A game changer for the Philippine capital market
The hope is the first Reit IPO could revive activity in the equity market
10 Feb 2020 | Paul Sutcliffe
A DECADE since the passage of the Real Estate Investment Trust (Reit) Act, the Philippines is still waiting for the first Reit to be launched and listed in the local market. In the meantime, several of the country’s neighbours have launched their own successful Reit market, led by Singapore, which has over 40 Reits and property trusts. And in March, India opened its Reit market with the listing of the Embassy Office Parks Reit backed by global private equity firm Blackstone.
The primary reasons the Philippines wanted to launch Reits remain as relevant today as they did with the passage of the Reit Act by Congress in 2009, namely, the deepening of the local capital markets, the democratization of wealth - allowing retail investors to invest in stabilized income producing assets, using Reits to finance infrastructure, and the implementation of enabling legislation and regulations that would protect the investing public.
In terms of size, the Singapore Reit market is over US$71 billion in terms of market capitalization, followed by Hong Kong at US$50 billion, and Malaysia and Thailand have US$10 billion. Citing an analyst’s estimates of the potential of the Philippine Reit market, Ayala Land CFO, treasurer and chief compliance officer Augusto Bengzon says they estimate that the top four listed property developers have between US$8 billion to $24 billion in leasing assets that could be put into REITs, allowing the issuers to raise anywhere between US$3 billion to US$8 billion of capital from a new investor base.
The Reit is unique in the Philippines, compared to the usual new products and issuances of plain vanilla bonds or typical equity offerings, as it is somewhere in the middle between a fixed income and an equity. “It affords the stability, or the fixed income type of return, of a regular bond with the upside of an equity. For the Reit sponsor, it allows them to unlock the value of their underlying asset,” says Ryan Martin Tapia, president of China Bank Capital Corporation.
He notes that it’s not only domestic portfolio managers who have been looking forward to this product, but also a lot of international fund managers, who would want exposure to the Philippines through a less risky instrument. “They would probably gravitate towards this product, so it would generate a lot more activity from the local investors and attract foreign investors to redeploy some capital back to the Philippines,” Tapia adds.
For Paul Joseph Garcia, chief executive officer of Leechiu Management, the Reit is a game changer. “We are creating a new asset class and a new investment product for both retail and institutional investors that will also underpin new issuance activity in the market,” he points out. “And with the new asset class, it would likewise create a new kind of fund manager [in the Philippines].”
For portfolio managers in the Philippines, whether local or foreign, the only way they can actually invest in a real estate asset is to buy into a real estate listed company. However, Garcia says, the risk profile of buying into a listed property stock is not the same as buying a Reit - the risk-reward factor is not the same.
He adds: “From an investor point of view, Reit offers a potential yield that would be comparable, if not better, than a risk-free government bond or a corporate bond will give you. It also has a lower volatility compared to equity or risky asset, which we know is the best performing asset class on a 10-year to 20-year horizon, but in terms of the volatility, you can actually lose a lot of money in one year. So, you have the best of both worlds.”
As highlighted by Ephyro Luis Amatong, commissioner of the Securities and Exchange Commission (SEC), the two main contentious items that prevented the full realization of the Reit market are both related to tax, and the considerable incentives that are given to a Reit in terms of tax.
The first major barrier to the full implementation of the Reit, he says, was the interpretation of the Bureau of Internal Revenue (BIR) that assets which are being transferred into a Reit, in what would normally be considered a tax-free exchange, would be subject to value-added tax (VAT). That changed with Train (Tax Reform for Acceleration and Inclusion) Act 1 – it clarified that all tax-free exchanges are also VAT-free exchanges. “So now it is possible to transfer, without an additional VAT payment, real estate assets into a corporate vehicle such as a Reit,” he adds.
The other remaining hurdle is the still existing minimum public float requirement as per the rules of the SEC and the revenue regulations of the BIR, that a Reit, in order to benefit from the tax incentives, needs to have a public float of up to 67% within a three-year period. And the SEC recently issued for comment rules returning the public float level back to the minimum 33% as provided by law. “In so doing, we hope to remove that obstacle,” says Amatong.
At the same time, he explains, in order to address concerns raised by the Department of Finance and the BIR, and also to help build up the local capital market and the local economy, there is an accompanying requirement under the new implementing rules and regulations (IRR) for the sponsor/developer that contributes real estate property into a Reit to reinvest the proceeds that it generates from the Reit flotation in the Philippines within one year in either real estate or infrastructure projects.
Reit is another way for real estate developers, and other companies, to raise capital. Typically, the best way for a company to raise funds would have been to borrow from a bank, issue bonds or tap the equity capital market via an initial public offering (IPO), for instance. So, the question now for a lot of the developers, especially the private companies, is whether it would make sense for them to launch an IPO or just do a Reit listing.
“The reinvestment requirement allows us to recycle capital, and this will clearly benefit all of the issuers,” says Bengzon. “We have quality assets from which we can raise capital when we establish the REIT. And with the proceeds that we raise, we will redeploy them into other projects. In many ways, it also serves to take down the risk of real estate developers, so rather than relying on debt exclusively, they now have an option to raise equity, tapping another investor base looking for stabilized yields.”
Tapia notes: “Obviously, each has its own advantages. There are a lot of benefits with Reits, especially the tax savings that the parent company gets, but having an alternative to doing an outright IPO for your company also would have other benefits as well. So, that is something that is pretty prevalent in a lot of the developers and the real estate companies, which they will be tackling, especially with the Reit IRR being formalized by the end of the year.”
Ayala Land is looking to list the first Philippine Reit in the first quarter of 2020 with a listing of about US$500 million market cap. “In terms of issue size, the sweet spot that foreign investors will be looking at will be at least US$500 million in terms of market capitalization, with a public float of at least 33%,” says Bengzon.
By ushering in the local Reit market after a wait of ten years, both local fund managers and international investors alike will start to allocate a percentage of their portfolios to this new asset class. And in doing so, it would help the Philippines get their fledgling Reit industry and their capital markets on the road to catching up with the other developed regional markets sooner rather than later.