PINNING HOPE ON REITs
by Lim Lay Ying
Property Times, New Straits Times
26th March 2005

On January 3, 2005, an event occurred that would prove a landmark move in Malaysian REIT history.

The Securities Commission (SC) deregulated several guidelines on property trust funds which had been in effect since November 13, 2002. Referred to as the 3rd Edition, the January 3rd regulations sought to position the trusts in the international scene by renaming them REITs – the acronym for Real Estate Investment Trusts.

Not wanting to be left out of the phenomenal growth of the global REITs industry, the 3rd Edition guidelines liberalised the borrowing limits for a REIT, relaxed rules on acquisitions of leasehold properties, and allowed a wider range of investment opportunities other than real estate-related types.

With the latest rules, a REIT – regardless of whether it is listed or unlisted, is allowed to invest in non-real estate-related assets, liquid assets, and asset-backed securities, in addition to real estate (both local and foreign ones), real estate-related assets, and single-purpose companies which own a particular real estate.

Asian property securities have been gaining worldwide attention since the region’s economies recovered from the mid 1997 financial turmoil. According to a survey by Global Property Research (GPR), REITs as well as shares in developers and property investors in Asia outperformed not only their counterparts in other parts of the world in the first half of 2004, but also other investment instruments such as equities and bonds.

Boom era of Asian real estate

GPR’s index of 250 property securities reported a return of 18.2 per cent for Asian Property, against 14.8 per cent for Europe and 6.1 per cent for North America. Benchmarked against global bonds and equities, Asia’s property securities gave an average return of 10.5 per cent in the first half. Global bonds on the other hand, yielded 0.5 per cent while equities (measured by the Morgan Stanley Capital Index) produced 4.8 per cent.

The boom era of Asian real estate is about to take off again. Hong Kong’s physical property market has rebounded from a six-year slide, and Tokyo’s is picking up in line with a reviving economy. Singapore too, is witnessing more stable property prices and rents after having suffered its fair share of a free fall of values. In Malaysia, property players are reaping hefty gains from a pick-up in demand and corresponding price levels.

Though relieved to see a turnaround in their property markets, governments in the region are concerned about the industry’s dramatic boom-and-bust cycles and hope to temper them by reconstructing their property-development models. The most popular approach so far is the encouragement of REITs as a new real-estate investment product for both institutional and individual investors.

REITs which are publicly listed companies that own properties and derive their income from rents, sales or mortgage-backed assets, helped to revive the moribund property markets in the U.S. during the country’s savings-and-loan crisis in the early 1990s. They helped raise money through the stock market to buy up vast chunks of cheap property through the U.S. government’s Resolution Trust Co. (The RTC was a body set up to help dispose of the assets of failed S&Ls).

Opportunity for global positioning

Countries in Asia, such as Malaysia, Thailand, Singapore, Hong Kong, Japan, South Korea, and Taiwan, are thus pinning their hopes on REITs, which they believe may help them avoid a bit of their property markets’ past volatility. What makes REITs attractive to these governments is also the opportunity they present for their countries to compete in the global market and help position them as financial centres in the region.

To property companies, REITs offer a new way to attract foreign investors and to raise money from the stock market to lower their corporate debt. To large institutional investors – many of whom are from the U.S. and Europe, and are fishing in Asia for cheap assets, REITs have their merits too.

Other than the exemption from corporate income tax as long as they distribute most of their taxable income to shareholders (which is the underlying premise of the REIT model), these institutional investors also appreciate the following advantages:

· REITs reduce portfolio risk

Since a substantial portion of their total return is derived from dividend income, yields from REITs are less volatile than other equities. Income yields are generally above 5 per cent or higher in some countries. Combined with the potential for appreciation, the risk profile for REITs is substantially reduced.

· REITs provide valuable portfolio diversification

The correlation between REITs and other stocks and bonds is low as observed over the past decade in countries with more matured REITs markets. Dividend income has generated a steady stream of cash to investors, hence reducing volatility in the equities market.

· REITs in countries with REIT structures provide higher returns

The UBS Global Property Investors Index which measures returns generated by publicly traded real estate operating companies throughout the world, reported double-digit figures over one-, three-, five-, and ten-year periods in 2004. They consistently out performed global stocks (measured by the MSCI Global Equities Index) and government bonds (measured by JP Morgan Global Bond Index).

Returns from REITs are historically higher in countries with REIT structures, due in part to the tax-efficient structures. Since 1994, countries such as the United States (legislation passed in 1961), Australia (1971), and the Netherlands (1972), have produced returns of 14.5 per cent, 15.3 per cent, and 10.8 per cent respectively.

· REITs increase transparency

REITs are required to disclose income and earnings, as well as report transactions and property performance measures such as average occupancy levels. Their operations including disclosing conflicts of interest and abiding by corporate governance standards, are subject to public scrutiny.

The REIT structure therefore provides added market transparency because investor interest emphasizes demand for accurate tracking of supply/demand fundamentals and emerging trends, both of which require on-the-ground knowledge.

With the increasing number of individual investors, pension funds, opportunity funds, and various types of institutions, seeking real estate investment opportunities in regional or global markets, Malaysia’s REIT vehicle will open the country’s property market to a whole new spectrum of opportunities.

Competition for investment capital will heat up and will not be just amongst REITs in the country but also others in the region and the rest of the world. To succeed, local understanding and tracking of market trends, and access to high quality data are essential.