REITs continue to expand their global footprint, with the Asia Pacific market playing a key role in that growth.
The modern REIT era has delivered remarkable growth, with equity market capitalization of listed REITs globally jumping from about $10 billion in 1990 to more than $2.5 trillion today. Yet that current market size could be just the tip of the iceberg as the REIT model continues to make inroads around the world.
The global REIT regime currently spans some 865 listed REITs operating in 41 countries and regions. Much of the recent REIT expansion has been concentrated in the Asia Pacific region, and new REIT legislation approved in China in 2021 could propel growth over the next decade.
“China is an enormous market from an overall commercial real estate perspective, and there is an awful lot of growth potential there to the extent that the government wants it to happen. And that’s probably the gating factor,” says Greg Kuhl, portfolio manager, global property equities at Janus Henderson Investors.
The Chinese government is using REITs to drive growth in strategic sectors. Its initial REIT legislation was limited in scope to include primarily infrastructure, ports, logistics, and data centers. The country’s first batch of pilot REITs debuted in June 2021, and the government modified REIT rules at the end of last year to also include residential.
“We would expect, over time, for the Chinese REIT regime to include more of the traditional real estate property types, but this is certainly an important first step in terms of China embracing the REIT structure,” says Brian Jones, portfolio manager at Neuberger Berman.
There are already many publicly traded real estate companies in China that are either listed on the Hong Kong Stock Exchange or the Shanghai Stock Exchange. The Chinese government is trying to encourage some of those listed companies to either sponsor REITs or potentially convert to REITs over time, as well as encouraging private owners to embrace the REIT structure, Jones notes.
India also announced changes to its REIT legislation in 2019 that has made the REIT structure more attractive to real estate owners in terms of listing their assets and taking advantage of that legislation.
The significance of these two countries embracing the REIT structure is that they have very large individual investor pools. “As REITs become more understood and appreciated by investors in China and India, there is potential for that interest in REITs and publicly listed real estate to flow through into other real estate markets and begin to influence flows into the REIT sector on a global basis,” Jones says.
Asia Pacific Accelerates
Although North America represents the majority of REIT market capitalization, there is growing momentum across Asia Pacific. According to Nareit data, North America accounts for 57% of global market capitalization, followed by Asia Pacific at 25%, and Europe, the Middle East, and Africa (EMEA) at 18%.
In Asia Pacific, the deepest REIT markets have traditionally been Australia, Singapore, and Japan. Those nations have had REIT structures for a number of years, and Japan and Singapore in particular have done a good job of offering a diverse universe of REITs, notes Ji Zhang, portfolio manager, global real estate, at Cohen & Steers.
South Korea is another important market, although one that is less talked about. “From a listed investment perspective, South Korea is a lot friendlier than China is to foreign investors, and in Korea, only about 1% of commercial real estate is listed today,” Kuhl says.
The Philippines has also seen growth recently, following government changes to its REIT framework in 2020. There are a number of REITs that listed in 2021 or are in the pipeline for 2022. For example, one of the largest property developers in the Philippines, Filinvest Land, debuted the Filinvest REIT Corp. last August.
Indonesia, meanwhile, has had REIT regulation since 2007. The market has been slow to gain momentum because the sponsor has to pay high transaction taxes when adding assets into the REIT, but there is potential for tax reform that could really help the expansion of Indonesia’s REIT market, Zhang says.
REIT expansion across these regions has occurred in property sectors where there are strong secular tailwinds, such as data centers. “I think a lot of that is driven by the capital formation, but also the investor demand in those areas,” Zhang says. On the demand side, there is a trend of larger technology companies making investments in data centers in those regions. As a result, capital expenditure has followed and investor appetite has increased because investors want exposure to some of these new economy sectors where they see strong growth, she adds.
Opportunities for Existing REITs
North American REITs have certainly leveraged the global REIT regime, forming joint ventures and tapping into fresh capital sources to fuel growth. Prologis, Inc. (NYSE: PLD) for example, has listed REITs in Japan and Mexico.
