Churchouse Letter
September 2011        by Peter Churchouse

Reducing Risk – A Window for Asian REITs Part II

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Diana Olteanu-Veerman, Green Investments Ltd. contributed to this report.

In August we published a piece entitled “Risk off the Table – A Window for Asian REITs”. This latest article is intended to add a bit more depth and colour to that analysis. Our August piece highlighted the following:

  1. REITs usually function as something of a halfway house in the investment risk spectrum between an equity (higher risk) and a bond (lower risk).
  2. Earnings of REITs are typically quite predictable, steady; and rules governing their operations require them to pay out very high proportion of earnings as dividends. That can be important for certain types of investors, both institutional and retail, particularly in an environment of low interest rates.
  3. They typically have tax benefits for investors.
  4. REITs allow smaller investors to gain access to large scale commercial real estate that would be impossible at the individual level.
  5. REITs rarely offer the rapid rates of growth that might be found in the property developer sector. Growing REIT portfolios efficiently without dilution to shareholders is not always that easy.
  6. Real estate markets in many parts of Asia have been in recovery mode, or at worst, bottoming out following the onset of the 2008 Financial Crisis, setting the stage for decent underlying fundamental property market conditions in some instances.

Here we look at some other points that we think have more merit to focus on at length and we did not dwell upon in our earlier piece.

Asian REITs as an Inflation Hedge

Many Asian countries have embarked on monetary and fiscal tightening measures in the past 2 years or so, following a rash of panic monetary easing in the wake of the Lehman collapse in September 2008. Not only did domestic monetary easing find its way into Asian asset markets and domestic consumption, but Asia also attracted a considerable flow of capital emanating from other parts of the world. These flows, domestic and from off-shore, have resulted in a surge in hard asset prices in many parts of Asia (particularly in real estate) and also notably in food prices (perhaps for slightly different reasons).

The FTSE ALL Share Singapore REIT index vs the Singapore CPI - since REIT inception (Q4 2003 - Q3 2011). The black candle graph represents the REIT index performance while the red line is the 15 day Small Moving Average (SMA) on the index.

Pressures on asset prices and general inflationary pressures have driven most Asian central banks and governments to embark on monetary and fiscal tightening initiatives over the past 12 months or so, nowhere more so than China. Pension funds, endowments, insurance companies and mom and pop investors saving for their retirement shudder to see the value of their investments slipping behind the rate of inflation that can drive one to the poor house!

In today’s low interest rate environment, inflation is well ahead of the bank deposit rates in just about all major economies around the world.

The Hang Seng REIT and Topix REIT indices vs the Hong Kong CPI and Japan CPI - since Hong Kong (Q1 2006 - Q3 2011) and Japan's (Q4 2004 - Q3 2011) REIT inceptions. Hong Kong's CPI and Hang Seng Index are on the left graph, and Japan's CPI and Topix REIT Index are on the right graph.

Additional Returns from Dividend Yield - The Hang Seng REIT Total Return Index vs the Hang Seng Price Index (August 2006 - August 2011). Since August 2006, the dividend yield generated almost 50% additional return for the Hong Kong REITs.

REITs can act as a hedge against inflation. The fact that REITs typically pay dividend yields well higher than bank rates and local sovereign bond rates puts them in a reasonably attractive position for income oriented investors, but also the value of REIT shares may provide an additional “safety-margin” against inflation over time. In many markets, especially across the Anglo-Saxon world, real estate prices have beaten inflation, i.e. have gone up in real terms over a long period.

Extensive studies from the US in the 1980’s and 1990’s and from the UK in the 1990’s have concluded that commercial real estate has provided an effective hedge against inflation over the longer term. (See the Appendix for further reference).

Additional Returns from Dividend Yield - the Japan REIT Total Return Indices vs the Price Indices from Sep 2001-Jun 2011. Dividend have comprised a major portion of returns for the Japanese REITs.

