In this chapter, literature related to Real Estate Investment Trusts will be discussed. In addition, the characteristics and performance of REITs between Malaysia and Singapore will be compared and considered.
Real Estate Investment Trusts is an indirect investment to property markets. It is a corporation or business trusts that pooling the capital of many investors to acquire or provide financing for all forms of income-producing real estate. The key features of REITs is not required to pay for corporate income tax if at least 90 percent of its taxable income been distributed to share holders each year (Tao & Guo, 2008). REITs allow small investors to invest indirectly in a truly diversified property portfolio, buying low cost and easily tradable units, instead of having to purchase entire properties.
NAREIT (2010) defines REITs as:
"A real estate investment trust, or REIT, is a company that owns, and in most cases, operates income-producing real estate. Some REITs finance real estate. To be a REIT, a company must distribute at lease 90 percent of its taxable income to shareholders annually in the form of dividends."
Types of REITs
In the global REITs market, there are commonly three types of REITs which are Equity REITs, Mortgage REITs, and Hybrid REITs.
Equity REITs
Equity REITs mostly own and operate income-producing real estate. Most of their incomes are derived from the rent of their properties. Furthermore, the appreciation value of the properties may increase the value of REIT since the properties are belonging by REIT (NAREIT, 2009).
Mortgage REITs
Mortgage REITs are mortgage backed securities. They mostly lend money directly to real estate owners. The income is generated by interest earned on the mortgage loans (NAREIT, 2009)
Hybrid REITs
Hybrid REITs is the combination of both investment strategies which able to generate income from rental and capital gains, and interest income (NAREIT, 2009)
Even though there are three types of REITs in the United States of America (USA) REIT market, the occupancy rate had a huge difference. Regarding to figure, Equity REITs has the biggest of the pie which occupy 91% of the REIT market; following by Mortgage REIT at 7% and Hybrid REITs at 1% (NAREIT, 2009).
Currently, Malaysia REITs and Singapore REITs are based on Equity REITs. Therefore, Equity REIT is the only one to discuss in this dissertation. All the references to REITs in the following sections will be referring to Equity REITs.
Types of properties invest by REITs
There are variety types of properties able to own and manage by REITs such as office buildings, shopping centres, warehouses and etc. United States of America (USA) as a pioneer of REITs industry kept exploring new opportunities for income growth and provided wide range of property type for investors as below:
However, the REITs market in Malaysia and Singapore are more focus on retail and office centres.
Structure of REITs
From the definition of REITs, it is easy to find out some key players in REITs such as unit holders, property manager and property assets. Figure 1 is shown the connection and functions of all the players.
The investors, normally termed as unit holders, invest their monies into REIT. The monies then became the capital for REIT to purchase properties. With the income generate by the rental, REIT distributed the profit back to the unit holders depended on their investment amount. By the involvement of trustee, they made sure the investment from unit holders are managed effectively. The asset manager of the REIT is the one who decides what kind of properties should be purchased and included in the portfolio that able to increase the value of REIT. All the properties which are under the ownership of the REIT will be managed by the property managers. They determined the number of leases, the kind of tenants, rental space, and rental price (Poh & Sean, 2005).
Benefit of REITs
REITs had a long history in USA and Australia and now been welcoming in a lot of countries especially Asia. Countries such as Singapore, Malaysia and Hong Kong are having a REITs-like structure and growing well in these countries. With the unique characteristics and features of each REIT, included REITs in the investment portfolio will bring lots of benefits to investors.
Diversification
REITs is able to own multi-property with diversified tenant in the same times, it helped to reduce the risk of relying on a single property and tenant. This is different with the direct investment in property market. Choosing the REITs based on the type of properties or region helps to diversify further for investors (MAS, 2010).
