The iShares FTSE EPRA/NAREIT Asia Property Yield ETF provides exposure to listed real estate companies and real estate investment trusts (REITs) from developed Asian countries. The index showed a high degree of correlation to international stock markets over the last three years; hence diversification benefits appear limited. The index correlated 81% with the MSCI Pacific USD Index and 85% with the MSCI World USD Index over the last three years.
The ETF is perhaps most suitable for investors with a favourable outlook for the Asian real estate market, and Hong Kong in particular as the index allocates 38% of its value to real estate related equities in the city-state.
REITs tend to provide a consistent dividend yield for their shareholders, making an investment specifically interesting for income seeking investors. As of this writing, the current dividend yield is 3.6%.
Property ETFs offer investors exposure to a traditionally illiquid asset class that has historically exhibited stock-like returns and bond-like income streams. However, investors should be aware that direct property investments behave quite differently from investments via real estate funds; meaning that funds tend to have high correlations to stock markets and thereby limited diversification benefits for a portfolio. Nevertheless, real estate funds offer a few advantages for investors compared to a direct property investment, e.g. no required mortgage or maintenance are required and improved liquidity versus direct investment.
Going forward, it will be difficult for REITs to mirror their pre-crisis performance. During the last decade, REITs mainly benefited from increasing leverage, lower borrowing rates, rising property values, and strong growth in demand for properties. For now, the latest interest rate developments are supportive of real estate markets as many central banks around the globe continue to keep rates at historical lows. However, rates will eventually rise again which will increase REITs' cost of capital, pressure asset values, and reduce cash flow.
Due to a very strong final quarter in 2012, with investment volume increasing 47% q/q, the full year volume increased by 2% in 2012, reaching a total of $435bn globally according to Jones Lang LaSalle. Global volume has increased by around $100bn in each of the last nine quarters – Q4 2012 being an exception on the upside – confirming that commercial property is through the recovery phase and has built a base for a positive long-term trend.
Geographically, the Americas showed the strongest growth in investment with an increase by 40% y/y to $64bn. In particular, investment volume in Mexico tripled to $4.4bn in 2012. Despite the fact that global direct commercial real estate volume increased only slightly by 2%, Jones Lang LaSalle argues that the structural shift evident in 2012 will remain and built during 2013 and beyond. In particular volume in the Americas is expected to grow by 15-20% in 2013.
Volume in the Asia Pacific region dropped slightly by 3% in 2012, with China (-26%) leading the way. For 2013, Jones Lang LaSalle expects volume to increase by 15% with sovereign wealth and pension funds deploying more capital in their home markets.
Listed property companies in Asia engage primarily in property development, the riskier business of the real estate industry, according to the National Association of Real Estate Investment Trusts, the industry trade group. REITs in mature markets tend to be more involved in owning and operating properties.
According to Jones Lang LaSalle, activity in Hong Kong increased by 2% in 2012 as government intervention to cool the market aimed at the residential sector are driving capital into the commercial sectors; in particular into strata-retail and strata-office units. Strata title property is a form of ownership where the individual owns a unit and a share of the common property. Residential, commercial, industrial and other types of buildings can be subdivided into different strata plans.
Australia, the second largest country exposure within this ETF’s benchmark of reference, continues to be a large investment market in the Asia Pacific region. Total investment activity in Australia has been mainly driven by international investors and is expected to continue to benefit from interest from offshore investors. Direct commercial real estate investment increased by 6% y/y in 2012.
Japan’s real estate market, the third largest country exposure within this ETF’s benchmark of reference, noticed a significant interest from overseas buyers as well. As a result, direct commercial real estate investment increased by 6% y/y in 2012 to reach $21.3bn.
The FTSE EPRA/NAREIT Developed Asia Dividend + Index offers exposure to listed real estate companies and Real Estate Investment Trusts (REITs) from developed Asian countries. The index is a free-float market capitalisation weighted index. Eligible securities must have a one-year forecast dividend yield of at least 2%. Constituents must pass a series of liquidity tests on two consecutive quarterly reviews before included in the index. As of writing, the index is heavily biased towards by Hong Kong (38%), followed by Australia (31%) and Japan (19%). The biggest single issuer exposure is Westfield Group (9%).
The iShares FTSE EPRA/NAREIT Asia Property Yield ETF uses physical replication to track its reference index. The fund intends to invest in all of the constituents of the FTSE EPRA/NAREIT Developed Asia Dividend + Index in the same weightings as in the index.
iShares may engage in securities lending within this fund to generate additional revenues for the fund. The lending revenues generated from this activity are split 60/40 between the fund and the lending agent BlackRock, whereby BlackRock covers the costs involved. To protect the fund from a borrower’s default, BlackRock takes collateral greater than the loan value. Collateral levels vary from 102.5% to 112% of the value of securities on loan, depending on the assets provided by the borrower as collateral. Additional counterparty risk mitigation measures include borrower default indemnification. Specifically, BlackRock commits to replace the securities that a borrower would fail to return. The indemnification arrangement is subject to changes, and in some cases without notice. Finally, BackRock limits the amount of assets that can be lent out by this ETF at 50%.Cash received as dividends from the underlying stocks is held in the fund’s income account until it is distributed to fund holders. Distributions are made on a quarterly basis. This dividend treatment can potentially create a drag on returns in upward trending markets as dividends are not reinvested into the fund. In practice this cuts both ways. It could also result in outperformance if the benchmark falls in the interim period.
The fund levies a total expense ratio (TER) of 0.59%. This lies at the lower end of the range for ETFs tracking Asian property indices. Other potential costs associated with holding this fund which are not included in the TER include rebalancing costs, bid-ask spreads and brokerage fees.
As of writing, there are three other ETFs tracking Asian real estate-related equities. The largest one in terms of total assets under management is also from iShares and tracks the STOXX Asia/Pac 600 Real Estate Index. This ETF uses full replication, levies a TER of 0.72% and provides less exposure to Australia and Hong Kong in favour of Japan. Investors with a strong preference for exposure to Hong Kong and specifically looking to exclude Japan will find the Lyxor ETF MSCI AC Asia ex Japan Real Estate ETF of interest. The ETF from Lyxor uses synthetic replication and levies a TER of 0.65%.