Introduction

In
26th October 2017, Bursa Malaysia has announced the newly launched
Real Estate Investment Trust (REIT) Index by Bursa Malaysia Berhad chief
executive, Datuk Seri Tajuddin Atan. He also said that the index will give
investors better access and clearer view of Malaysian REITs’ performance —
which has outperformed both benchmark KLCI and Property Index over the past
three years by 15% and 26% respectively. Tajuddin also did disclosed that this Index
will ultimately improve the depth and breadth as well as liquidity of REITs in
Malaysia, for future developments of by-products such as ETFs (Adam Aziz, 2017).

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According
to ARES Japan Property Index, a property index is a real estate investment
performance index, and generally shows the investment return in a certain
investment period. The Index is used as a reference when making decisions
concerning investing in real estate, as well as serves as an index to measure
and evaluate the investment result. (ARES Japan
Property Index, 2017). Certainly, the Index is comprised of three
elements which are the income return from rental income, the capital return
from changes in real estate value, and the total return of the two.

Purpose
of Property Index

Popularly,
there are three main advantages of the Index (ARES Japan Property Index,
2017).
First, the Index can be used to seize the trend of the real estate investment
market. Next, it could assist investors plan asset allocation and investment
strategy more effectively by quantitatively estimating volatility and yield
characteristics. Third, it might be used as a “Benchmark Index” to estimate
investment results and assess the performance of fund managers. Other than the
three advantages, the Index could measures the diversification characteristic
of the portfolio.

Dissimilarity
of Index from market price indicators

The
REIT Index is categorise as the performance indicator and calculated from
income and capital appreciation gained in a certain investment period. It
demonstrates the performance of real estate investment in the period. On the contrary,
there are other indices like price index and rent index in the real estate
market. However, these indices are classified as price indicator based on the
market price, and different from the REIT Index.

Dissimilarity
of Index from securities indices

In
the case of securities investment including stocks and bonds, a group of
securities (called a universe) that can be available for investment from the
perspective of liquidity is designated, and the indicator compiled from the
average return of the universe serves as the index. Investors decide on the
asset allocation after considering a combination of the expected return and volatility
based on the index. Investors’ performance is measured by the relative
assessment of the index.

Contrary
to that, in the case of real estate investment, real estate cannot be transacted
in the same way as is the case with securities products and it’s not regularly
traded. Therefore, in the real estate investment, it is impossible for
investors to construct the same portfolio as the designated composite of the
universe as securities investment.

 

 

Property
Index

Property
Index is the index measured from the universe of income-producing properties
owned by core real estate funds mainly for institutional investors (ARES Japan Property Index,
2017).
Property index is a weighted-average index calculated by actual NOI data from
operating activities and capital appreciation data based on changes in the
external appraisal value.

Source: ARES Japan Property Index 2017

 Capital
appreciation = The end of market value – The beginning of market value 

Property
Index is the performance index measured from weighted average income returns
and capital returns which are provided from unlisted private funds’ data and listed
REITs’ data.

As
for J-REITs, according to ARES, their REITs can be classified as “plain
core fund” and included in the Fund Index, as they are different from
REITs in other countries. J-REITs’ activities are regulatory restricted to be
rental businesses for the long-term investment. Besides, J-REITs disclose
actual NOI and external appraisal value by property twice a year. In addition, J-REITs’
loan to value ratio generally remains low.

On
the contrary, Malaysia REITs (M-REITs) has just begun implementing index in
REITS. According to Bursa Malaysia chief executive, he said that the new REITs
Index will attract more real estate players to enter the capital market, he
said, pointing to alternative REITs in the US, some of which with wider
portfolios  including exposure in
childcare or renewable energy (Adam Aziz, 2017).

Types of Property Index

Therefore,
there are many ways to determine the Index of property. The first one is
Monthly Index, next is Quarterly Return, Annual Return, Average Occupancy Rate,
and the last one is Average Monthly Rent. The performance index is calculated
based on the formula, taking into consideration the newly listed REITs will be
eligible for inclusion into the index three months after their initial public
offering date (Mahalingam, 2017).

1.     
Monthly
Index

The
formulas for this index are:

Present month’s index = previous month’s
index x (1 + present month’s monthly return)

Property Index total return = Property
Index income return + Property Index capital return

 This monthly index is based on the
“NCREIF Property Index” in the US in terms of calculation method and
the index is Beginning Market Value-weighted average monthly return of the
properties (REIT Indexes, 2017).

The
property index consists of three sets of figures. The first one is income
index, calculated using monthly income return; the second one is the capital
index, calculated using monthly capital return; and the third one is the total
index figure calculated using monthly total return.

