Hong Kong REIT market bolstered by new SFC measures

25 July 2014   Category: News, Asia, Australia, Global, Hong Kong, Japan, Singapore   By Hui Ching-hoo

New measures proposed by Hong Kong’s financial regulator could revive the local real estate investment trust (REIT) market, fund managers told Asia Asset Management.

Following extensive consultation, the Securities & Futures Commission (SFC) has recommended two major changes to the territory’s REIT rules:

  • REITs will be permitted to participate in real estate development projects. In the past, Hong Kong REITs were effectively barred from development activity, unlike most other REIT regimes around the world;
  • REITs will be allowed to invest in financial instruments that help improve capital management and cash flow.

Under the new rules, total development project costs cannot exceed 10% of a REIT’s gross asset value (GAV), and completed projects must be held by a REIT for at least two years.

In addition, at least 75% of a REIT’s GAV must comprise real estate assets that generate recurrent rental income.

Victor Yeung, a managing partner at Admiral Investment, said that the measures could significantly boost the competitiveness of locally-domiciled REITs.

“From the foreign investor perspective, the H-REIT market has been less attractive compared to regional rivals such as Singapore, Japan and Australia, partly due to the investment constraint. The market’s capacity relatively lacks breadth and depth, and there are only around ten REITs listed in the territory against more than 30 in Singapore or Japan,” he explains.

Tuan Pham, senior portfolio manager, Asia Pacific, at First State Investments, said that the change would help to bring Hong Kong REITs (H-REITs) in line with standards elsewhere in the region.

“This would allow REITs to take opportunities for better returns. At the same time, the 10% cap of GAV is fair and represents an acceptable risk for the REIT. In our view, this shouldn’t change the defensive character of Hong Kong REITs as the majority of their earnings are required to be recurring.”

However, Ms. Pham said that she is surprised by the second change: “It aims for REITs to have some flexibility with managing capital management and cash flow. Investment in stocks and property funds don’t necessarily guarantee a good return on investment for REITs shareholders – these seem to us opportunistic and speculative.

“In our view, with the exception of the Link REIT (the largest H-REIT), which adopts internal management methods, most other H-REITs are externally managed where you’d find that the sponsor/manager/related parties would tend to keep development opportunities for themselves. In most, if not all cases, the managers always make huge capital gains/development profits by selling completed assets to their REITs.”

She added: “Therefore, for those REITs, the new rules will not impact their earnings in reality. For other smaller REITs, their portfolio sizes are too small, such that a 10% GAV cap would still limit their ability to participate in development projects in Hong Kong.”

Peter Verwer, chief executive officer of the Asia Pacific Real Estate Association (APREA), said that the changes would place Hong Kong REITs on a more competitive footing with other countries.

“The SFC is striking a balance that ensures REITs focus overwhelmingly on generating passive rental income, while helping them better manage capital and achieve organic growth by participating in development projects,” he said, adding: “Hong Kong REITs have been at a disadvantage for several years and face increasing competition from India, which recently announced a new REIT regime, and the prospect of increased REIT listings in mainland China, as well as competition from more liberal financial centres, such as Singapore and Australia.”

Mr. Verwer also pointed out that “the additional flexibility offered by the modified REIT code may encourage more mainland China companies to consider listing their investment properties as REITs on the Hong Kong stock exchange.”