Practical measures to implement for REITs


Jeffrey Ng: Malaysian real estate investment trusts (M-REITs) may be one of the complementary solutions to help build long-term household equity and savings for Malaysians.

ACCORDING to the Employees Provident Fund (EPF), over 50% of contributors above the age of 54 have savings of below RM50, 000.

Considering that the average household expenditure in Malaysia is RM4, 534 per month, even if retirees were able to significantly reduce their expenditure to a stringent budget of RM500 per month (with 2% per annum long-term inflation rate), this means that over 50% of EPF contributors can only survive on their savings for 10 years.

This is even with 5% per annum dividends on their reducing savings.

M-REITs: A stable, highly regulated investment

With consistent quarterly/semi-annual income distribution and potential long-term capital upside, Malaysian real estate investment trusts (M-REITs) may be one of the complementary solutions to help build long-term household equity and savings for Malaysians.

As a highly regulated asset class, the high standards of corporate governance, transparency and disclosure requirements imposed on M-REITs provide additional protection for the interests of unitholders.

Over the years, the Securities Commission (SC) has been proactive in reviewing these regulations to ensure compliance and continued sustainability of the M-REITs industry in a dynamic environment.

A key example would be the inclusion of property development as a permissible investment in the SC Guidelines on Listed REITs, providing new options and opportunities for M-REITs to invest and grow.

That said, as the real estate landscape continues to evolve locally and internationally, some improvements in the regulations are necessary for M-REITs to keep up with the emerging trends and to remain competitive on the global stage.

Multiplier effects for the economy via the withholding tax exemption

In 2020, the 10% withholding tax on retail investors of M-REITs amounted to RM15.6mil, of which more than 97% or a RM15.2mil tax burden was shouldered by Malaysian residents in an especially difficult year amidst the ongoing pandemic.

As such, the exemption of the withholding tax on retail investors of M-REITs would boost the immediate household income received by Malaysian resident unitholders which could be reinvested, saved or spent on goods and services.

The increased consumer spending will lead to increased business income and employment.

This will, in turn, spur more spending, savings and investments in support of economic recovery and long-term growth.

Through the economic multiplier effect, this would create up to four times more economic value per annum (RM60mil), generating business, employment, income, investment and savings for Malaysians and creating new seeds of increased corporate income tax, personal income tax and sales and service tax (SST) for the government.

On top of the multiplier effect, the exemption of the withholding tax on retail investors of M-REITs would also enhance the awareness and robustness of the asset class, attracting more investments and reinvestments from local and international retail investors.

In the long term, this would encourage more listings of M-REITs, providing investors with more investment options and choices for diversification in the local capital market, growing the M-REIT industry platform and enlarging the base on which the economic multiplier effect could be applied.

Streamlining business structures to support the growth of M-REITs

In the real estate industry, joint venture (JV) structures involving special purpose vehicles (SPVs) are common as they enable mutually beneficial partnerships to embark on property development and investment projects. However, while the SC Guidelines on Listed REITs permit M-REITs to invest in real estate through SPVs, the assets owned via SPVs are not eligible for tax transparency (also known as tax exemption) on income received unlike assets under direct ownership of M-REITs, which income is tax-exempted as long as at least 90% of income is distributed to the unitholders.

This is compared to Singapore where tax transparency is streamlined across JVs (or more commonly known as sub-trusts) and direct ownership structures for S-REITs. This means that S-REITs will enjoy tax transparency for assets held via JVs and SPVs, allowing full flow-through of income to unitholders. This is crucial in providing practical options for REITs to form partnerships in developing and investing in real estate which may necessitate ownership via JVs and SPVs. This also opens up more opportunities for M-REITs to invest in larger-scale projects, reduce upfront capital commitments and diversify risk across different investments.

For example, instead of paying a purchase consideration of RM1 billion to own an asset, through a JV partnership, an M-REIT may invest RM500 million for 50% equity in the asset-holding SPV, reducing upfront capital commitments while reserving additional capital for other opportunities for diversification - avoiding placing all eggs in a single basket. Moreover, M-REITs may benefit from the synergistic sharing of knowledge, experience, costs and competitive advantages with the JV partner to optimise returns to unitholders.

However, under the current structure of taxation, if the asset is held via SPV with a JV partner, the M-REIT would be taxed at a rate of 24%, reducing the returns to unitholders as compared to directly owning the asset where tax transparency applies such that the full returns would be enjoyed by the unitholders.

How 1 + 1 can be equal to 3 (M&A as the New Horizon for Growth of M-REITs)

As with many industries, Mergers & Acquisitions (M&A) is a potential new horizon for growth for M-REITs. As the real estate landscape in Malaysia continues to develop and mature, M&As provide opportunities for M-REITs to consolidate and share expertise, experience, risks and synergies to reach greater heights.

In Singapore, M&As between S-REITs are common via Trust Scheme of Arrangement, with recent completed mergers of CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT) in 2020 as well as Ascott Residence Trust and Ascendas Hospitality Trust (A-HTrust) in 2019. Both of these mergers, at that time, resulted in two merged entities holding S$22.4 billion and S$7.6 billion worth of properties respectively, making them among the largest real estate investment trusts in Asia.

As such, M-REITs would greatly benefit from clear guidelines by regulators on merger by way of a merger of trusts to guide M&As moving forward, creating new merged and enhanced M-REITs with the necessary scale and scope to take on larger investments, developments and redevelopments across the country. The boost in financial and operational capability of the merged entity would also allow M-REITs to capitalise on new and emerging trends, attract international investments and compete on the global stage for the next phase of growth beyond the domestic market, bringing investment returns to Malaysia from assets across the world and revitalising the local capital market.

That said, as with any corporate exercise, not all M&A are perfect or smooth-sailing. To benefit from the synergies, many factors should be considered and aligned, including the asset portfolio composition, integration plans and strategies, cost savings and the interest of unitholders. A successful case study in the real estate industry would be the acquisition of I&P Group Sdn Bhd (I&P Group) by SP Setia in 2017, growing to become the 3rd largest property developer by landbank in Malaysia. The acquisition allowed SP Setia to tap into I&P Group’s diverse talent pool, strategic landbanks and customer base, enhancing value creation for the company, the real estate industry as well as the Malaysian economy.

Regulatory Transformation to promote Growth and Sustainability of M-REITs

As the saying goes, “The trees of tomorrow and the forests of the future, start with the seeds of transformation today” - the exemption of Withholding Tax on retail investors, tax transparency for asset-holding SPVs and mergers of trusts for M&As are a few key measures in facilitating a more conducive investment environment for M-REITs in Malaysia to attract retail participation, enable growth opportunities and enhance the continued vibrancy of the M-REIT industry and local capital market. As such, moving forward, regulators could review these guidelines and standards in line with emerging global trends to better support the growth of M-REITs in the new normal.

Dato’ Jeffrey Ng is the immediate past chairman of the Malaysian REIT Managers Association and CEO of Sunway REIT Management Sdn Bhd. The views expressed here are his own.

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