Foundations in place for large and credible Asian REIT market

The REIT market in Asia will continue to grow, despite current interest rate headwinds, says S&P.
Buoyed by favourable economic, investment, and regulatory conditions, Asia's nascent real estate investment trust (REIT) market has expanded at a feverish pace in the last few years. REITs have now firmly established themselves as a credible and alternative asset class in the region.

The total market value of REITs across Asia, including Australia, recently pushed through the $100 billion mark. Excluding Australia, Asia's REIT sector has grown from virtually nothing at the start of the decade to a $40 billion-plus industry comprising more than 100 trusts. Property owners and investors in Japan, Singapore, and Hong Kong have led the charge (see table 1).

Despite some headwinds, including rising interest rates, further strong growth of the region's REIT sector seems inevitable as equity and debt investors gain familiarity and confidence with the concept. Robust economic growth, an ongoing recovery in property markets, and hospitable regulatory frameworks are likely to encourage owners of real estate to unleash more REIT listings this year. Importantly, new entrants are poised to come from China, India, Malaysia, and Taiwan.

For existing participants, further growth opportunities will increasingly come from investments in real estate outside home markets and through M&A. Asian REITs may even start to follow their counterparts in other parts of the world by pursuing growth via property development and asset management activities.

What Is a REIT?
A typical real estate investment trust, or REIT, is an equity-oriented, tax-efficient investment vehicle that allows smaller investors to pool funds for indirect participation in real estate ownership or financing. REITs buy and manage real estate using money invested by shareholders, and derive most of their cashflow from rental income from tenants. Known for being relatively liquid and transparent instruments, REITs typically pay regular and predictable dividends to investors and offer high yields of 4%û7%. This is attractive compared with equity or fixed-income instruments.

As long as certain key criteria are met, a company that qualifies as a REIT is usually tax exempt and unitholders pay taxes on the distributions received. The REIT concept was born in the US in the 1960s. However, the global REIT market has grown most rapidly in the past few years, especially across Asia, as more countries embrace a tax-efficient property listing structure that encourages companies to offload their real estate assets and entices retail investors to invest in REITs. Rising property prices have also enticed property owners to securitize their real estate assets.

Although 'REIT' is used as a common notation for these types of entities worldwide, the instrument has different country-specific names, such as J-REIT in Japan, LPT in Australia, SIIC in France, and SICAFI in Belgium.

Apart from the tax incentives, property owners or developers may choose to set up REITs to free themselves from the administrative burden of tenancy and asset management, or because they want to raise money to pursue other development opportunities. On the other hand, there may be pressure from banks or other stakeholders to sell real estate assets to repay debt and improve their prudential metrics.

Slow Off The Mark, But Returns Healthy
Although a spate of tax-friendly and supportive regulatory measures have encouraged new issuances across Asia in the past few years, the region's REIT market is still characterised as young and immature compared with its counterparts in the US and Australia, which have larger and more diversified property asset portfolios. Asian REITs currently generate most of their income from rentals of high-quality office, retail, and industrial real estate.

Japan was the first country in Asia to set up a REIT market, with legislation passed in 2000 allowing for the establishment of Japan-based REITs. Since Nippon Building Fund Inc. and Japan Real Estate Investment Corp. listed in September 2001, more than 30 J-REITs with a market value of about $30 billion have been established. Although Singapore enacted its first investment guidelines for the establishment of Singapore-based REITs in 1999, it wasn't until July 2002 that the first REIT listed, CapitaMall Trust. Singapore, which is endeavouring to become the regional REIT hub by permitting cross-listing of REITs from other regions, now has 10 trusts, valued at more than $8 billion. Malaysia, Korea, Hong Kong, Thailand, and Taiwan have also met with some success in encouraging property owners to securitise their assets in the last year or so.

Aided by consistent double-digit rates of returns and competitive yields, Asian REITs have quickly raised their profile and gained investor popularity as an alternative investment vehicle. Indeed, the overall performance of Asian REITs has at least matched the performance of other global markets. The S&P/Citigroup World REIT index, which measures the performance of more than 200 REITs in 10 developed markets, had annualised returns of 23% over the last five years. Asia-Pacific posted annualised returns of 26% in the same period. At March 31, 2006, the S&P/Citigroup REIT index showed that annual yields were highest in the Asia-Pacific region, at 5.5%. There are, however, some patches of underperformance; almost half of the 17 J-REITs listed since 2005 are trading below their IPO prices.

Strong-To-Satisfactory Business Profiles Help Above-Average Credit Quality
Coupled with strong-to-satisfactory business risk profiles and moderate usage of debt and adequate debt service coverage, the majority of Asian REITs exhibit investment-grade characteristics. In fact, the region's REITs generally have better credit quality than their global counterparts. Standard & Poor's rates some 18 REITs across Asia, including Australia, with credit ratings clustered around the 'A-' category (see charts 1 and 2). Credit outlooks, a leading indicator of rating trends, further highlight the relatively stable credit quality of the region's REITs; 17 of the 18 rated REIT issuers have a stable outlook, with the remaining issuer on a positive outlook.

Asset Price Inflation, M&A, And Diversification Loom Large
The credit quality of Asian REITs may come under pressure as trusts adopt more aggressive strategies because of limited local growth opportunities. The local property markets are improving and as a result capital values are increasing. This asset price inflation will make it difficult for REITs to grow and ensure that the income yield is maintained. As a consequence, like its counterparts operating in more mature markets, Asia's trusts are expected to look for more growth through offshore markets, acquisitions, asset management fees, and property development.

In Australia and the US, several listed REITs have already increased their exposure to offshore markets and property development in a bid to bolster their income stream and returns to unit holders. Although Standard & Poor's considers that some diversification can assist creditworthiness, the inherent risks of developing property, combined with the absence of cashflow stability from these activities, tend to accentuate volatility to earnings, and reduce creditworthiness. In addition, offshore property investment often requires more intensive management and introduces an exposure to foreign exchange and cultural risks. An appetite for new growth sources could also lead to acquisitions of inferior assets or assets in unfamiliar markets.

Asian REITs are likely to undertake M&A activity and property development at some stage in the near future. They can accommodate some marginal increase in debt levels at current ratings, but more aggressive growth strategies that fund acquisitions or developments with debt beyond articulated financial policies may see ratings trend down. The ability to source solid income-producing assets while maintaining prudent levels of gearing will be key to success.

More Growth Likely, But Interest Rate Challenges Remain
Asia is expected to remain the growth story for the global REIT market over the near term, with new listings set to expand market penetration. However, challenges are emerging and the pace of market development is expected to remain uneven, partly because of regulatory constraints and a lack of liquidity in some countries, such as Korea. The ability of Asian REIT markets to maintain their competitive advantage over other asset classes will be a key challenge. With central banks across Asia-Pacific playing catch-up with the US Federal Reserve on monetary policy, a rising interest rate environment may lead to increased investor concern about property markets and curtail the growth momentum of the region's REIT sector. REITs are sensitive to a rising interest rate environment, particularly as many are carrying sizable debt loads. Even so, a major property downturn across Asia is not expected to materialise because the region's economies are generally robust. Moreover, signs of an end to the tightening cycle among Asian central banks may see enthusiasm for REITs to recover.

The above article was written by Craig Parker, Director, Corporate & Government Services, Standard & Poor's and John Bailey, Managing Director, Corporate & Infrastructure Ratings, Standard & Poor's

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[The article is an extract from RatingsDirect, Standard & Poor's Ratings web-based credit research and analysis system ( To learn more, please click on About RatingsDirect.]
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