Small investors riding the tiger as rage for reits grips marketplace

PUBLISHED : Saturday, 25 March, 2006, 12:00am
UPDATED : Saturday, 25 March, 2006, 12:00am

IN OUR INFORMAL and semi-random survey of retail investors in Hong Kong this week, it came as no surprise that seven out of 10 people interviewed thought of real estate investment trusts (reits) as nothing more than your plain-vanilla equities.

Worse, most of them erroneously believed that owning units - or shares - in reits was just like holding stock in property developers, with potentially big bonanzas from revaluation, asset sales and high-margin property development.

Alarmingly, 70 per cent of our little pool of retail investors were convinced they could make more money from the appreciation of the value of reit units than from the yields set in the prospectus. In Hong Kong, these yields are doled out to reit unit holders in the form of distributions - or dividends - equivalent to 90 per cent of a reit's total annual income.

Our survey is hardly representative of Hong Kong's 2.1 million retail investors who have had a punt on equities, funds or bonds in the past two years. That's about three out of 10 people - and the rate of growth is some 15 per cent a year.

Still, it flags some disturbing misunderstandings about the nature of reits, which could leave a lot of small retail investors in a deep financial hole if they've bet wrongly on this new product.

Hong Kong's reit market is still in its infancy, with three listed vehicles and four or six other companies indicating their reit-listing ambitions.

As with other alternative products, such as warrants and derivatives, there is no telling whether the city's reits will enter an accelerated growth period, leapfrogging from small listings to mergers with other reits, creating huge entities or leading to privatisations, mirroring the trend in the United States.

In the world's pioneering reit market, the number of reits fell from 226 in 1994 to 197 at the end of last year, largely due to consolidation and mergers, according to the National Association of Real Estate Investment Trusts.

Another unexpected trend observed in the US reit market is the increasingly poor valuation of property trusts, with some mature reits already trading at huge discounts on their net asset values (NAV), or their assets minus liabilities.

This goes against conventional wisdom in Hong Kong, where analysts believe that the listing of reits will help undervalued property developers - especially those rumoured to be seeking a reit spin-off - narrow the discount of their share prices on their NAV.

For instance, Morgan Stanley estimates Henderson Land's NAV at $53.30 as of March 23. With its share price at $42.40 yesterday, this means that Henderson is trading at a 20 per cent discount on its NAV. Cazenove puts that NAV discount at 18 per cent.

Meanwhile, BOC International estimates that Great Eagle Holding, whose share price was at $26.45 yesterday, was trading at a 29 per cent discount on its estimated NAV of $37.03 per share. For Sun Hung Kai Properties, BOC International puts its discount on NAV at 9 per cent.

In short, the market sees these companies as worth less than the property assets and other businesses they own. It is no surprise, then, that these developers have advertised their desire to spin off certain assets and have them bundled into listed reits.

The problem is some firms can be opportunistic, taking advantage of investment fads such as the dotcom boom and the Macau gambling frenzy to announce vague and probably abortive projects to prop up their stock. So there is a real need to protect retail investors from their own greed and gullibility.

According to the Securities and Futures Commission's latest retail investor survey, which covered 1,915 retail investors between September and November last year, local investors received a failing grade when it came to knowledge about basic investor rights and the most common investment tools.

The public knows about this inadequacy, as 90 per cent of retail and potential investors surveyed agreed that 'the securities industry should do more to educate the public about how to make informed investment decisions'.

It has to be pointed out that the SFC has been doing its share of investment education through press releases, newspaper columns, its website, radio segments and a planned TV programme on warrants and alternative investments.

SFC chairman Martin Wheatley, who called the survey results 'thought-provoking', reminded the industry that 'it is important for all parties - regulators, market operators, investment advisers, brokers and educators - to each play an appropriate role in increasing the financial knowledge of our retail investors'.

One very telling result from the SFC survey was the response to a question on dividends: Four out of 10 retail investors believe that it is mandatory for a listed company to distribute dividends if it earns profit.

The answer, as many shareholders who have felt shortchanged before know, is in the negative; it is entirely up to companies whether to distribute dividends or not, no matter how profitable they are.

Of course, reit unit holders can always expect a return, as this is part of covenant with investors. But then again, as we've found out from our own little survey, most unit holders expect unit-price appreciation greater than yields.

In such a heady market, we can only advise caveat emptor - buyer beware.