A lot of literature review been discussing about the diversification of REITs. Will including REITs into Mixed-Asset Portfolio offer benefits to investors? The value is varied on different time of period, agreed by Mull & Soenen (1997). Regarding to the monthly data from Kuhle (1978), he observed that in the period 1980 to 1985, REITs did not increase the benefits for investors. The performance is act as common stocks. However, based on the research from Mueller, Pauley & Morrill (1994), including REITs in a mixed-asset framework from 1976-1980 and 1990-1993 time periods were a valuable added investment, but not for the 1980-1990 sub-period. Ibbotson Associates, on behalf of NAREIT (NAREIT, 2008), showed that over the last 30 years, including REITs in mixed-asset portfolio was offered substantial benefits.
Dividends
Most of the countries which apply REITs in their country, have the same rules that REITs are required to pay out at lease 90 percent of taxable income to their shareholders in the form of dividends. In US, some REITs even pay out more than 100 percent to investors. Created a stable and consistent income will able to attract more investors (NAREIT, 2010).
Ibbotson Associates, on behalf of NAREIT (NAREIT, 2008), claimed that equity REIT is producing a high level of reliable income through all market conditions over the last 20 years. More than 50 percent of REIT total returns have come from dividend income over the long term.
Liquidity
REITs investment offers the advantage of liquidity - the ease of converting assets into cash. As long as there is trading day, investors can purchase or sell a REIT which listed on the stock exchange, and it is easier than direct investment in property market (MAS, 2010).
Performance
The performance of REITs used to compare direct investment property. REITs offer strong long-term returns in USA. During the period from 1978 to 2008, equity REIT had a better performance which exceeded the broad equity market and other forms of real estate investment (NAREIT, 2010).
Figure illustrated that the growth of global REITs market different in periods. In 1990-1992, due to the sharp decline in US real estate market, returns of REITs had fall more than -20%. With the occasions of REIT market boom in USA and in global which in the peak period 1993-1996 and 2002-2006, REITs is enjoying a strong market growth and the returns are over 100% and 200%, respectively. Asian Financial crisis, tech bust and global estate market decline in 1997-2001 had force the return dropped near to 0%. The credit crisis & global real estate market decline had been giving a big bang to the REITs returns in 2007-2008. A fall with more than -40% became the hugely lost in return over the last 20 years period.
As mentioned before, REITs performance is varying in different type of periods.
Affordability
The characteristic of REIT is pooling the capital of investors in REIT and acquire some properties that not affordable by personal capital such as office tower, shopping centres, warehouse and etc. By investing in REITs, investors get to invest in there large assets in bite-size chunks (MAS, 2010).
Transparency
REITs able to provide transparency and it become an important issue to attract investors. As mentioned before, REITs needed not to pay for corporate tax if 90% of the income been paid as a dividends. Taxes are paid only at the individual shareholder level instead. The second is operating transparency. Since REITs are listed in equity market, they had to register and regulate by the Securities Exchange commission and adhere to high standards of corporate governance, financial reporting and information disclosure. The third is market transparency. The property which invested or owned by REITs, can easily identify and value independently because they will be listed in the financial report or announced. They are real and tangible assets that can see, drive by or even walk in by investors and analysts (NAREIT, 2010).
Risk of REITs
The benefits from REITs are huge and it seems to be a sure-win investment for investors which able to increase the value of the investment portfolios and diversify the risks. Nevertheless, REITs nonetheless entail certain risks.
Each REITs are having their own unique characteristics and features, so the risks associated is vary and different. A lot of issues have to be taken as considerations such as geographical location of the investments, yields, quality and lease length of the underlying properties.
The risks that may consider are listed as below:
Market risk
As mentioned before, REITs are traded on the stock exchange. The price of REITs are subject to change depends on the demand and supply of the investors. The investors may find that the investment amount is differing than the original when selling their units in a REIT. It may increase or decrease. The price generally reflects investors' confidence in the economy, the property market and its returns, the REIT management, interest rates, and many other factors. The investors have to accept the volatility price of REITs (MAS, 2010).
