REITs Storm Asian Shores

In their rush to modernize, Asian countries have borrowed many Western inventions. One of the latest ideas to arrive is the real estate investment trust. Since the first REIT launched in Japan in 2001, several more have emerged on the scene in Singapore, Hong Kong, Korea, and other Asian markets.

By January of this year, the FTSE EPRA/NAREIT Global Real Estate Index included 64 Asian REITs with a market capitalization of more than $207 billion. That's about half the size of the U.S. REIT market, which included 126 REITS amassing a market cap of $412 billion.

Booming economies have accelerated the rise of Asian REITs. Strong demand by high-end tenants such as investment banks and hedge funds for state-of-the- art buildings is spurring new construction across the continent.

Government regulators, meanwhile, also are on the REIT bandwagon these days. They want to emulate the success of the REIT model in the U.S., which has attracted institutional investors and other major sources of capital to the real estate industry.

Still in its infancy, the Asian REIT market is poised to grow for the next several years, predicts Peter Mitchell, CEO of the Asian Public Real Estate Association, a trade group in Singapore. New REITs are appearing steadily, with about one initial public offering occurring somewhere in Asia every month. “Less than 5% of investment-grade Asian real estate is in REITs, and the figure is likely to continue rising,” says Mitchell.

To be sure, publicly traded property companies have existed in Japan for years, but REITs offer investors an added incentive. By law, REITs in the U.S. and most Asian countries must pay out 90% of their income as dividends to shareholders, resulting in fairly high dividend yields. Such stable income appeals to pension funds and other cautious investors.

U.S. REITs currently pay dividend yields of 3.4%, about the same figure as the Japanese REITs pay, according to Christopher Reich, senior vice president of ING Clarion Real Estate Securities. Conversely, real estate operating companies tend to pay lower dividends and produce more erratic returns in down markets, adds Reich.

Along with relatively high dividends, REITs offer Western investors a degree of comfort because the structure is common in developed markets. Many U.S. REITs have an operating history of a decade or more. In addition, REIT balance sheets tend to be transparent because the companies pay out nearly all their earnings as dividends.

Investor change of heart

In the past, Western institutional investors typically ignored Asian property markets, which they often perceived as volatile, says Mike Acton, director of research for AEW Capital Management, a Boston investment advisor. With the rise of REITs and other institutional-grade investments, attitudes are changing.

AEW recently created Asian property funds designed for pensions and other institutions, which are seeking to increase their allocation to the region. “Our clients now feel that they need to be in Asia for diversification,” says Acton. “The prices of Tokyo offices don't necessarily rise and fall with the Dallas apartment market.”

While the REITs may offer diversification, they won't necessarily deliver outsized results. Much of the returns from REITs historically have come from dividends, and most REITs in the U.S. and Asia are paying modest single-digit dividend yields. Share price appreciation could add something to total returns. But after already enjoying several years of rallying share prices, it is uncertain how much higher the stocks can go.

There are a scant number of real estate bargains to be had in Asia, or worldwide. A standard warehouse in Chicago sells for a capitalization rate — initial yield based on the purchase price — of around 6%, says Guy Jacquier, executive vice president of AMB Property Corp., a San Francisco-based REIT. The same property might have a cap rate of 5% in Japan.

Is Japan overpriced? Not necessarily, says Jacquier, because Japanese long-term mortgage interest rates are approximately 2.5%. “If you can buy at a 5% cap rate and finance it at 2.5%, you can get a good positive cash flow,” he says.

In the emerging markets, cap rates are higher. For example, in Shanghai an investor can purchase a warehouse with a cap rate of 7.5%, says Jackquier. But the newer markets come with some additional political risks. Regulators could surprise investors with new rules. In Singapore, the risk may be less obvious, but still real. While the government is stable, the country is an island nation. So the local REITs are placing bets on the fate of a small piece of land.

Abiding by the rules

REIT regulations vary slightly from country to country. In Hong Kong, local REITs may not buy vacant land, a provision aimed at discouraging development on an island that is already crowded. However, in Japan and the U.S., REITs can buy and develop vacant land. In the U.S. and Japan, REITs can borrow as much as their shareholders and lenders will permit. But in Singapore, there is a so-called gearing limit, only permitting REITs to borrow up to 35% of their gross asset value.

The rule is aimed at keeping REITs from getting weighed down by debt. “The Asian jurisdictions have looked at what works best in the U.S., and they are customizing the rules to fit their own markets,” says Mitchell of the Asian Public Real Estate Association.

While some of the Asian REITs are diversified companies with holdings in a variety of property sectors, many specialize in a single sector, such as apartments or industrial properties.

