ARA Asset Management

[mrEngineer]

There has been always one risk that I did not completely figure out on ARA: default risk

Given the current hot property trends in both residential and commercial, there will be bound to have one day it will collapse. When such a collapse occur, will ARA be not impacted?

The idea is often sold as ARA is an asset light company and capable of earning high ROE and getting fantastic growth rates.

Theorectically speaking, ARA manages the asset like Suntec Reits, Fortune, Dragon Funds etc. If revaluation is to occur during a property crash, it can be understood that ARA will be quite safe as the losers will be the investors that invest in these funds. However, ARA owns certain substantial holdings in these assets around 10-20% for strategic and investor confidence purposes. So during a crash, we will see a direct write off in b/s due to mark to market revaluation and impact on the profit statements as DPU decreases. On top of that, if the markdown is not managed properly, there might be a loss in reputation and legal lawsuits may ensue.

So is this risk correct? If so, has it being priced into the current market price?

Note: I am vested

[d.o.g.]

However, ARA owns certain substantial holdings in these assets around 10-20% for strategic and investor confidence purposes. So during a crash, we will see a direct write off in b/s due to mark to market revaluation and impact on the profit statements as DPU decreases. On top of that, if the markdown is not managed properly, there might be a loss in reputation and legal lawsuits may ensue.

ARA does not own meaningful stakes except in Suntec REIT and AmFIRST REIT. For the other REITs, the units it receives as fees are sold almost immediately for cash. So there is little direct impact in terms of balance sheet writedown.

ARA's fees derive from the total assets held by the REITs as well as the operating income derived thereon. Investment income (REIT distributions and REIT disposal gains) comprised less than 15% of revenues and less than 20% of profits in FY09.

In a recession, the assets suffer a writedown and rental income decreases, so ARA will be hit. However, unlike normal fund managers, the assets are sticky - REIT investors cannot redeem! So when the economy recovers, the income comes back very quickly.

[mrEngineer]

However, unlike normal fund managers, the assets are sticky - REIT investors cannot redeem! So when the economy recovers, the income comes back very quickly.

Thanks d.o.g for the explanation. Could explain further on the above statement? I do not really understand what is sticky assets and how does it allow income to recover quickly?

In your opinion, what are the other risks that might be interesting to look out for in the case of ARA? I am aware of some risks like John Lim and relationship with Cheung Kong, people management risk (no. of CEOs) and withdrawal/cash liquidity risk.

[d.o.g.]

I do not really understand what is sticky assets and how does it allow income to recover quickly?

Sticky assets means that the assets can't leave the manager. For ARA, no matter what happens, somebody has to own the REIT units. Investors can only sell to each other, they can't force the REIT to liquidate. As a result, since the REIT is still operating, it has to continue paying fees to ARA.

Since the REITs don't go away during a downturn, when the recovery comes the REITs are already there to benefit. The assets get revalued upwards (more fees to ARA) and the rental income also improves (more fees to ARA). So the loss of income is temporary - once the economy recovers the income returns, almost at the same time. Very high quality earnings.

In your opinion, what are the risks that might be interesting to look out for in the case of ARA?

ARA is paid by AUM. So there is a danger that it will make its REITs overpay (see: Suntec REIT and MBFC). In the long run this could sour REIT unitholders against the company, causing the REITs to trade at discounts, which would prevent further acquisitions. The company will still generate tons of cash - it just won't be able to grow that cash stream much if it gets too greedy too early.

And of course there is investment risk - if you pay too high a price for any business, no matter how fantastic, you probably won't do well even if the business does great.

[mrEngineer]

Sticky assets means that the assets can't leave the manager. For ARA, no matter what happens, somebody has to own the REIT units. Investors can only sell to each other, they can't force the REIT to liquidate. As a result, since the REIT is still operating, it has to continue paying fees to ARA.

