Reits look good, for now

[Musicwhiz]

Personally, an ideal business trust would be one that pays down its loans consistently with a portion of the cash-flow it generated.

Maybe "ideal" in this case would refer to a "balanced" business trust model whereby unit holders are given a fair and decent return on their investment, yet the Trust also pays down a fair portion of its debt. This can, admittedly, be a delicate balancing act. And who's to say that it will be easy for the Trust to refinance should the time come, or to negotiate for favourable rates when global interest rates rise?

[Nick]

Personally, an ideal business trust would be one that pays down its loans consistently with a portion of the cash-flow it generated.

Maybe "ideal" in this case would refer to a "balanced" business trust model whereby unit holders are given a fair and decent return on their investment, yet the Trust also pays down a fair portion of its debt. This can, admittedly, be a delicate balancing act. And who's to say that it will be easy for the Trust to refinance should the time come, or to negotiate for favourable rates when global interest rates rise?

I do agree with MW. The consistent refinancing puts the Trust at the mercy of the very volatile credit cycle. I always found it strange that a business trust would go all out to make its operation as anti-cycle as possible but seems to be more than willing to adopt a capital structure that involves rolling over 3-5 year loans on the back of very volatile asset valuation.

I always preferred a business trust with a long term amortizing loan with no loan covenant attached. It is far more 'anti-cyclical' in my opinion and presents a more sustainable investment. At the moment, I believe only Pacific Shipping Trust has adopted such a structure. It took a 10 year loan in 2006 with no LTV covenants and in return it pays down its loans quarterly. Sadly, REITs cannot adopt such a structure due to the 90% payout rule.

[d.o.g.]

Personally, an ideal business trust would be one that pays down its loans consistently with a portion of the cash-flow it generated.

Generally, no business trust will pay down its debts, because it is not in the interest of the trust manager to do so. The trust manager is paid as a percentage of assets, not equity. Therefore, the incentive is to borrow as much money as possible to raise the assets under management, thus raising fees, and never pay down the debt except under duress from banks.

An investor in a business trust has to understand that the trust structure is basically a packaging gimmick. It is given tax incentives by the authorities to encourage a more "sophisticated" capital market. Essentially, the original owner of the assets can enjoy tax savings if he owns the assets through a trust instead of within a normal corporate structure. With an IPO his ownership decreases, but he then enjoys the management fees. As a result he gains several advantages:

1. The management fees are economically an inflation-indexed annuity;
2. Partial asset divestment through the IPO raises cash for other higher-return projects;
3. Reduced ownership reduces the amount needed to fund a future rights issue; and
4. Trust distributions are taxed at a reduced rate (normally 10%)

Net-net, the overall income decreases slightly as the reduced share of trust income is partly offset by the management fees, but the potential liability decreases greatly. It is a huge risk-reward improvement.

Investors should not harbour any delusions that REITs are created primarily for their benefit. REITs are created first and foremost to help owners dispose of unwanted assets.

As a general rule, the best assets do not get sold into a REIT, they are held forever by the original owner. From a purely rational perspective, REITs are simply a convenient dumping ground to offload undesirable assets to a gullible public. An outright sale would be difficult since the buyer would likely do due diligence and negotiate a discount for lousy assets. But the public can be convinced to buy anything in a bull market. In fact very little convincing is needed - the public is happy to convince itself, especially in today's low-interest rate environment.

[Nick]

Personally, an ideal business trust would be one that pays down its loans consistently with a portion of the cash-flow it generated.

Generally, no business trust will pay down its debts, because it is not in the interest of the trust manager to do so. The trust manager is paid as a percentage of assets, not equity. Therefore, the incentive is to borrow as much money as possible to raise the assets under management, thus raising fees, and never pay down the debt except under duress from banks.

