REITs could lose momentum: report

Taiwan's fledgling real estate investment trusts (REITs) may lose growth momentum as interest rates gradually rise and rental yields fall, according to a report released by the Taiwan Ratings Corp (中華信評) yesterday.

Taiwan Ratings is a local arm of Standard & Poor's Ratings Services.

The first three REITs -- issued by Fubon Financial Holding Co (富邦金控), Cathay Financial Holding Co (國泰金控) and Shin Kong Financial Holding Co (新光金控) last year -- were well received and each initial public offering (IPO) was significantly oversubscribed, raising a total of NT$30.8 billion (US$950.62 million), the report said.

Shin Kong No.1 REIT

Taiwan Ratings considers the quality of the assets of Shin Kong No.1 REIT to be the highest among the three listed REITs. Its assets include the Shinkong Jasper Tienmu building (52 percent of the portfolio), Tainan Shinkong Mitsukoshi building (28 percent) and two office buildings (20 percent).

The strong demand for REITs has been stimulated by the nation's low interest rate environment.

The weighted average deposit rate in the banking sector hit bottom at 1.14 percent in the third quarter of 2004 from 4.62 percent in the first quarter of 2001. Although it increased slightly to 1.3 percent in the third quarter last year, the rate remains at the low end of the cycle.

In sharp contrast, the estimated dividend yields on the first three REITs are between 4 percent and 5 percent, making them one of the most popular investment vehicles in the country.

However, the central bank started lifting interest rates in October 2004 and had raised its discount rate by 87.5 basis points to 2.25 percent as of Dec. 23 last year.

"Rising interest rates will narrow the yield spread between REITs and other fixed-income products and, accordingly, demand is likely to weaken for these real estate investment vehicles," analysts Daniel Hsiao (蕭黎明) and Tony Tsai (蔡東松) wrote in the report.

Falling rental yields could also reduce demand for the nascent investment tool, they added.

The average rental yield on office buildings in Taipei dropped to 5.3 percent in 2004, from more than 6 percent in 2003. Although the average price of office buildings is expected to continue to rise over the short-to-medium term, rental yields are likely to trend further south over the same timeframe, making it more difficult to launch new REITs.

Regulators

As regulators are pondering revising rules governing REITs, the credit rating firm noted that allowing REITs to reopen to raise equity and invest in yet-to-be-completed real estate projects would represent a positive development as it would enhance financial flexibility.

Taiwan Ratings expects the REIT market to grow over the short term despite rising interest rates and property prices, as the relatively slow pace of interest rate increases has resulted in a still-attractive yield spread for investors.

However, "continuous interest rate and property price hikes over the medium-to-long term is likely to eventually hurt demand for new REITs," the report noted.

The total market capitalization of the REIT sector in Asia was about US$80 billion in 2004.