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REITS make the scene in Asia

There has been a global rise in the number of Real Estate Investment Trusts (REITS), particularly in the Asian markets. Such funds can offer returns of around six or seven per cent. But are private equity firms interested in such investments? Not with those returns, argues Joel McCormick of the AVCJ.

Despite some modest summer gains by land-holding corporates, depressed valuations and rental income keep Asian property in the doldrums, the lull broken now and again by funds sweeping into Japan and Korea to snap up distressed assets. To add some spice to this dull scene, some property companies have gone for real estate investment trusts (REITs) in the hope that all investors   from lowly punters to institutions and funds and private equity investors - will jump on their bandwagons.     

If Australian experience is any guide, REITs could account for perhaps ten per cent of market cap in bourses in Hong Kong and Singapore five years from now, according to Tom Lennox, a Hong Kong-based partner of international law firm Mallesons   Stephens Jaques.

Just approved last month in Hong Kong, the trusts bundle revenue properties into listed vehicles and pay out 90 per cent of their income to shareholders in dividends. In Australia and the US, they've also tended to outperform most market sectors. While US equities as a whole ended 23 per cent down last year, for example, the National REIT index ended up a positive three per cent.

Australia apart, Japan was the first in Asia to list REITs, followed closely behind by Korea and Singapore. While Hong Kong investors have yet to see their first locally-listed REIT, Li Ka-shing flagship Cheung Kong, bundled a handful of local malls into a REIT and listed it in Singapore last month. Fortune Trust, as it's called, delivers a yield of six per cent and is one of three traded in Singapore.

Hong Kong should see its first trust in a matter of weeks - from property giant Sun Hung Kai, if an ING analyst has it right.

Lennox told AVCJ that REITs would draw foreign institutional investors into Hong Kong's property market, where they have tended to be few and far between. Earlier Morgan Stanley announced it had acquired Vicwood Plaza, a slender shoot of glass and steel jammed into a pencil pot of towers overlooking the waterfront in Hong Kong's Central district. The purchase stirred a flurry of comment suggesting US institutions were about to sweep into town to buy office blocks.

The time is ripe
No question, local property could stand a lift. Valuations are down, rental income is down, shares in property companies are down - making a natural opening for property funds and other investors to come in for a sniff round. Indeed, were it not for the fact that local property companies were so tightly controlled by family interests, some takeover bids might well be in play by now, according to Lennox.

REITs come on the scene when Hong Kong banks are paying next to nothing on deposits and retail investors have little hope of realising capital gains either on their own properties or in traditional property plays in the stock market. From their perspective, it's easy to see how dividend payouts of six per cent might stir some interest.

But would private equity funds ever consider including property trusts in their portfolios   in Hong Kong or anywhere else in Asia? Only in the most exceptional      circumstances, said Chang Sun, managing director of Warburg Pincus in Hong Kong. ‘I don't think private equity firms would be interested in REITs, certainly not us, unless they happen to be grossly undervalued.'

Roger Marshall, managing director of ABN AMRO Asia Capital Investment, said he could imagine property funds giving property trusts a good look. ‘But with yields of six per cent or seven per cent, the REIT does not provide the level of return my masters would find acceptable.' Thinking aloud, Marshall wondered if trusts might provide a means of redeeming excess cash private equity plowed into China's typically overcapitalised companies. But even that idea, he conceded, was a mite   fanciful: mainland companies tended to be reluctant to give up cash in hand before they had to.

Quek Peck Lim, partner for Research and Strategy at PrimePartners Asset Management in Singapore, said he couldn't see his way to investing into property trusts either: ‘Most private equity groups have raised capital on the back of high IRRs, so I can't see how these yields - respectable though they may be - bolster their high IRR case,' he said.

The case should be even harder to make in Hong Kong where REITs managers face restrictions likely to impact yields, according to Moody's Investors Service. Last month, the rating agency warned that, with local trusts restricted to buying properties in Hong Kong, opportunities to push yields elsewhere would be missed. Singapore, which is considered the closest to SAR in looking out for investors, does not restrict trusts investing outside the republic.

