The Reits (Real Estate Investment Trusts)

Copyright © 2021 by Kim Hin David, HO (Professor) (Dr).

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Foreword

Over 100 years ago, this (Singapore) was a mud-flat, swamp. Today, this is a modern city. Ten years from now, this will be a metropolis. Never fear.

(The first Prime Minister of Singapore Lee Kuan Yew, 1965)

This book takes an in-depth look at the real estate investment trust (REIT), in particularly the immense Asia region. The REIT is a company, which owns, operates, or finances income-generating real estate. Modelled after mutual funds, the REITs pool the capital of numerous investors. The investors can earn dividends from direct real estate investments without having to buy, manage, or finance any properties themselves.

The REIT Is distinguished by the following key features:

• REITs generate a steady income stream for investors and offer slow to moderate capital appreciation.

• Most REITs are publicly traded like common stocks, which makes them highly liquid (unlike direct real estate investments).

• REITs invest in most direct real estate types like apartment buildings, cell towers, data centres, hotels, medical facilities, offices, retail centres, and warehouses.

There are three main REIT types:

• Equity REITs. Most REITs are equity REITs, which own and manage income-producing real estate. Revenues are generated primarily through rents (not by reselling properties).

• Mortgage REITs. Mortgage REITs lend money to real estate owners and operators either directly through mortgages and loans, or indirectly through the acquisition of mortgage-backed securities. Their earnings come from the net interest margin i.e. the spread between the interest they earn on mortgage loans and the cost of funding these loans. Such a mortgage REIT is potentially sensitive to rising interest rate.

• Hybrid REITs. These REITs use the investment strategies of both equity and mortgage REITs.

REITs can be further classified, based on how their shares are bought and held:

• Publicly Traded REITs. Shares of publicly traded REITs are listed on a national securities exchange, where they are bought and sold by individual investors. They are regulated by the US Securities and Exchange Commission (SEC).

• Public Non-Traded REITs. These REITs are also registered with the US SEC but do not trade on national securities exchanges. As a result, they are less liquid than publicly traded REITs. Still, they tend to be more stable because they’re not subject to market fluctuations.

• Private REITs. These REITs are not registered with the SEC and do not trade on national securities exchanges. In general, private REITs can be sold only to institutional investors.

Asia Governments are eager to ferment a REIT-friendly institutional environment because such an environment promotes more liquid and active capital markets, which enable local and international real estate developers and investors, to unlock value hidden behind each real estate holding, and offering investors a greater range of investment class assets for risk diversification. More developing markets like The Philippines, India, Thailand, and Indonesia pose fertile grounds, where the REITs listings on the public markets have been legalised, and there is available physical stock under real estate developers’ holds. The India REIT sector is established in year 2019, and the government is now taking significant steps to open regulatory strangleholds to improve liquidity, transparency and governance. Therefore, major international players like Blackstone and Brookfield sponsor REITs in India, and more REITs are expected to be listed in year 2021 and beyond.

According to the Asia Pacific Real Estate Association (APREA), the total market capitalisation of REITs in the Asia -Pacific continent (APAC) is to reach more than US$1 trillion by the end of the decade. Therefore, exciting opportunities are offered for domestic and international real estate developers, international investors and potential sponsors, as they look to bring their products to the Asia-Pacific markets for their next rounds of capital raising

Eight chapters are devoted to this book, to be followed by the ‘Conclusion" chapter. It is hoped that this REITs book is meaningful in practice and in scholarship.

Happy reading.

Yours sincerely,

Professor (Dr) Kim Hin David, HO

Singapore

November 2021.

Acknowledgements

The Author wishes to extend his most sincere appreciation to the School of Design & Environment, under the highly able Deanship of the Provost & Chair Professor (Dr) LAM Khee Poh, of the National University of Singapore. The same wish is extended to the University of Cambridge and the University of Hertfordshire in Hatfield, UK. These three tertiary institutions of higher learning and research are globally leading Universities, inspiring and encouraging both modern and contemporary studies of the ubiquitous real estate investment trusts (REITs) across Asia, Europe, the United States of America, North America and Australia.

