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Real estate investment trusts or REITs are nothing more than real property investments to investors like you and me who leave the administration of the assets, the maintenance of the buildings, the collection of rent and the enhancement of real estate to increase its value to the professionals. We also allow a trustee to own the real estate on our behalf. Investing in a transparent trust industry is the same as investing on your own in real estate and paying property taxes in your own tax bracket.
The standard operating procedure of REIT managers in Asia is modelled after that of the US and Australia, and REITs have been a successful financial instrument and a safe haven for investors worldwide, especially when investing in bulky real estate.
But in the aftermath of the financial crisis in the US — where US and Australian REITs have lost a lot of their value due to the buying over of inflated assets with cheap loans — there is pressure on fund managers of REITs that are highly leveraged on low interest rates and heavily supported by private equity to relook their portfolios and go back to the fundamentals. Australian REITs that had expanded to the US lost some A$19.5 billion in value, about a third of their market value, and have begun to sell their assets in the US and return to Australia.
The fundamentals are that REITs now have to shift their portfolios to be not only income-safe but also capital value-safe. At the same time, they have to satisfy the investor’s need for excitement via asset enhancements and acquisitions.
The US is going through a cathartic experience, with fund managers being axed by core investors of REITs and new managers being appointed to chart a new course.
Investors are seeking more innovative strategies from fund managers and asking for more varied products. A look at some new strategies may be useful to understand this new direction.
In the US and more recently in Singapore, while REITs have seen property values fall in line with the stock market, net yields have risen — a phenomenon not seen before. But high yields have not brought new investors to the table.
So, rights issues have been offered at a discount by REIT managers such as CapitaLand in Singapore and Simon Property Group in the US. While these will reduce the dividends paid to existing investors, they will also retire debt and provide managers with cash to acquire new assets.
Cornerstone investors and originators have to maintain their equity and subscribe for the rights issues or lose control of the fund.
In the US, REITs have raised more than US$10 billion in share sales since the start of the year. In the last six months, 20 REITs in the US, including some of the industry’s biggest names such as Simon Property Group and Vornado Realty Trust, have raised US$7.1 billion in fresh capital to help them pay off debt and buy the assets of competitors. (Source: Pere.com)
REITs are considered leading indicators of the US real estate market because the value of publicly traded trusts changes more quickly than when traded in the private market. REITs are not natural competitors of value-added and opportunistic private equity real estate players. More often than not, they acquire only pristine properties sold by private equity real estate players. But the performance of property trusts could be an early indication that the real estate market in the US — the creator of the REIT model — is beginning to thaw although it may not yet have bottomed out.
Private equity real estate players in the US, on the other hand, have gone back to basics when it comes to searching for the best opportunities.
Deals are no longer underwritten with cap rate compression or rent growth assumptions in mind. Rather, transactions are based on the cold hard reality of the property market today. This means buying cash flow. This retreat to safer, income-producing properties reflects the uncertainty still inherent in real estate markets globally.
Yet for lenders, this move by investment professionals back to cash flow fundamentals has not gone far enough. So, they have begun to use another back-to-basics tool to assess the viability of loans — the debt-yield test.
Stung by lax underwriting standards during the property boom years, most banks and lending institutions in the US have severely tightened lending criteria over the past years, introducing much lower loan-to-values and higher debt service coverage ratios while reserving most of their real estate capital for existing relationships.
But for those that are able to deploy fresh cash into the marketplace, debt yields have become an important means to underwrite deals. Debt yields measure net operating income as a percentage of the loan amount and are viewed as the most direct method for calculating risk. The higher the debt yield, the more attractive the mortgage to the lender.
Over the past few years, debt yields were deemed almost irrelevant as investors and lenders forgot about risk and gorged on a buffet of easy credit. With risk now fully occupying the minds of lenders, debt yields are once again the favoured benchmark. As a result, institutions that are able and willing to lend are setting minimum debt-yield levels, with many in the US looking at 11% to 12% at least or even higher.
When we compare the American REIT scenario with that in Malaysia, we have to acknowledge that we still have some way to go before we can become a leading player in the REIT market.
There are some historical reasons for this:
• Our REITs are not tax transparent like those in Singapore or even in the UK, and until our REITs are like bonds, which are tax transparent, they will not attract foreign direct investment.
• The management of REITs is still subject to equity distribution restrictions, which means foreign REITs will not want to list their products here, preferring the more open markets of Hong Kong and Singapore.
• Our REITs are too small in capital value due to the low exchange value of the ringgit and have very little outside potential because their current market prices do not allow new acquisitions as there is no yield accretion.
After looking at the prospects of the 11 REITs in Malaysia and inspecting the assets of the managers, we selected five REIT managers that have the potential to achieve new heights in the near future.
So, how have our REIT managers handled the assets and has the current economic slowdown affected their skills?
Overall, our impression is that Malaysian REIT managers are competent but unable to enhance the assets in their portfolio except to raise micro-funds. After injecting their originally owned assets into a REIT, they are unable to find independent assets that could be injected without affecting current yields and perhaps diluting debt servicing yields for the original promoters of the assets injected earlier.
