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Real Estate Investment Trusts – Fund Managers Eye a New Asset Class
REITs are a form of investment fund popularised in the United States that allow retail investors to gain an exposure to the property market without buying a direct property holding. They have been introduced with mixed success into Asia in Japan and more recently Singapore.
Structuring
The consultation raises questions that require serious consideration. One of the most important is one of structuring. The illiquid nature of property investments means that many property funds are often structured as closed-ended funds, i.e. a fixed number of shares are issued and traded on a secondary market, as opposed to an open-ended structure where units are created or cancelled according to demand. A corollary of this is that they are generally listed vehicles, to allow investors to buy into, or sell out of, the fund in the secondary market. Being closed-ended, the fund manager has a fixed fund to invest without the fear of mass redemptions forcing him to conduct a fire sale of the property assets within the portfolio.
This structure does have its downside however. The share prices of listed vehicles are determined by the supply and demand of the vehicle’s shares, as with any other company, and this does not therefore necessarily track the Net Asset Value (NAV) per share of the fund. Discounts of 15% and above to the NAV per share are not uncommon in UK property funds, and previous market downturns have seen some property vehicles’ discounts reach as high as 40%. Discounts of this magnitude do not normally last very long, as arbitrageurs step in and drive prices up.
One alternative is an open-ended unit trust. The threat of redemption can be countered by setting long redemption periods of between six months and a year. Institutional investors normally accept this, but few retail investors have the patience to wait that long for their cash, or are prepared to suffer if the assets decline in that period. If the REIT is listed, the issue of redemption may not be so much of an issue if the Singapore model is used. In the first REIT that was listed on the Singapore Exchange a few months ago, unitholders have no right to request to redeem their units while the units are listed. They are to deal in their units through trading on the Singapore Exchange only.
UK institutional investors currently favour limited partnerships as their vehicle of choice. This gives them some flexibility on an administrative front, as they are not regulated, yet still allows the fund manager to build a track record to entice future partners into the fund. These would be of limited use for the retail market as the administration would be overly complex and partnership legislation too restrictive.
In addition to this, retail investors will be aware of the problems that arose in Singapore with the launch of an early REIT. Properties were injected into the REIT at NAV, which investors deemed to be over-valued, and this was the main factor in the last minute withdrawal of the launch. The values that properties are put into REITs in any future Hong Kong offerings will be closely monitored.
Property Funds
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