About the Author

Professor (Dr) HO, Kim Hin / David

PhD (Development Economics) (Cambridge), MPhil (1st Cl Hons and a Star for Distinction) (Development Studies & Land Economy) (Cambridge); Honorary Professor (Development Economics & Land Economy) (Uni of Hertfordshire); Honorary Doctorate of Letters (International Biographical Centre) (Cambridge); Systems Engineering (US Naval Postgraduate School), MRES (UK), AM NCREIF (US), FARES (US), MAEA (US), MESS, MSIM. Retired Professor (Associate) (Tenured) (International Real Estate) (Department of Real Estate) (School of Design and Environment) (National University of Singapore, NUS). Home Address: Block 220 Ang Mo Kio Avenue 1 #02-807, Singapore 560220; email address: davidhokh1@gmail.com.

Professor HO Kim Hin / David spent 31 years across several sectors, including the military, oil refining, aerospace engineering, public housing, resettlement, land acquisition, reclamation and international real estate investing. 6 years were in Pidemco Land Ltd (now CapitaLand Ltd) and GIC Real Estate Pte Ltd. 17 years were in the NUS School of Design and Environment at the Department of Real Estate. He holds the Master of Philosophy (First Class Honours with Distinction), Doctor of Philosophy from the University of Cambridge; and the Honorary Professor from the University of Hertfordshire. He has published widely in 275 articles (inclusive of 91 articles in top peer reviewed, international journals; pertaining to real estate investment, real estate development, urban policy, consultancies, public cum private funded research projects and so also published 15 major books. He was governor of the St Gabriel’s Foundation and member (District Judge equivalent) of the Valuation Review Board under the Singapore Ministry of Finance and the Singapore Courts.

Contents

Foreword

Acknowledgements

About the Author

Introduction

Chapter 1Green Buildings and The REIT (Real Estate Investment Trust)’s Performance

Chapter 2S-REIT Market Efficiency Through a Binomial Option Pricing Tree Approach

Chapter 3A Comparative Risk Analysis between the Markowitz Quadratic Programming (QP) Model and the Multivariate Copula (MC) Model for The Singapore REIT’s Portfolio

Chapter 4A Value Investing Assessment of the Singapore-Real Estate Investment Trust (S-REIT)

Chapter 5Direct Real Estate Market Reaction to Public Listings and Acquisition News of Malaysia REITs

Chapter 6The REIT Regulatory Environment for Singapore (SG) By The Monetary Authority of Singapore (MAS) And Private REIT Case For SG

Chapter 7Key Issues and Notes On The Valuation Of The Public Real Estate Investment Trusts (REITs) And The Real Estate Companies

Chapter 8The Asian Real Estate Investment Trust (REIT) Institutional Environment - The Singapore S-REIT And The Hong Kong HK-REIT

Chapter 9The Conclusion

Introduction

Chapter 1 examines the significance of ‘green’ buildings on the operational and financial performance of REITs. It covers different direct real estate sectors, namely office, retail and residential, for the REITS concerned to evaluate the consistency of the results. The three most popular and large publicly listed K-REIT Asia (K-REIT), Capitamall Trust (CMT) and City Developments Limited (CDL), represent largely the office, retail and residential REITS in Singapore respectively. Ordinary least-square multiple regression models per trust are adopted to estimate the measurements of REIT performance–return on assets (ROA), the ratio of funds from operation to total revenue (FFO/Total Revenue) and return on equity (ROE) – against the ‘green’ variables. Properly certified and measured ‘green’ buildings have significant impacts on REIT performance for both the K-REIT and CMT but no such significant impacts are found for CDL. Results for K-REIT differ from those for CMT and that different measures of ‘green’ buildings in a REIT’s portfolio should have different impacts on REIT performance. Chapter 1 produces meaningful insights as to how the different REIT managers should invest in ‘green’ properties to create value for investors.

Chapter 2 examines the risk neutral and non-risk neutral pricing of real estate investment trusts in Singapore (S-REITs), via comparing the average of the individual ratios (of deviation between expected and observed closing price/observed closing price) with the ratio (of standard deviation/mean) for closing prices, via the binomial options pricing tree model. If the ratio (of standard deviation/mean) ratio > the ratio (of deviation between expected and observed closing price/observed closing price), then the deviation of closing prices from the expected risk neutral prices is not significant and that the S-REIT is consistent with risk neutral pricing. If the ratio (of deviation between expected and observed closing price/observed closing price) is greater, then the S-REIT is not consistent with risk neutral pricing. It is found that the Capitacommercial Trust, the Capitamall Trust and the Keppel REIT, have large positive differences between the two ratios (39.86%, 30.79% and 18.96% respectively). The implication is that these S-REITs are not trading at risk neutral pricing. Suntec REIT has a small positive difference of 2.35% between both ratios, implying that it is trading at risk neutral pricing. The Ascendas REIT has the largest negative difference between the two ratios at -4.24%, to be followed by the Mapletree Logistics Trust at -0.44%. Both S-REITs are trading at risk neutral pricing. The analysis shows that Capitacommercial Trust, Capitamall Trust and Keppel REIT exhibit risk averse pricing.