We have excluded the Al-Hadharah Boustead REIT in plantations and the Al-Aqar KPJ REIT in hospitals from our Top 5 as they are outside the normal REIT products. We acknowledge Boustead’s plantation REIT as the first in the world and possibly the beginning of such products in the future as smallholders come together to raise funds for plantation REITs. However, as plantations have a life span of around 25 years before the trees need to be replaced, the acquisition of new plantation land may be the key to maintaining dividends and interest in the REIT.
KPJ is a dry lease model where the REITs get net rent from the hospital operators. Being in the same group, it is possible for them to massage income to make the yields attractive. The KPJ hospital group has a niche market and is run by dedicated professionals with a large number of hospitals under their leadership. There are opportunities to balance the dividend yield, depending on market conditions.
After inspecting some of their hospitals, we note that some of them could do with a building upgrade as the facilities for visitors and patients have not reached the level of, say, Subang Medical Centre, Sunway Hospital or our premier hospital Prince Court. True, KPJ caters for the middle-income group but patients will begin to notice the difference over time.
Our Top 5 REITs are, in descending order: Quill Capita trust; UOA REIT; Axis REIT; Starhill REIT; and Hektar REIT.
These have exemplary asset and property management skills and more importantly, a deal flow of REIT-able assets that will grow their portfolios to a critical mass, attracting more FDI over the next few years.
Quill Capita Trust
This is run by a joint venture between Quill, a Malaysian project developer, and CapitaLand Singapore. They started off with an injection of Quill’s assets in Cyberjaya, which were specifically built for business process outsourcing (BPO) clients such as DHL, HSBC and BMW.
After securing Quill’s assets, CapitaLand sold Wisma Technip, which it had purchased earlier, into these. They were on a campaign to purchase more assets until the financial crisis in Singapore slowed them down.
The most relevant acquisitions have been the purchase of a retail podium in Plaza Mont’Kiara and retail and BPO properties in Shah Alam and Penang.
CapitaLand has a good track record in managing REITs, having had a successful run in Singapore. Being a Singapore government-linked company, it has the resources and deep pockets to park assets, retrofit them and inject them into a REIT when they reach a certain yield.
Quill Capita, therefore, has the ability and the deal flow to manage REITs well and could be the biggest player in Malaysia’s REIT playground over the next few years.
UOA REIT
This Malaysian REIT started off building Hong Kong-style office suites in Jalan Kia Peng, Kuala Lumpur, placing them in a REIT and recycling the capital to develop more office buildings and purchase land in strategic secondary markets in the Klang Valley.
It is very good in what it does, focusing on modern, efficient and pleasant office buildings and standardising their design.
It has a strong strategy based on the Australian model and we expect more good news from them over the next few years.
Axis REIT
A portfolio of assets owned by private developers of office warehouse-type projects in Petaling Jaya and Shah Alam, the fund is run by business savvy property group and has begun to buy assets that are not owned by the original partners, which bodes well for the group.
Axis REIT is a well-run company always on the lookout for yield-accretive assets. It will be a successful yield-driven REIT, although not so exciting in terms of capital-value enhancement.
Starhill REIT
With the distinction of being the largest REIT in terms of capital value, Starhill REIT is run efficiently and the original assets, such as Lot 10, Starhill and Ritz Carlton Residences in Kuala Lumpur, are well maintained.
As it presents itself as a six-star REIT, Starhill REIT has had difficulty in purchasing new assets that match the original portfolio. Its inclusion in our Top 5 list is due to its recent acquisition of a REIT in Singapore. It is only a matter of time before these two REITs have cross-holdings, thereby giving Malaysian REITs the opportunity to participate in the Singapore REIT and increase their chances of capital appreciation.
Hektar REIT
A retail-centric REIT with assets like Subang Parade and Mahkota Parade in Melaka, Hektar would not have made it to the Top 5 if not for its strategic partner Frasers Centrepoint, a Singapore-based REIT manager.
The partner is an aggressive investor and will steer Hektar into better performances over the next few years.
There are new REIT entrants that are mulling whether or not to list their assets on Bursa Malaysia. Among others, these are Sunway, TA Properties — an owner of assets in Penang and Johor — and, of course, PNB, which has been quietly acquiring assets to park them in a large REIT that could dwarf all of the above.
PNB’s first foray into property trusts did not go very well but it is now the biggest asset owner in the country. A REIT structure will give PNB the transparency and yields that are missing from its portfolio.
There are exciting times ahead for REITs and they will be good alternatives to holding cash or investing in normal stocks. They just need to work at their business model and start moving on information and public accountability.
Kumar Tharmalingam, chairman of Hall Chadwick Asia, started the first property trust to be listed on the KLSE in 1989 and has been monitoring the performance of REITs in the region since. The opinions expressed are strictly his own and not meant to represent any recommendation for investment.
This article appeared in City & Country, the property pullout of The Edge Malaysia, Issue 773, Sep 21-27, 2009.