Thanks! I did not consider before that REIT holders are unable to redeem/withdraw their units as like any other investment funds. This will enable to sustain the REITs at any time. In that case, the remaining risk left would be the inability of the manager to refinance debt properly. However it does not seem to be a problem for ARA team of managers.

ARA is paid by AUM. So there is a danger that it will make its REITs overpay (see: Suntec REIT and MBFC). In the long run this could sour REIT unitholders against the company, causing the REITs to trade at discounts, which would prevent further acquisitions. The company will still generate tons of cash - it just won't be able to grow that cash stream much if it gets too greedy too early.

Do you mean that when the REITs are trading at a discount, the low revalution surplus does not provide income for ARA or because poor ratings will be given to ARA managers / REITs and cause unattractive refinancing for ARA to make future acquistions?

I am also totally lost in your statement that it won't be able to grow cash stream much if it gets too greedy early. I am in the line of thoughts that there is a limit on the leverage that it can impose before becoming too large to manage effectively.

I am still uncomfortable with the ARA structure. It can just make lots of money without owning much of the real assets or without baring much risk. This is not typical in other industries of high risk leading to high returns. Essentially the barriers of entries are the reputation of ARA and John Lim relationship with Cheung Kong.

If one day, ARA relationship with Cheung Kong sours or Cheung Kong do not wish further develop properties and sell it to ARA subsequently, ARA might be left stranded as it currently does not have the expertise to develop properties on its own. I also wonder if one of ARA CEO decides to move out and compete directly with ARA head on by offering better management rates and lowering of rentals, would the barrier of entry really help ARA?

Lastly, I would like to thank d.o.g. for your valuable inputs. I have gained tremendously by just thinking deeper on the few points mentioned above. I really appreciate it.

[d.o.g.]

Do you mean that when the REITs are trading at a discount, the low revalution surplus does not provide income for ARA or because poor ratings will be given to ARA managers / REITs and cause unattractive refinancing for ARA to make future acquistions?

When the REITs trade at a discount they cannot make yield-accretive acquisitions. If the REIT is yielding 10% it can't buy a building yielding 9% because it would be yield-negative; unitholders would not want to fund the purchase. If the REITs don't buy then they can't grow. If they don't grow then ARA's income remains static, except that it still shares in the rental increases.

So if ARA makes the REITs overpay, the REITs may trade at discounts in future and further acquisitions will be difficult. They did push through a rights issue for Fortune REIT; that exercise destroyed a lot of unitholder value.

I am still uncomfortable with the ARA structure. It can just make lots of money without owning much of the real assets or without baring much risk. This is not typical in other industries of high risk leading to high returns.

Asset management is one of the industries that is truly low-risk, high-return. You can manage hotels, office buildings, condominiums, shopping malls, warehouses, ships, airports, ports, train stations etc. Even plain old money (which is of course the most flexible asset and hence usually the most fun). Investors supply assets, managers supply brains. The equity required is so low that it can be borrowed, thus ROE can be infinite.

The risk is borne by the investors, the returns are taken by the manager. That is why so many people try to run an asset management business, whether or not they actually have the skill to do so. In order to weed out the incompetents, investors typically require the manager to have a big part of their own wealth invested in the same assets. That way if the fund blows up the manager will go bust too.

barriers of entries are the reputation of ARA and John Lim relationship with Cheung Kong.

There is only one real barrier to entry: supply of buildings. Property managers can be hired. You can be famous, but if nobody will give you buildings to manage you still have no business. Cheung Kong gave its buildings to John to manage, in exchange for a 30% stake. ARA started life as a 70/30 JV.

If one day, ARA relationship with Cheung Kong sours or Cheung Kong do not wish further develop properties and sell it to ARA subsequently, ARA might be left stranded as it currently does not have the expertise to develop properties on its own.

ARA's Dragon Fund does do development. So the know-how already exists within ARA. Anyway, development is not rocket science. It is more know-who (to get first bite of good land/buildings) than know-how.

