HK Reit reform welcomed, with caveats

The Asia Pacific Real Estate Association has welcomed wide-ranging changes coming in under Hong Kong’s framework for real estate investment trusts, although some market participants disagree on some points.

Under the amendments, Reit managers will be allowed to participate in property development projects and invest in financial instruments to manage cashflow. Some market participants have taken issue with the cap on investment in development projects and the ability for Reits to invest in financial instruments

“This is a positive step by the Securities and Futures Commission [SFC] that will place Hong Kong Reits on a more competitive footing with other countries,” said Peter Verwer, chief executive of Aprea.

The SFC published its proposals in January and started a consultation process that ended on February 26. A total of 113 respondents submitted opinions, including the likes of Dutch pension fund manager APG Asset Management Asia, Citigroup, Goldman Sachs, property services firms CBRE and Jones Lang LaSalle, and the Hong Kong Investment Funds Association.

“The amendments ... will help to promote the growth of Hong Kong’s Reit market in a manner that protects investors’ interests and market confidence,” said Alexa Lam, SFC deputy chief executive.

They include various restrictions. Investment in development projects cannot exceed 10% of a Reit’s gross asset value (GAV), and completed projects must be held for at least two years. Further, at least 75% of a Reit’s GAV must comprise property assets that generate recurrent rental income. Investment in vacant land is prohibited.

A few respondents to the consultation process suggested that no investment cap should be imposed at all, or that a higher threshold should be implemented.

“The SFC is striking a balance that ensures Reits focus overwhelmingly on generating passive rental income while helping them better manage capital and achieve organic growth by participating in development projects,” said Verwer.

For investment in financial instruments, the combined value of relevant investments and other non-real estate investments should not exceed 25% of GAV, hedging instruments excluded. Investments in such instruments should not result in any material change in the overall risk profile of the Reit, the SFC said.

Several respondents, including two Reit managers, disagreed with allowing investment in financial instruments, citing lack of expertise of managers and the potential to engage in high-risk, speculative investments.

“It is generally expected that Reit managers should not invest in any high-risk, speculative or complex financial instruments or structured products, or enter into any securities lending, repurchase transactions or other similar over-the-counter transactions,” the SFC said.

“There are people for the amendments and some [who are more conservative],” said Stephen Chan, associate at law firm Latham & Watkins in Hong Kong, when the proposals were published. “The SFC took into account the people for and against, and I think it’s sensible to impose the thresholds.”

Hong Kong’s stock exchange currently lists nine Reits. The first to be listed was the Link Reit in November 2005, which was established by the Hong Kong Housing Authority and is now Asia’s largest by market capitalisation. Several products listed in Hong Kong have large allocations to China and are seen as a way to access the mainland’s property market.

The SFC first regulated Reits in July 2003 and amended the rules governing them in 2005, 2007 and 2010.