Wednesday, April 16, 2014

Reits still attractive, despite a rise in long bond yields

DESPITE a rise in long bond yields, a comparatively higher return from real estate investment trusts (Reits) makes it a compelling case for investors who are looking for yields that are better than 10-year Malaysian Government Securities (MGS).

Malaysian REIT Managers Association chairman Datuk Stewart Labrooy says a rise in long bond yields since the beginning of this year has narrowed the arbitrage between Reits and government bonds to 200-250 basis points.

“A difference of 200 basis points is still a 50% higher return that is inflation-hedged. A bond will provide return to its capital at the end of 10 years and that could be worth 50% of what it represented 10 years ago,” Labrooy says, pointing out that the average retail investors are unable to invest directly in government bonds.

The annual yield rate for 10-year MGS is now about 4.1% while Reits offer annual dividends in the 6%-8% range.

He says investment in Reits has an added advantage over equity investment.

“Equity investment depends on capital gains to give its total return story and rarely give dividends in the 6%-8% range, while the total return of Reits is largely made up of cash payments provided quarterly,” Labrooy explains.

He says that as long as there is an arbitrage on total return between bonds and fixed deposits, there will still be a strong interest in local Reits.

“Getting a dividend in the mail every three months is a strong argument for having Reit stocks in your portfolio,” he says in jest.

Labrooy says Reits also represent an excellent proxy to high quality real estates, some of which are trading at a discount to their market values, bearing in mind these values are decoupled from the real market where transactions are being done at yields of 3% to 4%.

“Reit valuations are done on the basis of discounted cash flows on real rents with a discount factor of 6%-8%. If you look at any Reit’s annual report, you will be pleasantly surprised to see that its value per sq ft is much lower than what is being transacted in the market,” he says.

In such a situation, Reits will find getting new acquisitions to match their current yields difficult and many Reits will embark on asset enhancement initiatives to drive their values and returns higher while they wait for a correction in the market, he explains.

Labrooy, who is also Axis REIT Managers Bhd chief executive officer, says there has been a surge in retail investor interest in Reits, with Axis REIT witnessing a 10% rise in new unitholders in the first three months.

He says investors who are long in the market (or long-term investors), be they institutional or retail, have long seen the value in diversifying their investments by holding Reit stocks – especially those funds with cash dividend payouts or redemptions.

“Our pension funds, unit trusts and insurance funds are all big investors in Reits. A key benefit of a vibrant Reit market is the improved efficiency and more rational allocation of capital.

“With their focus on income-producing assets, Reits are better able to attract capital seeking property exposure, thereby freeing capital that can be better invested elsewhere to expand businesses and invest in new ventures,” he says.

Intrinsic benefits

Among the main beneficiaries are traditional property companies that use Reits to separate the roles of developers and landlords, and achieve a more efficient deployment of capital.

Property companies also see Reits as natural buyers of completed assets. The ability to recycle capital for further property development and an increased supply of investment grade properties brings further economic and job-creation benefits.

Labrooy says developers are also seeing Reits as a way of monetising their assets in order to recycle capital or reduce debt. Recent examples of developer-sponsored Reits are Pavilion, IGB and Sunway where valuations were optimised and capital deployed in more profitable development opportunities.

He says the recent takeover of Quill Capita REIT by Malaysian Resources Corp Bhd was another strategy to monetise assets by developers.

However, the high proportion of institutional interest in Reits has resulted in the stocks being tightly held.

Labrooy says exacerbating the situation is the fact that in some Reits, the promoters hold large positions of the listed units, thus reducing the liquidity and the foreign interest in the stock.

Some examples are KLCC Property Holdings Bhd (KLCCPH) and UOA where the promoters hold about 75% of each of the stock. Meanwhile, much of the balance is being held by the pension funds, investment funds and insurance funds, which left little for the retail investors.

He says when KLCCPH was restructured as a stapled Reit with development capabilities, it was very well received.

