Hong Kong Residential Real Estate versus Stocks and REITS

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

March 2013

Bricks and mortar feel tangible, no?

To participate and invest in the Hong Kong real estate market, there are broadly two approaches:

A) The Direct Approach

1) Buy a property, be it residential, office, retail, industrial, or whatever one fancies

2) Become a real estate developer, and one not only benefits from rising prices where any, but also from creating value in the land e.g. via changing its land use or density

B) The Indirect Approach

1) Buy a real estate related stock e.g. Sun Hung Kai Properties (016)

2) Buy a REIT (Real Estate Investment Trust) e.g. the LINK (823)

Naturally, there are other more complicated approaches involving complex finances yet these are beyond the scope of this article and your humble author.

From time to time, one would find debates in news media among investors and commentators on which of the above approaches would offer better returns. Real estate agents tend to favor the bricks and mortar type while stocks traders would say equities offer better expense ratios especially if all the stamp duties are taken into account.

Out of curiosity, we have done a quick and dirty comparison between the two asset types i.e. the bricks and mortar real estate holdings versus the paper equity real estate holdings:

a) Data sources = the bricks and mortar type is represented by the various residential indexes published by Centaline Property Agency and the real estate stock performances are abstracted from www.Webb-Site.com where the total return of each stock could now be found.

b) Time period = arbitrarily from 30^th December 2007 to 20^th January 2013 i.e. roughly 5 years in between.

c) Not exactly apples to apples = do note the bricks and mortar data are averages of the residential real estate sector and the stock performances are based on selected real estate stocks and REITS.

d) Technicalities = while the real estate rentals have been taken into account, they are not deemed to be poured back into the property because unlike stocks, one either buys a whole unit or nothing, i.e. one simply cannot use the net rents collected in a year to acquire a few more square feet of property. The stock performances assume the dividends are to be poured back to buy more of it.  

e) Total returns and compounded annual returns = the total returns for the bricks and mortar real estate have taken rental yields into account and for simplicity, we have assumed the average rental yield for the period and for all geographical regions to be 4% pa i.e. roughly 20% in total for the 5 year period. For stocks (including REITS), the total returns have included the dividend yields. Likewise, the compounded annual returns for both the brick and mortar and paper equity types have taken into account the rental yield and dividend yield respectively.

Observations

I) The bricks and mortar = the CCL reflects the overall Hong Kong residential real estate sector while HKI, KLN, NTE, and NTW represent Hong Kong Island, Kowloon, New Territories East, and New Territories West respectively. NTW offers the best total return during the period while HKI is the worst.

II) The paper equities = CKH stands for Cheung Kong Holdings and SHKP is Sun Hung Kai Properties, and both are amongst the popular and sizable property development stocks. The rest are the REITS, which dwell in mostly if not exclusively commercial properties, and one should also note that Yue Xie REIT (405) involves properties in Mainland China, not Hong Kong.

III) REITS offer better or competitive returns = the REITS as a group offer some of the best total and annual compounded returns [yellow color ones mean the returns are higher than any of the Centaline’s bricks and mortar indexes and beige color ones represent competitive returns compared to Centaline’s].  

As such, should one focus on investing in REITS?

Conclusion

The simple answer is: no, because this observation may only apply to the period and the items studied i.e. there is no proof beyond any doubt that REITS will at any time in any place do better than bricks and mortar, or vice versa. Your humble author thinks timing and reasoned selection of assets are (more) crucial.

Also, if one takes financing into the equation, then bricks and mortar generally offer better terms as mortgages are usually less expensive than say a personal loan.

Given that the REITS are heavily leaned toward commercial properties, and given the typical brick and mortar investor would find the residential sector easier to comprehend and participate, it makes sense for the typical investor to dwell in both to achieve an investment portfolio which offers some degree of:

i) Asset type (residential, office, retail, and so on) diversification (note: there is no market risk diversification by investing in both residential and commercial properties in Hong Kong because the price correlations between them are high)

ii) Recurrent income (rentals, dividends) diversification, not only in terms of sources but also in aspects of taxation e.g. rentals involve taxes while stock dividends do not for a Hong Kong resident

iii) Buy and sell flexibility i.e. stocks and REITS are easier to buy and sell (the latter action especially vital if the market goes down)

The risks are still alive and kicking but probably reduced.

Disclaimer: your humble author at the time of writing this analysis owns both bricks and mortar real estate and paper equity real estate including REITS.

Notes: The article and/or content contained herein are for general reference only and are not meant to substitute proper professional advice and/or due diligence. The author(s) and Zeppelin, including its staff, associates, consultants, executives and the like do not accept any responsibility or liability for losses, damages, claims and the like arising out of the use or reference to the content contained herein.    

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