In the UK, rental growth data from real estate index providers IPD showed yearly increases of about 9.0% during the high inflation period of 1975-1990, when the Retail Price Index (which is together with the Consumer Price Index one of the most important inflation measures) went up by about 8.7% per year. In Asia a recent study by APREA (Asia Pacific Real Estate Association) published in May 2011 demonstrates a strong correlation between the listed property sectors of Hong Kong, Japan and Singapore and local inflation rates.

Figures 1 and 2 track the performance of REITs in Singapore, Hong Kong and Japan against the local inflation indices. What does seem apparent is that the REIT indices typically peak and trough before the respective inflation rate peaks and troughs. REITs do seem to deliver upside share price growth in excess of the domestic inflation rate, as well as delivering dividend yields higher than domestic bank rates or government bond yields. The global financial crisis of 2008 dented the inflation beating characteristics of the REITs as REIT prices plunged along with most other stocks, trading at deep discounts to underlying assets values. The general recovery in the stock markets from H1 2009 has seen REIT prices trading closer to their Net Asset Values (NAV) in most markets and resuming traditional pattern of outperforming inflation.

One might argue that the REIT markets in Singapore and Hong Kong, with a history in each case of less than 10 years, may not offer enough data support to conclude that REITs do in fact provide the hedge against inflation over the longer term. However, if experience in other markets where REITs have been around for a considerably longer time are anything to go by, it may well prove to be also in Asian markets over the longer term.

REITs Provide Lower Volatility

Given the greater predictability of earnings and lower risk of wild swings in earnings from year to year, it should be expected that REIT share prices enjoy a lower beta as measured against their local stock index.

Table 1: Hong Kong REIT Betas

Top Hong Kong REITs Stock Beta
The Link REIT 0.51
Champion REIT 0.74
Sunlight REIT 0.63
Properity REIT 0.65
Average Beta 0.62

In simple terms the beta of a stock or index against a local stock index reflects how much that stock has historically moved in relation to the index. A beta of below 1 suggests that the stock will move less than the benchmark index and a beta of 1 that it will move more than the benchmark. Many investors are skeptical of beta as a measure of risk as it is a backward looking measure, and can change constantly. Nevertheless it does provide us with some indication, albeit perhaps a flawed measure of the level of risk attached to a stock against its benchmark.

Table 2: Betas for top REITs in Asia

Top Japan REITs Stock Beta Top Australia/New Zealand REITs Stock Beta Top Singapore REITs Stock Beta
Nippon Building Fund Inc. 0.51 Westfield Retail Trust 0.69 CapitaMall Trust 0.85
Japan Real Estate Investment Corporation 0.63 Stockland 0.85 Ascendas REIT 0.55
Japan Retail Fund Investment Corporation 0.89 CFS Retail Property Trust 0.58 CapitaCommercial Trust 0.86
United Urban Investment Corp. 0.57 Commonwealth Property Office Fund 0.75 Suntec REIT 0.89
MORI TRUST Sogo Reit, Inc, 0.61 Investa Office Fund 0.85 Mapletree Logistics Trust 0.75
ORIX JREIT Inc. 0.72 Charter Hall Office REIT 1.02 K-REIT 0.93
Nippon Accommodations Fund Inc. 0.53 BWP Trust 0.67 Ascott Residence Trust 0.92
Japan Logistics Fund Inc. 0.71 Kiwi Income Property Trust 0.62 Starhill Global REIT 0.73
Daiwa Office Investment Corporation 0.71 Goodman Property Trust 0.59 Fraser Centrepoint Trust 0.80
TOKYU REIT, Inc. 0.83 Charter Hall Retail REIT 0.79 Fortune REIT 0.76
Average Japan REITs Beta 0.67 Average Australia/NZ REITs Beta 0.75 Average Singapore REITs Beta 0.81

Source: Bloomberg, Portwood Capital Ltd.
Betas for REITs in the region (Hong Kong, Japan, Singapore, Australia/New Zealand) are substantially below 1 in all instances. For a selection of larger REITs in the region the average betas range from a low of 0.62 in Hong Kong to a high of about 0.81 in Singapore.

What a low beta suggests is that holding that stock (or index) during a downturn will produce outperformance against the benchmark, and underperformance in a general upturn of the market.

