REIT Assets Not Necessarily Lackluster

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

January 2006

Recent discussions with real estate counterparts indicated that some tend to see real estate assets in (Hong Kong) REIT (Real Estate Investment Trusts) as less than prime and that real estate companies simply use REIT to offload their less competitive properties to the market. This is not a totally unfound perception because the possibility remains, just like an equity stock IPO (Initial Public Offering) through which a company owner may simply wish to liquidate his share eventually without the actual desire to bring the operation into the next stated (in the IPO) stage of development. Also, for the real estate companies, using REIT offers a few advantages; first, the buyers’ pool is enlarged implying the possibility to sell for a better price because general folks can join the game apart from the big investor groups, second, the real estate companies can retain a certain portion if they wish versus having to sell all or nothing. Naturally, REIT induces on the other hand a much complex and expensive set up and operational process.  

Regardless of the foregoing, to say that all REIT offers only lackluster properties is an overstatement. Some do and some do not. It depends. Here are a few observations: 

A)     USA REITS own some very prime real estate assets = REIT has a long history in the USA though it is in the last 15 or so years that REITS have collectively grown to be a significant real estate market player. In some ways, the real estate bust in the late 1980s and early 1990s led to many real estate developers and financing institutions having to offload their property portfolios to REITS at relatively favorable prices. Coupled this with a maturing baby-boomer generation looking for steady yields and a tax regime that favors REITS over publicly listed real estate companies-stocks, REITS has taken off in high flying gear. In short, many REITS, not all, own and operate some very prime properties, be these residential, office, retail, industrial, and the like. Also, many USA REITS trade at price levels that are higher than the total value of properties held, thus implying the market seeing (well managed) REITS as having some ‘management-value added’ premiums. This is different from many local publicly listed companies whose assets generally outweigh the total property stock value.

B)     Real estate funds are not necessarily REITS or publicly listed = when REIT is mentioned, it generally refers to real estate (investment trust) funds that are listed in the stock market. Yet, there are also many real estate funds which do not list themselves in the public market. Some rules and regulations still apply to these and some may be more ‘open’ than others in terms of investor pools and reporting etc. Like all business operations, some of these are well run with prime real estate assets while some are less than desirable.

C)    Even lackluster properties may have some appeal and / or redevelopment potentials = a property generally goes through a) a kid-young development stage, e.g. when a piece of farmland is turned into building land, b) a grown up investment stage, e.g. a building that has just been built and reaching stabilization years collecting the best prices or rents, and c) a maturing-aging stage, e.g. due to obsolescence or lack of maintenance etc. Given all things being equal, the price that can be fetched is likely to be higher in stage b than in stage c, and this may mean (not a must but a good possibility) the cap rate is lower in b than c. That is to say, investors going for stage b can expect to get a higher price for the asset but a lower rental yield rate, and vice versa when going for stage c. The former favors those looking for price appreciation while the latter favor those looking for a slightly higher rental yield. As such, assuming no major deterioration in stage c, investors looking for income streams may find stage c of appeal. Moreover, though this may imply quite a wait, there is always the possibility that someday the stage c property may reach a state where it is ripe for redevelopment which brings it into a higher value plateau.

In summary, REITS do not solve all real estate problems, and there will still be times of real estate financing tightness, real estate price fluctuations, wrong market timings, improper property selections, and so on even with REITS added to the market investment pool. Yet, there will be good ones and there will be bad ones, and investors need to scrutinize them and make (hopefully good) investment decisions.

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