Income risk
Investing in REITs will able to enjoy the dividends paid from the rental income. However, if there is an operating loss in REIT reports, the investors might not gain the dividends from REIT. Termination on tenancy agreements renews a contract at a lower rental rate or occupancy rate increase may reduce the income of REITs. Even worst case is the underlying properties are financed by debts; there might be a financing risk when cost of debt varies (MAS, 2010).
Concentration risk
If REITs are concentrating on a particular field or property, it will increase the risk if something untoward will happen to one of these properties or fields. Over depending on limited tenants for its lease income will also exposed to greater risk (MAS, 2010).
Liquidity risk
The liquidity of REIT is lower than other funds investing in financial securities such as bonds and stocks. As the character of the REIT is investing in properties, REIT is still facing some similar problems like direct investment to property market such as the difficulty to get any buyers or sellers for property, especially if the value of property is high (MAS, 2010).
Leverage risk
If a REIT will use debt to finance the acquisition of underlying properties, it might face a leverage risk. REIT allows leveraging under a certain percentage set by the government. Same as any other company which listed in stock market, if the REIT is facing bankruptcy, the debtors will be the first to pay off by the assets of REIT rather than the unit holders. The unit holders may distributed on any remaining value of REIT (MAS, 2010).
Refinancing risk
Since the characters of REITs are distribute at least 90% of the rental income as dividend to unit holders, it may difficult to build up cash reserves to repay loans as they fall due. Therefore, looking for a new borrowing agreements or other capitalisation measures such as rights or bonds issues became the typical way to refinance. They might bear a higher refinancing cost when loans are due for renewal. However, if the REIT is not secure to refinancing, selling the properties may require. These will affect the unit price and income distribution of a REIT (MAS, 2010).
Summary
A REIT is an easy investment vehicle which able to increase the value of investment portfolio for investors. However, the benefits of REIT sometimes will become the risks for investors. For an example, the liquidity of REITs are giving the advantages for investors to trade easily on the stock markets and it save the procedures and fees compare to direct investment on property market. Nonetheless, the investors may trap on the capital in stock market if the demand of the REITs is less or in economic crisis. Leverage on the properties will able to create greater profits for investors, but the other hands may exposed to greater risks. Thus, REITs had to be regulated by some rules and regulations which may different in countries.
Requirement of establishing REITs
According to Geltner and Miller (2001, p636), some major restrictions on REITs were summarised.
Five-o-fewer rule (5-50 rules). A REIT cannot be a closely held corporation in the sense that five or fewer individuals may not own more than 50% of the REIT's stock.
75% or more of the REIT's total assets must be real estate, mortgages, cash, or federal government securities, and 75% or more of the REIT's yearly gross income must be derived directly or indirectly from real property ownership (including mortgage, partnerships and other REITs).
90% or more of the REIT's annual taxable must be distributed to shareholders as dividends each year (in order to maintain their tax-exempt status).
REITs must derive their income from primarily passive sources such as rents and mortgage interest, as distinct from short-term trading or sale of property assets. They cannot use their tax status to shield non-real estate income from corporate taxation. A REIT is subject to a tax of 100% on net income from "prohibited transactions", such as the sale or other disposition of property held primarily for sale in the ordinary course of its trade or business. However, if the REIT sells property it has held for at least four years and the aggregate adjusted basis of the property sold does not exceed 10% of the aggregate basis of all assets of the REIT as of the beginning of the year, no prohibited transaction is deemed to have occurred.
REITs and direct real estate
While invest in REITs, the first question for the investors: Are REITs stock or real estate? Regarding to Peyton, Park & Lotito (2007), he agree with few real estate researchers that REITs are indeed real estate but may not obviously on the similarities. Both of them are generated by income returns and calculated as the change in the value of the underlying assets. However, the derivation of value differs.