An investor in a business trust has to understand that the trust structure is basically a packaging gimmick. It is given tax incentives by the authorities to encourage a more "sophisticated" capital market. Essentially, the original owner of the assets can enjoy tax savings if he owns the assets through a trust instead of within a normal corporate structure. With an IPO his ownership decreases, but he then enjoys the management fees. As a result he gains several advantages:

1. The management fees are economically an inflation-indexed annuity;
2. Partial asset divestment through the IPO raises cash for other higher-return projects;
3. Reduced ownership reduces the amount needed to fund a future rights issue; and
4. Trust distributions are taxed at a reduced rate (normally 10%)

Net-net, the overall income decreases slightly as the reduced share of trust income is partly offset by the management fees, but the potential liability decreases greatly. It is a huge risk-reward improvement.

Investors should not harbour any delusions that REITs are created primarily for their benefit. REITs are created first and foremost to help owners dispose of unwanted assets.

As a general rule, the best assets do not get sold into a REIT, they are held forever by the original owner. From a purely rational perspective, REITs are simply a convenient dumping ground to offload undesirable assets to a gullible public. An outright sale would be difficult since the buyer would likely do due diligence and negotiate a discount for lousy assets. But the public can be convinced to buy anything in a bull market. In fact very little convincing is needed - the public is happy to convince itself, especially in today's low-interest rate environment.

Thanks for the very insightful reply. I guess this is rampant among sponsor-based business trust and its 'pipelines of assets' ready to be injected at a moment notice. And we have seen many new REITs IPO'ing recently at share prices which exceeds its NAV.

But how does this square with sponsor-less business trust ? I believe a few exist locally though the lack of acquisition visibility and big sponsor backing has made it difficult to grow ?

I do agree with the first part. It gives a very good insight why none of the listed business trust here (with the exception of PST) has paid down its debts. I guess it makes far more sense to invest in a REIT Manager instead !

[d.o.g.]

But how does this square with sponsor-less business trust ? I believe a few exist locally though the lack of acquisition visibility and big sponsor backing has made it difficult to grow ?

Sponsored trusts are created to help owners divest unwanted assets. The management fees are just a bonus.

Non-sponsored trusts are created primarily for the management fees.

Growth:

Since a trust seeks to grow by buying the type of assets it already owns, its own assets and unit price are likely to be marked down at the same time that bargains are available in the market. Therefore it can't buy these assets since its currency (its units) is also marked down. In a bull market its units are priced higher, but so are the targets, so we are back to square one.

This is true regardless of whether or not there is a sponsor. Where the sponsor can help is to market/hype the trust to get its units overvalued against the physical market e.g. if the cap rate in the market is 5% and the trust yields 4% then yield-accretive acquisitions can be done.

A sponsored trust can rely on the bigger marketing budget of its parent to help hype the units. A non-sponsored trust has only the limited resources of its trust manager. So all things being equal, the sponsored trust has a better chance of becoming overvalued and thus able to grow.

Ideally one would buy a sponsored trust at a low valuation. Then, while waiting for the hype/revaluation, one can still enjoy the higher dividend yield. The sponsor wants to unload their assets to the trust, so they have an interest in getting the trust units overvalued.

Of course, the sponsor's hype machine doesn't always work - see Hyflux Water Trust. The trust never traded at a sufficiently low yield to be able to overpay for projects from Hyflux. Eventually Hyflux decided to kill it and find a Japanese buyer for its projects instead. But due credit to Hyflux management for their intelligent attempt to (ab)use the capital markets.

I guess it makes far more sense to invest in a REIT Manager instead !

This is precisely why non-sponsored trusts exist - because people want to own a REIT manager. It is no accident that while there are plenty of listed REITs, there are very few listed REIT managers.

[flinger]

As a general rule, the best assets do not get sold into a REIT, they are held forever by the original owner. From a purely rational perspective, REITs are simply a convenient dumping ground to offload undesirable assets to a gullible public. An outright sale would be difficult since the buyer would likely do due diligence and negotiate a discount for lousy assets. But the public can be convinced to buy anything in a bull market. In fact very little convincing is needed - the public is happy to convince itself, especially in today's low-interest rate environment.

