A decade lost:How can HK reach its REIT potential?

Andrew Neil March 15, 2022 08:32

From introducing attractive tax incentives to bringing more dynamism and diversification to the types of real estate investment trusts on offer, there are a number of key areas where Hong Kong can raise its game regarding REITs, according to Capco Hong Kong’s Andrew Neil and Jonathan Long Hei Ip.

In recent years, real estate investment trusts (REITs) have gained momentum around the world with growing market capitalisation. For APAC investors, REITs have become an attractive option amongst other investment instruments due to their generally higher dividend yields. REITS often provide attractive tax incentives, mandatory dividends to investors and provide a good diversification option for investors with an often heavy equity or bond investment portfolio.

While Hong Kong enacted of its Code on Real Estate Investment Trusts (REIT Code) in 2003 and today accounts for 13 listed REITs with an aggregate marketing capitalisation of approximately HKD 217.49 billion, its ongoing efforts to enhance its overall competitiveness continues to lag behind its regional market peers, notably Japan, Australia and Singapore.

Four recommendations to allow Hong Kong to reach its full potential in respect of REITs:

1. Capture cross-border opportunities – Positioned as a financial gateway to China and Asia, Hong Kong has the potential to develop into a regional REITs hub. Owning a deep offshore RMB liquidity pool of RMB 750 billion, Hong Kong can leverage such exceptional strength onto its H-REIT development. A comprehensive examination of the role of H-REITs in RMB internationalisation can help broaden the offshore RMB product basket.

In addition, Hong Kong can capitalise on the momentum of mainland infrastructure across the Greater Bay Area (GBA), utilising REITs to better resource allocation efficiency and support industrial upgrade within the real estate domain.

2. Diversify product offerings – Given ongoing COVID disruptions have presented immense
challenges for traditional real estate assets, a greater variety of underlying REITs assets – such as 5G facilities, logistic parks and data centres – should be explored. Most of the H-REITs focus only on residential and commercial properties, such as shopping malls, hotel and office buildings, within their portfolios, in contrast to the diversified portfolios of overseas REITs. As the world’s second largest biotech funding hub and Tier-1 data centre market, Hong Kong still has much room for improving the H-REITs market to bridge the gaps and capture the growth in emerging real estate sectors.

The product scope of H-REITs can be also expanded to other forms of investment vehicles, notably REIT ETFs and REIT futures, to raise its competitiveness against regional peers. REIT ETFs, either actively or passively managing the holdings of REITs, can allow investors to diversify their investment portfolios and risk exposure with easier access to overseas REITs at a lower cost.

3. Explore tax and financial incentives – Asset acquisition is a typical way for REITs to expand their portfolios. In Hong Kong, direct transfer of non-residential properties is subject to buyer’s stamp duty at 4.25% which is significantly higher than Singapore’s 3% and Japan’s 1.6%. The inadequate tax benefits available to H-REITs remains as one of the key reasons why H-REITs continue to struggle to compete with overseas markets.

Both Singapore and Malaysia have set a practical example for Hong Kong to reconsider some of its tax and financial incentives to build a more flexible framework that attracts both domestic and foreign investors as to better embrace the mounting challenges from its regional rivals.

4. Implement regulatory enhancements – The Financial Services Development Council (FSDC) has identified two key regulatory challenges as negatively impacting the capacity and flexibility of H-REITs to engage in M&A transactions. These are the absence of ‘squeeze-out’ provisions facilitating takeover of a REIT (making it difficult to obtain complete ownership); and the lack of a ‘scheme of arrangement’ in the privatisation of a REIT (which means there is no capacity to impose a binding scheme of arrangement on all shareholders, including those who object). Although the revised code on REITs published in December 2020 sought to address those issues, there remain an abundance of formalities and procedures that continue to constrain the setting up of a REIT.

The SFC could also act in a more decisive and timely fashion in respect of future REIT code enhancements. Post 2005, it took nearly 15 years before any material regulatory enhancements were made to progress the REIT market. (In Singapore, a relief campaign for S-REITs has been rolled out due to COVID-19, covering an increase in leverage limit and cash grants – this may explain why S-REITs have stayed competitive under such trying circumstances). The SFC has announced the implementation of the grant scheme for the setup of REITS, which would allow eligible parties to claim up to 70% of the professional fees paid to local Hong Kong service providers, up to a cap of HK$ 8 million per REIT – but the scheme has met with criticisms for being overly restrictive in its eligibility and restrictions on the subsidy coverage.

In conclusion, while Hong Kong often positions itself as the financial hub of APAC, there remain many areas in which it needs to raise its REIT game to compete with the other APAC markets. To move past this ‘lost decade’, it will require many groups – including investors, REIT trustees and sponsors, the government, the SFC and the wider trustee community – to work together to inject the stimulus that the local REIT market requires.

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Andrew Neil

Principal Consultant at Capco