Lee and Stevenson (2005), citing Clayton and Mackinnon (2001) views on the sensitivity of REIT returns to private real estate showed a significant increase in the 1990s. It indicated that REITs are more integrated with private real estate than financial assets. These findings indicate that the public real estate market provides information about real estate performance that is subsequently impounded into the direct market and that the public market leads the private market. Moreover, Lee and Stevenson (2005) concluded the returns of REITs and direct market have a place in optimal portfolios in the short-run. However, it will become a substitute for the other in the long-run and so only one may have a place in optimal portfolios.
Fei, Ding and Deng (2008) found little asymmetry in the conditional correlations of REITs stock and direct real estate returns which different to the previous evidences of existing significant asymmetry in correlations among financial assets by Cappiello et al. (2006). They concluded that the higher (lower) correlation between equity REIT and direct real estate is, the higher (lower) the future returns of equity REIT.
REITs and stock market
In the research of Fei, Ding and Deng (2008), they discussed about the nature and behaviour of the correlations between REITs and other financial assets. A broad body of literature show that macroeconomic variables that have been found to explain stock and bond returns and risks have significant power in explaining REIT return and risks (Ling and Naranjo, 1997; Peterson and Hseih, 1997; Karolyi and Sanfers, 1998; Calyton and MacKinnon, 2003). However, the empirical results about the direction and extent of the relationship between REITs and stock have been also mixed and sometimes contradictory depending on the time periods or the methodology used in the studies (Chen and Peiser, 1999; Hartzell, et al., 1999; Clayton and MacKinnon, 2001). Fei, Ding and Deng (2008) found strong relationship between correlations and REITs returns. When the correlation between REITs and S&P are the lowest, the future performance of REITs is the best.
Global REITs history and performance
In USA, REITs created by Congress in 1960. The aim is to make investment in large-scale, income-producing real estate accessible to all investors in the same way they typically invest otherwise - through the purchase and sale of liquid securities (NAREIT, 2010). Nowadays, REIT industry has become an important segment of the US economy and investment market. According to NAREIT (2010), US REIT has seen their equity market capitalization soar from $90 billion to roughly $200 billion in just the past 10 years.
Based on the data from DWS (2010), is giving a closer look of the geographic region wealth of globe real estate. USA is the biggest player which occupies 43% of the REITs market. Hong Kong became the second with 16% which higher than Japan on 10%. United Kingdom occupy 6% while Canada occupy 4% which same as Singapore.
Figure
From the research report from EPRA (2010), it showed the return of global real estate is -1.8% in June 2010. However, it had the highest YTD return at 12.2% compare to global equities and global bonds. European real estate is the highest return at 1.6% on June 2010; North America real estate is the highest YTD return at 23.1%. Asia real estate is the highest rolling 5 years return and average annual return at 19.8% and 3.7%, respectively.
Asian REITs market history and performance
REITs market in Asia is growing and expanding rapidly with significant performance, although it starts quite late compare with REITs of USA and Europe countries. Japan became the first country in Asia established REITs, following by Singapore, South Korea and Taiwan. Hong Kong, Malaysia and Thailand also established REITs in late 2005.
Involve Asian real estate as part of global portfolios is essential by most of institutional investors. Asian REITs have their own unique regulations and structure, which different than USA REITs; create a lower risk but same return for the global investors is sounds attractive. Besides, the geographic differences are likely to cause a small correlation between assets (Yu, 2009).
The Trust Company (2010) has researched a report aim on Asia-Pacific REITs. The result shows that Singapore has become the most important REITs for institutional investors in Asia-Pacific. Singapore is the first rank at 62% in the overall REIT potential rating in Asia country rating 2010. Malaysia is 45% in the overall REIT potential rating and rank at number 7th.It is calculated by three main measures which are property market growth, REIT opportunities and regulatory support.
In the report, it showed the summary of individual countries in Asia. Singapore and Malaysia are having a steady growth on property market in 2007 and 2008 but facing a big impact in 2009 due to the global financial crisis. The market is back to track in 2010 and the growth is increasing. Singapore had rank no.1 in REIT opportunity and regulatory support in Asia-Pacific 2010 with 60% and 70%, respectively. However, Malaysia maintained the same as 2009 in REIT opportunity and regulatory support with 44% and 46%, respectively.