D.O.G., do you really believe that the purpose of REITS is purely for business to dump the "unwanted" assets to the public? All REITS purpose is this and nothing else?

All people who buy into REITS are basically gullible public who are been suckered into buying useless assets ?

Your advice is to all people is to don't buy REITS, they are all out to get you?

There is no reason why anyone should ever buy into REIT. All REITS are bad. They are an investment class to be avoided.

Am I correct in understanding what you are stating?

OR is there a right time to buy REITS? Or are there characteristics that a REIT should have that enables it to be a good buy?

REITS certainly are not no-risk investment or low risk investments , they certainly contain risks, but are they as bad as S-chips ;P ??

The risks are open similar to stocks, or am I wrong to compare them with stocks? Yes, they are different class and gain growth differently.

Some REITS carry more risk than others.

I would like to hear if you feel there are good aspects of REITS etc.

Appreciate your insightful replies as always.

[pianist]

hi flinger, i guess d.o.g. is not advising, but merely sharing with us his own personal view, and many of us including myself have benefited from this forum discussion.

for me i dun realli like reit for its cash-call which usually will reverse back/eat back all the reit distribution received by a reitholder..

[Nick]

Hi d.o.g,

Thanks for sharing your views on REITs. What are your opinions on the latest business trust structure - a property developer trust - which develops its own assets for rental or sale to other REITs. At the moment, there are only 3 such Trust namely Indiabulls, Ascendas India Trust and Treasury China Trust. Treasury China Trust is developing a logistic park in Beijing and an extension to its City Centre building and has hence forecasted a doubling of its revenue by 2012. Ai-Trust is building 3 properties which will be ready next year. Since they are developing their own assets, does it negate the risk of asset dumping from sponsors ? If they sell their structures, they can also recycle capital for new projects. But I guess it is highly risky as well with plenty of capital risk since the Trust is paying interest expense NOW for an asset that may generate cash-flow in the FUTURE. I guess it will be interesting to see a shipbuilding shipping trust haha ! Then again, some of the local shipbuilders build their own fleet and charter it out hmm.

Cheers,
Nick !

[dydx]

for me i dun realli like reit for its cash-call which usually will reverse back/eat back all the reit distribution received by a reitholder..

This to me is like many people - including many unsuspecting retirees - happily taking in their daily meals (the regular, predictable dividends from a Reit), and suddenly and unexpectedly, have to vomit out everything they have swallowed, plus their guts! This must be quite a painful experience!

[flinger]

hi flinger, i guess d.o.g. is not advising, but merely sharing with us his own personal view, and many of us including myself have benefited from this forum discussion.

for me i dun realli like reit for its cash-call which usually will reverse back/eat back all the reit distribution received by a reitholder..

Hi Pianist,

I agreed with exceptions. Cash calls are bad generally, but some cash calls can be good.

You mentioned about the reversal of the distributions/ dividends.

However, in my humble opinion, it might not be bad for everyone, depending on your purchase price, how much dividends/yield you have received, how much cash you have to outlay etc... your timeline for investment, your perspective on the reason for the cash call etc..

Some of the cash calls are just pure robbery. Some of the cash calls are actually good in my view, both valuing from the trust perspective as well as my own stocks perspective.

For example, I have sold some of the stocks after a cash call when the price of the reit went up to maintain my % for a particular REIT.

This led to my yield getting higher, as I recovered my cash outlay while reducing the amount I needed for holding the stocks. The yield got higher due to the lower total price.

So I think , it depends on a lot of factors. Just another point of view.

Oh, I strongly believe that REITS are not made for consumers to profit only ( as popular marketing material might put it ). It's a good easy way for companies to make money easily by fees etc.. But it does have some good things that you can use.

But isn't every business like that?