going to press Hong Kong regulators have increased allowable gearing for Hong Kong REITS from 35% to 45%. More importantly Hong Kong REITS are now not restricted to investing solely in Hong Kong listed assets putting them in a much more competitive/attractive position to Asian and Australian REITS.
Chris Reilly is director of property, Asia, for Henderson Global Investors