Opening Address by Mr Shane Tregillis, Deputy Managing Director (Market Conduct), MAS, at the Real Estate Investment World Asia 2005, 4th Annual Conference, The Grand Hyatt, Singapore, 27th June 2005
An Update on the Regulatory Environment for Real Estate Investment Trusts in Singapore
1 Good morning, ladies and gentlemen. I am pleased to be here, in the company of many experts from the Real Estate Investment Trusts (REITs) industry.
2 In the past decade, the global REIT market has registered healthy growth, particularly in the US and Australia. The success of the market in these countries has motivated Asian and European jurisdictions to facilitate their own REIT markets through judicious regulation and in some cases, tax incentives. For market players, prospects have never been brighter. This annual conference provides a good platform for interaction between the offerors, managers, investors and regulators of REITs.
Growing Importance as an Asset Class
3 REITs were first introduced in the US in 1960 as a means for the average investor to pool their capital for investment into large-scale income producing commercial properties. With major economies of the world experiencing a generally low interest rate environment in the past few years, it is no surprise that investors have rapidly embraced this asset class for its promise of a stable and relatively higher yield.
4 REITs are recognised as a product with many merits. They offer retail investors exposure to professionally managed real estate in a liquid and usually tax efficient vehicle. REITs have also found their way into the portfolios of institutional investors, such as insurers and pension funds, because they are considered to have low correlation with conventional asset classes. For companies, REITs provide an option to move property assets off their balance sheets and free up their capital for more efficient uses.
5 The history of REITs in Singapore is relatively short when compared to the more mature markets. But the REITs market here has developed quickly within a short period. Since the launch of the first REIT in July 2002, our market has grown strongly. Today, there are five REITs listed on the Singapore Exchange with an aggregate market capitalisation of about S$10 billion offering investors exposure to income streams from shopping malls, office buildings, industrial properties and car parks. I understand there are more launches in the pipeline.
Structural Differences between REITs and conventional unit trusts
6 In designing any regulatory structure, I consider that regulators must increasingly better understand the incentive structures that drive specific types of conduct, and misconduct, so that we seek to influence problems at their source rather than just continue treating only the symptoms. So in designing our regulatory regime for REITs, we have sought to examine the particular risks for investors involved in this type of product.
7 Let us look at some of the particular characteristics of REITs and what this means for the way in which we regulate them. By way of background, the five REITs in Singapore are constituted as unit trusts and are regulated under the Collective Investment Scheme regime. Despite being regulated under the same regime, REITs and conventional unit trusts investing in securities have some inherently different characteristics. Let me mention two.
8 First, while investors redeem unit trusts that invest in securities with the fund managers at their net asset value (NAV), investors can only liquidate their units in REITs on the stock exchange at the market price. As supply and demand as well as market sentiment plays a part in determining the market price of listed REITs, they usually do not trade at NAV.
9 Second, the nature of the underlying assets is markedly different. A much longer time is needed to divest properties compared to securities and the market for real estate is less liquid, efficient and transparent than it is for securities.
10 These differences make it necessary to customise the current regulatory framework for unit trusts to accommodate REITs so that investors' interests are adequately safeguarded. MAS recently reviewed our REIT regulatory regime to take into account international best practices and market developments. Our proposals are detailed in a consultation paper that was released two weeks ago.
11 In summary, our consultation proposals aim to better align the longer term interests of investors and REIT managers, augment the requirements for related party transactions and enhance disclosure requirements to better enable investors to make informed decisions. They also incorporate flexibility in key areas to accommodate domestic and overseas expansion by REITs.
12 I will briefly reiterate some of the key proposals and share our thinking behind them.
Licensing of REIT Managers
13 We propose to exercise greater oversight of managers of Singapore constituted REITs that are offered to retail investors. As REIT managers engage in the management of monies sourced from the public, the management of a REIT is akin to the conduct of fund management. Hence, a REIT manager should meet and maintain high standards of professionalism, competence and business conduct to discharge its fiduciary obligations to investors.
