Cover story: Will REITs in Asia-Pacific continue to deliver?

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on February 3, 2020 - February 09, 2020.

Yield spreads in the region range from 340 to 400 basis points, whereas it was previously about 200bps, on the lower end of the range, prior to the US Federal Reserve policy rate cuts. From this perspective, we think REITs will continue to have investor support. - Wong

Investors should not invest in REITs based on sector or country alone, but should also take into account the demand and supply dynamics, says Khoo

The emergence of 5G will help boost the overall earnings of the REIT industry in Asia-Pacific, says Chong

Our observation shows that in both interest rate scenarios — during the interest rate hike cycle and interest rate cut cycle — REITs in Asia performed relatively well compared with the equities market. - Ng

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Real estate investment trusts (REITs) in Asia-Pacific saw healthy returns in 2019, outperforming equities in the region. Fund managers expect this asset class to remain attractive this year, citing its growth in the currently low interest rate market environment.

Last year, the S&P Asia Pacific REIT Index achieved a total return of 23.01%, which is more than five times the year before at 4.29%. REITs also outperformed equities in Asia-Pacific, which generated a total return of only 18.04%, according to the S&P Asia Pacific Broad Market Index.

According to Wong Yew Joe, chief investment officer at AmFunds Management Bhd (AmInvest), yield gaps have widened in most regional markets due to the bond yield compression in line with declining interest rates. This has been one of the supporting factors for the REIT sector.

“On the back of the continued opaque macro and dovish monetary policy stances, investor interest in defensive, dividend-yielding stocks such as REITs is expected to be sustained. The supportive low interest rate environment also allows lower cost of capital for REITs, promoting cheaper funding for yield-accretive acquisitions. Anecdotally, Singaporean REITs tapped equity markets of more than S$6 billion last year to fund the acquisitions of assets,” he says.

He adds that despite dividend yields compressing as a result of share price performance, the relative valuations of REITs are attractive when compared with 10-year government bond yields, which have declined in line with monetary policy easing. “As such, yield spreads in the region range from 340 to 400 basis points (bps), whereas it was previously about 200bps, on the lower end of the range, prior to the US Federal Reserve policy rate cuts. From this perspective, we think REITs will continue to have investor support.”

Jason Chong, CEO of Manulife Investment Management (M) Bhd, says REITs are an excellent hedging tool in the current market environment. “Given all the uncertainties, when about 25% of government bonds around the world are yielding negative interest rates, we believe that REITs will do relatively better than equities in general because of their ability to cushion the volatility and the yields that they provide.”

Wong says REITs tend to outperform when interest rates are low and underperform in a rising rate environment, and this has proved to be largely true for REITs in Asia-Pacific. “From our observation, this negative correlation is shown to be 60% and 80% accurate for Singaporean and Australian REITs respectively. A similar relationship can be observed for other REITs in the region as demonstrated their performances since central banks turned more dovish at the beginning of 2019.”

Khoo Hsien Liang, portfolio manager at Affin Hwang Asset Management Bhd (AHAM), points out that REITs as an asset class performed well last year. However, the performance differs country.

“The Singapore FTSE REIT Index was up 23% in November 2019 while Australia REITs returned 25% during the same period. However, Hong Kong REITs underperformed, posting a return of just 4%, weighed down the protests in the city,” says Khoo.

“Singapore has garnered a reputation in the region as the preferred marketplace for REITs to be listed. If I were to list a REIT, I would lean towards Singapore because all the major players are there. Apart from having ample liquidity, bankers, fund managers and sponsors are familiar with the marketplace. This creates a positive network effect, which further attracts more investors and sponsors to the market.”

Chong describes the Australian office REIT market as being very stable. “If you visit Sydney or other major cities in Australia, you will find that the skylines in the central business districts have largely remained unchanged for many years. There is not much new supply of commercial space coming into the market,” he says.

“As the economy grows, there is always a demand for office space. So, in developed countries such as Australia, rental rates have always been resilient in good times and bad.”

According to the S&P/ASX 200 Index, Australian REITs had registered a total return of 19.36% for the year ended Dec 31, 2019, providing an indicative dividend yield of 4.5% per annum.

