These days, as banking interest rates flirt with zero and choppy stock markets are hit by volatility, investors are increasingly turning to safe havens. The Real Estate Investment Trust (REIT) is no doubt a new love for yield-seeking investors.
But rumour has it REITs are losing their glamour amid US recovery. Even Hong Kong’s flagship The Link REIT, Asia’s largest REIT in terms of market capitalisation, seems headed for a downturn. The big question now is: What’s next? Is the REIT still an attractive option for long-term investment?
What’s REIT, What’s Wrong
REITs, as the name suggests, are another investment related to real estate only. They own properties that generate a rental stream that pay dividends to unit holders. Subject to regulation, REITs in Hong Kong are required to distribute not less than 90 percent of their net income as cash dividends.
Put simply, REITs generate returns for investors at average dividend yields of 5 to 7 percent these days, says Thomas Lam, head of China research at Knight Frank. This is compared to a return of just 3 percent from properties and 10 percent from stocks.
It wasn’t until 2005 the first REIT was launched in Hong Kong as a new financial product. “Before REITs, we only had two options: Buying properties or investing in property stocks,” Lam says.
Back in the old days, “REITs weren’t popular at all among Hongkongers — who love stocks and speculation more than anything else,” he recalls. The prevailing wisdom has long been that REITs are for risk-averse conservatives to hedge against inflation.
The global financial crisis has changed that perception. In a low interest-rate environment, REITs increasingly suit the appetite of many yield-hungry investors. They are neither as unpredictable as (sovereign) bonds, nor likely to have huge swings as stocks that prompt heart attacks every minute or so.
So what makes REITs attractive compared to direct property investment? Global law firm Mayor Brown summarises it well in an investment guide: “Investors in a REIT enjoy the economic benefits of owning real estate while the ownership and operation of the real estate are with the professional REIT managers.”
Hong Kong REITs can only invest in income-producing real estate — not land or empty buildings. Typically, they are platforms for developers to sell a bundle of properties such as offices, shopping malls, serviced apartments and car parks to raise capital. But REIT codes in other jurisdictions are slightly different. For instance, Singapore allows factories, logistics and business parks to be included.
A total of eight REITs are traded publicly on the Hong Kong stock exchange with a market capitalisation of $150 billion, accounting for 2 percent of total global REIT market. REITs such as The Link, Sunlight, Fortune, Regal and Champion focus on local properties, whereas Yuexiu concentrates on Mainland properties.
There are some downsides to investing in REITs versus traditional properties. “REITs have professional management which needs to be paid out of the income of assets in REITs,” says the Mayer Brown investment guide. For example, the Sunlight REIT paid a hefty sum of $61 million in REIT management fees, which accounted for nearly 40 percent of its net profit in 2011.
Needless to say, no investment instruments are 100 percent risk-free. REITs are vulnerable to cyclical changes in the city’s rollercoaster-like property sector — which has a direct impact on dividends. A notable shock ahead is the US Federal Reserve’s decision to scale back quantitative easing as early as the end of this year, a move that is expected to cause an exodus of capital from Asia to riskier equities in Western developed markets.
Short, Sharp Shock
The logic is that if rates continue to climb, Asian and Hong Kong REITs will be hardest-hit due to higher borrowing costs. Dividends to investors will be less attractive than US treasury yields. A wave of dumping of REITs is likely. Brokerage CLSA earlier slapped the Link REIT with a “sell” rating after its share plunged 20 percent since May, the time when the Fed announced its possible pullback.
However, others believe the impact of the policy shift will be short-lived. There are still reasons to be hopeful about REITs in the long run. “At least REITs still generate a fixed income from contracts signed in the past few years. I’m more optimistic about REITs than the city’s bricks and mortar,” says Knight Frank’s Lam.
A robust commercial property market is one positive aspect. While office REITs (particularly Grade A offices) are considered safe bets, high-end malls and hotels are hot sectors not to be missed.
It’s no wonder a spate of new hotel REITs is ambitiously being added to the pipeline. Great Eagle and New World Development launched REITs earlier to spin off their hospitality assets, revealing their intention to raise capital before rates rise further towards the end of the year.
On the other hand, trusts involving office tenants who sign multiple-year leases tend to offer a stable stream of income despite downturns. Hence, they are almost immune from the government’s cooling measures in the residential market.
Although the number of Mainland visitors to Hong Kong has peaked, their per capita consumption level has plenty of room to grow. “The second and third-tier malls may be more at risk, but the hotel and luxury retail sector is no doubt the beneficiary,” Lam says. Who says REITs have lost their allure? No one, as long as there are still fans of stable yields and hard assets in times of uncertainty.