14 To achieve this, MAS proposes to subject REIT managers to the regulatory framework under the Securities and Futures Act. This requires REIT managers to maintain proper records, have adequate internal controls and employ competent and qualified professionals. Such professionals are expected to possess experience managing a portfolio of real estate properties.
Aligning the Interests of REIT managers and unitholders
15 REIT managers often structure their fees to include a percentage-based acquisition fee for the purchase of properties and another fee for their disposal. This is in addition to the general management fee usually set as a percentage of assets under management. We have some concerns that the presence of such transaction fees might provide an incentive for managers to churn properties or to buy or sell properties which may not add to the best long term value for investors. So we considered placing limits on the ability to charge such fees.
16 But, we have been told that placing a curb on the payment of such transaction fees might lead to REIT managers losing the incentive to actively source for yield accretive properties. It would also appear that institutional investors do not have a problem with such fees and that some even prefer this type of fee arrangement in comparison with the manager charging a higher overall management fee. Also as a practical matter trying to devise a detailed regulatory regime to determine the type of fees that are acceptable would be difficult.
17 Accordingly, MAS proposes to require the disclosure in dollar value of the acquisition or divestment fee payable to the REIT manager and the expected incremental income for the REIT when it acquires a property. The enhanced disclosure of these fees will allow investors to make an informed decision. We are also proposing in our consultation paper that the fee be paid to the manger in the form of units. This will help better align the interests of the manager with those of other unitholders when assessing the value of acquiring the specific properties. As a general matter, we expect trustees to scrutinise all transaction fees and other fee arrangements to satisfy themselves that they are consistent with the investors' interests and the fiduciary obligations of managers.
18 We have observed that after listing, many REITs continue to acquire properties from their sponsors. While a REIT manager currently is required to conduct related party transactions at arm's length, potential conflicts of interest are inherent in such transactions. These concerns are compounded by the subjective nature of property valuations.
19 Hence, MAS proposes to bolster the guidelines on interested party transactions by requiring the REIT to obtain two independent valuations of the properties to be bought or sold to these interested parties. One of these valuations should be commissioned by the trustee. In instances where unitholders' approval for the transaction is not needed, we propose requiring the trustee to provide a written confirmation that the terms are in unitholders' interests.
Enhanced Investment Guidelines
20 MAS has also taken the opportunity to review the investment guidelines to ensure that they remain current and provide sufficient operational flexibility for REITs.
21 As our market develops, REITs will increasingly look overseas for investment opportunities because there is a limited pool of properties that a REIT can acquire in Singapore. We are mindful that the laws and regulations in some jurisdictions may disallow 100% foreign ownership of properties. Another consideration is that it could be commercially expedient to enter into a joint venture with local partners who are more familiar with local conditions.
22 In order to facilitate these transactions while still protecting the interests of the REIT and its unitholders, MAS proposes a number of safeguards to address the risks of partial ownership of properties. These include requiring the REIT to have the veto power over key operational issues of the single purpose vehicle formed to hold the property, and agreeing upfront with the joint venture partners on the minimum percentage of profits that will be distributed to unitholders.
23 To provide our REITs with more investment discretion, we also propose to rationalise our position on property development. Currently, investing in an uncompleted property development is subject to a cap of 20% of a REITs deposited property, while property development, per se, is prohibited. Both activities entail similar risks as they involve anticipating future property market conditions.
24 Accordingly, MAS proposes to simplify these requirements and set a single limit of 10% for both property development and investing in uncompleted property development. REITs will be able to engage in the development of a property that it intends to hold in its portfolio when completed but subject to a 10% aggregate limit on such commitments to ensure that the REIT's exposure to non-income producing assets is limited. The cap serves to ensure that the REIT remains primarily a vehicle for holding income producing properties.
