ASIA HAS THE makings of a new investment favourite in REITs (real estate investment trusts). The launch of two recent REIT IPOs – one in Singapore, one in Hong Kong – have proved immensely popular and could herald the start of a new asset class for the region's yield-hungry investors.
As the name suggests, a REIT is an investment vehicle created specifically to hold a portfolio of properties, typically of the same class, the income from which is paid out to investors, normally in its entirety.
REITs are designed to yield a steady and predictable revenue stream. "REITs are simply the best way of owning mature, income-producing real estate," says Matthew Whittell, director of equity capital markets at Citigroup in Singapore. "It's the closest thing you can get to owning the property itself."
Specialist companies, often owned by the original sellers of the properties, manage the portfolio according to strict guidelines that enable a REIT to benefit from tax breaks, essentially relief from corporation tax. REITs offer property companies a chance to offload mature investment properties and release valuable capital that can then be recycled into new projects that offer a higher potential return. Those property companies that retain a significant interest in the REIT also gain from the management fees as well as upside from the investment.
For investors, REITs offer a transparent investment with a predictable income stream that, in current markets, can provide a significant yield premium to other available investments. In some jurisdictions investors also benefit from tax exemption on income received from REITs, further boosting returns.
All of this might explain the recent fuss over Asia's two largest REIT IPOs. In Singapore, Suntec REIT, a company that controls Singapore's largest integrated commercial development, Suntec City, raised S$722 million (US$438 million) on an annualized dividend yield of 5.8%. After the IPO was subscribed 10.3 times and the institutional placement 13.7 times, the shares began trading 10% above their issue price on December 9.
Suntec is the fifth REIT in Singapore, which is leading the development of the market in Asia outside Japan from a standing start in 2002.
A management upgrade
Although late to the party, Hong Kong will trump its arch-rival in one go when, or rather if, its own LINK REIT ever goes ahead. Comprising low-grade shopping centres and car parks previously owned by the Hong Kong government's housing authority, the IPO will, say analysts, place poorly managed assets into the hands of more competent and professional management. This is likely to eke out significant cost and yield improvements.
The world's largest ever REIT, raising US$2.7 billion, the LINK REIT IPO priced at the top of the range, yet would still have paid a yield of almost 7%. With the public offer oversubscribed 130 times and the institutional placing 16 times, everything seemed set for a spectacular trading debut.
However, Hong Kong's plans to steal a march on Singapore came embarrassingly unstuck after legal challenges from disgruntled tenants forced the government to shelve temporarily the IPO in late December. The government is already planning to re-launch the offer after the legal issues are resolved definitively.
So is the recent euphoria with which the public greeted both Suntec and especially LINK a sign of vast pent-up demand for specialist property investment? Not according to John Saunders, property analyst at CLSA, who detects a far more familiar reason for the LINK REIT IPO frenzy.
"Mr and Mrs Hong Kong are smart," he says. "They sniff a deal. They know it's being sold off on the cheap. They'll be in, wait for the pop and be out again. If it had been priced down the middle, they wouldn't have been interested in it."
Despite such healthy cynicism about the investment motives of Hong Kong retail punters, most practitioners believe that in REITs Asia is witnessing the dawn of a new asset class. Behind the growth in REITs, they argue, is a search for yield in a low interest rate environment from the buy side coupled with a growing sophistication among Asian property businesses, the supply side, over the need to rationalize portfolios in tougher, maturing markets.
"People are beginning to understand the efficiency-of-capital argument," says Whittell, "but it's an education process. The only thing REITs are doing is packaging up assets in an investor-friendly way, limiting leakage to the tax man and making the assets more tradable."
Michael Smith, head of real estate investment banking in Asia at UBS in Singapore, is also bullish. "One of the key things Singapore has done is to make REITs completely tax-free to the man in the street," he says. "That's unique."
The favourable tax treatment afforded to REITs, whereby they attract no corporation tax, unlike property companies, makes it increasingly compelling to hold property in these vehicles, argues Smith.
Smith points to the recent success of the Suntec REIT as evidence that the message is now getting through to the developers. "The fact that six billionaires in Suntec decided to launch a REIT says a lot. They're all pretty smart investors and it's put some of the private family companies in Singapore on notice."
Physical constraints
REITs might be on their way to Asia, but they have a long way to go before they can be regarded seriously as a separate asset class. According to UBS, just US$12.2 billion of capital has been raised from Asian REITs since September 2001, with the bulk of issues coming from Japan (see table). And while governments around Asia are rapidly passing legislation to encourage the growth of the REITs market, there are still physical constraints to mass adoption of the structure.
"The big thing about a REIT is that you're giving up control of your assets," says CLSA's Saunders. "The idea is that you get upside from developing a REIT management business and Hong Kong is just too small to support this kind of business because, at the moment, you're not allowed to put non-Hong Kong assets into a REIT, so there's just not enough quantum."