The REIT stuff

2 December 2011
Ong Kah Seng

In recent years, as buyers sought physical property amid fears of missing the market as prices continued to hit record highs, real estate investment trusts (REITs) have remained popular, though not with the same level of interest as before.

K-REIT's announcement that it was acquiring Ocean Financial Centre triggered a rash of discussions on REITs and the financial diagnosis point to a consensus that not all such trusts deliver the envisaged investment returns.

While the financial mathematics seem to put selected REITs in disfavour, the entire sector should not be tarred with the same brush. The REIT sector should be looked at holistically, including how they contribute to property market development and how they bring in the best market practices, notwithstanding the competition they create.


REITs stiffen competition?

It has been contended that REITs, which mainly hold portfolios of non-residential properties, create stiff competition and are a leading cause of rental increases.

Some of these non-residential properties may be the livelihoods of small business operators and affordability becomes a concern. In the context of a retail operation, there are also concerns that businesses may quickly pass on the rising rents to consumers, thus contributing to inflation. However, it must be said that retailers, particularly the smaller ones which have weaker financing power, can opt away from REIT-operated malls.

Some of these retailers could have been dazzled by the vibrancy in REIT-operated malls and committed to the shop without a thorough evaluation of overall business cash flows. Consumers who find prices beyond their budget can forgo the purchase or look for lower-cost alternatives. If it is beyond one's budget and yet one chooses to purchase an item, it could very well be a desire to "get it out of one's system".

It may be the same for some occupiers of REIT offices and industrial premises who opt for such space or continue to renew their tenancies, although it must be said relocations do come with a cost. Nevertheless, for highly-specific, non-homogenous space, e.g. some industrial units, the users may indeed have no choice but to renew, although rightfully, exclusive space providers can price their properties at a premium.

The previous office market upswing and space crunch in 2007 prompted developers to start many projects but when they were completed in 2009 and last year, the anticipated demand had dissipated. Hence, building owners have learnt the need to be contrarian, to refurbish their assets during market slowdowns so that they can potentially receive a better response in the subsequent upswing.

As REIT-operated properties have better funding, the managers are likely to be in a better position to execute these newer and more efficient property market strategies.


REITs drive asset prices?

There have also been arguments that REITs drive up asset prices, especially the properties they seek to acquire for their portfolios as part of growth strategies. However, asset prices are often appraised prior to acquisitions although the decision to buy at fairly high costs poses challenges, especially in the current situation where property market sentiment has moderated.

The appraisal for investment properties will hence require a skilled and sharp judgment for long-term income projections. The range projected may be either near or far from the current property income, depending on how close the current market condition is to a "steadier state", often derived from historical averages.

However, historical performance may have different underpinnings - the users' intentions or requirements may have since changed. The market expectations for the value of a property can be very different from that of the buyer or seller. The difference can be justified if the appraiser's skills are unparalleled.


REITs bring changes

REITs have brought about significant changes in the property sector. First, spaces are creatively conceptualised and usage maximised more often than before. This can be seen very prominently in the REIT-operated malls where the function of the retail space is to offer excitement to shoppers, who will then be more likely to spend money.

The creative and frequent innovations by the REITs have become a reference for other landlords. Such moves to innovate and differentiate are also positive for property market development as a whole, particularly in the context of new or forthcoming supply.


REITs improve transparency

Property market information, specifically of leases and rentals, have never been transparent until the arrival of REITs. A whole range of REIT-related financial and property information are released every quarter by the trusts. This strengthens overall market knowledge and also raises the profile of industrial and office properties, which may be less familiar to investors or less close to their hearts.


A product for everyone, someone for each product

An evaluation of REITs, fundamentally of their longer-term contributions beyond mere financial perspectives, shows that the product should continue to be relevant. Perhaps the price to pay for all the benefits is intense competition and aggressive expansion strategies that may be felt to be out of sync with market norms.

But such stimulation is often necessary in maturing property markets which have hit the plateau of mere buying and selling and other standard transactions.

Having raised property standards over the past decade, the next stage for REITs is to justify the value of newer standards and expansion strategies. Major challenges confront REIT managers, who really have to work hard to justify acquisitions to help unit holders maximise returns.

The quieter market resulting from an expected economic slowdown next year may be a good time to revisit and formulate long term growth strategies. When the fundamentals eventually improve, it could be a case where REITs find their real fans - those who really feel their money will be safest in nowhere other than REITs.

As REIT holders have chosen to leave the management of the trust to a specific party, the factor they can control is the timing of the investment, although vocal investors may find it meaningful to express their views to REIT managers when necessary.


Ong Kah Seng is a director at R'ST Research, an independent property market research firm in Singapore.