2.     
Quarterly
Return

The
quarterly return is calculated based on a rate of change in property Index per
quarter. The formula of this return is:

Property
Index at the Present Quarter Ended    – 1 x 100 (%)

Property
Index at the Previous Quarter Ended

The
Property Index for Quarterly Return consists of Property Index Quarterly Income
Return, Quarterly Capital Return, and Quarterly Total Return, each of which is
presented as the non-annualized return for the relevant quarter.

Among
of these three Property Index quarterly return indices, Property Index quarterly
income return and Property Index quarterly capital return are calculated to
represent the quarterly rate of change in the Property Index. Meanwhile, Property
Index quarterly total return is explained as the sum of Property Index
quarterly income return and AJPI quarterly capital return.

3.     
Annual
Return

The
annual return is derived from the rate of change in the Property Index per
quarter. The formula is as follow:

Present
month’s Property Index    – 1 x 100 (%)

Year-ago
month’s Property Index

The AJPI annual return consists of AJPI
quarterly income return, AJPI quarterly capital return, and AJPI quarterly
total return.

AJPI annual income return and AJPI
annual capital return are calculated to represent the quarterly rate of change
in the AJPI. Meanwhile, AJPI annual total return is defined as the sum of AJPI
annual income return and AJPI annual capital return

 

4.     
Average Occupancy Rate

To find the average occupancy rate, the
formula is as follows:

Total leased area      x 100(%)

Total leasable area

In regards to the real estate owned by the
respective funds, monthly data gained when assuming the simple average data at
the end of the previous year and at the end of the current year are to be
continued every month during the current fiscal period and then calculate the
monthly data by taking the weighted average using the leasable area of
individually owned real estate for each month (denominator).

5.     
Average Monthly Rent

The average of monthly
rent is defined from the amount of rent paid per sq meter. The average can be
calculated through:

Gross rental income from leasing business

Total leased area

 

In
respect to the real estate owned by each J-REIT, the index value, calculated
using the actual value of the income from the leasing business in the current year
and the total leased area at the end of the current year, is assumed to be
maintained each month during the current year. Based on this, monthly data
consisting of the weighted average on the basis of the total leased area of the
individually owned real estate for each month is calculated.

It
also need to be taken into consideration that half-year data is converted into
monthly data.  Provided that the rent is calculated as the amount
including common expenses. In addition, income from parking lots, etc. is
included in the case of same properties. Please note that, since the ratio of
income from parking lots, etc. to income from leasing is 2-4%, this index
calculated on the basis of numerical values including such also has a
fluctuation band of about 2-4%. 

 

Dispute in the Construction of
Property Index

There
are some issues arise in the construction of Property Index as the result of
the characteristic of property and property market. According to (Ball, Lizieri, &
MacGregor, 1998),
the issues identified is defining the property market, property index represent
solely offices, shops and industrials which represent only 15% of the property
stock. Secondly, how are these property types be given weight? Is it based on
equal weightings or weight them by market value? In addition, the different
sample selections are used in the construction of different indices resulting
in different series that have different index values.

Furthermore,
the size of sample also influences the property specific risk contained in the
sample. The larger the sample, the greater the diversification but more costs
involved. Thus the sample size is a trade-off between accuracy and the removal
of property specific risk on one hand and the cost and availability of data on
the other. Moreover, the lack of a central trading market on property price
info also causing  difficulties to
compare the prices of a sample of prop on a regular or frequent basis. Besides,
the lack of price information on commercial property is due to traded
infrequently and with little info on finer details of the transactions. Thus, it
is not possible to construct transaction based indices for commercial prop
instead have to be appraisal based.

The
sixth one is the depreciation of property is handled differently by different
indices. Jones Lang La Salle  reflects
depreciation and refurbishment costs in their quarterly index while Hillier
Parker assume their hypothetical subject prop are all identical and ‘new’ with
no depreciation (JLL, 2017) (Hillier Parker, 1998)

Last
but not lease, arise issue regarding construction of property index is the smoothing
of property indices. Appraisal based indices for commercial properties are based
on valuations. Therefore, this can result in smoothing with the volatility of
the indices being lower than actual market values. In simpler words, the true volatility
is much higher for the de-smoothed indices. Thus, it tends to be worse for
monthly & quarterly series than annual series.  

Conclusion

As
Bursa Malaysia has announce the implementation of REITs Index, this can be a
new beginning for our local REITs to improve, diversify and offer investor a
wider opportunity in assessing their investment. It is a need for M-REITs to
follow NAREIT, A-REITs and J-REITs footsteps in order to attract investors and
provide such facilities to ease the decision making for investors. It’s been
reported that ss at Sept 30, 2017, the market capitalisation for REITs stood at
RM44bil compared with just RM5bil in 2007 (Mahalingam, 2017).  This shows that there are potential and
opportunity for local REITs to boom.