Singapore and Malaysia
Singapore as a neighbour country of Malaysia, in the same geographical location, gains the first rank of REITs in Asia-Pacific by The Trust Company (2010); Malaysia had a lot to learn from Singapore. Based on the three main measures from The Trust Company, it will find out the difference between Malaysia and Singapore REITs.
Singapore REITs history and regulatory
Singapore REITs had become one of the most famous REITs in the world in less than 10 years time. However, it is not smooth-sailing for the development of REIT market in Singapore. In 1986, REITs idea was suspended by the Property Market Consultative Committee. It is an informal committee set up under the Economic Review Committee when Singapore property market was in doldrums following its first post-independent economic recessions in 1985. Their responsibility is to generate ideas on how to revitalise and restructure the real estate market. After a long period of lobbying by interest groups like the Real Estate Developers' Association of Singapore (REDAS), REIT been accepted. The Monetary Authority of Singapore (MAS), the de-facto central bank of Singapore, issued the guidelines of real estate funds and trusts in May 1999 (Ho, 2007).
Different of incentives had introduced by Singapore government to increase the attractive of Singapore REITs. As the table shown, the changing and supporting on the regulatory and operating environment from Singapore government has undergone substantial liberalisation over the years. The introducing of SREITs has revolutionised Singapore's real estate market. Singapore government had further deepened and broaden Singapore's capital market in 2005 and increase the gearing cap of the SREIT in 2006. To create a more safety and flexibility for investors, MAS is keeping revision of the SREIT regulations in order to keep SREIT as the preferred choice for a REIT listing in Asia. Investors are beginning interesting on SREIT after it getting popularity and recognise the potential in offering a relatively higher risk-adjusted return in comparison to real estate common stocks (Ho, 2007). Continuing stated by Ho (2007), the assets in the SREIT market have grown more than five times from $1.8 billion in 2003 to $10.5 billion in 2005. In the report from Ernst & Young (2010), there are 20 S-REITs listed in Singapore Exchange with market capitalisation of $23 billions in 2009 which double in four years.
A closer inspection of the regulatory environment for the SREIT is necessary. Table summarizes the SREIT regulatory and operating environment.
Malaysia REITs history and regulatory
Malaysia is the first country in Asia to introduce property trusts which listed on the Kuala Lumpur Stock Exchange (KLSE) in 1989. Although Malaysia is the first Asian country to develop Listed Property Trusts, the development had been slow (Ting, 2002 and Newell, et al. 2002 cited in Lee, Ali and Lee, 2005). Lee, Ali and Lee (2005) agreed with Ting (1999) and Shun (2003) that the factors which constrained the development of Listed Property Trusts in Malaysia are:
Poor perception and lack of demand for product amongst investors including institutional investors.
Properties available for acquisition are providing low yield.
Too few institutional investors in Malaysia
Strong performance by competing investment options
Local investment psyche favours speculative investment.
Lee, Ali and Lee (2005) further research the reasons for disinterest in LPT amongst investors which are:
Thin trading volume of LPTs
LPTs required being subsidiaries of financial institutions, it deter LPTs from acquiring prime, high yielding properties. Lack of attractiveness on the existing real estate assets of LPTs cause low transaction volume and resulted in the lowered liquidity level of LPTs market.
Small market size of LPTs in Malaysia
Small market capitalisation and strict gearing limit are the reasons prevent LPTs from acquiring more lucrative prime properties.
Low capital appreciation, historical returns, dividend yield and returns fluctuation
The returns of LPTs are unattractive and even lower than other investment options. Lee, Ali & Lee (2005) agree with Newell, et al. (2002) that all LPTs except Amanah Harta Tanah PNB underperformance the Bursa Malaysia Composite Index (CI) and the Kuala Lumpur Stock Exchange Property Index within March 1991 - March 2000. LPTs tend to highly volatile investment, high risk, lower average annual returns and low dividend.
