Analysing REITS

[weijian]

Excellent piece by Colin Tan on this and the REIT industry as a whole.....He writes in TODAY on a weekly basis on friday.


A decade on, REITs remain a mystery
by Colin Tan 04:45 AM Nov 25, 2011It has been a decade since real estate investment trusts (REITs) made their appearance on the Singapore bourse, but it appears many investors are still grappling to understand this asset class.

The REIT sector hit the headlines recently when K-REIT Asia's plans to buy 87.5 per cent of Ocean Financial Centre (OFC) and raise S$976 million through a rights issue to fund part of the cost was approved despite howls of protest by minority shareholders.

K-REIT Asia had earlier announced it would pay some S$1.57 billion to buy parent company Keppel Land's entire stake in the OFC office building. Keppel Land will book a net gain of about S$492.7 million from the sale.

It would be fair to say that the controversy would not have erupted if the once optimistic market sentiment in the office sector had not suddenly turned cold. Dissenting shareholders had questioned the historic high price paid for the purchase - especially at a time when the economy is slowing down.

The prime Grade A office building in Raffles Place has a tenure of 999 years and 850 years remaining on the lease. However, Keppel Land is selling its stake with only a 99-year lease. Excluding rental support from Keppel Land, the estimated sale price of OFC works out to S$2,380 per sq ft.

Leaving aside the equally contentious issue of independence for the time being, it must be said that REIT managers have mostly had to acquire their properties on the higher side of valuations if only because it is the only way they can get the owners to sell it to them.

A REIT can get a property on the cheap only when the owner is ignorant of its true market value or if it is a forced sale - many investors still do not realise this. At the same time, the REIT manager can only justify the acquisition to shareholders if it is yield-accretive. Otherwise, the REIT is better off not doing anything.

So, a spot of financial engineering is required to get it to be so. This will buy the REIT manager some time to get the asset to perform to expectations or for the market to turn around and justify the values. In a rising market, this is not a problem.

Otherwise, for the acquisition to be yield-accretive, the REIT will have to buy a property of lower quality or one with higher risk because such properties have higher yields.

As more properties in Singapore are acquired by the REITs, there will be fewer available on the market. As such, the asking price by the remaining landlords can only get higher. Given more time, it will become clear, if it is not so now, that the current model is not sustainable in the long run.

REITs are often presented as defensive plays as it relies on revenues generated from income-producing properties held in its portfolio. While it may be so in more mature economies, the situation is different in Singapore.

In mature economies, a typical portfolio of properties in a REIT is a lot more stable. The leases are longer, which means the payout is much more consistent. In Singapore, most REITs are on the acquisition trail and their portfolios are always expanding.

This may have to do with the existing reward structure - the payoff is better with acquisitions than getting the existing assets to perform better. Is this what the Monetary Authority of Singapore (MAS) intended when it drew up the regulatory framework for REITs?

There may be better justification for a hands-off approach in the early days when the industry was in its fledging stages and when the MAS needed to build up the industry.

However, as the recent K-REIT Asia controversy has highlighted, it may be time for further regulation, especially in the areas of independence and avoidance of conflict of interests.

Many times in the past, I had prodded journalists to look further into certain REIT issues but all have declined, citing a lack of understanding of the subject matter.

Also, as pointed out by one reader, most REIT unitholders are not sophisticated enough to look after their own interests because of their lack of understanding. Even a representative of an institutional fund I spoke to immediately after the K-REIT controversy erupted showed a lack of understanding of the issues. They simply trust the management to do the right thing.



Colin Tan is head of research and consultancy at Chesterton Suntec International.

[Musicwhiz]

Good article Weijian, thank you.

So I guess my next question would be - how many of us here truly understand how REITs work?

For myself, I only own a very small stake in Suntec REIT which I purchased immediately after the launch of it IPO (it was then only the third listed REIT back in Dec 2004). In the years since, I had never invested further in any REIT in Singapore as I do not understand the dynamics of the industry, and the intricate details of the debt:equity cocktail used to secure higher yields for unit-holders, as well as the valuations of the assets within their portfolios. What I do know is that most REITs are heavily leveraged in a rising property market (since 2006-2007, there has not been a major crash).