Cheung Kong needs the REITs as a vehicle to offload buildings it doesn't want. ARA serves a useful purpose to help manage the REITs. If Cheung Kong and John fall out, which is unlikely, the immediate impact is that the acquisition pipeline dries up. The existing revenue stream continues.

In theory Cheung Kong could appoint a new REIT manager, but in practice it is very difficult as you need to get majority (50% + 1) approval to change the REIT manager. It used to be near-impossible (75% approval), now it is merely very difficult. It would be simpler for Cheung Kong to just sell down its stakes in the REITs and walk away. After all, if it wanted the buildings so much it would never have sold them into a REIT to begin with.

I also wonder if one of ARA CEO decides to move out and compete directly with ARA head on by offering better management rates and lowering of rentals, would the barrier of entry really help ARA?

As pointed out above, it is very difficult to "steal" another firm's REIT management contract. Anyone who wants to start a REIT management firm had better have a committed supply of buildings lined up.

[wee]

Hi D.O.G.

Cheung Kong (CK) holds only 15% of ARA if I am not mistaken. Why do you think CK would want to share such a profitable business with John Lim and ARA, and not set up their own asset management business, just like capitaland / keppel land? They can probably list their own reit vehicles and not rely on ARA?

On a separate case, I am wondering if you have a view on the brokerage business in Singapore. I am vested in one of them (uob kay hian), which i have posted on. I hope to have a more balanced view on it (since I am probably bias due to the vested interest) and hence any comments you have on that thread would be greatly appreciated.

[d.o.g.]

Why do you think CK would want to share such a profitable business with John Lim and ARA, and not set up their own asset management business, just like capitaland / keppel land? They can probably list their own reit vehicles and not rely on ARA?

Good question. I couldn't get a straight answer either when I talked to some folks at Cheung Kong. Probably only the close associates of John Lim and Li Ka-Shing would know - and I doubt they would tell anybody.

[mrEngineer]

When the REITs trade at a discount they cannot make yield-accretive acquisitions. If the REIT is yielding 10% it can't buy a building yielding 9% because it would be yield-negative; unitholders would not want to fund the purchase. If the REITs don't buy then they can't grow. If they don't grow then ARA's income remains static, except that it still shares in the rental increases.

So if ARA makes the REITs overpay, the REITs may trade at discounts in future and further acquisitions will be difficult. They did push through a rights issue for Fortune REIT; that exercise destroyed a lot of unitholder value.

Icic. I finally get it now. Had been trying to understand it for the past few days. Thanks alot of sharing and answering my questions. I have learnt alot from this discussion!

There are no concerns during downturns as AUM are revalued downwards as well. In good times, as long ARA is able to focus to grow the rental and yields faster than AUM revaluation, investors would have no reason to trade down the REITs.

Next, I will study more on what are the risks involved with ADF funds. I got replies from the other forum that investors funds get writedown to $1 if they are unable or unwilling to cough up the next tranche. I wonder would there be any underlying risks then. hmm..

[d.o.g.]

Next, I will study more on what are the risks involved with ADF funds. I got replies from the other forum that investors funds get writedown to $1 if they are unable or unwilling to cough up the next tranche. I wonder would there be any underlying risks then. hmm..

The management said this "writedown to $1" thing at the AGM I attended.

The people running ADF get their bonus only when ADF earns a carried interest (profit sharing). So they have to make sure they don't screw up.

However, some of the past ADF investments seem to me like "buy and flip" transactions rather actual value-adding development or asset-enhancement work. For example, they bought 53 units in the Grange Infinite condo in 2008, and are now selling them off piecemeal. Cost was about $2,700 psf, and they are asking $3,200 psf. URA caveats lodged in the past 6 months indicate an average price of $2,900 psf, so either ADF hasn't sold any, or they have lowered their prices. I personally think they paid too much to begin with.