A Real Estate Investment Trust (REIT) is a collective investment scheme constituted as a trust that invests primarily 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.). It may borrow up to 45% of its gross asset value and has to distribute at least 90% of its after tax net income in the form of dividend. Learn more about general features and risks of a REIT.
REITs investing in real estate located in mainland China
Each REIT is different. The types and location of real estate a REIT invests in and the way it holds the real estate may vary from one REIT to another. Currently, apart from those that hold real estate in Hong Kong, there are REITs that invest in real estate located in mainland China.
- Title to the real estate: The holding of real estate in mainland China by a REIT may take various forms. Foreign interest in real estate located in mainland China are generally held via a Sino-foreign cooperative joint venture (CJV), an equity joint venture or a wholly foreign-owned enterprise. While the land use rights granted is generally by way of agreement for a term of years, some of these grants may be renewable/extendable, while others may be finite and not renewable/extendable due to the nature, value or purpose of the land in question.
Where land use rights are held under a CJV, the land use rights would typically be granted for a finite term, and these rights would revert to the domestic partner in mainland China after the term of the CJV. In other words, the CJV and the foreign partner (being the REIT) have no reasonable expectation of being able to extend the term or obtain another grant of those land use rights. This is very different from the situation in Hong Kong where owners holding grants of land leases generally have an expectation that upon expiry of the lease term, they may, upon payment of a land premium, obtain an extension or renewal of the lease.
- Value of real estate under a finite term: If a REIT's interest in real estate has a finite term and no expectation of renewal or extension of the term, the value of the REIT's investment in the real estate will decrease over time and there will be no residual value at the end of the term. Any suggestion that an interest in real estate held to the end of the term would still provide value because of the expectation that the real estate would appreciate in value over time may be unsupportable.
- Continuity: A REIT that holds investments in mainland China land use rights through a CJV that only have a finite and non-renewable term and does not hold any other investments, may have to be de-authorized and delisted upon expiry of the CJV term, since it will no longer own any income generating real estate and it will not be able to meet the requirement under the Code on Real Estate Investment Trusts to remain to be authorized.
- Impact of a joint venture set-up: Where a REIT holds interest in real estate in mainland China through a joint venture company with other partner(s), decisions on issues, which may have significant impact on values of the underlying real estate, may also require the approval or consent of the other joint venture partners. If such approval or consent is not obtained, there may be material and adverse effect on the joint venture itself and material impact on the REIT. In addition, if the other joint venture partners breach the joint venture's constitutive documents, there may be material adverse impact on the REIT.
- Distributions: The amount of distributable income of a REIT is determined based on its profit determined under the Hong Kong Financial Reporting Standards (HKFRS) or International Financial Reporting Standards (IFRS). However, if a REIT holds real estate in mainland China through a special purpose vehicle established onshore, the accounts of such special purpose vehicle will be prepared in accordance with the generally accepted accounting principles in mainland China (PRC GAAP). In addition, the profit available for distribution by an entity established in mainland China is determined after transfers to statutory reserve funds as required by the laws and regulations in mainland China.
Due to differences in the accounting and legal requirements in mainland China, the profit available for distribution of the special purpose vehicle may be less than that of the REIT as determined under the HKFRS or IFRS, the REIT may need to borrow additional amounts, subject to the maximum limit on borrowings, to finance its distribution to unitholders. Any additional finance costs incurred in respect of these borrowings will reduce the profit available for distribution.
- Mainland China withholding tax on dividends: The dividend income of a foreign corporate investor received from an entity established in mainland China is subject to the withholding tax in mainland China and the current rate of such withholding tax is 10%. Depending on the availability of any tax treaty between the foreign corporate investor's jurisdiction and mainland China, such withholding tax may be subject to a preferential treatment where the taxation rate may be reduced. In any event, such taxation charge, if any, will reduce the profit available for distribution of a REIT holding real estate in mainland China. You should check the offering document of a REIT and understand the impact of the withholding tax. Also, the tax rate and policy are also subject to change.
REITs that are denominated and traded in renminbi
A renminbi REIT is a REIT, the units of which are denominated, traded and settled on the Stock Exchange of Hong Kong (SEHK) in renminbi. In general distributions from a renminbi REIT will be made in renminbi rather than Hong Kong dollars. You should pay attention to the following risks associated with the investment in renminbi REITs.
- Currency risk: Non renminbi-based investors may have to convert local currency into renminbi when investing in a renminbi REIT. You may also have to convert the dividends and the proceeds (received when selling your renminbi REIT units) back to your base currency. During these processes, you will incur currency conversion costs and be exposed to risk of fluctuation in the exchange rate of renminbi against your base currency.
Remember, like other foreign currencies, the exchange rate of renminbi may rise or fall. There is no guarantee that renminbi will not depreciate. Investment in a renminbi REIT shall not be used to bet on the appreciation of renminbi.
Furthermore, renminbi is not freely convertible and is subject to foreign exchange controls and restrictions.
- Liquidity risk: Renminbi REIT is listed on the SEHK and is denominated, traded and settled in renminbi. Unlike Hong Kong dollars denominated securities, there may not be a liquid or active market for trading of renminbi REIT units on the SEHK. Therefore, you may not be able to sell your REIT investment on a timely basis, or you may have to sell your units at a deep discount to the net asset value.
Also, the liquidity and trading price of the units of a renminbi REIT may be adversely affected given the limited availability of renminbi outside mainland China and the restrictions on the conversion of foreign currency into renminbi.
Hong Kong Exchanges and Clearing Limited (HKEx) has expanded the scope of its Renminbi Equity Trading Support Facility (TSF) to enable investors who have insufficient renminbi to buy renminbi-traded units of REITs in the secondary market with Hong Kong dollars. For details about this arrangement and the list of securities supported by the TSF, please refer to HKEx's website.
- Risk relating to distributions: Distributions of a renminbi REIT may be made in a currency other than renminbi if it is unable to source sufficient renminbi on satisfactory terms.
What factors should be considered before investing in REITs?
Like investing in any product, you should always understand the nature, investment objective, key features and inherent risks of REITs and assess whether these products are suitable for you in terms of your own investment needs and risk profile. Even though the REIT allows you to gain exposure to real estate market outside of Hong Kong, you will also be subject to investment risks associated with that market.
In addition, you should also note that renminbi REITs may not necessarily bring you benefits arising from appreciation in renminbi (if any).
When in doubt, please seek professional advice.