The Royal Institution of Chartered Surveyors held a forum in October, discussing why the development of REITs in Hong Kong seemingly lags behind the development in other Asian countries.
Currently, the market value of Hong Kong REITs accounts for only about 10 percent of REITs in the Asia-Pacific region, while the share of Australia and Japan is about one-third each and Singapore is about 20 percent.
Since Japan, Singapore, and Hong Kong all started their REIT regimes in the early 2000s, the smaller market cap of Hong Kong REITs seems to suggest a slower growth path.
Within the local Hong Kong market, REITs constitute a small sector that contributes less than 5 percent of the total market value of all real estate stocks, which commonly include REITs as well as developer and landlord stocks.
However, the overall real estate industry in the city is quite active. As a whole, the listed real estate sector in Hong Kong is the third largest in the world, ranking behind those of the United States and Japan.
Hong Kong does not lack the opportunities or talent to make its real estate business successful. In fact, some of its REITs are more successful than their international peers. The Link REIT, the city’s largest REIT, is currently the largest Asia-Pacific REIT by market capitalization.
This shows that the development of Hong Kong REITs is more uneven than it is unsuccessful.
Despite their small size, Hong Kong REITs have performed well for investors in the last several years. With general market sentiment being buoyant this year, REITs did underperform other real estate stocks. However, over the last year, the last three and five years, REITs have outperformed other locally listed real estate stocks.
Furthermore, as mandated by regulation, a REIT must pay nearly all its net income to investors in the form of dividends. This provides a relatively higher and more stable cash yield to investors. If investors choose to re-invest the dividend consistently, the total return in five years could increase by 30 percent or more.
All around the world, a REIT’s ability to grow through acquisition during market upcycle is weaker when compared to many of its competitors.
In addition to developer and landlord stocks mentioned earlier, private equity funds, family offices and other institutional investors are also competing for similar real estate assets. Many of these investors can complete the acquisition process faster than a REIT, and thus, during an upcycle when speed is a concern, REITs may have a difficult time in completing acquisitions.
In view of this, a 2014 rule revision allowed REITs to invest 10 percent of their asset value in development projects, potential providing another way for growth. However, the high land prices have made it difficult for smaller REITs, with smaller balance sheets, to truly consider development projects.
To boost the REIT market further, Hong Kong could follow the example of Singapore and lift the development limit to 25 percent of the total asset value. Hong Kong could also consider that the US and Australian markets have no legal limits on development, and each individual REIT’s strategy is set by market forces.
Overseas acquisition is another avenue for growth. There are several cross-border REITs from Australia and Singapore that invest in a number of economies on asset types that they are familiar with. Hong Kong REIT rules are among the more liberal in this regard, with no limits on the location of the REITs’ assets. Fund managers and other investors could consider a Hong Kong-listed, cross-border REIT as investment exit. When there are synergies, existing REITs could also consider acquiring assets from other markets.
Last but not least, selling assets is a healthy strategy for REITs. The management team of each REIT should consider whether an existing asset can continue to drive value creation. In some cases, it may make more sense to sell an existing asset and buy other assets.
Thus, a REIT market is healthy when, as a sector, there are both acquisitions and disposals. Recent activities and news flow on potential REIT activities are certainly welcome, and we believe that it could be a harbinger for more REIT actions in Hong Kong.
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