Moody's said managers would also have less room to manoeuvre with Hong Kong's 35 per cent leverage limit. ‘It is crucial that Hong Kong's REITs maintain sufficient alternative liquidity arrangements to at least cover their short-term cash outflow requirements,' the credit rater said.

The betting is Hong Kong's Securities and Futures Exchange will eventually loosen up. Noting the SFC's commitment to review the rules, Jones Lang LaSalle national director Nicolas Wong told AVCJ: ‘The first [rule to go] will definitely be overseas assets   they will allow overseas assets in one or two years. ‘The first frontier REITs will have to cross if they hope to spike investor interest is the one separating Hong Kong from the rest of China.

Gripes won't hinder REITs
Each market seems to offer excuses to gripe about regulators. In Korea, the complaint is over the minimum required capital - W50bn ($427m) - to set up a trust.  In Singapore, it's the 25 per cent cap on gearing. But these details are unlikely to stop REITs popping up everywhere, according to Jones Lang LaSalle Asia Pacific research chief Yu Lai Boon. ‘As both developers and investors get familiar with the REIT instrument, more Asian countries will be introducing REITs,' he wrote in a paper earlier this year.

Lennox said REITs may take some time gaining acceptance, what with Asians traditionally focused on capital gains. Dividends may be boring but ‘investors like boring' these days, he said. ‘It won't happen overnight but once investors get used to receiving those checks every six months... you'll start to see some take-off. There'll be a range of investing people, including outside institutions,' he said. ‘There hasn't been a lot of institutional base for property holdings in Hong Kong and I think that will change.'

Earlier this year in a conference presentation, Antony Green, JP Morgan's head of real estate banking for Asia Pacific, reported that Asia's REIT sector was growing fast, more than doubling capitalisation in less than two years - from $2bn in mid-2001 to $5bn. Green even suggested property companies might consider using these vehicles to ‘reinvent themselves' to lift their sagging valuations.

Nothing new to investors in Hong Kong, top property companies have traded at substantial discounts for years. Between their net asset value and the cash they generate, punters have discounted some big land-holding corporates by as much as 20 per cent or more, says one analyst. Why? Because investors don't think they're getting as much return as they should as management had the discretion to divert income into pet projects like mobile phone networks.

Some investors like property companies going off into different ventures, some don't. And in Hong Kong at last, goes the argument, REITs provide an investment option for investors who like their property investments clean and simple. Or that's the theory: some commentators have warned that REITs may be just the package some other investors have been waiting to use to unload their dodgier holdings. Prospectuses must be read very carefully, say the cynics.

The slow build-up
REITs have a history. First offered in the 1960s in the US, interest in REITs didn't really spike until the 1987 ‘Black October' crash. Between 1991 and 2001, capitalisation of US-listed REITs rose by nearly 13 times, to $155bn. In Australia - where the first trust was offered way back in 1971 - REIT total market cap multiplied nine times between 1992 and late-2002, to nearly $30bn. Today there are over 30 trusts, forming one of the strongest stock groups on the ASX.

Asia's first REITs appeared in Japan in 2001 when the Office Building Fund of Japan and the Japan Real Estate Investment Corporation started trading on the Tokyo Stock Exchange. Their number has since grown to six. What sets J-REITs apart is the investors drawn to them   conglomerates in   the main.

If Japan had REITs, Korea was bound to, and by early last year, legislation was drawn up enabling special asset management companies to launch three REITs. Singapore was next to okay REITs. The first, CapitaMall Trust, began trading on the SES in July 2001. The second, the Ascendas REIT, comprised of industrial and business park buildings, launched the following November. Cheung Kong's Fortune REIT followed   in August 2003, a signal, some say, of the conglomerate's impatience with Hong Kong's fussy regulators.

Copyright © 2003 AVCJ

Joel McCormick is a senior writer for the AVCJ.

This article first appeared in the Asian Venture Capital Journal in September 2003.

The Asian Venture Capital Journal is the region's leading publication on private equity and venture capital. With readers worldwide, AVCJ provides monthly coverage of fund raising, investments, exits and the people behind them. For more information please visit www.asianfn.com