When Link REIT went public in November, investors across the globe clamored to get a piece of Hong Kong's first property trust and the world's largest REIT offering.
Link REIT, which owns 180 retail properties and car parks, went public at HK$10.30 per share ($1.33) and was 19 times oversubscribed. Within 30 days, two more Hong Kong REIT IPOs followed Link REIT — Prosperity REIT and GZI REIT — further whetting investor appetites. GZI REIT, which owns just four commercial properties, was priced significantly lower at HK$3.075 per share ($0.40), but was 496 times oversubscribed.
Hong Kong is the most recent addition to the global REIT landscape. It joins established REIT markets such as the United States, which represents roughly 50 percent of publicly traded real estate with 139 REITs and a market cap of $327 billion, as well as newer REIT markets such as Japan, Korea and Malaysia.
But that's all about to change. The European REIT market could reach $300 billion to $400 billion in the next three to four years — matching the size of the U.S. market today — predicts Rick Imperiale, portfolio manager of Forward Uniplan Real Estate Investment Funds and author of Real Estate Investment Trusts — New Strategies for Portfolio Management. “In terms of physical real estate, the European market is as big as the U.S., so it could produce opportunities that are similar to those in the U.S. public real estate sector,” he notes.
Next up: Legislators in the United Kingdom and Germany are now crafting REIT laws, which could set off a spree as investors, anticipating the lush returns, gobble up REIT IPO offerings. In fact, many investment banks and institutional advisers have already launched global real estate funds to take advantage of real estate markets outside of the U.S. in anticipation of the explosion of the REIT structure worldwide.
Up to now the REIT structure has only been legal in a handful of countries. Outside of the U.S. and Australia, there are fewer than 60 REITs around the globe. In Europe, there are five countries with REIT regimes: The Netherlands, France, Belgium, Italy and Bulgaria, which introduced Eastern Europe's first REIT in October 2005. Russia also has a REIT-type structure, although companies that operate under that format find it hard to compete with other property owners that are not regulated.
“There is concern that the U.S. REIT market is fully priced, yet investors are eager to increase their exposure to real estate,” says Jim Keagy, managing director of Barclays Global Investors, one of the world's largest investment managers with $12 billion worth of REIT funds under management. “That's why I expect to see considerable demand for non-U.S. REITs” where investors can buy shares and get potentially better bargains.
And, as the Hong Kong situation illustrates, retail will be a big part of the story.
The addition of Europe to the U.S. and Asian REIT universe would double the global REIT market to $610 billion, according to Jorrit Arissen, a researcher with the European Public Real Estate Association (EPRA) in The Netherlands. Further, he predicts that the global listed real estate market will hit $1 trillion within the next five years and about one-third of it will be retail real estate.
Investor interest in global real estate is so strong that NAREIT and European Public Real Estate Association partnered in March to launch the FTSE Global REITs and Non-REITs Index. The Index consists of the largest and most heavily traded real estate stocks in Asia, Europe and North America, and there are a total of 313 stocks.
Nine of the 10 largest global REITs are based in the U.S. The exception is Australia's Westfield Group, the biggest company with a REIT-like structure in the world. Organized as a limited property trust, Westfield has a market cap of $17.9 billion. Overall, four of the top 10 are retail REITs.
Of the largest global property companies that are not REITs — either because their home country has not allowed them to elect REIT status or they have chosen not to — three are based in Japan and four are based in the U.K.
In Japan; private property companies Mitsubishi Estate, Mitsui Fudosan Co. and Sumitomo Realty & Development have a combined market cap of $49.8 billion, according to the FTSE Global REITs and Non-REITs Index. Similarly, in the U.K., huge owners Land Securities Group, British Land Co., Liberty International and Hammerson collectively amount to $31.6 billion.
Today, there's about $600 billion worth of real estate owned by non-U.S. property companies that have not yet converted to REIT status, estimates James E. Rehlaender, managing director of Euro Investors, a New York-based investment adviser that focuses solely on non-U.S. real estate investments. “It's hard to say which ones will want to stay property companies,” he notes, adding that most REIT structures have a bias against new development.
PricewaterhouseCoopers wrote in a recent report on Asia that “certain property funds are reported to have been building up property portfolios with a view to a REIT listing.” Specifically, experts anticipate that more than six new Hong Kong REITs will be launched this year. “Should the level of REIT listings meet current expectations, it may not be long before Hong Kong becomes the major REIT market in the region,” the report says.
Paving the way for an EU REIT
The U.K. was expected to pass its REIT legislation two years ago, but couldn't come to an agreement over how to deal with the tax implications of the REIT structure. In a nutshell, the issue is that many U.K. property owners have decided to incorporate in the Guernsey Channel Islands, located between the U.K. and France, to pay cheaper taxes. The REIT regime is moving forward because the U.K. government has come to the realization that it's better to receive some tax revenues rather than none at all, Arissen says. To that end, industry experts say that approval for U.K. REITs will occur any day now.