To me, this seems to indicate a calm before the storm (my personal views).

[weijian]

hi music whiz,
No problem. Colin Tan's articles drove a few truths into me, n i thought it should be shared with a wider audience here.

i do not know in depth about REITs. I just know that if i had a cash cow (parent), i would never give it up to others (my sponsored REIT), of course, unless i am mad or it is grossly overpriced.

[Musicwhiz]

hi music whiz,
No problem. Colin Tan's articles drove a few truths into me, n i thought it should be shared with a wider audience here.

i do not know in depth about REITs. I just know that if i had a cash cow (parent), i would never give it up to others (my sponsored REIT), of course, unless i am mad or it is grossly overpriced.

The way I see it - I am vested in Boustead and one of their aims is to be able to sell off their industrial leasehold properties to a REIT, thereby unlocking value for their shareholders. This would mean selling them at significantly above cost, of course. So what happens to the REIT's unitholders? Are they getting a good deal in that case? Boustead is already leasing out their properties for a decent rental yield, so if the REIT were to buy over at a higher price, obviously rental yield has to fall.

[Drizzt]

the laws have to penalize welfare for sponsors and reward performance for shareholders.

[header]

REITs serve a certain purpose for all parties:
1) for the sponsor: able to monitise the asset w/o losing control. They also will earn fee income
2) for REIT investor: able to earn rental income w/o having to manage the asset. A portfolio of asset will also enable better diversification.

In this case, the issue is whether the trust manager act in the interest of the REIT or the sponsor. Here, the whole incident may give a bad reputation to the Keppel group if not handle properly. I wonder which other companies the independent dirs of K-REIT sit?

[weijian]

The way I see it - I am vested in Boustead and one of their aims is to be able to sell off their industrial leasehold properties to a REIT, thereby unlocking value for their shareholders. This would mean selling them at significantly above cost, of course. So what happens to the REIT's unitholders? Are they getting a good deal in that case? Boustead is already leasing out their properties for a decent rental yield, so if the REIT were to buy over at a higher price, obviously rental yield has to fall.

When Boustead talked about 'unlocking value', did they mention it was to (1) sell at a high price, or (2) recycle the capital into other higher yielding projects?

The REIT unitholders will be made to believe it is a good deal....
As colin tan mentioned, with a little bit of financial engineering (use debt), the managers will show that their acqusition is yield accretive...

[Musicwhiz]

Hi Weijian,

Sorry if this is a bit OT (Boustead) - Management feels that the way to unlock value is to sell off the assets for substantially more than what they paid for, even if this means a recurring income stream is terminated. Of course, with the proceeds, they can then use the cash for more M&A ventures to further boost ROE.

[Qiaofeng]

REITs serve a certain purpose for all parties:
1) for the sponsor: able to monitise the asset w/o losing control. They also will earn fee income
2) for REIT investor: able to earn rental income w/o having to manage the asset. A portfolio of asset will also enable better diversification.

In this case, the issue is whether the trust manager act in the interest of the REIT or the sponsor. Here, the whole incident may give a bad reputation to the Keppel group if not handle properly. I wonder which other companies the independent dirs of K-REIT sit?

You have identified the issues correctly....
see
Blog
for My1cGibberish.

[KopiKat]

REITs serve a certain purpose for all parties:
1) for the sponsor: able to monitise the asset w/o losing control. They also will earn fee income
2) for REIT investor: able to earn rental income w/o having to manage the asset. A portfolio of asset will also enable better diversification.

In this case, the issue is whether the trust manager act in the interest of the REIT or the sponsor. Here, the whole incident may give a bad reputation to the Keppel group if not handle properly. I wonder which other companies the independent dirs of K-REIT sit?

You have identified the issues correctly....
see
Blog
for My1cGibberish.

The last time I checked (~1 year ago), Keppel Corp was directly / indirectly holding 76% of K-REIT. Keppel would have made their decision based on an overall net positive benefit to them as a sponsor cum shareholder.

But, in this particular case, with Keppel as a majority shareholder, IMO, the key issue is whether the minority shareholders' interest had been compromised.