Real estate investment trusts or REITs own income-producing real estate assets and can play an important role in investment portfolio diversification. Required to pay out at least 90% of income to unitholders, they offer high dividend yields of 4%–8% per annum in Asia, significantly higher than other equities.
By requiring a smaller capital outlay than direct investments in the property market, REITs are an excellent way to gain access to real estate without buying property outright and provide a stable income stream via regular distributions.
According to the National Association of Real Estate Investment Trusts (Nareit), the global REIT market is worth about US$1.9 trillion ($252 billion), with a total of 893 listed REITs as of December 2022. According to REIT AsiaPac, there are 183 Asia Pacific REITs with a market capitalisation of US$238 billion as of Oct 31, 2023. Asian REITs comprise Australia, Japan, Hong Kong and Singapore, and their total return reached 51% in the last 10 years, relative to the broader equity markets. Most REITs are focused on a particular type of property or hold multiple types of properties in their portfolios. Major types in Asia include retail malls, warehouses, data centres, hotels, apartments and offices.
History and growth of Asian REITs
US REITs, established by Congress in 1960, have flourished and served as the model for around 40 countries across the globe, giving all investors — especially small investors — access to large-scale, diversified portfolios of income-producing real estate. Since then, the US REIT approach has flourished and served as the model for around 40 countries around the world. REITs help build local communities through new development.
Australia’s first REIT, the 1971 General Property Trust, gave investors an alternative to direct property investment, and the country now has nearly 50 REIT listings with market capitalisation exceeding A$100 billion ($90 billion). The market once dominated by malls and offices now has the option to invest in logistics, storage, data centres and build-to-rent housing proxies. The managers of REITs have also warmly embraced sustainability and governance practices.
The Japan REIT market has expanded significantly since the first two J-REITs were listed, Nippon Building Fund and Japan Real Estate Investment Corporation, in 2001. The government aimed to promote real estate securitisation to boost the economy. The market was initially heavily weighted in offices but over time, REIT managers diversified their income streams through mergers and reconstituting their portfolios.
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Singapore’s REITs debuted in 2002 with the listing of CapitaMall Trust on the Singapore Exchange S68 and the city now has 41 S-REITs with a total market capitalisation of $101 billion as of February 2023. Comprising 12% of SGX’s market capitalisation, S-REITs enjoy the support of well-known sponsors and employ an M&A strategy to grow their dividend per unit. Unique for their dominance of cross-border listings, over 90% of S-REITs and property trusts own properties outside Singapore across the Asia Pacific, South Asia, Europe and the US. There are 17 S-REITs whose real estate portfolios comprise entirely of overseas properties.
Hong Kong’s biggest listing, Link REIT at HK$22 billion ($3.7 billion), is a dominant retail mall manager. Hong Kong has a well-developed regime and clarity in market regulation and the government has announced incentives to promote development.
Market trends in REITs sector post-pandemic
Post-pandemic and with the birth of a more flexible, remote working style, some employers have started downsizing office space required, leading to more vacancies. Moving forward, landlords must deliver better quality or modernised facilities to meet the new expectations of tenants.
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Digitalisation will continue to accelerate post-pandemic with the development of generative artificial intelligence. This will change the way businesses and consumers interact, and there will be an increase in demand for data centres. Also accelerating in Asia is e-commerce penetration and brands continue to deploy omnichannel distribution strategies. There is also still an undersupply of quality modern city centre logistics space with potential growth opportunities in this space.
Regulators are increasingly concerned about the impact of unchecked climate changes and are demanding property owners and managers upgrade and future-proof their assets to become more environmentally friendly, as asset managers need to undertake cost-effective improvements for their buildings to meet more stringent requirements and their tenants’ preference for ESG-compliant buildings.
Challenges for Asian REITs
Asian markets are confronting high inflation, high interest rates, increasing labour and utility costs, escalating debts, and the impending risk of a global recession. In times like this, REIT managers take stock of their corporate strategy to diversify their income, lengthen their leases, index their rents, control the operating costs through automation and improve their tenant mix. They also became more prudent in making any acquisitions of assets.
In 2022, global REITs fell 26% while Asian REITs fell 20% due to rising interest rates and a reversal of quantitative easing by the Fed. Despite this, Asian REITs still have a strong foothold, and leasing momentum remains resilient. Amid rising geopolitical uncertainty, Singapore still attracts capital, given its perceived safe-haven status. Deal-making is slower due to a higher cost of funding but as the valuation of assets adjusts lower, there are buying opportunities for REITs that have strong balance sheets and debt legroom.
The pivot on interest rates policy by central banks would be essential in lifting the overhang on Asian REITs. Any interest rate uncertainty or further rate hikes will be key headwinds that will limit performance, as rising rates make deposits more attractive and REITs less competitive. Higher borrowing costs could also lower earnings and slow acquisition growth for REITs. Nonetheless, Asian REITs are generally well managed, and most have hedged 50%–80% of their debt borrowing at fixed rates much earlier on, to manage the high interest rate environment.
The market broadly expects the Fed to start cutting interest rates in 2024 as rate hikes start to bite. The improved odds of a soft landing would bode well for the Asian REIT market, as property managers will be able to resume acquisitions and reduce financing costs.
Bottoming out & opportunities in the Asian REITs market
The Reserve Bank of Australia has raised interest rates to an 11-year high (4.1%) to cool inflation. Businesses and households in Australia are adjusting well, and immigration has bolstered the economy and housing market. While the office sector may still see downward pressure in asset prices, most other segments look resilient.
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In Japan, the Bank of Japan has adjusted the yield curve control programme, effectively raising the upper limit of 10-year Japanese government bond yields to 1% from 0.5%. As a result, J-REIT assets have underperformed their non-REIT peers, however, the fundamentals of the J-REIT market remain sound, and the REITs typically borrow on a long-term basis with a high fixed-debt ratio.
Singapore and Hong Kong REIT markets have seen some aggressive equity-raising activities to repay debts and buy properties. Generally, investors would support accretive fundraising.
Why invest in Asian REITs
Asian REITs outperformed global REITs in 2022 and most have healthy leverage and financing prudence. The average gearing ratio of an Asian REIT is at 25%–50%. REIT managers have gone through the Asian Financial Crisis and the Global Financial Crisis and are better prepared to manage indebtedness. Asian REITs also produce higher dividend yields, paying out a high level of their income.
Moreover, equity REITs provide diversification given a lower correlation with bonds. They also provide better liquidity compared to a physical property investment, which has a longer holding time period.
In the long term, the returns of REITs are less correlated to the stock market, making them an excellent way to diversify and improve the investor risk/return profile on investments. As we come to the end of the rate hiking period, this could be a favourable entry point for investing in REITs, which have stayed resilient, supported by tight supply, healthy cash flows, gearing ratios and balance sheets. With this inflection point in sight, Asian REITs could be a good addition to your investment portfolio in 2024.
Sng Jia Hao is head of mandate advisory Singapore, Julius Baer. Alison Seng is senior portfolio manager for Asia equities, Julius Baer
