The listed market is an obvious route for investors wanting exposure to global emerging markets. Lynn Strongin Dodds highlights some important considerations
Real estate investment trusts (REITs) and listed property stocks can provide a means of gaining global real estate exposure, including emerging markets. But investors need to be aware of the realities of investing in different vehicles and markets.
According to research from Cohen & Steers, emerging markets represent a fraction of the $1.3trn (€1trn) market capitalisation of the global real estate securities market. The US and Asia Pacific dominate with a one-third share each, while Europe and other regions account for a much smaller piece of the pie. Over three quarters of companies in the universe are REITs or REIT-like structures, with the rest consisting of real estate development companies and non-REIT owner/operators.
Anna Weickart, investment consultant at Towers Watson believes it is important to make a distinction between listed property companies and REITs, particularly in emerging markets.
“They need to be cautious and weigh up the risks against the expected returns when investing in property companies that are not listed as REITs. They could be more volatile, less transparent and not produce the stable income or tax certainty associated with REIT legislation.”
Nikita Johal, portfolio manager in the global listed real estate team at AMP Capital, echoes the sentiments. “There are interesting opportunities in emerging markets, but you have to be careful about the political and corporate governance issues because in many of these countries there is limited legislation to safeguard the interest of investors. Also, it is important to understand that there are differences in corporate structures and company profiles. For example, the Asian market which has the largest emerging market component is dominated by developers which can make it riskier.”
As with the developed world, it will take time for the emerging-market listed sector to grow and mature. It is easy to forget that the US REIT industry, which came into existence in 1960, did not gain meaningful traction until the 1990s.
“At the moment, it is still difficult to get a huge diversification effect if you go the REIT route because many of the markets are small,” says Melissa Reagan, head of property research – Americas at Aberdeen Asset Management. “They are in the same place the US was in at the beginning of the 1980s when the market cap was $2-4bn. I think, though, that we will see the listed sector develop over the next 10 years.”
Reagan adds: “Investors prefer to look in their domestic markets because they do not want to deal with the political, social and currency risks of emerging countries. For example, in the US, even though the performance in the listed property sector is not as strong as last year, equity prices are still rising and, as a result, they do not feel the need to go outside the country. Also, they think there are hidden, higher yielding opportunities to be found.”
Philip Cropper, managing director of CBRE Real Estate Finance, agrees, adding that many of the property companies in emerging markets are focused on development. “This offers a completely different risk-adjusted return profile than the income-producing returns of a REIT, which should be offering investors an income distribution,” he says.
“The other problem is that if you look at many markets in Asia, such as Malaysia, Korea and Indonesia, pricing is fairly tight because of the sheer amount of local capital that is invested, and a REIT would find it difficult to provide an attractive distribution yield. This means that opportunities to gain exposure through REITs are limited.”
James Cowen, senior director and securities portfolio manager at Invesco, believes attitudes in the listed property sector will mirror shifts seen in equity and debt investing. “In the established markets of Australia and the US, REITs have become popular and set themselves apart as an asset class,” he says. “They are structurally and conceptually newer in Europe, but we are seeing increasing investor interest.”
What is more unlikely to change is the volatility. Once valued for their individualistic character, real estate stocks across the geographic spectrum have moved in tandem more with the broader market and correlations are now about double what they were around a decade ago, according to estimates from research group Morningstar.
“These fluctuations are amplified in the emerging markets because of the capital racing in and out,” says Reagan. “However, without significant knowledge of how to perform due diligence within the unlisted fund market, the listed property may be the only transparent way to access property in these countries.”
Jason Yablon, vice-president at Cohen & Steers, concurs. He also believes investing in listed real estate in emerging markets is an optimal and more direct way to tap into the burgeoning consumer story of these countries. One of the main reasons is that these home-grown property companies derive nearly all of their income from local sources compared with, for example, commodity or manufacturing groups, which are dependent on global appetite for their exports.
“The demographics and urbanisation are long-term trends in emerging markets,” says Yablon. “We believe that as these economies continue to grow and become more consumer-oriented, the demand for more and better quality real estate is likely to increase.
The other driver is the move to real estate securitisation. About 95% of all real estate in these countries is held privately and often within the same family. However, many are now looking for liquidity and publicly-traded vehicles are a good way to achieve this.”
Jamie Perrett, director, index research at FTSE Group, also thinks that the strong performance last year will spark interest. After producing negative returns in 2011, emerging markets real estate securities rebounded sharply in 2012. By year-end, the group had managed to outperform both global developed real estate securities and developed and emerging equity markets by a wide margin.
The FTSE EPRA/NAREIT Emerging Real Estate index rose 42.1% in 2012, significantly higher than the 18.1% in the US, according to the FTSE NAREIT Equity REIT index. The star performer was Asia, which has a 61.25% weight in the index.