One of the ways local investors can get broad-based exposure to REITs in the region is via unit trust funds. Of the 10 unit trusts listed under the “Equity sector real estate Asia-Pacific” category, nine belong to the conventional category and delivered strong returns of 12.58% to 21.67% over the one-year period ended Jan 3.

In this category, some funds — such as the AmAsia Pacific REIT Class B Fund — are pure REIT funds, with the majority of their holdings comprising REITs in Asia-Pacific. Some funds invest in other asset classes as well, such as the RHB Asian Real Estate Fund, which holds both REITs and other real estate securities.

Some funds only invest in REITs in certain countries, such as Maybank Singapore REIT Fund and KAF Australia Islamic Property Fund, while others diversify across sectors, such as Public Mutual’s Far-East Property & Resorts Fund, whose holdings include hotels and resorts. The Manulife Investment Asia-Pacific REIT Fund is far the largest in the category, with a fund size of RM801.49 million as at Jan 10.

“Based on our fund’s performance in 1H2019, Singapore REITs recorded a growth of 20%, Hong Kong, 12.3% and Australia, 9.4%. In terms of sectors, industrial REITs saw a growth of 23%, office REITs, 16.9% and healthcare REITs, 16.42%,” says Manulife’s Chong.

However, achieving similar returns will prove more challenging in 2020 as the tailwind from rate cuts may not be as strong as it was in 2019, he adds. “That is because, in 2019 alone, the US federal fund rate saw three interest rate cuts. However, we are expecting only one rate cut in 2020. Unless there are three more rate cuts in 2020, we do not expect REITs to perform as well as 2019.”

While retail investors can directly buy into REITs, Khoo highlights the benefits of investing in a REIT fund. “Investing in a REIT fund gives you access to the expertise and resources of the fund manager, which the average retail investor would have difficulty accessing.

“For example, fund managers get to meet the REIT’s management and visit the sites if they want to. If there are any equity placements, fund managers will be able to access these more easily than, say, retail investors.”

AmInvest’s Wong points out that portfolio diversification is a key advantage in investing via REIT funds. “In line with the general investment advice to have diversified investments, REIT funds provide access to a diversified portfolio across assets, sectors and geographical locations, with the portfolio manager adding value through stock selection.

“The returns from REITs are partly income-driven as well, which adds stability to investment returns. The portfolio manager actively manages risks that may include economic, interest rate and currency volatility, as well as corporate and consumer sentiments. The entry level of such funds is also much lower compared with buying and managing physical properties, with the added benefit of REITs being more liquid than physical properties.”


Opportunities in the market

Fund managers say pockets of opportunities can be found in the regional REIT sector, particularly in the office, logistics and healthcare segments. Manulife’s Chong believes that the emergence of 5G will help boost the overall earnings of the REIT industry in Asia-Pacific.

“To allow for the fast speeds of 5G, telecommunications companies will need to set up base stations to provide coverage. These companies will seek to rent space on rooftops and inside buildings to set up the infrastructure, such as repeaters, to send out 5G signals. Rooftops will then become another source of revenue for the buildings’ management, which will feed into the REITs’ earnings,” he says.

“As more people develop e-commerce platforms, they will need offices to house these new companies. They will also need warehouses to store goods. Regardless of the type of e-commerce business, physical infrastructure will still be needed to support it.

“Don’t think of REITs as purely part of the old economy such as shopping malls and hotels. There are also new growth areas coming from renting out rooftops to telcos and logistics for e-commerce operators.”

AmInvest’s Wong says in the industrial space, logistics warehouses are well taken up due to the growth of e-commerce as well as the drive for corporates to streamline their supply chains through the occupation of more modern and efficient facilities. “The long-term prospects for data centres are structurally positive, which is attributable to the intensification in digitisation. The construction of commercial developments has been more measured since the global financial crisis, leading to a regional-wide situation where new supply coming onstream is well absorbed tenants.

“In the three core markets [Australia, Singapore and Japan], there is limited new supply over the next two to three years, which will be supportive of office rental rates in key gateway cities such as Singapore, Tokyo, Sydney and Melbourne.”

