Hong Kong Proposes To Allow REITs

by Mary Swire, Tax-News.com, Hong Kong

11 March 2003

Following the Hong Kong government's announcement in last week's budget that it wanted to dispose of HK$112 billion worth of assets in the next five years, including HK$21 billion this year, the Securities and Futures Commission yesterday announced a proposal to allow fund companies, property developers and bodies such as the Housing Authority to launch real estate investment trusts (reits), making real estate assets directly available to retail investors.

SFC executive director Alexa Lam denied that the proposed code had been formulated to assist the government's privatisation plans, saying that several property developers and the Housing Authority had expressed interest in reits. ''We have planned for the new rules for more than a year after market participants requested that the commission study introducing reits to Hong Kong,'' she said.

Currently there is a ban on property fund products. Under the SFC proposal, the funds would only be allowed to invest in Hong Kong property, and would have to hold their investments for at least two years. The reits could also be listed on the stock market to allow investors to trade them like shares.

Says the government's consultation document:

'A REIT is a company or trust that is involved in the business of owning and managing property. In recent years, REITs have risen in importance in several major securities markets. Since the beginning of last year, industry practitioners have requested the Commission to consider the feasibility of introducing REITs in Hong Kong. In response, staff have conducted in-depth research on the regulatory experiences regarding REITs in a number of major financial markets, namely, the United States, Australia, Japan, Korea and Singapore.

'Chapter 7.14 of the Code on Unit Trusts and Mutual Funds clearly states that authorised funds are prohibited from investing in any type of real estate (including
buildings) or interests in real estate. However, in view of the development of real estate investment trusts overseas, the Commission believes that this is a good time to consider the possibility of introducing REITs to Hong Kong to allow investors access to a broader range of investment products.

' The Commission believes that given the unique features and investment characteristics of REITs, the most efficient and sensible way to introduce REITs in Hong Kong is to introduce a separate code to regulate REIT offerings. This code is designed to have a clearly defined, self-contained format and to provide both operational clarity and the flexibility for future expansion as the market evolves. The proposed Code is therefore the basic building block which lays the foundation for the future development of REITs in Hong Kong. The Commission will review and update the Code on a regular basis. The Commission foresees that there will be a learning period as the Commission and the market work together to develop this new investment product.

' In considering this new product and the relevant guidelines, one of our primary objectives is to ensure that sufficient investor safeguards are put in place. The
Commission believes these safeguards should include: -

• proper management experience and expertise;
• clear description of the scheme’s investment policy and objective(s);
• segregation of management and the safekeeping of assets;
• appropriate valuation methodology;
• adequate financial reporting;
• transparent and convenient exit mechanism;
• accurate, meaningful and timely disclosure of financial reports and scheme activities;
• and proper voting rights for investors on key issues relating to the interests of the
  REIT.

'In most of the major jurisdictions, specific investment guidelines are imposed on REITs that are marketed to the public. These investment restrictions usually include asset allocation criteria such as a minimum percentage of assets that must be invested in real estate or related assets; and a prohibition from investment in vacant land or property development projects.

'Given the unique investment nature and operational aspects of REITs, it is considered appropriate to draft a separate Code for the authorisation and regulation of REITs, called the Code on REITs. It should be noted that the proposed Code outlines the core requirements and basic framework for the authorisation of REITs. It is expected that as REITs gain acceptance among the Hong Kong investing public, the Code can be expanded or modified at a later stage in response to market development.

' The following paragraphs highlight the major proposals in the draft Code:

• Legal Structure of REITs: The Commission proposes that all REITs shall be structured in the form of a trust, to ensure clear segregation of assets of the REITs. In this regard, every REIT shall appoint a trustee that is functionally independent of the management company of the REIT, and that acts in the best interest of the unitholders.
• Responsibility and eligibility of Management Company of REITs: Since REITs are a new type of investment product in Hong Kong, local fund managers may not have expertise in managing REITs. However, given that there are two aspects to the management of REITs, namely fund management and property
  management, we propose that while the management company is to be responsible for the overall management of a REIT, it can delegate the property management function to a professionally qualified property manager. In doing so, the management company must carry out proper due diligence in the selection and on-going monitoring of its delegate.
  

'In terms of investment restrictions, it is proposed that a REIT shall:

• only invest in real estate in Hong Kong which is income generating;
• have a clear statement regarding its investment policy and its investment objectives;
• distribute 100% of its after tax income as dividend to unit holders;
• not hold non-income generating real estate in excess of 10% of the total net asset value of the scheme;
• not invest in vacant land or property development with the exception of refurbishment and renovation;
• hold its real estate for a period of no less than 2 years unless otherwise approved by its unit holders;
• not engage in investment in hotels or recreation parks which do not generate recurrent rental income;
• not borrow more than 35% of the total net asset value of the scheme; and
• only hold cash or cash equivalent, up to a maximum of 10% of the scheme’s total net asset value; and
• return excess cash to unitholders in accordance with the proposed Code requirement.

'In view of the illiquid nature of real estate, it is preferred that a REIT is listed on the Hong Kong Stock Exchange so that investors may divest from or invest in the REIT without impacting the cashflow or operations of the REIT.

'Under the existing listing regime in Hong Kong, collective investment schemes can be listed on the Hong Kong Stock Exchange under Chapter 20 of the Listing Rules. The Commission is currently working with the Hong Kong Exchange on means to streamline the listing procedure of a REIT authorized under the proposed Code. In the meantime, it is proposed that a REIT shall provide an annual redemption facility which allows redemption of up to 10% of the outstanding units of the REIT. Such redemption facility can be dispensed with once the REIT is listed.'

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