A new asset class: Underdeveloped so far, REITs have plenty of potential

Since real estate investment trusts (REITs) were given the legislative green light in 2007, Indonesia’s real estate market has boomed. With annual price increases that have regularly been among the world’s highest, coupled with heightened investor interest and a track record of strong economic growth, there has also been a widespread expectation that real estate could become a major asset class on the local stock exchange. Yet while the Indonesian Stock Exchange (IDX) features many property developers and construction firms in its main board’s property, real estate and building construction index, REITs are still under-represented.

Slow Start

In 2011, several years after the law allowing REITs was passed, the first application to set one up was received. The Kuala Lumpur-based Al Aqar Healthcare REIT, a sharia-compliant trust that owned two hospitals in Indonesia, became the first outfit to submit a proposal for such a trust. The decision to move into Indonesia was made because analysts and investors saw the country as having major potential for REITs, with an untapped market ready for development. In addition, a growing problem for the REITs in Kuala Lumpur and Singapore was the limited number of sizeable assets on offer there – a hitch that could be easily overcome, it was felt, by the addition of the large Indonesian market.

Indeed, a survey amongst Asia Pacific real estate professionals by the Trust Company and Baker & McKenzie conducted in 2011 showed Indonesia leaping ahead of Malaysia, Philippines, Taiwan, South Korea and Thailand as the market with the best prospects for real estate growth. In terms of potential opportunities for REITs, in 2011 the country also rose by more points in the survey than any other market in Asia Pacific, except for Malaysia. This confidence in the potential of the Indonesian real estate market had also been gathering steam thanks to the performance of two REITs that held major Indonesian property portfolios and ownership, yet which had chosen to list in Singapore – a market with a larger and more established board for REITs.

Scaling Up

Lippo Malls Indonesia Retail Trust (LMIR Trust, listed as SGX: D5IU) and First REIT (listed as SGX: AW9U) have both seen success in the Lion City. LMIR Trust was ranked amongst the largest REITs there in January 2014, with a market capitalisation of $789.56m, and at 8.5% had the second-highest dividend yield after Sabana REIT, a Singapore-based, sharia-compliant trust. LMIR Trust has most of its property portfolio in Indonesia, in the fast developing retail mall sector. Linked to Indonesia’s Lippo Group, a major conglomerate, via its sponsor, Lippo Karawaci, the REIT had eight malls and seven retail spaces within malls in its portfolio in February 2014. According to its year-end 2013 results, occupancy in the trust’s retail space was around 95%, with gross rental income up 16.5%, year-on-year. The REIT’s retail locations are well chosen, in Jakarta and Bandung on Java and Medan on Sumatra.

Yet the group did take a knock from the depreciating rupiah in 2013, as it held debts in Singaporean dollars, which appreciated by 15.4% against the rupiah in the fourth quarter of 2013. Nonetheless, the current moratorium on construction of shopping malls in Jakarta, which is likely to squeeze supply and limit competition, along with underlying trends, such as the growth of the Indonesian middle class, per capita incomes and urbanisation, will likely see LMIR Trust continue to be a reliable pick in 2014 and beyond.

First REIT, meanwhile, is also sponsored by Lippo Karawaci, but operates in the health care and hospitality sectors, with a portfolio of 14 properties, 10 of which are in Indonesia. In March 2014 First REIT also announced plans to purchase Purimas Elok Asri’s Siloam Hospitals Purwakarta (SHPW), for $24.62m. This would boost the trust’s portfolio to 15 properties, with many of its Indonesian assets already Siloam hospitals, located in places like Bali and Makassar, as well as on Java.

Expanding

Purwakarta, a city in West Java, is a growing regency capital. As Jakarta becomes overcrowded, secondary cities are becoming a greater draw for businesses across the island, with demand for quality health care outside of the capital one side effect. At the same time, the health sector is also benefitting from higher per capita incomes, economic and population growth, and urbanisation unconnected to Jakarta, with secondary cities developing all over Indonesia. The acquisition should boost First REIT’s asset base to some $865.82m, from its current $834.05m. The company’s distribution yield in March 2014 was 7.03%.

Small Hold

Yet despite success across the water, back home REITs continue to be under-represented for a real estate market that has recently shown such dynamism. In February 2014 only one REIT was recorded as trading on the IDX, DIRE Ciptadana Properti Ritel Indonesia. DIRE Ciptadana is also the first REIT to be offered in the country and focuses on retail real estate. The question remains, why, to date, REITs have not secured a stronger foothold in the Indonesian market. Part of the answer lies in the response to questions from The Jakarta Globe given by Al Aqar Healthcare REIT’s executive director, Yusaini Sidek, in May 2012. He reportedly said that his trust would consider opening in Indonesia provided there were clearer rules on foreign ownership of land and tax incentives.

Legislation

Regulatory issues are thus key to unlocking the potential. The Trust Company and Baker & McKenzie report highlighted the same point, when its respondents ranked Indonesia last in Asia Pacific when it came to assessing how supportive the regulator was to new REITs. The law on foreign ownership of land and real estate remains restrictive in comparison to other regional peers (see overview). Title is often limited to leases granting the right to use, cultivate or build on a plot for a period of 20-25 years, or purchase can be made via local proxies or by Indonesian registered companies. For many investors, this is not as satisfactory as the clearer rights to title available elsewhere. When it comes to taxes, Singapore also operates a system under which taxes are only imposed on trust income not disbursed to unit holders. Additionally, as in Malaysia, no stamp duty charges are imposed on the transfer of assets between approved trusts. Thus, while Indonesia passed the necessary laws to establish REITs in 2007, some analysts feel that for such trusts to take off, similar tax and other incentive regimes also need to be applied by Jakarta. Without these, REITs may prefer to continue listing in neighbouring countries.

The strength of the sharia-compliant markets – in Malaysia in particular, as well as Singapore – may also draw international REITs, given that sharia-compliant trusts and securities remain relatively undeveloped in Indonesia, while some of the world’s biggest REITs are from Islamic countries, such as Malaysia and the Gulf.

Asia Pacific has seen some spectacular growth in REITs over the last decade, becoming the world’s second largest market for REITs after North America. There is still much room for expansion, too, with Indonesia likely to be one of the top picks for investors in the region, once the regulatory issues have been ironed out.