The important role that REITs play in the economy

HAVING been involved with real estate investment trusts (REITs) since 2004, I thought it was timely to revisit the basics of what REITs are essentially for investors and capital markets.

REITs changed the game when the first such instrument, Axis-REIT, listed in August 2005 with a modest market capitalization of RM300 million.

I had no idea how the sector would become an RM40bil industry today and is now a major part of the Malaysian capital markets.

As CEO of Axis REIT, it was the start of an incredible journey to see how this industry has become a mainstream investment product favored by institutional funds and retail investors.

So what exactly is a REIT?

A REIT is a listed vehicle that invests in a portfolio of income-generating properties. Rents collected from tenants, net of expenses, are distributed on a regular basis in order to provide stable returns to unitholders.

This income distributed to unitholders is subject to a flat-rate withholding tax of 10% for natural persons. The REIT is not taxed by the Inland Revenue Board (IRB).

The largest asset class the average Malaysian invests in their lifetime is real estate. They see it as a hedge against inflation, a measure of wealth and for some, building up an inheritance for their children.

At that time, the only properties available for purchase for an investor were houses, commercial land, offices or condominiums.

However, many Malaysians quickly faced the following problems when buying property for investment purposes:

> When they had to dispose of a property, it was a difficult, expensive and time-consuming process. Quick kills were not accessible to them.

> They were exposed to fluctuations in interest rates, which could increase the cost of their loans.

> They were taxed on their rental income unless they took the risk of not declaring the rental income from their properties to the IRB.

> Finding tenants for their invested properties was probably the hardest part of the investment, being new to the skills of professional estate agents

With the advent of REITs, a whole new mode of ownership has opened up to local investment funds, insurance companies and the general public.

This has allowed any investor to have what is best described as fractional ownership of many iconic properties which they would normally be denied.

On top of that, investors were rewarded with regular contractual cash dividend payments every three or six months, unheard of at the time.

What was more exciting was the fact that the dividends received yielded an average return on investment of 6% per year, coupled with the growth in the share price.

By purchasing units of a REIT, it quickly became apparent to investors that it was a stake in the assets of the REIT. It provided them with indirect access to large, stable and high-quality real estate portfolios in a tax-efficient way.

As REITs are governed by a trust deed, stock exchange and securities commission regulations, this ensured a high level of corporate governance.

Being publicly traded, REITs also offered the following advantages to the investor:

> Units in a REIT are a liquid substitute for physical real estate assets – you can buy and sell units like stocks.

> Unlike a physical good, its value is evaluated daily on the market and the investor can decide to sell at any time.

> Like physical property, REITs are a hedge against inflation.

> Due to its co-ownership feature, it has an incredibly low entry cost – the investor can purchase 100 units at a time and build a portfolio.

> Because it is professionally managed by the manager of the REIT, it excludes direct ownership risk.

From the perspective of the real estate developer or owners of quality real estate portfolios, it quickly became clear that REITs enabled the building of an integrated real estate business.

It has also enabled companies wishing to adopt an asset-light strategy to sell their real estate to a professionally managed, listed and well-governed REIT.

What appealed to real estate owners and investors was the fact that the REITs managed their real estate in-house and that the REIT manager had a variety of skills in real estate development, redevelopment acquisitions, divestitures, rental and property management.

If integrated with a real estate-based business, REITs can create long-term value for such a business.

Prior to REITs, real estate companies struggled to access capital, whether debt and equity, public and private. REITs have quickly emerged as a vital resource for attracting long-term capital into the real estate industry.

What has made REITs important to our country’s economy is their ability to attract foreign capital. There is a huge amount of global capital out there looking for opportunities in commercial real estate.

Particularly since the quantitative easing exercises by many central banks around the world in the wake of the global financial crisis in 2008, when billions of dollars were pumped into global financial markets, which in turn needed to find a home.

Transparent and liquid entities such as REITs have found favor and profited by tapping into this pool of funds, adding to the financial flexibility of REITs.

REITs can also help grow the broader economy, as capital recycling helps inject private sector capital back into the economy, which boosts gross domestic product and creates jobs.

As REITs are more transparent and efficient, they can access this stable, global capital at more competitive prices.

The growth of REITs has benefited many new players, including developers such as UOA and Sunway Group, financial sponsors such as AmBank and Hong Leong Group, entrepreneurs such as Axis and Atrium, and government-linked companies such as Boustead, CapitaLand, Permodalan Nasional Bhd and KPJ Santé.

With their participation, they were able to combine the integration of developers, private equity funds and REITs in the effective recycling of capital in the economy.

Of course, the landscape of a post-pandemic world has posed many challenges for REIT management teams, ranging from changing lease requirements, inflation concerns, to the rise of sustainability, which is today today on the agenda of most investors.

The good news is that REIT managers are adapting faster than others to these challenges as they rebalance their portfolios and move forward.

That being said, REITs are still a great investment choice with stable returns and low stock price volatility, which is what we need in these uncertain times.

Datuk Stewart LaBrooy is Honorary Secretary of the Malaysia REIT Managers Association and Chairman of Alpha REIT Managers Sdn Bhd. The opinions expressed here are those of the author.

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