Lack of portfolio management expertise and poor performance of domestic property market
Lee, Ali & Lee (2005) argued that the vacancy rate of properties which under management of LPTs are performance better then sub-sector average in Kuala Lumpur. In addition, they found out the office sub-sector in Malaysia (Kuala Lumpur) actually performed better than overseas property markets which possess active REITs. All REIT corporations believe that a diversified portfolio of properties from different sectors will predictably perform better.
Since LPTs are not accepted by institutional investors, it renamed become MREITs in January 2005. A new Guidelines on Real Estate Investment Trusts been issued by the Securities Commission to administrate the operation and administration of MREITs in Malaysia. The changes of the regulation are making the industry players become excited and considering injecting their sizeable investment properties into MREITs (Hamzah, Rozali & Tahir, 2010). They outlined the major improvements which different than the old guidelines, which are:
Liberalisation of the borrowing limit for a REIT
Relaxation of rules on acquisition of leasehold properties
Flexibility in the acquisition of real estate that is encumbered by financial charges
Eligibility requirements for management companies that manage MREITs have been streamlined
Introduction of a declaratory approach in the establishment of MREITs, and
Enhancement in the amount of exposure and reporting required which is consistent with international standards.
The changes of regulatory had attracted lots of different MREITs listed in the stock market. In the report from Ernst & Young (2010), there are 12 MREITs listed in Malaysia stock exchange with of $1,542million in December 2009. It is not included the latest REITs listed in Malaysia stock market in 2010, Sunway REITs which is the largest listed REIT in Malaysia market (Yap, 2010). Table outlines the summarised of the regulatory and operating environment for MREITs.
The Guidelines of Islamic Real Estate Investment Trusts (Islamic REITs) been issued by the Securities Commission on 22 November 2005 to assist further development of new Islamic capital market products. Malaysia was the first country developed Islamic REITs in the global Islamic financial sector. The guidelines had set as a global benchmark for the development of Islamic REITs (Hamzah, Rozali & Tahir, 2010).
Ting & Noor (2007) had outlined the two major different between conventional REIT and Islamic REIT which are Syariah Committee/Syariah Avdisor and Syariah compliance criteria. The Syariah Committee/Syariah Advisor act as an advisor on all Syariah related matters which under the Guidelines for Islamic REIT. Their responsibility are included ensuring the Islamic REIT complies with the investment guidelines, providing references and consultations to the manager on permitted investments as provided in the Guidelines. Besides, monitors and ensures the fund under Syariah principles are part of their responsibility. For the Syariah compliance criteria, activities which contrary to Syariah principles had listed out:
Financial services based in riba' (interest)
Gambling
Manufacture or sale of non-halal products or related products
Conventional insurance
Entertainment activities that are non-permissible according to Syariah
Manufacture of sale of tobacco-based products or related products
Stock broking or share trading in Syariah non-approved securities
Hotels and resorts
Other activities deemed non-permissible according to Syariah.
The fund manager has to make sure the rental income from the activities mentioned above does not exceed 20% of the total turnover of the Islamic REITs.
The table below had point out the different between conventional REIT and Islamic REIT.
The three famous Islamic REITs are Al-'Aqar KPJ REIT (Alaqar), Al-Hadharah Boustead REIT and Axis-REIT. Al-'Aqar KPJ REIT is focus on the private hospital, Al-Hadharadh Boustead REIT is focus on oil palm estates and palm oil mills and Axis-REIT, turning Islamic in December 2008, focus on office and retail which are not violate with the Islamic REIT regulation (Aziz, 2009).
Different regulation of REITs between Singapore and Malaysia
Referring to the table, it had showed the different on the main regulation between both countries. Investors may choose whether which markets are suitable for them regarding on the regulation and incentive that provided from the REITs.