Chapter 2’s results are consistent with the prudential asset allocation for viable S-REIT portfolio investing, but that not all these S-REITs exhibit strong market efficiency in their pricing. The pricing may be risk neutral over a certain period but investor sentiments, the fear of risks and speculative activities, can affect an S-REIT’s risk neutrality. With enhanced risk diversification activities, the S-REITs should attain risk neutral pricing.

In Chapter 3, one can observe that while the Markowitz portfolio theory (MPT) is popular in modern finance to model portfolios with maximum total returns (TRs) for a given systematic risk, the more flexible multivariate copula model is introduced that enables investors and portfolio managers to obtain the optimal portfolio. Chapter 3 conducts a comparative analysis to evaluate how the multivariate copula model fares against MPT in capturing the systematic risk for an S-REIT portfolio. The S-REIT portfolio comprises seven pioneering S-REITs. A dynamic ex ante analytical hierarchy process-strategic asset allocation (AHP-SAA) model is adopted to estimate a diversified portfolio. The resulting efficient frontier is examined under the Markowitz quadratic programing-tactical asset allocation (QP-TAA) model, which is constrained by tactical bands around the AHP-SAA model. The alternative Multivariate Copula-tactical asset allocation (MC-TAA) model is adopted to estimate the optimal diversified portfolio. The QP-TAA and MC-TAA are comparable as the expected portfolio total returns (TRs) of both models are close and within the random error range. Both these models are equally effective alternatives, and each is robust in constructing and estimating the TAA portfolio that enables investors to undertake active portfolio management, and to take advantage of arbitrage opportunities in the market.

Chapter 4 looks at a value investing framework, in which an investment operation is deemed to be one, where a thorough analysis, should promise the safety of a principal and an adequate return. A value investing framework is developed to examine the intrinsic value of S-REIT (Singapore-Real Estate Investment Trust) companies, and to infer that the S-REITs can offer investors an adequate margin of safety. Margin of safety, as a highly interesting investing concept, recommends that the price an investor pays for an investment asset must always lie significantly below its fundamental or intrinsic value. A true margin of safety is one that is based upon a thorough analysis, which is substantiated with facts, persuasive reasoning and with reference to a body of actual experience. This thorough analysis in turn involves the examination of factors like the regulatory environment of the S-REITs, the soundness and prospects of S-REITs, the risks facing SREITs and their market, the economic outlook for the S-REITs and the potential competition facing the SREITs.

Chapter 4 finds that while S-REITs operate in one of the friendliest regulatory regimes in Asia, the S-REITS may be facing competitive threats, as other Asian countries continue to deregulate. The S-REITs, backed by strong parentage, enjoy several competitive advantages over their competitors and these S-REITs have accordingly adopted sustainable growth strategies. The outlook for S-REITs looks favorable as the structural demand for S-REITs remains robust. Investors’ positive sentiments in the S-REITs are recognized by the market that explains why S-REITs are currently trading above their book values. This paper also finds that S-REITs are currently trading at a premium and purchase of overpriced S-REIT stocks will not offer investors an adequate margin of safety.

Chapter 5 looks at the real estate investment trust (REIT), or property trust, a relatively new instrument in Malaysia that is first listed in 1989. Chapter 5 seeks to examine the market reactions of Malaysia’s listed property trusts and property common stocks to corporate restructuring activities – direct real estate asset acquisitions and new listings. Tests of price behavior - the price discovery process for real estate in the public markets - of fifty-eight listed property common stocks and three property trusts in Malaysia, associated with the announcement of the new listing of the Mayban Property Trust Fund One (MPTF1) in 1997, show that property common stock and property trust prices react significantly with a negative abnormal return of some 2.3% and 4.9% respectively, during an interval of 10 days before the new listing announcement.

