Wrong turn for REITs
2 April 2014
On 27-Jan-2014, the SFC announced a consultation paper on proposed amendments to the Code on Real Estate Investment Trusts (the REIT Code). The consultation only lasted 30 days (including the Chinese New Year holidays) so we are a bit late, but hopefully not too late to stop bad things prevailing.
For readers who haven't heard, a REIT is a unit trust which (until now) only invests in property and is required under the REIT Code to distribute 90% of its net income. REITs are "closed-end", meaning that there are normally no opportunities for subscription or redemption of units, so they are traded on an exchange. The neatest thing about them is that they are required to distribute 90% of their earnings, which stops them hoarding cash the way some controlled companies do.
REITs were introduced in HK in 2005 in a state of Government-induced panic because Singapore had begun listing them. Fortune REIT (SGX:F25U,HK:0778), owner of malls in HK and ultimately controlled by Li Ka Shing, was listed in Singapore on 12-Aug-2003. So on 25-Nov-2005, after a certain amount of legal challenges, the HK Government's Housing Authority listed The Link REIT (0823), which owns the shopping centres under public housing estates.
Over 8 years later, there are still only 11 REITs listed in HK, 3 of which (Fortune REIT, Prosperity REIT (0808) and Hui Xian REIT (87001)) are related to Mr Li's Cheung Kong group. Of the remaining 7, Champion REIT (2778) is a spin off from the Lo family's Great Eagle Holdings Ltd (0041), currently run by Lo Ka Shui, and another, Regal REIT, is a spin off from Regal Hotels International Holdings Ltd (0078), part of a separate group of 3 listed companies run by his brother Lo Yuk Sui. Another tycoon spin-off is Sunlight REIT (0435), from Lee Shau Kee's Henderson Land group.
Now, the SFC proposes to allow REITs to do two things:
- invest in properties under development or engage in property development activities; and
- invest in financial instruments, including listed securities, unlisted debt securities, government and other public securities, and local or overseas property funds.
We can understand the logic of the first point. REITs, after all, invest in properties, and even if they don't buy development sites, sooner or later, the properties they own will need extensive renovation or redevelopment, taking them out of the rental market for a period of time. It wouldn't make much sense to force the REIT to sell a clapped out property just because it needed redevelopment, so this should be permitted, and therefore we might as well let them buy land and properties for development or redevelopment, as long as it doesn't deviate too much from the purpose of generating a stable rental income stream. The SFC proposes a limit of 10% of gross asset value, and Webb-site considers that this is reasonable.
But on the second proposal: No. Absolutely not. REITs are not general-purpose punting funds, and there are enough problems already with listed companies squatting on cash and then diverting it into equities, "entrusted loans", "structured products", money-lending subsidiaries and the sort of junk you wouldn't let your mother-in-law buy. Most of all, we suspect that the tycoon-controlled REITs are asking for this because they want to use the cash to buy shares of their other listed companies.
REITs have to pay out 90% of their accounted earnings anyway. If the difference, plus depreciation, allows a pile of cash to grow, then they can pay out more. The consultation paper lapses into the passive voice:
"Via recent discourse with the industry...it was pointed out [by whom?] that it could be difficult to identify suitable property acquisition opportunities"
No problem. Just return the cash to investors, and let them invest it themselves. That's what investors do. Institutional investors in particular don't want listed companies to invest their money for them, other than in the core business, because that takes away the stock-picking discretion of investors. The SFC continues:
"given the benefits to investors by making available a broader range of investment options to REITs...".
But who says it is beneficial? It isn't. Listed vehicles punting with shareholders' money outside of their core business is usually negative to shareholder value. And there is nothing in the proposal which would stop REITs buying shares in their tycoon's other companies either. The SFC does propose a limit of 5% of gross assets in any single group of companies, and up to 25% in total, including development properties, but this would be very difficult to enforce afterwards, because of subsequent movements in share prices. Should a REIT have to sell stocks in a group if they subsequently amount to more than 5% of gross assets? The SFC doesn't say.
The SFC also proposes monthly disclosure of the investment portfolio, within 5 business days of month-end. That is something that they should be requiring listed companies to do as well, to deter this kind of behaviour, but they should not be polluting the REIT market with such behaviour. So, yes to a small amount of property development, and no to allowing REITs to play the securities markets. After reading the SFC's paper we are left with the nagging feeling that somebody has put them up to this.
© Webb-site.com, 2014