“You’re seeing more interaction between the global markets, both in terms of REITs that operate on a global basis using local REIT markets to own assets in those markets or finding ways to list assets in their home markets in foreign REIT structures,” Jones says. “It is happening from different angles in terms of how individual REITs are taking advantage of the growing global demand for real estate and global demand for REIT investing.”
Singapore, for instance, has a regime that allows companies to list non-domestic assets on the Singapore Exchange. Last December, Digital Realty (NYSE: DLR) listed a portfolio of U.S. data centers on the Singapore Exchange, creating Digital Core REIT. “This is an opportunity for Digital Realty to diversify their funding sources and really tap into the Singapore REIT market, which is a very established market in Asia, and offer an entity that invests in U.S. data centers,” Jones says.
Given the growing global interest in REITs, market participants see plenty of runway ahead. “I think we’re really far away from being oversaturated,” Kuhl says. For example, listed REIT penetration into overall commercial real estate is around 15% in the U.S. and lower than that in most other markets.
“The listed REIT vehicle is the most logical and efficient vehicle for owning commercial real estate for a number of reasons,” Kuhl says. The daily liquidity via the exchanges is one notable benefit. Listed vehicles also have an infinite life, and theoretically, so does quality real estate. “So, it’s a good match of time horizon between the ownership vehicle and the assets they own compared with a private fund that might have a 5- to 7-year life,” he says.
When it comes to developing REIT regimes, it isn’t a one-size-fits-all approach. Often, the biggest stumbling blocks to regimes gaining traction include the tax structure and any constraints that impede the ability to grow. For example, a REIT’s ability to access debt financing and the cost of capital for borrowing can restrain external growth prospects. Other important factors are whether the stock offers sufficient liquidity and participation from institutional investors.
We would expect, over time, for the Chinese REIT regime to include more of the traditional real estate property types, but this is certainly an important first step in terms of China embracing the REIT structure.
Although REITs were first introduced in Europe in 1969, only nine years after the first REITs in the U.S., the region has lagged both the U.S. and Asia Pacific in market penetration. One of the headwinds in Europe is an ingrained preference for investors to put their capital into open-end private equity real estate funds.
Another issue is a lack of consistency across certain European markets, which creates some confusion, Kuhl notes. For example, the German REIT regime excludes residential real estate, which has held back the embrace of the REIT structure in that country. However, there is an opportunity for listed REITs to grow in Europe as the benefits of the structure play out and governments iron out some of the inconsistencies, he says.
An additional challenge in Europe, as well as in some parts of Asia, are restrictions on development within the REIT structure. “Many companies that have compelling external growth opportunities choose not to convert to the REIT structure so that they can redeploy capital in accretive developments,” Zhang says.
It is important to note, however, that there are European countries that have done well with their REIT regimes. In Belgium, for example, REITs tend to trade at premium valuations. “In those types of regimes, REITs benefit from the favorable tax treatment and can take advantage of their access to lower cost of capital to grow externally. Those are areas where we do see the REIT structure being very successful,” she says.
One of the benefits of the growing global REIT regime is the expansion of the global investor pool. “There has really been a lot of enthusiasm from markets in Asia for investing in international publicly traded REITs,” says Chuck Schreiber, president and chairman of KBS Realty Advisors.
One of the key drivers behind that investor interest is the desire to invest in hard assets and take advantage of investments that are generating a strong dividend along with potential value growth, Schreiber says.
Singapore, for example, is a highly sophisticated investment marketplace where there is both strong awareness of REITs and high expectations in the level of transparency and governance. Retail investors are also very aware of the REIT structure as REIT IPOs are marketed on billboards and investors can buy shares in a publicly traded REIT from an ATM. “So, it’s really a different level of interest from investors,” he says.
An important factor that has helped propel growth for the global REIT regime is the multi-year low-yield environment where investors are on the hunt for yield. “That has created a real sweet spot where investors are looking more and more at the public REIT market as a solution for yield and particularly for growing income,” says Todd Kellenberger, REIT client portfolio manager at Principal Real Estate Investors, the real estate investment team of Principal Global Investors.
A larger and more diverse opportunity set for us to choose from to find attractive ideas creates greater opportunities for us to deliver returns to our clients.
