Since the H-Reit market opened in 2003, Hong Kong has seen an average of less than one Reit listing a year — despite a thriving property sector and the fact that the city's stock market is the largest and most liquid in the region.
Bankers largely put this down to unfavourable tax regulations. H-Reits are subject to a 16.5% profit tax. Combined with an 8.5% stamp duty charged on the transfer of assets, this means an H-Reit’s chance of pricing competitively all but disappears.
In Singapore, on the other hand, Reits are exempt from rental income tax, there is a 2%-3% stamp duty remission on their purchases of assets, and the transfer of properties is not subject to the country’s 7% goods and services tax.
It is clear why companies tend to bypass Hong Kong and head straight for the Lion City.
But now, after months of being pestered to reconsider its conservative rules, the Securities and Futures Commission has started to listen. The regulator published a consultation paper on changes to H-Reit rules, on January 27.
The proposed rules focus on increasing flexibility for H-Reit portfolio managers. The two main points are that they will be able to invest up to 10% of the Reit in properties under development, and up to 5% in financial instruments. At the moment, H-Reits can only include developed, income-generating properties.
However, while this increased flexibility would make the H-Reit market more attractive both to issuers and investors, issuers are still likely to make a beeline for Singapore unless Hong Kong embarks on tax reform.
It is the tax benefits that make these products so attractive to investors and make them a viable alternative to investing directly in real estate. Without tax breaks, the relative value of Reits falls, and as rates rise, investors will pay increasing attention to the returns of income products.
The SFC paper acknowledges that removing profit tax could be a good idea. However, it also states that, unlike in other jurisdictions, investors are not subject to dividend or capital gains tax in Hong Kong. This means that if profit tax was removed, H-Reits could become completely tax free.
This would be no bad thing. At the moment, Hong Kong’s conservative stance means it is missing out on a growing business opportunity. Between 2011 and 2021, assets in the Asian real estate market will grow by 160%, from $7.2tr to $19tr, according to the Asia Pacific Real Estate Association (APREA).
More importantly for Hong Kong, China is likely to drive this growth. The mainland property market should increase from $1.9tr to $9.7tr over the same period of time, according to APREA.
China accounts for 7% of the global investable real estate market, according to APREA, and this share should rise to 30% by 2031. There is no Reit market in China yet, which means that as the property market grows, Chinese companies will increasingly want to list property offshore. Hong Kong will be their natural first port of call.
Regional competition is also heating up, with regulators in countries including Thailand and India working to encourage Reits to list on their exchanges.
As the SFC itself has pointed out, the development of a Reit market is important in Hong Kong’s bid to become a leading asset management centre – both regionally and globally. But Hong Kong needs to act on tax if its wants to have the Reit stuff.