According to a PwC report, Emerging Trends in Real Estate Asia-Pacific 2019, the logistics sector has seen growing demand, mainly driven a maturing e-commerce industry, with a particular emphasis on last-mile delivery hubs. The report also describes data centres as a rapidly growing segment due to the rapidly rising demand for network services and a shortage of infrastructure. It highlights China as the fastest-growing prospect because of massive demand from internet companies such as Alibaba Group Holding Ltd, Tencent Holdings Ltd and Baidu Inc.

Chong points out that healthcare REITs are a growing segment in the industry. “The world’s population is getting older and there is a growing demand for healthcare services such as old folks’ homes and hospitals. In developed countries, you will see a mature healthcare industry and a growing healthcare REIT industry.

“These are trends we can learn from the West. Asia-Pacific is also home to many ageing populations such as China, where the population is getting older and there is a growing demand for healthcare services.”

A February 2019 report international tax and advisory firm Grant Thornton points out that populations in Asia-Pacific are ageing more rapidly than in other regions in history. The report adds that small healthcare operators in rural areas are being merged into large groups to create economies of scale. Meanwhile, private investors are actively looking to build day hospitals in the region.

From a country perspective, Manulife is eyeing buying opportunities in Hong Kong’s REIT industry, which has seen share prices drop 10% to 20% since the start of the Hong Kong protests. “One of the biggest REITs that we have in our holdings is Hong Kong-based Link REIT. In the recent semi-annual earnings release, Link REIT reported financial performance that was above expectations,” says Ng Chze How, head of retail wealth distribution at Manulife.

“It has significant exposure to retail and it is the biggest REIT in Asia market capitalisation. We used to have larger holdings in Link REIT, but we have trimmed the position due to the political unrest. We are looking to get back in there if there are good buying opportunities.”

AHAM’s Khoo says investors should not invest in REITs based on sector or country alone, but should also take into account the demand and supply dynamics. “A good example would be office space. Assume that in a Singaporean office REIT, there are tenants that have signed leases of two to three years but the rental rate they are paying is actually below the current market rate.

“When they renew their leases, the rate will naturally increase and the REIT will make more profit and give out a higher dividend. This is very specific to each and every REIT, so you have to study each individual tenancy agreement — when it is expiring, what the current market rate is and what it was two or three years ago.”

All three fund houses believe that REITs are the go-to defensive asset class to look at in the current market environment. “The underlying earnings of REITs are underpinned tenancy agreements, which provide earnings visibility. Investors consider REITs a defensive asset class due to the recurring income, which enables them to pay dividends on a regular basis,” says AmInvest’s Wong.

However, AHAM’s Khoo warns that REITs, despite being perceived as a defensive asset class in a slowing economy, is not a tool to hedge against recession. “REITs are a defensive asset class, but only to a certain extent. It is not immune to macro-economic changes. It is not as defensive as government bonds, for example, because the REITs’ performance depends on their tenants’ ability to pay rent which, in proxy, depends on the state of the economy.

“If you look back at the 2008 global financial crisis, the REIT index was not spared and corrected 55%. If tenants are struggling to pay rent, the REIT will also face difficulty in making distributions.”

Manulife’s Ng, however, argues that the underperformance is exaggerated. “During the 2008 global financial crisis, REITs were not spared. REITs saw their worst-ever performance for about 1½ years. But right after the crisis, we saw REITs become very resilient, picking up momentum when customers and investors returned to the asset class. Our observation shows that in both interest rate scenarios — during the interest rate hike cycle and interest rate cut cycle — REITs in Asia performed relatively well compared with the equities market,” he says.

“I believe that if REITs encounter a major sell-off, it will be when equity markets go through a super bull run. People will take a risk-on approach and rebalance their portfolios to be more overweight on equities and more neutral towards REITs.”

Despite that, he is confident that REITs will remain an attractive asset class as their underlying assets are real estate. “Physical buildings are the underlying assets of REITs, tangible assets which they can visit for themselves. They know where the location is and how much rental income it can garner. That alone is a pull factor for many investors,” says Ng.



