Japan is the most notable victim of the credit crunch. But there are new opportunities in Asian REITs, says Peter Mitchell
The Asian REIT market has been a significant success story but still it is just at the start of its journey.
As at 31 December 2007 there were 110 REITs in Asia (ex-Australia), with a total market capitalisation of over US$81bn (€55bn). Some 52 of these REITs were launched in the last two years and growth in market capitalisation in the last 12 months was around 18%. This despite the stock market decline which occurred in the last few months of the year.
In the 12 months to December 2007, a period in which major REIT markets globally generated negative returns, all Asian REIT markets with the exception of Japan and Taiwan generated positive returns. In December, only Asian REIT markets generated positive returns.
These numbers suggest that the Asian REIT markets have weathered the storm fairly well as the effects of the sub-prime crisis works its way through the global credit markets.
However, there have been some significant consequences of the credit crunch in the Asian real estate markets and dangers continue to exist, requiring all players to exercise caution and prudence. It also creates a period of opportunity for capitalised and moderately geared funds and investors.
There are at least two reasons for this. First, what we have been witnessing is not a real estate problem but a real estate-related debt problem. It is a widely held view that real estate market fundamentals remain strong in Asia - there is no concern about oversupply, for example, while demand for higher-quality buildings and a general demand generated by high growth rates remain strong.
Stock market investors have reacted to the credit crunch, and a general concern about overvaluation of equities, by retreating from real estate as well as equities. This is almost to be expected in a period of stock market panic and uncertainty but probably will prove to be an overreaction. The apparent failure to distinguish between the characteristics of listed real estate and general equities in the sell-off has created significant investment opportunities.
An additional effect of the credit crunch is that for the foreseeable future the use of financial engineering in inflating distribution yields is at an end. There will be a return to an emphasis on fundamentals, and therefore the attraction of well managed, moderately geared, well-capitalised REITs with quality assets. In the current environment REITs that are undercapitalised and/or more highly geared may find it hard to compete from a performance viewpoint.
One impact of the market volatility has been the deferring of IPOs. This has been felt in particular in Singapore, the region's cross-border centre. Some IPO plans have been put on hold in recent months, including asset listings in Indian, Chinese and Japanese markets. In 2005 and 2006 there were respectively 31 and 35 REIT IPOs. Some US$27.2bn (€18.5bn) was raised in IPOs in 2006 and US$5.2bn in 2007. Singapore has 20 REITs and, prior to the market deterioration, it was confidently expected that the number would increase to 30 by the end of this year. It is unlikely this target will be achieved.
The Asian REIT market most affected by the sub-prime fallout has been Japan. Foreign investors affected by sub-prime quickly exited the J-REIT market late last year. J-REITs, at one time the darling of the stock market, have seen their stock prices tumble and many are trading below NAV. Many J-REITs have been more popular with foreign investors rather than local investors, who see them as too volatile
relative to equities.
The comment above regarding difficulties facing undercapitalised REITs applies particularly to Japan. There are a number of smaller J-REITs that are now trading well below NAV, are undercapitalised and cannot compete on a cost of capital basis. This has been the subject of much debate in Japan, with a push for easier regulation to enable consolidation. Current regulation makes friendly consolidation difficult and hostile takeovers are not part of the way of business in Japan. The regulators now seem to appreciate the need to facilitate consolidation to ‘unlock' the REIT market and so we may see some movement in this area in the near future.
There is also likely to be some movement to permit J-REITs to acquire offshore assets. They are currently not permitted to do so. There are mixed views on what might happen if this restriction is lifted. One view is: why would a J-REIT take on political, currency and other risks attached to an offshore acquisition when there are plenty of opportunities in the local market?
Another view is that foreign assets will be attractive as a means of increasing distribution yields. While the spread between yields and the long-term bond rate remains highest in Japan, in absolute terms yields do not compare favourably with those in the other mature REIT markets in Asia Pacific.
These last two points may prove to be related. J-REITs are anxious for foreign investors to re-enter the market and, while the correction that has occurred must present some excellent re-entry opportunities, there is little sign of this happening. However, if J-REITs are able to acquire foreign assets they would arguably become much more attractive to foreign investors and some would also be attractive acquisition targets. It will be very interesting to see how this unfolds during 2008.
Listed real estate, and Asian REITs in particular, is a very transparent investment, in contrast to the often opaque debt instruments that have led to the current problems. The market overreaction with respect to REIT stocks at a time of sound real estate market fundamentals in Asia has created opportunities for some and difficulties for others. We are in for a very interesting 2008.
Peter Mitchell is CEO of the Asian Public Real Estate Association (APREA)