Saturday, November 26, 2011

Reits, A Mystery?

The KReitAsia case has been discussed at length in BT by Wong Wei Kwong. The 3 main issues of Corporate Governance, viz the voting vs the polling process during the EGM, the incentive scheme for Reit managers, the independence of the IDs, were all correctly identified.

But, I guess  the KReitAsia issue has turned out to be a hot topic, so that some in the media wants their one-minute of fame. and  in TodayOnline , there is an article on Reits by Colin Tan  dated 25/11/2011 entitled  "A decade on, REITs remain a mystery".

Wow, what a eye-balls grabbing title; and coming from a property professional, I am quite baffled that he find Reits, a property "staple", a mystery!!

Contrary to the spirit of the BT article, which was to seek clarity and had a a value-add  in pointing to ways to improve Reits, as an asset class on SGX, Colin's article sought to mystify and muddy the Reit vehicle; in fact, the entire fleet of 23 listed Reit vehicles, at that.

First, lets start with the positives, what Colin got right.....
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 thinks that Reit holders, even IIs are not sophisticated enuff to understand the issues.
He probably pushed it too far....
The rest of the article is peppered with  serious assertions that are highly contentious and unsubstantiated.

Colin might be an expert. But he needs to back up his assertions which must be challenged!!

Excerpts... 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
This is a gross generalisation.
The property market is cyclical.
Reit managers acquire most properties at close to valuations.
Property prices rise and fall; subject to demand and supply, so do valuations.
Remember, property prices and rents are cyclical,  at any time there will always be valuation "gaps" and differing opinions creating opportunities for buy or sell.
Reit managers actually have the luxury to choose their timing so that they buy (only) in a down cycle, when assets are fairly priced or under-priced (hence, my objection to KReit timing for OFC's purchase), so long as the properties are reitable (able to be let out to good tenants and generate NPI  after Op Expenses and Interest charges) and that the Net Present Value of the DCF  exceeds valuations.

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.
Wow, unless the property is miniscule in size terms , which then means that it is not reitable, most  properties will be properly valued before sale. Many investors know this!!  Try taking a  property loan or a Refi, the banks will make U pay for a valuation, not to mention a SPA for a property.

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
Serious accusations!!
If the Reit manager do any of the 3 mentioned above:
1) A spot of financial engineering
2) Buy an asset of lower quality
3) Buy an asset  with higher risk,
 then that Reit is surely headed for disaster.
Of the 23 surviving Reits on the SGX, will Colin care to substantiate with just 1 example, which Reit Manager, do any of the above to get accretive yield?
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.

Sounds prophetic and self congratulatory.

Contradicts the point he, himself made earlier----- that Reits can only justify their acquisitions, if the DPU are accretive. Reits, can simply say "NO", if prices are too high.
I can cite many cases Katong Mall, Chinatown Mall, Yew Tee Point, Parc or Bugis Junction---- the landlords chose to sell becos of certain internal issues such as a change of strategy or biz direction. For 77 King Street that was acquired by KReit, the owner was a Greek, who had personality issues with the tenants and hence could not get the occupancy higher.

Reits is an asset class that has worked in many jurisdictions eg US, UK and Australia.
The model is sustainable and has worked;  the biz model can evolve as the size grows----- with AEI (Asset Enhancements), Development ( up to 10% of asset value), sale of Old Properties. There is also less need for cash calls as size evolves, since placements will be  smaller  and bite- sized, relative to the size of the evolved Reit (Kreit will become No 2 in size in SG)  and easier to find subscribers; after the growing pains.

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.

Is SG, not a maturing economy?
Colin should check out the WALE, before and after the acquisition  for most of the acquisitions by Temasek-linked Reits,  before he makes all the bold statements, above.
Almost all the Reits, I am vested in or know of ( i.e. with good sponsors), have no issues with consistent divd payouts.With the exception of some Reits hit by the Japanese triple whammy, most Reits have a stable portfolio of properties.

As a vested Property Professional, Colin should clarify
NOT sensationalise and mystify.

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