In Chapter 5, the property common stock and the property trust prices adjust upward in the post-listing period of over five days. In the tests of the acquisition announcement for twenty-two property common stocks and two property trusts, the results show no significant excess total returns (TRs), accumulated in the listed property common stock market around the event window intervals. For Malaysia’s emerging listed property trust market, there are significant negative price adjustments of some 8.2% and 1.9% during the event intervals [-10,0] and [-1,0] respectively. Therefore, the two securitized real estate markets do not perfectly share or respond to the same set of information, concerning corporate restructuring activities. The implication is that local and institutional investors with a portfolio, comprising real estate investment trusts and real estate common stocks, can still achieve the diversification benefit associated with unsystematic market shocks.

Chapter 6 reports that as early as June 2009 that the Monetary Authority of Singapore (MAS) in consultations with the Inland Revenue Authority of Singapore (IRAS) and the Ministry of Finance (MOF), the MAS then introduces the Income Tax Act (ITA) amendments, and a new temporary relief measure for real estate investment trusts (REITs) in Singapore. Chapter 6 also looks at the proposal by the Asian Public Real Estate Association (APREA) to the MAS, to create a private REIT structure. Such a proposal is against the backdrop of a challenging direct real estate market and economic environment, impacting the S-REIT sector. The unprecedented environment is posing significant challenges to the proper functioning of the S-REIT sector. APREA want to preempt the real possibility of corporate failure and enhance the functioning of the wider market.

Chapter 7 looks at the key issues and notes on the valuation of the public real estate investment trusts (REITs) and the real estate companies. Chapter 7 adopts several valuation metrics to value REITs on a stand-alone and a relative basis, including: the price to FFO (funds from operations), the price to CAD (cash available for distribution), the price to NAV (net asset value), and the dividend yield. Singapore’s Frasers Commercial Trust is utilized as the case example. Other key issues include REIT accounting, the balance sheet, equity accounting versus consolidation, cash flow statements, the similarities and differences between purchasing direct real estate and the REITs.

Chapter 8 looks at the unique Asian REIT institutional environment, pertaining to the Singapore real estate investment trust (S-REIT), while cross referencing it to that of Hong Kong in the specific instances of Singapore’s CapitaMall Trust (CMT) and Hong Kong’s Link REIT. The presence of both private and public institutions may well increase the market costs of information flow, non-transparency, higher transaction costs and the cost of capital for REIT investing. Chapter 8 also examines the S-REIT performance sustainability under the value investing framework, which upon a thorough analysis promises safety of principal and an adequate total return (TR). The analysis involves the examination of factors like the institutional environment of the S-REIT, the soundness and prospects of the S-REIT, the risks facing it and its sector, the economic outlook for the SREITs and the potential competition facing the SREITs. While the SREIT operates in one of the friendliest regulatory regimes in Asia, it may well be facing competitive threats, as other Asian countries continue to deregulate. The S-REIT has accordingly adopted sustainable growth strategies.

Chapter 9 offers this book’s conclusion.

Chapter 1

Green Buildings and The

REIT (Real Estate Investment

Trust)’s Performance

Society has become more aware and concerned with the rapid environmental changes that are taking place around the world. With increasing environmental consciousness, it has led to the implementation of various green initiatives in the hope of slowing down environmental degradation. Besides the introduction of policies to limit the amount of greenhouse gas emissions from industries, policy makers are coming up with initiatives, targeted at activities that may have negative impacts on the environment. The direct real estate sector is of particular interest because buildings play a significant role in affecting the environment. Studies show that the direct real estate sector constitutes a significant negative impact on the environment. It is well documented that buildings are responsible for an estimated 30 to 40 percent of all primary energy use, greenhouse gas emission and waste generation (United Nations Environment Programme, 2007). A similar situation is observed in Singapore where buildings constitute the third key contributor of carbon dioxide emission (see Figure 1). The Intergovernmental Panel of Climate Change (IPCC) has identified buildings as the single largest potential component for the reduction of greenhouse gases. Therefore, by improving the energy efficiency within the building, a reduction in the usage, the demand for energy and other scarce resources can be expected.