Meanwhile, political infighting in Germany has slowed the implementation of a REIT regime, but a formalized REIT market is not more than 12 months away, Imperiale predicts. He expects German investors to embrace REITs with alacrity and package their institutional quality real estate for the public markets.
Arissen agrees, pointing out that REITs would provide an exit strategy for Germany's open-ended funds. Previously, if an open-ended fund investor wanted to withdraw his money and the fund didn't have any cash flow available, it had to sell buildings. It reached a point where some fund managers had to freeze withdrawals from the funds.
Moreover, a lot of German companies have massive property portfolios, and Arissen expects that they will spin off their buildings to free up cash. “REITs are a really good option for these companies,” he contends, adding that the German REIT market could reach 80 billion euro ($98.6 billion).
Currently, the U.K. and Germany are the only countries in Europe that are close to approving a REIT regime, Arissen says. “They are the two biggest countries and economies and once they have REITs, other countries in the EU will have to follow,” Arisson says. He names Finland and Spain as the next countries that will establish REIT legislation, while France and Italy's existing markets will grow substantially.
“Those countries are aware of the advantages of the REIT structure, so we should sit back and wait to see what happens in the U.K. and Germany,” Arisson says. “We believe that REITs will take off in Europe, but not overnight.” He adds that it's possible to even have European Union-wide REITs 2016.
However, other industry players are less confident that REIT regimes will spread to other parts of Europe and Asia quickly. “There's tremendous interest in real estate in Eastern Europe and India, but there are issues related to property rights that make a REIT market difficult,” Imperiale says.
More retail REITs
The emerging REIT markets of the U.K. and Germany, along with the nascent, but growing Hong Kong market, have the potential to create several retail-focused REITs, says Dennis Yeskey, head of the real estate group for Deloitte Consulting. He contends that most cities outside of the U.S. have very underdeveloped retail markets where shopping centers are new concepts.
Currently, only a few global REITs specialize in retail, points out Rehlaender, managing. “The rest of the REIT markets are not as advanced as the U.S. and Australian markets and because of that, most REITs have not yet reached the point where they specialize in one particular property type — most of them are diversified,” he explains.
Arissen counts 12 non-U.S. retail REITs with eight in Australia. In addition, there's Link REIT in Hong Kong, one in Singapore (Suntec REIT), one in Japan (CapitaMall Trust) and one in France (Mercialys, floated by Casino supermarket group). However, he notes that property companies across the globe are beginning to pursue retail rather than office properties, the traditionally preferred product type.
“Most of the global REITs [focus on office], but I would argue that the rise of consumerism across the globe presents an excellent opportunity to package and monetize retail real estate,” Imperiale says. “For the past 10 years, we've heard the persistent drumbeat that the U.S. is over-retailed, so other countries have tremendous room to grow retail.”
Rehlaender is particularly excited about the potential for new non-U.S. retail REITs. “One of our focus points is to get more retail exposure, especially in these emerging markets,” he explains. Right now, Euro Investors' funds — which have about $1 billion under investment — are about 40-percent invested in retail-related REITs and property companies outside of the U.S.
Rehlaender, who first became involved in non-domestic REIT funds in 1998, says that demand from his institutional clients for global investments has accelerated dramatically within the past 12 to 24 months. It's no wonder considering that his fund, E.I.I. International Property Fund, established in July 2004, ranked as the second-best performing real estate mutual fund in 2005 with a return of 21.36 percent, according to Lipper. The fund invests at least 80 percent of its holdings in non-U.S. based public real estate companies.
Currently, there are 68 global real estate funds with close to $14.5 billion of assets under management, according to EPRA. In 2000, only 10 global funds existed, and by the end of 2003, the number had doubled. In 2004, the total number of global property funds more than doubled again to 41, and in 2005, momentum continued and 26 new funds were added.
The Alpine International Real Estate Equity Fund, often described as the grandfather of global real estate funds, is still going strong — it was the fourth-ranked fund with a return of 17.31 percent, according to Lipper. Launched in 1989 by Sam Lieber, the fund invests in a mix of U.S., Asian and European real estate companies. Roughly 31 percent of the fund is held in Asian stocks, 46 percent in European and the remainder in North American stocks.
“Everybody's going global because there's more growth abroad,” Lieber says. “There's more upside potential.” However, he explains that the Alpine fund shuns Australian and Japanese REITs because of their cost and low returns and prefers Singapore and Hong Kong REITs.
Ted Bigman, portfolio manager of Morgan Stanley's Institutional U.S. Real Estate Fund, believes that international funds will outperform domestic funds this year. “I think there's more room for capital value growth with non-U.S. REITs,” he says, adding “it's an asset ‘reflation’ story.”
Even fund managers that have never played in the global markets are coming up to bat. As of press time, Barclays Global Investors, for example, had plans to launch an international fund for institutions in early May, Keagy says.
The fund, which will invest in major markets across the globe, will not limit itself to REITs, but will also look at property companies. “Whenever they go into REIT status, we may get a boost,” he says.