Innovations in the industry

Innovative real estate investment trust (REIT) structures in more developed markets such as the US can serve as an indication of what Asian investors can look forward to in the future. The US is a good reference point as its REIT market is far the largest in the world with a market capitalisation of US$1.05 trillion in 2018, according to EY’s Global REIT Market Report.

“The beauty of being part of a global organisation is that you get to see what is happening in the US. The West is generally the trendsetter in this space and Asian countries normally follow suit,” says Jason Chong, CEO of Manulife Investment Management (M) Bhd, citing the example of prison REITs, which own the real estate, manage the prisons and rent their services to the government.

At press time, the prison REIT sector only consisted of two publicly traded counters — CoreCivic Inc and GEO Group Inc, which have a combined market capitalisation of US$3.78 billion. According to an article in Forbes magazine, Geo Group and CoreCivic are providing healthy yields of 13.5% and 11.4% per annum respectively.

The Forbes article paints a positive outlook for the prison REIT industry, saying that all US prisons are currently operating at more than 100% capacity and outsourcing to prison REITs serves as a valuable place setting for state governments.

However, this sector has been shrouded in controversy, with many investors not in favour of investing in businesses that encourage incarceration. Last year, JPMorgan Chase, Wells Fargo and Bank of America stopped financing private prisons amid pressure from social activist groups, which resulted in a drop in the share prices of prison REITs.

Chong says other innovations in the industry include structures where REITs do not necessarily need to have physical properties as assets. “This could include commodities. Take timberland REITs. Although the gestation period is longer, the concept is similar. The REITs manage the land, grow the trees, do the logging and sell the timber for income.”

According to an article published US-based REIT Institute, there are four publicly listed timberland REITs, which have a total market capitalisation of US$31.87 billion. The largest far is the Weyerhaeuser Company, which manages about 12.2 million acres of timberland in the US alone.

Some timberland REITs have found alternative ways to profit such as capitalising on minerals, oil and gas and other natural resources on their land as well as leasing some of the land to other businesses.



Top holdings of Asia-Pacific REIT funds

 As at end-December last year, several local real estate investment trust (REIT) funds that focus on investments in Asia-Pacific had a few holdings in common. These included Singapore-based CapitaLand Ltd and Mapletree Investments Pte Ltd. Hong-Kong-based Link REIT also featured as one of the top holdings of some funds.

CapitaLand is one of the largest real estate companies in Asia, with a total portfolio of S$131.7 billion as at Sept 30, 2019. It currently manages eight listed REITs and business trusts as well as more than 20 private funds. CapitaLand Malaysia Mall Trust is a Bursa Malaysia-listed REIT while Singapore-listed Ascendas REIT is one of the top holdings of many of Asia-Pacific REIT funds in the market.

According to the Singapore Exchange (SGX), the eight listed counters of CapitaLand had generated an average total return of 28.2% for the year to September 2019. SGX described the returns as above the average and median returns of the 100 largest capitalised property stocks in the world, as well as the 100 largest in Asia-Pacific, which stood at 20% and 16% respectively.

Mapletree is one of the major players in the Singapore REIT space, managing S$55.7 billion worth of office, retail, logistics, industrial, residential and lodging assets as at March 31, 2019. It currently manages four Singapore-listed REITs and seven private equity real estate funds, which hold a diverse portfolio of assets in Asia-Pacific, Europe, the UK and the US.

Founded in 2004, Link REIT was the first REIT listed in Hong Kong and is currently the largest in Asia in terms of market capitalisation, which stood at HK$171.69 billion as at Jan 3. It has assets in Hong Kong and Mainland China, with a combined portfolio of about 13 million sq ft of retail and office space plus 56,000 parking bays.

In a research report published last month, DBS Bank notes that Link REIT’s earnings will remain resilient across economic cycles as the bulk of rental income derived from tenants selling consumer staples in Hong Kong. The REIT’s suburban retail properties have been less affected disruptions due to the protest movement in the city compared with landmark shopping malls, making it a safer bet in a shaky market. The report says the REIT had distribution yields of 3.6% to 3.9% for FY2020/21, which translates into a yield spread of 1.8% to 2.1%.