With a market capitalization of $3 billion, the Nippon Building Fund owns 55 prime office properties, including many in the central business district of Tokyo. The company owns 7.1 million sq. ft. with an occupancy rate of 98.7%.

CapitaMall Trust, a Singapore REIT, has a market cap of $1.7 billion. The company owns five malls in city and suburban areas. Most REITs focus on their home countries.

But more are beginning to spread across borders. Maple Tree Logistics, based in Singapore, now owns industrial properties throughout Asia. Ascott Residence Trust owns apartments in Singapore, China, Vietnam, and the Philippines.

In some cases, listed property companies have been bundling some of their holdings and spinning them off as REITs. In the past five years, CapitaLand, a Singapore company, has spun off four REITs in Singapore and one in Malaysia. Such spin-offs can result in a payoff for shareholders, since the potential exists for assets to command a higher price as part of a REIT.

Long-time family businesses also are using REIT markets to take their holdings public and cash in shares. Whether they are family businesses or public companies, managers may see spin-offs as a way to divide holdings, offloading mature income-producing holdings into a REIT, while leaving faster-growing buildings in the property company.

“If companies feel that their assets are not being properly recognized in the market, the shareholders may be better off if some of the assets are put into a REIT,” says Khiem Do, portfolio manager of Asia Pacific Fund, a closed-end fund.

Property fundamentals rising

No matter how they were created, Asian REITs have been benefiting from the healthy demand for offices and malls in the region, a sharp turnaround from the recent past.

In Japan, real estate suffered a massive recession from 1989 to 2002. Prices of many buildings dropped 60%. During that time, there was little construction and renovation. In the last several years, Japanese real estate has revived along with the country's economy. Prices of many properties have risen more than 20%. Even in cities where growth is moderate, there are still many new developments rising as outdated buildings are replaced with new construction.

Other Asian countries are recovering from a variety of setbacks. In 1997 and 1998, currencies collapsed in Thailand and throughout much of developing Asia. Then in 2000, Asian technology companies went into a tailspin along with Wall Street. Now the emerging Asian economies are enjoying vigorous growth, led by China where the gross domestic product is expected to rise more than 9% this year.

“The strong economies have helped to produce some solid Asian REITs,” says David Kruth, vice president of Goldman Sachs Asset Management. “In the future, the pool of high-quality investments will continue growing.”

Stan Luxenberg is a New York-based writer

Handful of U.S. REITs Are Players in Asia

Trying to capitalize on Asia's economic growth, a few U.S. REITs such as Simon Property Group are testing the waters. The largest shopping mall owner in the U.S. operates five retail outlet centers in Japan and recently announced a joint venture to develop outlet centers in South Korea.

The expansion has been good for retail consumers in Nagoya, Japan who don't have to travel far to sample American brands. The nearby Toki Premium Outlets shopping center owned by Simon houses 85 tenants, including Brooks Brothers, Timberland, and Tommy Hilfiger.

So far, the American invasion is limited to a handful of powerhouse REITs with aspirations to become truly global operators. ProLogis, a Denver-based industrial owner and developer, has 4.1 million sq. ft. of industrial space in operation in China and another 3 million sq. ft. under development.

AMB Property Corp., another giant industrial REIT based in San Francisco, entered Japan after requests from corporate clients. A big operator of warehouses, the REIT counts DHL and Federal Express among its customers. As those logistics companies expanded in Asia, they suffered from a shortage of state-of-the-art distribution centers.

Some U.S. REITs are developing new properties instead of buying existing facilities because there is less competition for developers in Asia. “In the U.S., there is a lot of good development talent,” explains Guy Jackquier, president of Europe and Asia operations for AMB. “But in a place like China, this is really a new business. A lot of the existing stock does not measure up to international standards.”

Still, building near cramped Asian ports and airports poses challenges, Jackquier concedes. Land is more expensive in Tokyo than Dallas. Asian warehouse facilities make use of limited land by rising up to seven stories, far taller than American structures, which are typically one story. To serve the higher floors, the Asian buildings must include elevators or ramps. All those additions add to expenses. While it costs $60 per sq. ft. to build a warehouse in Chicago, a similar structure costs $200 a sq. ft. in Japan, says Jackquier.

The volume of foreign capital pouring into the Asian property markets isn't expected to slow down anytime soon. “U.S. REITs are just starting to get their feet wet in Asia,” observes John J. Kriz, managing director of real estate finance for Moody's Investors Service. “We are still in the early days of the Asian expansion.”
Stan Luxenberg

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