Analysing REITS

[weijian]

Let's do some math to confirm our hypothesis:

Let's assume a REIT has asset A (value=100, distribution=3, cap rate = 3%) and rest of assets (value=900, distribution=57, cap rate= 6.3%).

The profile of this REIT as below:
asset = 1000, debt = 400 (leverage = 40%, within limit)
equity = 600, market cap = 400
no. of shares = 600
NAV = 600/600 = 1
market price per share = 400/600 = 0.667 (0.667x of NAV)
yield = 60/400 = 15%, DPU = 60/600 = 0.1

One day, it sells asset A at valuation and hence locked in the low cap rate --> gets 100cash. Balance sheet becomes:
distribution = 57
asset = 900, debt = 400, cash = 100
equity = 600

Option 1: repays all to debt
distribution = 57
asset = 900, debt = 300 (leverage = 33%)
equity = 600, market cap = 400
no. of shares = 600
NAV = 600/600 = 1
yield = 57/400 = 14.3%, DPU = 57/600 = 0.095

Option 2: pays out all in the form of share buyback
distribution = 57
asset = 900, debt = 400 (44.4%, within limit)
equity = 500, market cap = 333 (assume similar 0.667x of equity)
no. of shares = 600 - 150 = 450 (100 will buy 150shares at market price=0.667)
NAV = 500/450 = 1.11
yield = 57/333 = 17%, DPU = 57/450 = 0.126
(post action, market cap will adjust upwards to reflect the better DPU and compress the yield)

The example above is simplistic in the sense that costs related to debt, trading and supply/demand mechanics are assumed to be zero. A few notes:

(1) From option1, as mentioned by ghchua, low debt is never what REIT managers want. As long as debt costs are low (as they were before 1H22), leveraging up always juices returns for all stakeholders. Of course, interest costs are not accounted here. If debt interest costs are higher than what the asset yields (low cap rate), then it probably make sense on a DPU basis to do so.

(2) It is entirely possible for REIT managers to divest assets and generate value at the same time. An example would be Option2 where assets are sold at valuation (hence low cap rates) when it is in contrast with the REIT's overall market valuation/yield. Sell dear and buy cheap always work. We could argue that this is a way for REIT managers to create value now. But of course, it generally wouldn't happen If divestment do happen, the better way is to use the proceeds from the low yielding asset to repay high interest debt now. Survive now and when times are right in the future, leverage up when your asset valuation starts increasing again. Probably much easier to ask banks than shareholders for money!

[ghchua]

Hi weijian,

There are some limitations with respect to unit buyback mandate. One important point to note is that there is a maximum limit of up to 10% of the total number of issued Units (excluding treasury Units and subsidiary holdings, if any) when passed at AGM. You can't simply just buy so much as shown in your example in one year, unless it is being executed over a few years. There are also some other restrictions in place like maximum price to buy, blackout period etc.

All in, it is not easy to simply just use all your divestment proceeds to do unit buyback to generate value for unitholders.

[weijian]

hi ghchua,
Let's have an option3 then.

Option 3: Pay out all as capital returns to a shareholder who owns 10shares (and the shareholder uses all the proceeds to buy more in the market)
distribution = 57
asset = 900, debt = 400 (44.4%, within limit)
equity = 500, market cap = 400 - 100 = 300
no. of shares = 600
NAV = 500/600 = 0.83
DPU = 57/600 = 0.095

Capital return per unit = 100/600 = 0.167
Market price per share after capital return = 0.667 - 0.167 = 0.5
Shareholder receives 1.66 from his 10units and buys 1.67/0.5 = 3.32units
Future dividend received by shareholder with 10 + 3.32 = 13.32units x 0.095 = 1.2654
Dividend received by shareholder with 10 units (ie. no action taken) = 10 x 0.1 = 1

The shareholder will eventually still gain more. Of course, this assumes the shareholder does his asset allocation correctly (REIT manager sell expensive and shareholder buy cheap). So "DPU reduction" with asset sales is not really a true worry in reality as value accretion will happen when proceeds are returned to shareholders via capital reduction/sharebuyback. The true worry is that the REIT manager's fees are dependent on AUM.

