BUYING ASIAN REITS – WHAT’S HOT AND WHAT’S NOT

REITs are expected to stand the test of turbulent times.

I am not an economist by any measure of means, but remain an avid listener to the analyses given by experts in this field. I have had the opportunity recently to listen to a global expert delivering his views on Asian economies and it did not look very bright.

Among his forecasts was the indication that the US Federal Reserve Bank will raise interest rates for the first time in a decade to around 2-2.5% by the end of 2016 with consequences to the emerging Asian countries.

The end of Quantitative Easing (QE), and the approaching rise in interest rates in the US, will have a particularly severe impact on Emerging Asian Market Economies (EAMEs)—not only in terms of real economic growth but even more so, on the financial stability of some EAMEs. The Federal Reserve’s (Fed) QE program and near zero rates since 2009 has resulted in a massive global money liquidity injection by the Fed, and it was argued that much of that money flowed out of the US economy into EAEs and offshore financial markets. That outflow did little to help the US, European, and Japanese economic recovery. The US economy has bounced along the bottom with three bouts of zero or negative GDP growth since 2011; the Eurozone economy experienced a double dip recession, and the Japanese economy a triple dip recession.

In contrast to the minimal impact on the US and other Advanced Economies (AEs), the massive Fed money injection that began in 2009 contributed significantly to EAME’s robust economic growth from 2010 to 2013. As the US Federal Reserve plans to reverse the free money policies of the past five years, the opposite impact on EAME’s real economic growth will soon occur.

The destabilizing effect on EAME’s is occurring as US Fed monetary policy shifts where they are experiencing increasing financial instability and slower economic real growth. Moreover, the onset of this financial instability may prove far more severe than central bankers and mainstream economists have anticipated.

Investing in Turbulent Times

With all these negativities, what is the investor to do?

We are seeing for the first time that commodity prices are falling and with that the fortunes of many listed companies on stock markets in Asia. Prices in the equity markets will fall as companies start posting poorer results. Aggravated by the weakening of many Asian currencies, many nervous investors are leaving the equity markets.

But having done that, what do you do with one’s money? Putting it in a bank gives a very poor return with the very low interest rates being offered. Besides, fixed deposits, despite being a safe place for leaving one’s money, does not safeguard the value of the cash in the bank as inflation erodes the purchasing value of the deposited cash over time.

In Asia, the one investment that always makes sense is property. It has remained as a natural hedge against inflation for decades – no one loses on an investment in real estate.

Let’s look at some of the main reasons for owning real estate:

  • Buy and sell for fast speculative profits
  • For long term investment income and capital appreciation
  • To hedge our capital against inflation
  • To let the word know how wealthy we are
  • To leave an inheritance for our children
  • To have a permanent abode that is ours

For many years, the only way private investors could own property was to buy into houses, shop lots, office suites, condominiums or serviced apartments. Many investors faced problems such as obtaining a bank loan as well as not being able to dispose of the property quickly, being exposed to interest rate volatility, and taxed up to 25% on income and finding tenants who will pay a rent that justified the investment. However, with the advent of Real Estate Investment Trusts or REITs, they have a means of investing in very high grade properties and receive a steady return of cash dividends over the life of the investment.

Listed REITs are traded on the Stock Exchange and provide unitholders with consistent returns in the form of income distributions and capital gains as well as a quick divestment if needed. The REIT market is a liquid one.

It’s a perfect investment asset class for investors who favour property but want a safe investment during turbulent times.

The Malaysian REIT market has seen tremendous achievements over the last 10 years. Today, we have a total of 15 REITs with a total market capitalisation of RM38 billion and a total asset size of RM49 billion.

What’s Hot and What’s Not

Asia Pacific REITs have performed very well since 2002, outperforming equities over a 10- year period by 1.35 per cent on an annualised basis. Bonds provide stable but low returns over the long term while it is somewhat surprising that REITs which have traditionally been viewed as an income instrument appear to outperform equities.

Picking your winners

Asian REITs invest in a wide array of asset classes — retail malls, office towers, hospitals, hotels, industrial and logistics properties, retirement homes, data centers, residential properties for rent and service apartments; so investors have a huge choice in front of them to pick from. It is important that the investor chooses the asset class that he or she is comfortable with.

In addition to the advent of Islamic REITs, the Shariah investor can now acquire properties which are run on Islamic principles — finding favour with many established Shariah Funds.

It’s similar to when you buy a physical property — you can choose either a condominium, link house or semi-D, shop house or office suite. They all have risk profiles but you have a choice to determine the asset class, the yield and the capital growth strategy that you wish to adopt.

In the Asian markets, the following countries have accommodative tax structures coupled with high governance and transparency: Singapore, Malaysia, Hong Kong and Japan.

The other markets in Asia are still small and illiquid. The current market yields are highest in Singapore and Malaysia and the assets are of high quality.

Singapore REITs trade at an average yield of 6.6% whilst Malaysian REITs trade at 6.9%. In Singapore, the highest yields are 8.9% and in Malaysia it is 9.5%, but many high yielders tend to be REITs with poor growth track records — both in assets and dividends, and this is evidenced by their poor unit price performance over the years. You will soon discover that those REITs with lower yields are the ones with the highest growth track records and provide investors with a strong combination of cash dividends and share price appreciation.

Retail REITs have the lowest yields in both countries at 5.3% but have the best assets for capital gain — for example Pavilion Mall, Mega Mall and Sunway Pyramid are excellent examples of Grade A Malaysian REIT assets.

If you have the appetite for risk you can venture to Japan — but yields are typically low at 4% due to the near zero interest rates and dividend growth is slow and heavily taxed. In addition, you have the risk of a very volatile currency as of late.

To the investor, it’s best to stay close to home as you know your local assets and you have the pulse of the market. Singapore does offer an excellent diversification of a REIT portfolio, where you can get exposure to Chinese, Japanese, German and Indian assets but has no exposure to currency risk as dividends are in SGD.

The Taxation of your REIT income

Another point one has to bear in mind when investing in REITs is the manner in which your income will be treated.

If you look at the chart above, Singapore leads with the lowest taxation for the individual investor, followed by Malaysia (10%) and Hong Kong (which taxes the REIT income 15% at Trust level). What it means is that when you receive your income, it is net of any additional taxes and doesn’t need to be declared in the individual’s income tax returns.

As a Malaysian investor, if you invest in Singapore or Hong Kong REITs, you can also bring the dividend income home without any further taxes being imposed on that income.

Why REITs remain attractive

In today’s turbulent times, especially when interest rates are at record lows, commodity prices have fallen and the equity market is underperforming, REITs are generally regarded as providing a safe haven investment as REITs display characteristics that lie between stocks and bonds. Similarly to bonds, REITs offer a relatively secure and steady income in the form of dividends derived from rental income with low stock price volatility. Unlike most bonds, the income from REITs is not fixed, but rather may fluctuate with changes in the income generated from leases. Rents can rise through terms of lease contracts or in times of healthy economic growth. But you are fully asset backed with some awesome properties.

mApart from being the CEO and Executive Director of Malaysia’s first REIT, Axis REIT Managers Berhad, Dato’ Stewart LaBrooy is also a leading speaker and columnist on the topic of REITs.
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