Hence in the current “Risk off the table” environment, even benchmarked investors are likely to outperform by having solid exposure to lower beta REITs. And of course the higher dividend yield will add further to the total returns.

In principle therefore, given the lower betas of REITs generally, investors should enjoy a more stable longer term performance with less in the way of wild swings that might be occurring in the overall markets.

Table 3: Betas for Top Asian Property Companies

Top Japan Property Comp Stock Beta Top Singapore Property Comp Stock Beta Top Hong Kong Property Comp Stock Beta
Mitsubishi Estate 1.14 Capita Land 1.10 Sun Hung Kai 1.04
Mitsui Fudosan 1.22 City Developments 1.04 Cheung Kong 1.02
Sumitomo Realty 1.38 Keppel Land 1.27 Wharf Holdings 1.08
Daiwa House Industry 0.99 United Industrial Corp 0.63 Hang Lung Properties 0.95
Sekisui House Ltd 0.90 Overseas Union Enterprises 0.71 Henderson Land 1.09
Nomura Real Estate 1.24 Singapore Land 0.76 Swire Pacific 0.97
NTT Urban Development 1.14 UOL Group 0.96 Sino Land Co 1.29
Tokyo Tatemono 1.51 Wheelock Properties 0.81 Kerry Properties 1.08
Goldcrest Co Ltd 1.32 Wing Tai Holdings 1.21 New World Development 1.19
Leopalace21 Corp 1.36 HoBee Investments 1.02 Hysan Development 1.01
Average Japan Property Company Beta 1.22 Average Singapore Prop Comp Beta 0.95 Average HK Property Company Beta 1.07

Source: Bloomberg, Portwood Capital Ltd.
Within the real estate sector, one would expect also lower betas for the REITs than for the other property companies. The betas for the non REIT top property companies tend to be much higher, between 17- 45% above the REITs betas as Table 3 shows.

As an aside, beta should not be confused with correlation. Generally speaking real estate stocks in Asia have quite high correlation with the overall market index. They tend to go up and down together, and it is not often that stocks in the real estate sector – REITs included – go in the opposite direction to the overall market for any sustained period of time.

Attractive Dividend Yield

In our earlier article we highlighted the higher dividend features of REITs. Over the long term, dividend yields can comprise a very significant part of total performance.

Some of the US Studies (Refer to the Appendix) consider the dividend yield to be even the main contributor to returns over a long period of time. In the long sideways market in the US between 1965 and 1985, the contribution of dividends was more than 90% of the total returns in that market, with share price gains adding very little to the total returns (See Appendix).

While there are many valuation metrics and criteria for stock selection, the likes of Benjamin Graham and Warren Buffet have long recognised the power of dividends and the compounding process that these bring to investment returns.

Dividends have proven to have long term predictive power in investment performance and we might do well to remind ourselves of that observation in today’s volatile markets. Asian largest REITs that we highlight here currently enjoy high dividend yields of close to 6%, much higher than the current bond yields (as per Figure 6) and significantly above the savings deposit rates.

Historically, the Asian REITs dividend seem to have also significantly contributed to the returns; as Figure 3 and 4 show, in Hong Kong more than 50% and in Japan more than 90% of the returns came from dividends.

Figure 5 shows also an example of the total returns performance for two of the largest Asian REITs. Although the two REITs are very different in terms of the share price performance, the impact of the dividend reinvestment on their overall return is in both cases significant.

Top Asian REITs - Example of Dividend Yield Impact on Total Returns on a USD 10,000 portfolio (2005-2011). Blue - Westfield Share Performance Including Dividend Reinvestment (Improved 7%). Light Blue: Westfield share Performance Excluding Dividend Reinvestment (-30% growth). Light Green: The Link REIT Share Performance Including Dividend Reinvestment (Grew 130%). Green: The Link REIT Share Performance Excluding Dividend Reinvestment (Grew 80%). Note: for both a top performing REIT like LINK and a poor performing REIT like Westfield, the dividends had a major impact on the total returns.

