REIT question to ask is a taxing issue
YOU MAY HAVE noticed how government officials and developers are talking up real estate investment trusts (REITs) while professional investors declare themselves far from as certain about the prospects of these instruments.
The basic idea is simple: put a number of properties into a trust, sell units of the trust at the net asset value (NAV) of these properties and then pay out the net rental income as dividends to the unit holders. Hey presto, where a term deposit with a bank now pays less than one-tenth of 1 per cent interest, the REIT unit holder can get 6 per cent.
Government officials like the idea because REITs are a big thing in other countries and Hong Kong should do what other countries do or else Singapore will catch up with us and we cannot have that. This, of course, is no sort of reason at all to put money into a REIT but did you really expect commercial sense from government?
Developers say they like the idea because it provides another way to raise capital for property development. Most of them are gung-ho to list REITs on the stock market after the Securities and Futures Commission finally clears the way with new regulations.
And then we get the fund managers who spend their professional lives looking at investments in the way that you should look at them when considering a REIT - will we make money from this, and more than we can make from something else at an acceptable risk? They start with a healthy dose of suspicion about the motives of the developers. Why should it be such a big thing that REITs provide a new avenue for raising capital when there is plenty of money available through the old avenues?
Our banks are running a loan to deposit ratio of only 82 per cent in Hong Kong dollars at the moment and are so desperate to get deposit money out to work that they are willing to lend it at an average of 235 basis points below the best lending rate on new mortgages. We are not short of capital. We are brimming over with the stuff. The investment shortfall is one of opportunity, not of money.
And then there is that follow-up dose of suspicion: are you developers keen on REITs because you think they offer you a chance to foist your duff properties on the investing public?
Let us have it straight that we are talking about the investment business and moral standards in this business are drawn somewhat lower than in child care. It is an entirely appropriate question to ask.
The managers of property investment holding companies in Hong Kong invariably own a considerable proportion of the share capital of their companies. If you buy shares in those companies and you lose, they lose too. You are riding with them and that gives you some protection.
But their intention with REITs is to sell all the units to the public. What self-interest would they then have in doing a good job for you when they inject properties into their REITs and subsequently manage those properties? Conflict of interest is a definite consideration here.
And then we get to that matter of price again. The share price of any property investment holding company is rarely higher than its NAV. Some trade at smaller discounts from NAV, some at greater and in general the discounts are greater when the property and stock markets are in a slump.
My guess is that the average discount figure is now greater than 30 per cent but, if you want a precise number, ask Peter Churchouse at Morgan Stanley who is running the computerised NAV model that I set up for him 15 years ago.
So here is the obvious question: if you want to put your money into property investment, why not buy the vehicle that trades at a 30 per cent discount from the value of the properties it holds, one in which management also shares its risks with you, rather than a vehicle that trades at no discount? You will not get the tycoons injecting property into REITs at 30 per cent discounts, not if they can sell that property in the direct market at the full value, and, if they cannot, it is probably duff property.
Yes, you get a higher dividend payment with the REIT. They talk of 6 per cent while with a property company you get an average of only 4 per cent. Here is a secret for you then: buy the property yourself directly and you can get more than 7 per cent.
And, if after asking yourself what to do with this income, you decide to re-invest some of it, you are doing exactly what the property company does with its profits, which is why dividend yield is only 4 per cent. You get the rest later in a rising asset value of your investment.
The simple fact about REITs is that they are a tax dodge devised in the United States to dodge US taxes. We are not in the US. They do not make the same sense for investors here.
