REITs, the real deal

02 August 2017
By Manjit Singh, Asset Management and Insurance Practice Leader, PwC Malaysia and Lum Kar Hoe, Senior Manager, PwC Malaysia

When the concept of Real Estate Investment Trust (REIT) was first launched in 2005, it was a niche alternative investment group. Fast forward 12 years later, it has become a major asset class for property players and investors. Consistent with the trend globally, over the past years, REITs have had a strong come-back from the financial crisis and showed an impressive upswing. As at 31 December 2016, there were 17 REITs listed on Bursa Malaysia with a total market capitalisation of RM44.19 billion. Despite the soft stock market sentiments in 2016, the market capitalisation of REITs saw a remarkable 17.9% increase in 2016 from RM37.48 billion the year before.

In response to the fast changing market environment and the evolving needs of REITs and REITs investors, in 2016, the Securities Commission Malaysia (SC) undertook a comprehensive review of the Guidelines on REITs (REITs Guidelines). Boosting investment growth through an expanded scope of REIT activities was one of the main aims of this review. The proposed changes were well received by the investing community as it aligns the features and characteristics of REITs in Malaysia with REITs in Singapore.

Proposals to enhance the REITs market: The key changes

REITs are allowed to acquire vacant land and also undertake property development subject to a cap of 15% of their total asset value.

REIT managers are allowed to enter into long term leases with registered proprietors of real estate.

These attractive features are among the leading factors encouraging participation in the REIT sector. Consequently, we are seeing the emergence of unlisted REITs (where investment trusts are not listed on the stock exchange). The key advantage for REIT managers is the ability to start small and focus on a niche differentiated area and grow the asset base one property at a time instead of aiming to build a sizeable property portfolio on listing. Subsequently the unlisted REITs can be listed on the stock exchange.

Unlisted REITs – Starting small and building your portfolio one property at a time

Seven key differences exist between unlisted REITs and listed REITs, in the way that these types of offerings are set up and sold to investors.

An unlisted REIT may be potentially attractive to investors as:

Fund sizes are relatively smaller and there is no minimum public shareholding spread requirement.

Unlisted REITs are not subject to the same disclosure requirements as listed REITs and are relatively easier to set up.

The issuer does not need to enter into tedious novation agreements with the tenants upon listing as the contracting party remains the same[i].

The initial capital outlay is smaller as you don’t need to set up a diversified portfolio of properties.

Other distinguishing features of an unlisted REIT:

It may be only offered to institutional investors. This is due to high concentration risk at the initial stage as there are only a handful of portfolio properties as outlined in Proposal 16 of SC’s Public Consultation Paper No 3/2016.

Depending on the circumstances of the fund, it may make sense for REIT managers to apply for certain exemptions from REITs Guidelines. For example, it may not be practical to have daily valuation and publication of prices in the national newspaper if the investors’ pool is small.

However, the REIT itself is not tax exempt. Taxation is assessed at the unitholder’s level. The unitholders can then claim tax credit on tax which has already been paid by the REIT.

Stimulating sustainable investment activities

The unlisted REIT model can help fund the emergence of new real estate development concepts such as buildings with high sustainability ratings as well as Shariah compliance. For instance, although there are only four listed Shariah REITs on Bursa Malaysia, they are fast gaining popularity, accounting for 42% of the total market capitalisation of listed REITs as at December 2016.

From the investor’s perspective, a new generation of real estate investors are now guided by ESG (“Environmental, Social and Governance”) principles[ii] in making investment decisions. A recent report prepared by Property Funds World which quotes a study by Carbon War Room found that REITs with higher sustainability rankings performed better in terms of return on assets and return on equity. This builds the case for more sustainable investment activities considering that energy consumption accounts for 40% of the lifecycle costs of buildings on average. Other factors facilitating the growth of these investment activities is the increasing popularity of GreenTech solutions and the development of ‘smart meters’ which are encouraging real estate developers to go green to lower the cost of energy. At the end of the day, more tenants want greener buildings as well.

Enhancing earnings and diversifying risks

In addition, a new generation of savvy investors are also appreciating the need for a diversified portfolio. The low risk feature of REITs as well as its ability to be a good inflation hedge compared to equities and bonds makes it a good addition to the portfolio. Furthermore, in its unlisted state, REITs will have a lower correlation with equities, providing even better diversification.

This meets the needs of institutional investors looking to shift their strategic asset allocation towards alternative investments especially real estate in enhancing earnings and diversifying risks. For instance, the Employees Provident Fund (EPF) recently announced that it is seeking to double its exposure to alternative investments from around 4% to between 8% and 10% of the fund’s total AUM (“Asset under Management”). Lembaga Tabung Haji will allocate RM2 billion for real estate investments in UK and Australia for the next three years.

On the other hand, some institutional investors such as Khazanah are using REITs as a vehicle to divest their investments. As for Kumpulan Wang Persaraan (KWAP), CEO Dato’ Wan Kamaruzaman Wan Ahmad recently announced that KWAP is planning to allocate more money to the real estate space and will be increasing their asset allocation in alternative investments from 10% to 14%.

A buyer’s market once again

The proposed changes to the REITs Guidelines, the emergence of unlisted REITs and the rise of new real estate concepts can help provide new funding and investment avenues for the development of innovative real estate concepts. This opens up opportunities for REIT managers and investors to undertake new property developments instead of managing established ones.

This over time will help enrich the local property market, making it a buyer’s market once again.

It’s not hype, it’s the REAL-ity.

[i] In a conventional REIT, properties are typically transferred from an investment holding company into the REIT upon listing and this involves the tedious process of executing novation agreements/signing new lease agreements.

[ii] Companies wishing to optimise their energy consumption strive to seek compliance with global ESG standards such as Europe’s Energy Efficiency Directive (EED) and Leadership in Energy and Environmental Design (LEED).