Top Asian REITs Dividend Yield vs 10 Year Government Bond. Hong Kong: The Link REIT Dividend Yield vs 10 Year Hong Kong Governmentt Bonds (02 June 2008 - 02 June 2011). Singapore: Ascendas REIT Dividend Yield vs 10 Year Singapore Government Bonds (02 December 2008 - 02 August 2011).

As concluded in our earlier piece, we believe it is possible to build a portfolio of REITs across the region that will give a blended dividend yield of 6% – 6.5% with a relatively low risk profile both in earnings terms and in terms of stock price performance. Modest earnings growth is likely in many cases in the short to medium term, and highly likely over the longer term. This portfolio would comprise a good many companies that investors would be comfortable owning for the long term given the quality of managements involved, quality of assets and ability to provide long term sustained competitive advantage within their particular markets.

Table 4: Top Asian REITs – Dividend Yield vs 10 Year Government Bond Yield Historically

Top REITs Asia Market Cap (USD Mln) Average Stock Beta Average Dividend Yield 10 Year Gov Bond Yield Div Yield to Bond Spreads
Top 6 HK REITs 12,296 0.625 5.99% 1.70% 4.29%
Top 10 SGP REITs 21,237 0.806 6.02% 1.60% 4.42
Top 10 Japan REITs 25,093 0.671 4.99% 1.01% 3.98%
Top 10 AU/NZ REITs 23,136 0.748 6.82% 4.50% 2.32%
Total 81,762 0.712 5.96%

Source: Bloomberg, Portwood Capital Ltd.

Left Hand Side: UK Property return vs Inflation (as measured by CPI) during the high inflation periods of 1947-67, 1967-81 and 1981-2009 (chart measures Total Returns, Capital Growth, Income Return and Inflation). Right Hand Side: S&P 500 vs the S&P Dividend Yield from 1965-1985, with the S&P 500 in blue and the dividend yield in red.


US Studies on Commercial Real Estate as Inflation Hedge:

The Impact of Inflation and Vacancy of Real Estate Returns, Ch H. Wurtzebach, Glen R Mueller, Donna Machi, Journal of Real Estate Research, 1991

REIT Investments and Hedging against Inflation, Bahram Adrangi, Arjun Chatrath, Kambiz Raffiee, Journal of Real Estate Portfolio Management, 2004

The Inflation-Hedging Characteristics of Equity REITs: An Empirical Study, Murphy, J. A. and R. T. Kleiman, Quarterly Review of Economics and Business, 1989

Is Commercial Real Estate an Inflation Hedge?, Miles, M. and J. Mahoney, Journal of Real Estate Finance, 1997

The Inflation-Hedging Properties of Risk Assets: The Case of REITs, Yobaccio, E., J. H. Rubens and D. C. Ketcham, Journal of Real Estate Research, 1995

The Inflation-Hedging Characteristics of Equity REITs: An Empirical Study, Murphy, J. A. and R. T. Kleiman, Quarterly Review of Economics and Business, 1989

The Asymmetric Response of Equity REIT Returns to Inflation, M Simpson, S Ramchander, J Webb, Journal of Real Estate Finance and Economics, 2007

REIT Returns and Inflation: Perverse or Reverse Causality Effects?, Glascock , J Lu, Raymond W, Journal of Real Estate Finance and Economics, 2002

UK Studies on Commercial Real Estate as an Inflation Hedge:

“Inflation Hedging and UK commercial property”, JA Schofield, Journal of Property Finance, 1996

Property and Inflation: The Hedging Characteristics of UK Commercial Property, 1967 –1994, C Barber, D Robertson, A Scott, Journal of Real Estate Finance and Economics, 1997

The Short-Term Inflation-Hedging Characteristics of U.K. Real Estate, M Hoesli, Journal of Real Estate Finance and Economics, 1997

Dividend Yield Studies:

Triumph of the Optimists, Elroy Dimson, Paul Marsh and Mike Staunton, Princeton University Press, 2002

Market Anomalies: A Mirage or a Bona Fide Way to Enhance Portfolio Returns?, Michael Lenhoff, Capel-Cure Myers Capital Management, March 1991

The Importance of Dividend Yields in Country Selection, A. Michael Keppler, The Journal of Portfolio Management, 1991

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