Figure 1. Key Carbon Dioxide Contributors In Singapore

Source: Solidiance and Singapore Green Building Council, 2010; Author, 2021

However, for green practices to be successfully adopted in the direct real estate industry, it requires the joined effort from both the consumer and the government. From the consumer perspective, rising environmental consciousness has led to an increase in the individual’s and business’s interest in sustainable asset investing. As a result, it has contributed to a faster pace of ‘greening’ direct real estate assets and a significant rise in the number of ‘green’ buildings that are developed on the principles of human-centeredness and sensitiveness to the environment. Nevertheless, the Singapore (SG) government as the regulatory body has put in place regulations and legislations to push for such a ‘green’ building movement.

The SG government has come up with various initiatives and incentives to encourage industry players and consumers to particpate in this movement. In Singapore, the Building and Construction Authority (BCA) introduced the BCA Green Mark Scheme in January 2005, as an initiative to drive Singapore’s construction industry towards more environment-friendly buildings. To speed up the pace of ‘green’ building revolution, BCA also enhanced regulations to make it mandatory for all new buildings and existing buildings undergoing major retrofitting to achieve the minimum Green Mark certified standard. The BCA also provided various incentives under the Green Mark Incentive Scheme to encourage the different market players to ‘green’ their direct real estate assets. With strong demand generated by various direct real estate players and the government’s will to push for ‘greenness’ of the built environment, these will help to support the growth and development of a ‘greener’ and more sustainable direct real estate industry.

The investment in ‘green’ buildings holds many benefits for the environment and the various players in the direct real estate industry. For tenants, ‘green’ buildings serve as a more cost-effective place for conducting business owing to the potential savings in electricity bill. ‘Green’ buildings can provide better working environment, which would contribute to higher productivity of occupants. Landlords benefit from holding ‘green’ direct real estate assets in their portfolio as they should be able to realise higher rental and capital values for such direct real estate assets. They will also enjoy a competitive edge over conventional non-green buildings, as the benefits to tenants are likely to be translated into more demand for space within such buildings. This will lead to higher occupancy rate, thereby favouring owners who hold ‘green’ buildings in their portfolio.

The realizable positive effects of ‘green’ direct real estate assets on financial performance have inevitably become the interest of real estate investment trusts (REITs) in Singapore, to invest in sustainable real assets. Not only will REITs seek to achieve ‘green’ ratings for its existing buildings, they will be also interested to acquire certified ‘green’ direct real estate assets to reap the potential benefits. Consequently, the number of ‘green’ buildings held in a REIT’s portfolio is likely to increase over the years. Such an increase is further supported by the government’s aim to have at least 80 percent of buildings in Singapore achieving the BCA Green Mark Certified rating by 2030 (Building and Construction Authority, 2009). Since an improvement in the sustainable performance of direct real estate is well aligned to enhance the financial performance at the asset level, with a similar result that is expected to be observed at the REIT level

Several studies relate to energy-efficient and sustainable direct real estate assets. Some look at the demand and acceptance of ‘green’ developments while others look at the impact of energy-efficient and sustainable direct real estate assets, the direct and indirect benefits of ‘green’ developments, the cost of ‘green’ buildings and the future of such developments. Despite a wide coverage, theses studies tend to focus on the asset level using panel data and not at the REIT level. It is because the ‘green’ building movement is still at its developing stage, in Singapore and that it is only until recently that REITs have become more interested in sustainable asset investing. There is therefore a dearth of studies that examine the significance of ‘green’ buildings on REIT’s performance. Since ‘green’ buildings should command a premium in terms of rental and capital values at the asset level, such buildings should be translated into positive financial effects on REIT’s performance. The main contribution of Chapter 1 serves as an insightful exploration as to whether the ‘greenness’ of REITs, as measured by the ‘green’ direct real estate assets held in the REIT’s portfolio and its greenness score, have any significance on its operational and financial performance, in the context of Singapore. Chapter 1 has three objectives in mind:

• To examine whether or not ‘green’ developments have any effect on the REIT’s operational and financial performance.

• To examine whether or not the observed effects are significant.

• To examine whether or not the effects of ‘green’ developments on the REIT’s performance is consistent across the different direct real estate types namely office, retail and residential.

Chapter 1 comprises six sections with the introduction as the first section, which gives an overview of how green buildings are gaining interest in the direct real estate industry and how it contributes to the Chapter. The next (second) section discusses the related literature, concerning the rising popularity of REITs as an investment instrument, the various benefits of green buildings, the effect of green buildings on REIT performance and the Singapore (SG) Building and Construction Authority (BCA) Green Mark Scheme. The third section covers Chapter 1’s approach while the