Investors could see the capital gains from developing the land banks around KLCC as well as the upside to be realised by enhancing existing assets in the portfolio.

He says enabling Reits to undertake some development, a practice in Singapore, could result in superior returns for unitholders.

“Trading assets will also definitely be welcomed by investors, especially when the gains from a disposal are returned to unitholders. That results in “turbocharged” returns to unitholders. In these cases, when the assets are sold, the net gain also translates to a tax free distribution that does not attract withholding tax,” Labrooy explains.

He says one way of promoting greater interest in Reits is for the illiquid funds to have a higher public spread.

As far as the tax legislation is concerned, Labrooy says Malaysia should look at having a tax regime for Reits that matches Singapore’s, while pension fund members should be allowed to mandate their investments in Reits and not just in mutual funds like now.

Reits should also grow their portfolios, and give more education to the public as to what Reits offer investors.

Labrooy’s views coincided with the recently released report commissioned by the Asia Pacific Real Estate Association on “The Impact of Reits on Asian Economies”.

The report observes that given the relatively young Asian Reit market, the asset class is not yet fully understood by the wider public in Asia.

“It is not often understood that Reits are in fact a financial instrument (and relatively new at that) that broaden and deepen the capital markets, and that they have characteristics that distinguish them from equities and bonds,” the report says.

A growth catalyst

Real estate has investment characteristics distinct from that of the traditional asset classes – being equities and bonds – and so offers diversification benefits in a mixed portfolio.

The report says Reits are an investment that can help investors achieve better return/volatility outcomes, and that pension funds and insurance companies have long valued real estate investment for its steady income and potential for capital gains.

“Reits allow both institutional and individual investors to access this investment sector in a more manageable quantity and with the benefit of better liquidity,” it adds.

Despite a higher correlation of returns with stocks, Reits are found to be more popular among pension funds and insurers because they provide global exposure and asset variety in a form that is more liquid and that comes in more manageable quantities.

“Reits are found to be valuable options for long-term institutional and individual investors, leading to capital market diversity and development. It has also been found to be a positive force in the development of property markets.

“One catalyst for growth in Reit markets across the world is coming from traditional large-scale investors such as pension funds and insurance companies that need steady returns to meet long-term liabilities. The general consensus among pension fund managers appears to be that 10%-20% of their investment should be devoted to property,” the report observes.

Reits support the healthy development of the property industry. As listed vehicles, they are required to provide detailed information to shareholders about rental and capital values as well as their tenant mix, thereby increasing industry transparency.

In turn, this improves the planning capacity of all industry participants, and may help to smooth property cycles. As dedicated landlords, Reits are improving asset management capabilities and enhancing professional standards in the real estate industry. By providing an attractive vehicle for institutional and individual investors, they have the potential to attract additional capital into real estate.

The report says growing competition and transparency that should arise with a dynamic, vibrant Reit market should lead to better maintenance and operation of assets. Reit managers can grow their portfolios through internal and external growth strategies. Internal growth strategies typically involve maximising the earnings and economic value of the existing portfolio through active asset management and enhancement programs, structured leasing strategies and the like. External growth strategies typically involve active portfolio management to maximise shareholder value through acquisitions, development and disposals.

Asia’s Reit market is now worth over US$140bil in market capitalisation, with the most developed markets being Japan, Singapore, Hong Kong, and the other developing markets include South Korea, Malaysia, Thailand and Taiwan.

Many Asian countries are also showing interest in introducing Reit legislation or enhancing existing Reit regimes.

“Although some governments fear a loss of tax income, studies showed Reits actually result in higher tax revenues. Their taxation regimes put Reits at par with direct real estate, and the resultant increased economic activities and job creation far outweigh any impact of tax leakage.

“Asian REIT markets are expected to continue their trajectory of healthy growth, with Singapore, Hong Kong and Japan seen as the most welcoming to market development, and the preferred markets for investors,” the report concludes.

by angie ng, thestar.com.my
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