CONCRETE ANALYSIS

Tax-break proposals would give Hong Kong reits a shot in the arm

Tax-break proposals could help city give Singapore and Tokyo a run for their money

PUBLISHED : Wednesday, 15 January, 2014, 5:33am
UPDATED : Wednesday, 15 January, 2014, 5:33am

If implemented, changes to regulations governing real estate investment trusts (reits) proposed by the Financial Services Development Council in November, could speed up development and further boost Hong Kong's standing as a major international financial centre.

The Hong Kong reit (H-reit) market remains underdeveloped in comparison to many other markets in Asia. As of the end of November, just nine H-reits were listed on the Hong Kong stock exchange, compared with 30 in Singapore and 43 in Tokyo.

Singapore's reits (S-reits) have been busy acquiring offshore assets to expand their portfolios, which has solidified the island state as a focal point for reits in Asia. Singapore also offers specialised industrial and health care S-reits, which are not available in Hong Kong.

South Korea's Lotte Group is reportedly seeking a reit IPO in Singapore. If the plan goes ahead, it will be the largest overseas IPO by a Korean company.

The relatively immature state of the Hong Kong reit market is partially due to the dominance of the major Hong Kong property conglomerates and mainland property developers. At the end of November, H-reits accounted for just 5 per cent of the listed real estate market capitalisation in the city, compared with more 30 per cent in Singapore and Japan.

H-reits' lack of acquisitions, particularly of mainland assets and those in other overseas markets, has also played a significant role in limiting their growth. Also, the restrictive regulatory regime now in place has made H-reits a static income play, passively passing rental income to unit holders.

To ensure Hong Kong remains competitive in the financial market, the new proposals would provide H-reits with greater flexibility to undertake development projects, give them preferential tax treatment and lure more capital from pension funds.

According to the proposals, landlords would be given greater incentives to inject assets into their sponsored H-reits. Income would not be taxed at the 16.5 per cent corporate rate but taxed after income was distributed to unit holders.

While these proposed tax incentives might be attractive to sponsors, it remains uncertain they would encourage landlords to inject quality assets into H-reits, which to date has been a major factor limiting the market.

Pricing of H-reits is also a major hurdle. With most H-reits trading below net asset value, it would be difficult for landlords to justify spinning off their assets into H-reits, even if the proposals were implemented.

The introduction of reits in Singapore and Japan broadened the business of major property companies by adding a real estate investment management platform. Many companies in these markets now possess a solid track record in structuring and managing real estate private equity funds and reits.

This has opened more channels for these companies to raise funds, for example, in the private equity sector from global institutional investors. They also have greater flexibility in how they hold a property, either by a direct holding on their balance sheet, a real estate private equity fund or by a reit. Hong Kong property firms should consider the benefits of setting up a real estate investment management platform, alongside the proposals.

In the case of H-reits, aside from a few acquisitions and asset enhancement programmes, their longer-term growth strategy remains unclear, leaving the impression that their only purpose is to provide a static cash stream. Again, this is partly due to the restrictive regulatory framework that the proposals seek to address.

The proposals could provide H-reits with greater flexibility to manage their portfolios via acquisitions and investing in development projects, which would provide a major boost to the long-term growth of the H-reit market.

The proposals are encouraging. But the Financial Services Development Council is an advisory body and they would be implemented by statutory bodies such as the Inland Revenue Department, the Hong Kong Securities and Futures Commission and the Mandatory Provident Fund Schemes Authority. The timescale of the implementation of the proposals therefore remains unclear. Also, while the proposed changes would improve the environment for the development of H-reits, property companies in the city would have to commit to setting up real estate investment management platforms in order ensure the proposals had the greatest possible impact.

Ada Choi is a director, CBRE Research, Asia Pacific

business-article-page