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Asian REIT Review

Consolidation on the horizon

If Asian REITs follow the path of their U.S counterparts – and they have so far – then a wave of consolidation will begin sometime over the next two years, experts say.

It’s been almost six years since Japan ushered in Asia’s first real estate investment trusts in September 2001. Today there are 41 in Japan, with a total market capitalization of approximately $50 billion. The trend toward public ownership of real estate is sweeping other Asian regions as well, with nearly 100 listed REITs and pending initial public offerings (IPOs) in Hong Kong, Singapore and a handful of Southeast Asian countries.

“It’s an exciting market and it will grow much bigger than it is today,” says Christine Kim, a partner in the Hong Kong office of law firm Jones Day. Japan and Australia aside, Singapore and Hong Kong are the predominant Asian REIT markets today, she says, noting that Singapore has 16 listed REITs, and Hong Kong has six.

“There is definitely room to grow, and there are about 15 REITs in the pipeline to go forward this year,” Kim says. “The outlook is that it will follow the U.S. cycle, which is where everybody goes public, and then consolidation will happen.”

The U.S. path

In the United States, REITs grew slowly in the 1970s and 1980s before really taking off in the 1990s. In 1990, U.S. REITs numbered 119 and had a collective market capitalization of $8.7 billion, according to the National Association of Real Estate Investment Trusts. By the end of 2006, domestic REITs grew in number to 183 and to a whopping market cap of $438 billion.

The U.S. story shifted after the 1970s and 1980s, when much of their growth was asset-by-asset acquisitions, to a period of rapid expansion in the mid 1990s, when properties were plentiful and affordable (and again after the high tech bust this decade). As competition to acquire properties grew fiercer, driving up asset prices, many healthy REITs began gobbling up their weaker competitors. This strategy helped REITs grow faster by adding entire portfolios rather than piecemeal assets and also boosted efficiency to lower operating costs.

Today, mispricing between the public and private markets is reversing the trend toward public ownership, with private equity groups taking REITs like the former Equity Office Properties Trust private. In 2005, 37 U.S. REITs were involved in mergers and acquisition representing $170 billion in total asset values, according to CB Richard Ellis. Roughly half of that volume, or $73 billion, was REIT equity being privatized.

“Most of the recent U.S. REIT activity has been privatization, whereas in Europe and Asia you’ve had the reverse: IPOs,” points out Steve Carroll, managing director of CB Richard Ellis Global Real Estate Securities.

Global REITs mature

Privatization is beginning to show up outside the United States. Two big deals in Australia last year removed $9 billion AUS in value from the REIT market, reducing the sector’s market capitalization by 5 percent, Carroll says. In Canada, six recent deals carved 20 percent from the REIT market.

Mergers and privatization are reflections of mature markets, Carroll says. Immature markets, including those in Europe and Asia, haven’t reached that stage. For now, shares in most Asian REITs are selling well and enabling those companies to buy a lot of properties. “That’s not happening in the U.S. market,” Carroll says.

Yet competition for assets is driving up prices globally, and will eventually force REITs to look for additional means of growth. Japanese REITs (J-REITs), for example, face an uphill battle as real estate prices escalate and REITs lose some of their edge over bond yields, which are increasing with an expanding economy. Eventually, some J-REIT shares could begin to trade for prices below the value of their underlying real estate, and that’s when equity investors are likely to step in with privatization.

Japanese law prohibits REIT takeovers. In Singapore, however, legislation adopted in June paves the way for mergers & acquisition, expanding existing law to allow hostile takeovers.

Asian REIT outlook

Most real estate observers say Singapore REITs won’t bother with M&As in the near term because it’s easier to buy properties on the open market. Even underperforming Asian REITs are enjoying value appreciation in their asset portfolios, so it’s becoming more and more costly to acquire them.

Kim, the Hong Kong-based attorney, doesn’t expect to see Singapore’s new M&A law manifest itself in actual deals for at least a year, probably two. Yet Peter Mitchell, CEO of the Singapore-based Asian Public Real Estate Association (APREA), believes mergers or takeovers could begin within a year. That’s why APREA worked to have Singapore’s Takeovers Code amended to cover REITs. “One of the purposes of takeover laws is to protect the interests of minority investors, and so it was a concern for us that the code did not apply (previously),” Mitchell says.

George Noon, an international director at LaSalle Investment Management in Baltimore, says REITs around the globe will grow more akin to the U.S. model as their markets mature and investors grow comfortable with that structure. For example, the U.S. once required that a REIT be externally managed. That is currently a requirement in Japan and Singapore, Noon says, but will likely be eased over time.

“It’s a walk before you run approach,” says John Kriz, managing director of real estate finance at Moody’s Investors Service, explaining why most markets initially adopt conservative REIT structures and then relax restrictions later. Even with conservative structures, however, REITs create liquidity, boost transparency in real estate markets, and improve standards for financial governance.

“In Europe and elsewhere, there’s a growing realization that REITs are a core characteristic of a modern economy,” Kriz says. “These are good things that help everybody.”

Noon predicts REITs will proliferate across Asia because REITs are an ideal vehicle for placing capital in international real estate. “The only effective way to do that with a lot of diversification, and to place it quickly, is through the securitized format,” he says. “It’s going to be a permanent part of the real estate landscape across the world, and Asia is the least securitized right now.”

CBRE’s Carroll agrees: “The market’s growing fast, and you’ll continue seeing a structural shift from private to public ownership of real estate,” he says. “This isn’t a fad, this trend is going to last.”

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