Figures from APN Property Group revealed that an investment in Asian REITs in April 2006 would have generated a cumulative total return of 91% as measured by the Bloomberg Asian REIT index. This is in sharp contrast to the 28% hike for global REITs as measured by FTSE EPRA/NAREIT Developed Total Return index and 23% of the MSCI Asia Pacific Equities index in the same period. They also delivered lower volatility of 20% compared with global REITs at 26%, over the same period.
Asia will continue to be the fastest growing market if a recent report by the Asia Pacific Real Estate Association (APREA) is anything to go by. It noted that overall the region accounts for $7trn in investable real estate and by 2020 this is expected to grow significantly to $17trn due to the strong growth in its emerging countries. The REIT market is dominated by Japan which has a 40% market chunk, Singapore at 32% and Hong Kong on 17%. They are followed by Malaysia with 5%, Thailand, 4% and Taiwan, 2%. China does not have a REIT industry, although investors can gain exposure through Hong Kong listed property shares. Indonesia and the Philippines have registered to have a market while India is contemplating going down the REIT road.
According to Stephen Finch, CEO of APN Property Group, the main difference between Asian REITs and their counterparts is that most are spun out of the region’s existing property development groups, which means they are not independent in the same way as in the US and Australia. “This structure can make investors nervous, but I think it has created a much stronger commercial property skillset,” he says. “The REITs are very focused on the asset management side and sweating the assets to add value.”
He also notes that Asian REITS have strict disclosure requirements as well as stringent guidelines regarding capital structure, related-party transactions, and types of investment and gearing limits. In addition, APREA recently launched a corporate governance index that provides further transparency guidelines on REIT corporate governance in Asia.
“The best way to gain access to emerging markets in the region is through REITs listed in Hong Kong or Singapore,” says Finch. “For example, the Lippo Malls Indonesia Retail Trust invests in a diversified portfolio of shopping malls in Indonesia, while Mapletree Logistics has a blended portfolio across the region, including China.”
In terms of opportunities in the region, Yablon along with Charles McKinley, senior vice-president and portfolio manager at Cohen & Steers are optimistic about China’s prospects especially in the industrial and retail sectors. They see the stabilisation in the country’s economy having a positive impact particularly for mid-market retailers, as a recent backlash against conspicuous consumption has dampened enthusiasm for luxury sales. Domestic-oriented industrial properties are better positioned than those more dependent on exports.
In recent research, they commented that, “the government recently renewed its efforts to keep home prices in check through tighter mortgage restrictions and other housing-related policies. However, we expect broader economic policies will remain in place to support growth in the near term, providing a favourable backdrop for a variety of real estate companies.”
Philippines retail is also on their radar screen due to a growing and affluent middle class, which has unprecedented levels of disposable income. “Their conﬁdence in the future and aspirational ambitions have translated into some of the strongest consumer spending growth in the world. The main beneficiaries are likely to be mall owners and developers with SM Prime, the country’s largest mall operator, standing out as the region’s dominant player,” the report said.
The picture is not as bright for the Americas, although market participants are positive on Mexico’s future. Industry analysts note that commercial real estate in the country looks more attractive than in other Latin American countries such as Brazil, Colombia and Chile, where rents in Mexico City are around 40% lower than those in Sao Paulo.
To date, Mexico’s listed sector is miniscule especially compared with Brazil. Mexican REITs, or Fibras, made their debut with the launch of Fibra Uno in 2011. It cut a lonely figure until late last year when it was joined by Fibra Hotel, Fibra Maquarie, Fibra Inn and Fibra Terrafina. Another three are slated for 2013.
“Currently, Fibras are revolutionising the real estate market in Mexico,” says Javier Kutz-Clever, managing director of Savills Mexico. “This is because they represent efficient vehicles through which to invest in the Mexican real estate market and are accessible to both local and international buyers whether institutional or not. They also increase liquidity in a market traditionally perceived as not liquid, and they have stirred up interest from foreign institutional funds in the Mexican market.”
Johal is also optimistic about its prospects. “Although the listed market in Mexico is very small, we expect to see a growth spurt in the number of listed companies coming to the market,” she says. “The economy is in good shape with fiscal and monetary policy being well managed by the government. Gearing and high debt is not as much of an issue as in other emerging market countries. The story is completely different in Brazil which is heavily reliant on commodity prices and inflation is becoming problematic. We do not think the government here has good control over policy and as a result, we are relatively more cautious.”
The Brazilian REIT market has enjoyed stellar growth with about BRL14bn (€5.11bn) worth of REITs and similar instruments being sold in initial public offerings last year compared with BRL7.66bn in 2011, according to data by the country’s securities regulator CVM. In 2009, this figure was BRL2.88bn.