Investor demand is further magnified in those countries that have been battling flat or even negative interest rates in recent years, such as Japan and Germany. “From an investment manager standpoint, we appreciate what’s happening with the growth of the global REIT market. A larger and more diverse opportunity set for us to choose from to find attractive ideas creates greater opportunities for us to deliver returns to our clients,” Kellenberger says.
Principal Global Investors follows a bottom up stock selection strategy. Specific to emerging markets, the firm is following newly listed REITs, their fundamentals, and their relative valuations. “When it comes to investing in an emerging market opportunity, it’s going to have to stand on its merits in terms of an attractive idea, as a company, and the assets they own,” he says.
As the REIT model gains more traction throughout the globe and listings increase, “REITs become too large to ignore for investors,” Jones says. “We think the growth of the global REIT market will help to shine a light on the sector, the attractive total return attributes and attractive current income attributes of REITs. It should generally be positive for both existing REITs and the real estate owners who are considering the structure as a way to own commercial real estate assets.”
Asia Pacific’s Looming Potential
REIT magazine spoke with Sigrid Zialcita, CEO of the Asia Pacific Real Assets Association (APREA). APREA’s members collectively own and manage over $20 trillion in real assets across the Asia Pacific region.
How do you think the Chinese REIT market will develop?
In the middle of last year, the Chinese government amended the REIT regulations by lifting restrictions on geographical limitations and by allowing rental apartments to be included as underlying assets. This is obviously a clear sign that this is just the beginning of more things to come.
Just looking at infrastructure alone, which is the focus of China REITs to date, we estimate that the size of the market could be $10 trillion. Also, if we adhere to the World Bank definition of a high income country, which China should reach in 2025, then the implications for the China REIT market are really quite massive. We think this is the single biggest opportunity in the region and globally.
How might the Chinese REIT regime impact the domestic or broader global investment market?
Right now, it is still a domestic investment market, and we think we are just scratching the surface when it comes to investing in REITs. The market in Asia Pacific has been growing, but it is tiny compared to the U.S. The REIT universe that we track is close to $350-$400 billion. Japan has the lion’s share of the REIT universe, and the rest is spread out in Singapore, Australia, Hong Kong, and the Philippines. We’re not including China in the universe right now because they are infrastructure REITs.
If the question is, where will growth be coming from, I think Asia Pacific alone will be the center of global growth over the next decade. China has the ability to have the highest growth because of its scale. We see other parts of the region, like Southeast Asia and India, that we believe are untapped. We have seen global investors park their capital in this part of the world because money always chases yields.
Today, countries must make sure they lay the foundation for foreign investments to happen. So, a lot of the countries in Asia Pacific today are open for business and are actively looking at regulations that will allow for foreign investments.
In India, for example, foreign investors can now invest money via debt into REITs.
SEBI (the Securities Exchange Board of India) also reduced the minimum lot size that can be bought. Institutional investors, of course, have the ability to buy, but there also is a huge untapped retail investor base. So, there is more opportunity to grow the REIT universe and the investor base, and as more education takes place, I think we are going to see a shift in capital allocation to REITs.
Have you seen any markets in Asia Pacific where REITs haven’t taken off?
REITs in Indonesia were launched in 2007. There are two listed REITs, but there are also several REITs with Indonesian assets that are listed in Singapore. The main impediment is high tax rates. The dividend payouts in Indonesia are taxed at 15% in the hands of the unit holders. Unit holders in Singapore or Hong Kong are tax exempt.
Long-term government bond yields in Indonesia have always been quite high at over 9% historically. REIT yields there are much lower than the bond yield. So, the risk return profile for most REITs is not very appealing. The government is aware of this, but it does take time to bring about change.
The main catalyst at the end of the day is economic growth and Asia remains the hotbed of global growth. Growth was stalled by the pandemic, but recovery will be inevitable. Over the last two to three years, governments across Asia Pacific have shown that they are flexible and will do whatever it takes to support growth.
There may be some impediments in existing REIT frameworks, but that doesn’t mean we won’t see enhancements. Progress will happen over time, and it will happen across the region. REITs in the region have a $350 million market cap today and have the potential to grow to more than $1 trillion in a few years.