December is the second consecutive month that a new stock from the commercial property space has listed on the local exchange. ESR Cayman (01821.HK), a Beijing-based logistics operator with portfolio across the Asia Pacific, listed on the Hong Kong stock exchange in November, and it was followed this month by China Merchants Commercial REIT (01503.HK). The two listings are significant in their own ways.
ESR Cayman is not a REIT but a commercial real estate operator. The company owns only about 20 percent of its portfolio on its balance sheet, with the rest owned by various institutional and other investors.
The company, thus, has two related but different income streams. First, the balance sheet assets produce a rental income stream like any other REITs or landlord stocks. Second, the company charges asset management fees on the other assets it manages.
This hybrid income model is rather common for asset managers. Even simpler shops like hedge funds would typically invest some balance sheet or director capital into their fund products, and as such, yearend income would come from both rentals and fees.
A commitment of firm capital is sometimes seen as an indication of the firm’s confidence in the investment idea, and it is often welcomed by investors.
Some of ESR’s closest competitors, such as Sydney-based Goodman Group, also operate on a similar split between balance sheet and client capital.
By accepting client capital, these operators can afford to grow their managed portfolio much faster. A larger managed portfolio can secure better market positioning and in turn help the operator to further grow its business.
Because of the potential for higher growth when compared to REITs and landlord stocks, successful asset managers can often command a higher P/E ratio.
China Merchants Commercial REIT is a more conventional REIT. But since this is the first Hong Kong REIT listing since 2013, it is still a welcome development in the commercial real estate space.
Since 2013, two major conglomerates have spun off their commercial real estate arms into separate listed entities, but in both cases, landlord stocks were chosen as the structure.
The spinoffs have led to questions about the future of the Hong Kong REIT market, especially as investors compare our listings drought with the continued launching of initial public offerings in Japan and Singapore.
The lack of corporate tax benefits is often seen as the core issue of Hong Kong REITs. REITs are required by law to hold only rental real estate assets and to pay out all core net income as dividends.
Without tax benefits, a landlord stock structure can look more attractive as landlord stocks and REITs have similar operations but landlord stocks do not have the legal restrictions mentioned above.
Nonetheless, REITs have a role in the financial system. REITs, with the legal restrictions, carry a naturally higher dividend yield than landlord stocks.
En bloc commercial real estate, when limited to a reasonable gearing level such as REITs’ legal limit of 45 percent, is also a relatively stable asset class.
These two factors together should justify giving REITs a role in a mature retirement system, where more well-off retirees should have a portfolio of options to create stable cash income from their net worth.
Because of legal restrictions, REITs need to have some benefits in other areas to effectively compete.
We doubt that policy discussion should be limited to corporate tax issues. For example, the Hong Kong REIT sector, other than the Link REIT, has few asset transactions in the last several years. A partial reduction of transaction stamp duty could incentivize current landlords to sell their assets to REITs.
REIT laws are seldom left unchanged through time. Hong Kong’s law was changed in 2014 to allow for development activities. After that, an office asset was developed jointly by a REIT.
In the United States, the REIT law has undergone three major revisions before the modern REITs were born. Thus, some policy aid to REITs can unleash the sector and help build a retirement tool for our society.
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