Real Estate Investment Trust
A Real Estate Investment Trust ("REIT") is a collective investment scheme constituted as a trust that invests primarily (at least 75% of its gross asset value) in real estate with an aim to provide returns to investors derived from the recurrent rental income of the real estate (eg shopping malls, offices and hotels, etc.)
Following the amendments to the Code on Real Estate Investment Trusts with effect from 29 August 2014, a REIT is also allowed to invest (within specified limits) in:
- property development and related activities (up to 10% of the REIT’s gross asset value); and
- certain liquid financial instruments, including listed securities, unlisted debt securities, government and other public securities, and local or overseas property funds.
However, it should be noted that the total investments of the above together with other non-real estate assets of the REIT must not exceed 25% of the REIT’s gross asset value.
Unlike property stocks, a REIT that is authorised for sale in Hong Kong has the following characteristics and is required to:
- invest primarily in real estate that generates recurrent rental income;
- distribute to its investors as dividends each year an amount not less than 90% of its audited annual net income after tax;
- comply with a maximum borrowing limit of 45% of its gross asset value; and
- appoint an independent trustee to oversee the operation of the REIT and to hold the assets of the REIT in trust for the benefit of its investors as a REIT is constituted as a “trust” while a property stock is essentially a “company”
In addition, a REIT must:
- adhere to and uphold good corporate governance principles and best industry standards for all activities and transactions conducted in relation to the REIT;
- observe the relevant regulatory requirements applicable to connected party transactions (eg disclosure and holders’ approval requirements);
- keep investors informed of any material information pertaining to the REIT in a timely and transparent manner; and
- be listed on the Stock Exchange of Hong Kong.
Major risks of investing in REITs
- Investment risk: A REIT is an investment product. There is no guaranteed return of investment in a REIT and you may suffer from substantial losses of capital. The distributions received from a REIT may not be sufficient to recoup your loss of investment capital.
- Market risk: Investments in real estate are subject to the risk of the general economic conditions. Any cyclical economic factors may cause fluctuations in occupancy and rental rates of the real estate held by a REIT. This will in turn adversely affect the income derived by a REIT from its real estate investment.
- Concentration risk: Where a REIT relies on a single property to generate all of its revenue, any circumstance that adversely affects the operations or business of that single property, or its attractiveness to tenants, may adversely affect the revenue generated and the REIT will not have income from other property to mitigate any ensuing loss arising from such circumstance. A concentration of investment in a single property causes the REIT to be highly susceptible to the relevant real estate market conditions.
- Interest rate risk: Fluctuations in interest rates may increase the interest costs incurred by a REIT in respect of its borrowings and may have an adverse effect on the level of activity in the property market. The financial position of the REIT and its ability to make distributions may be adversely affected. Moreover, the trading price of the REIT units is likely to decline if there is an increase in interest rates.
- Distribution risk: The distributions of a REIT may be made out of capital. You should pay attention to the composition of distributions declared by a REIT (for example, the extent to which the distribution declared is composed of, and the types of, income and capital) as disclosed in the relevant results announcement and the financial reports of the REIT.
Risks associated with property development and related activities
Where a REIT is to undertake property development and related activities (subject to maximum cap of 10% of its gross asset value pursuant to the REIT Code), it may be subject to the following risks associated with property development:
- Construction risk: A REIT may be subject to various construction risks such as those associated with the pricing of the construction materials, sufficiency of construction expertise, quality and design of the construction works. There may also be delay in completing development projects.
- Time delay risk: Delay in construction projects may lead to increase in financing costs, as well as reduction and delay in revenue generation.
- Financing risk: A REIT may not be able to source and secure adequate financing to complete a development project. Increase in interest rates and liquidity shortage are examples of other financing risks that a REIT may be exposed to.
- Planning permit risk: A REIT may encounter delays in obtaining all necessary building approvals for development projects.
- Counterparty risk: Cooperation with other parties to carry out development projects may involve various counterparty risks such as the risk of default by contractors in performing their obligations.
- Market risk: Market environment may change between the commencement of the property development project and by the time when the project is completed. A REIT may be subject to various market risks such as fluctuations in rental yield and property value.
- Legal and regulatory risk: A REIT may be involved in disputes with parties in development projects which may lead to construction claims and litigations. In addition, a REIT may need to revise the original property development plan as local legislation, rules and regulations relating to property development may change, leading to extra cost and time needed for completion.
Risks associated with investment in financial instruments by a REIT
Investment involves risks. Where a REIT is to invest in financial instruments (subject to maximum cap of 25% of its gross asset value pursuant to the REIT Code), it may be subject to the following risks associated with investment in financial instruments:
- Investments in equity securities: The value of stocks will fluctuate in response to the activities and results of individual companies or as a result of general market and economic conditions. Learn more about the risks associated with investments in equity securities.
- Investments in debt securities: The value of debt securities will fluctuate depending on market interest rates, liquidity considerations and the credit quality of the issuer. Increase in interest rates, decrease in liquidity and decline in the credit quality of the issuer will adversely impact the value of these investments. Learn more about the risks associated with investments in debt securities.
- Investments in property funds: The value of property funds will fluctuate depending on the value of the underlying investments and general market and economic conditions. There is also no assurance that a property fund will achieve its investment objective and strategy. Depending on the nature of the funds, investments in property funds may also involve other risks including investment risk, market risk, concentration risk, interest rate risk, country/regional risk, management risk, liquidity risk, currency risk and credit/counterparty risk.
Getting more information about a REIT’s investments in property development and related activities and financial instruments
- Interim and annual reports: These reports will provide you with certain key information about these investments such as:
- summary of all investments in property development and related activities;
- summary of all investments in financial instruments that the REIT invests in; and
- extent (in percentage terms) to which the maximum investment limits to undertake property development and related activities and to invest in financial instruments respectively have been applied.
- Website of the REIT: The REIT’s website should contain the full investment portfolio of the financial instruments with the related key information (eg credit ratings of financial instruments) that the REIT invests in, which will be updated monthly.
- Announcements/circulars published on the websites of HKEx news and the REIT: You may also refer to announcements and circulars published on these websites from time to time by the REIT (eg when the REIT enters into a contract to invest in property development and related activities and when there is a delay in the project progress) for material information pertaining to the REIT’s investments.
Things to note for the REIT investor
You can buy and sell units of REITs like stocks. However, you should be aware that REITs may trade at a premium or discount to their respective net asset values.
As an investor of a REIT, you receive semi-annual and annual reports on the REIT to understand the REIT's operation and assets.
The REIT Code contains provisions which entitle its investors to vote on important issues such as:
- transactions where there are potential conflicts of interest between the REIT and its connected persons;
- sales of assets before the minimum holding period of two years;
- changes in the management company;
- new issues of units and merger of schemes.
In addition, before a REIT may make use of the flexibility to invest in property development and financial instruments pursuant to the REIT Code amendments which took effect on 29 August 2014, the REIT would have to first amend its existing investment scope set out in its constitutive documents. These amendments would require approval of the REIT’s unitholders by way of a special resolution.