25 Any review would not be complete without discussing the borrowing limit.
26 MAS has received feedback from market players that the borrowing capacity of a REIT, particularly one which holds overseas properties is crucial. This is because the interest expenses incurred may be deducted from the REIT's income tax liability. This tax deductibility can have a significant effect on the profitability of a REIT that holds properties in jurisdictions with high income tax rates.
27 On the flipside, higher leverage brings with it a number of risks. Increased leverage results in higher debt servicing costs, which may have a significant impact on the REIT's distributions in a rising interest rate environment. A higher borrowing limit may also encourage the listing of properties that are only able to meet the yield expectations of the market by being highly leveraged.
28 We are also mindful of the impact that a property market slump can have on a highly leveraged REIT. Property markets are cyclical in nature. A highly leveraged REIT may be forced to liquidate property at the downturn of the market to meet interest payments. Such fire sales would be detrimental to unit holders and could increase downward pressure on property prices more generally in the relevant market.
29 In order to allow REITs some more flexibility in determining their debt ratios and simultaneously take into account the associated risks of increased leverage, MAS proposes to retain the current 35% borrowing limit where the REIT is not rated. A REIT may exceed the current 35% borrowing limit so long as it obtains and discloses a credit rating. We propose a cap on total borrowings of 60% of its deposited property. This is in contrast to the current guideline where there is no upper limit on borrowings if a REIT obtains a credit rating of at least "A".
30 The disclosure of a credit rating provides additional information to the marketplace. The valuation of the risks and returns involved in a property portfolio is complicated as it involves modeling multiple variables to determine likely cash flows. So a credit rating on the property portfolio imposes a market discipline on REITs managers and allows investors to make a more informed evaluation of the risks of their investment.
31 Collectively, these measures, when implemented, will further enhance our regulatory regime governing REITs. The proposals that I have highlighted are currently open for public consultation and MAS welcomes feedback from industry.
32 Besides fostering a robust regulatory regime, we also recognise the importance of being responsive to commercial needs.
33 Last year, the Singapore government announced further tax concessions for REITs players. The stamp duty on the transfer of Singapore properties into REITs was waived for a five year period. Any income derived from a REIT and paid to foreign institutional investors is now taxed at a concessionary 10% tax rate. These measures are in addition to the tax transparency that REITs already enjoy which allow REITs to be taxed at the investor rather than at the trust level.
34 In order to further support the growing REITs market, we are pleased to note that a group of regional real estate players have come together to set up the Asian Public Real Estate Association (APREA) in Singapore. APREA is modeled after similar initiatives in the US and Europe, where industry bodies such as the National Association of Real Estate Investment Trusts and the European Public Real Estate Association are instrumental in providing industry feedback towards the development of their REIT markets. MAS is confident that APREA will serve to better represent the needs of the listed real estate sector in the Asia Pacific and enhance the level of professionalism in real estate fund management. More significantly, the set up of APREA here is a strong affirmation that Singapore is now the location of choice for REITs in the Asia Pacific.
35 We are optimistic about the growth potential of the REITs market. We believe that REITs are on the cusp of developing into an important asset class in Singapore and the region.
36 But to sustain long term growth, we need to ensure we do not create "bubble" style expectations among investors that REITs are a capital growth product rather than one that can provide stable, long term yields. We also need to prevent the misuse of the REIT structure as a means to offload poor quality properties at inflated prices and minimise the use of perverse incentive structures for managers to acquire assets at any cost because of the fees generated. If we work together to ensure that our REIT market avoids these types of problems and is built on sound commercial and regulatory foundations, I am confident that REITs will occupy a significant and growing place in the region's financial markets.
37 To uphold our high standards of regulation and to keep pace with the market's growth, MAS will constantly keep our regulatory regime under active review. To this end, we are committed to continually actively engage industry players on issues of mutual interest.
38 I wish all of you a fruitful conference.