Hong Kong's first real-estate investment trust (reit), known as the Link reit, has received mixed reviews from analysts, with some worried the vehicle has a poor track record in its previous life as a government agency under the Housing Authority, while others argue its generous 6 per cent yield marks the investment a 'no brainer'. Since the offer prospectus was released on Wednesday no clear consensus has emerged, apart from the view management will have a more difficult time boosting yields on its sprawling array of property assets than initial fanfare would suggest. Research analyst at Quamnet Henry Chan says the financial statements clearly paint a picture of deteriorating rental income on an asset mix that includes key properties in areas that are little more than urban ghettos. 'If you read the prospectus carefully, they gave results from April to July which posted a considerable year-on-year improvement,' he says. 'I believe the results for August to November were worse. For the whole year ended March 2005, I believe the rental income might drop year-on-year, but the profit might improve marginally because of retrenchment [layoffs].' Operating income fell 26 per cent to $1.5 billion between 2002 and last year as revenue from sales and car-park operations declined. Figures for August to November were not included in the prospectus as they were still being audited. The forecasts for December to March reveal a small decline. Mr Chan believes profits will fall marginally next year as the vehicle loses it status as a non-profit government agency under the Housing Authority and becomes liable for profits tax. The trust will include 950,000 square metres of retail space and 79,000 car-parking spaces, many within or near public housing estates, making it by far the largest single owner of retail property by internal floor area in Hong Kong. By privatising the assets the government will gain a cash windfall of $32 billion. The Hong Kong offer will start on December 6. The price will be finalised on December 15, and dealing will begin the following day. Retail investors will enjoy a 3 per cent discount to the official offer price. Credit Suisse First Boston analyst Victor Kwok writes in a research report the 151 government-run shopping centres to be injected into the trust suffer from a long record of poor management. Despite operating margins which are expected to increase to 56 per cent, the current 43 per cent is well below other Asian reits and other listed property companies. The occupancy rate of the shopping complexes and the utilisation rates of car parks, 92 per cent and 73 per cent respectively, also leave something to be desired. 'Operating efficiency is expected to improve but will remain low after listing,' Mr Kwok writes. 'With less than full occupancy and utilisation rates ... the manager will be focusing largely on operational improvements in the near future.' Credit Suisse First Boston has not issued a rating on the Link reit. Management says it will strive to perk up its efficiency with an improved operational structure, more active managing and leasing agreements, a better tenancy and trade mix, minor cosmetic enhancements on malls, renegotiation of operators' agreements on expiry and better customer service. The reit will partner with Singaporean-listed CapitaLand to enhance its management performance. Boosting rental yield may be tough given that so much of the property mix is located among middle-class communities. Only 7.5 per cent of the retail facilities are located on Hong Kong Island. Sixty per cent of retail floor space is in the New Territories and 33 per cent in Kowloon. Supermarkets comprise 12 per cent of the leased retail facilities, while food and beverage outlets, including McDonald's and Cafe de Coral Group, occupy 35 per cent. Wet markets tenants, perhaps the group most likely to challenges the reit's new role as landlord, occupy 11 per cent of total retail floor space. For the first two years, yields are effectively guaranteed at 6.28 per cent and 6.65 per cent respectively, one of the highest rates of return among Asian reits. Beyond 2006 there is a pledge to pay out a high percentage of income as dividends, but no cast-iron guarantee. The prospectus says the trust will uphold a 90 per cent dividend payout ratio in the absence of unforeseen circumstances. Mr Chan says: 'There is no guarantee it will pay a fixed dividend - this is not a bond, this is an equity.' While under the management of the Housing Authority, Mr Chan says, capital expenditure was excessive, with up to 40 per cent of income churned into capital reinvestment. 'In the past few years its horrendous capital expenditure ended up with no improvement in rental income and profit,' he says. 'It kept building more shopping malls, renovating shopping malls, but it still ended up earning less rental income and profit.' To uphold the pledge to return 90 per cent of income in the form of dividends, he says the reit will have to take an $8 billion loan shortly after listing. Down the road, Mr Chan sees an inevitable clash when it faces refinancing charges and has to uphold its profits as dividends pledge. He believes the reit could easily fall below its offer price over time. Jorik van den Bos, manager of ING's Global High Dividend Fund, says he still has to digest the Link offering in detail, but likes what he sees so far. 'We are of the opinion there is enough cash flow coming out of this company to pay the yields,' he says. 'We don't expect that much growth, but we see some opportunities for efficiencies and we think they are in a strong position for the longer term as they have first right to buy assets from the government.' He says the asset quality is not bad, and overall the reit meets the fund's criteria of investing in stable-income products. Japanese reits yield only about 3 per cent, while American or Australian reits yield about 6 per cent, but quality assets at this level of return are not easy to find. Mr van den Bos plans to allocate between half to 1 per cent of the fund holdings to the Link offering. Mr Chan says there are attractive alternatives for those looking for strong yields and real-estate exposure. Among his top recommendations are Wing On Company and Swire B shares, with dividend yields of 5 per cent and 2.6 per cent respectively. Both companies have a strong management track record and commercial real-estate portfolios that should benefit from improving rentals. 'Swire has a lot of rentals in Quarry Bay and North Point and they are charging rentals much lower than properties located in Central,' he says. 'There is a good chance they will be able to raise rentals substantially this year.'