[CY09]

Option 3 is ideal but as mentioned lower AUM or lower distributable income will affect REIT manager's fee.

The REIT manager will want to lever as much as possible to add more assets. When bad times happen and banks dont want to finance, the solution is simple- raise money from unitholders or take loans with adverse conditions to the detriment of the unitholders. Elite commercial REIT was facing this possibility so it raised funds from shareholder to enter the loan negotiation on a stronger footing.

It's pretty easy to be a REIT manager in Singapore. What's more being voted out seems to be difficult as seen in the Sabana saga.

The solution is more regulation on the REIT industry in Singapore but this will affect our country's status as a financial hub.

[weijian]

It's pretty easy to be a REIT manager in Singapore. What's more being voted out seems to be difficult as seen in the Sabana saga.

The solution is more regulation on the REIT industry in Singapore but this will affect our country's status as a financial hub.

Hi CY09,

I thought the Sabana saga actually demonstrated that it is not hard for a REIT manager to be removed? Despite holding the largest stake in the REIT and allowed to vote, ESR, the parent of the REIT manager, was convincingly removed via a simple majority.

What's hard is changing the trust deed (a requirement to internalize the manager function) requiring >75% approval votes. It is a different ting with voting out the REIT manager. Don't be confused by Quarz Capital's attempt to conflate the two.

Finally, what do you mean by "more regulation on the REIT industry in Singapore"? Other countries generally have internal managers for REITs and Singapore does not - Does this difference means that Singapore has "less regulation"? As a matter of fact, Singapore probably has "more" regulation (or tighter) than others. Or from another standpoint, we could say that Singapore's stricter limits are self imposed and should be loosen to allow REITs a "freer reign" or bail out some of them!

More leverage means ability to compete

OCBC Bank analysts said the proposal to raise the leverage limit would give REITs fuel to compete with the other global REITs and grow their asset base.

Singapore and Hong Kong REITs have one of the stringiest debt caps in the world — both imposing a leverage limit of 45%. Malaysia imposes a 50% limit while Thailand allows up to 60% if the REIT has an investment-grade credit rating.

Belgium, Germany and the Netherlands have limits ranging from 60% to 66.25%. Meanwhile, the U.S., Canada, Australia, France and Japan do not impose any leverage limit. The UK also does not cap REIT debt but requires them to maintain a minimum interest coverage ratio (ICR) of 1.25 times.

https://www.reitasiapac.com/ocbc-safegua...be-raised/

[CY09]

Hi if I had the liberty to impose. These are the things I would do.

1) Valuers for properties will not be hired by REIT but picked among a pool of valuers SGX has. This would include prospective sales into a REIT

2) A two tier leverage limit where on good times, a lower leverage percentage is imposed. When recession comes, a higher leverage percentage is imposed. It can be any number but I feel this mechanism is better to protect unit holder

my worry now is frequently property are sold into the REIT at peak cycles, this could simply be due to a parent developer trying to maximize it's gains or that the REIT manager is trying to raise it's AUM/distributable income to the max. However when bad times come, the REIT is shown to be swimming naked or in breach of MAS regulatory limits.

[BigFatWhale]

Given the recent correction of S-Reits, we try to take a look to see if it is an optimal time to load.

Based on the spread to 10-year treasury and price-to-book of 0.8, coupled with the Fed's potential pivot for lower rates, we are of the view that it looks like a decent risk-reward investment at current levels.

Also, this is a US election year, so it increases the probability of a reduction of US interest rates.

Click here for the full article:

https://thebigfatwhale.com/are-singapore...ial-pivot/

[CY09]

Hi blue whale,

S-reits and SORA no longer seems to follow the Fed US risk free rates. Singapore sets its own interest rate even if MAS is violently saying it is not. Our daily SORA fluctuates and is not fixed like the Fed US rates.

The cap rates used by Singapore S reits especially office and retail has been rather low as well. If you look at office space reits, their cap rate is 3.25%-3.50%. This is lower than Singapore's SORA risk free rate of 3.7%. For retail, it is at 3.75%-4.25%.