|The following is a very timely article by BT's Wong Wei Kwong, dated 15/11/2011 entitled "Don't let Reits be the next wave of governance lapses ."|
SINGAPORE boasts of a thriving real estate investment trust or Reit sector, but recent events have served another reminder that beneath the glowing surface, there are some key fundamental concerns.
K-Reit Asia, last week, pushed through its plan to buy 87.5 per cent of Ocean Financial Centre (OFC), and raise some $976 million through a rights issue to fund part of the cost. It had earlier announced that it would pay some $1.57 billion to buy parent company Keppel Land's entire stake in the OFC office building. Keppel Land will see a net gain of about $492.7 million from the sale.
Put before shareholders for their approval at an extraordinary general meeting (EGM), the proposal ran into howls of protest. Shareholders questioned the stiff price and timing of the deal, at a time when the economy is facing a slowdown. Shareholders noted that while the prime Grade A office building in Raffles Place has a tenure of 999 years with 850 years remaining on the lease, KepLand is selling its stake with only a 99-year lease. Others questioned why K-Reit is paying its manager (which is owned by KepLand) an acquisition fee - even though it is buying the asset from its parent company.There were also rumblings about the independence of the manager.
In a nutshell, the EGM brought to the fore two key issues relating to Reits here that corporate governance advocates have been highlighting for some time:
This isn't the first time - and probably it won't be the last - that issues like these arise at a Reit. For some time now, there has been growing disquiet among corporate watchers about weaknesses in the corporate governance structures in Singapore Reits.
Earlier this year, a review of Asia-Pacific Reit markets by the CFA Institute produced less-than-assuring results. Looking at the governance of Reits in Singapore, Australia, Hong Kong and Japan, the institute in its report called strongly for Reit managers to be independent. In the current most common scenario, the Reit sponsor wholly owns the Reit manager, and also holds a large stake in the Reit.
And even before the latest K-Reit development, cases of sponsors selling properties to Reits have triggered concerns about conflict of interest, and unitholders have often questioned the purchase of these assets and how they were priced. The CFA Institute said that to better protect ordinary unitholders, most directors on the boards of Reit managers should be independent of management, sponsors and substantial unitholders. This should be made law, rather than just a best-practice guide.
There is also the need to have more transparent structures to pay Reit managers and to tie these more closely to performance, and indeed to require all Reits to hold annual meetings for unitholders.
Reits are often presented as defensive plays, and given their yield structures, there is some truth in this. But it would be unfortunate if investors buy into Reits for their relative safety just to have their interests as minorities undermined by weak corporate governance structures. If nothing is done, the Reit sector could be where the next wave of governance lapses emerge, and that would be a pity for a sector that has done quite well so far.
A stitch in time saves nine!!
Corporate Governance is an evolving process which needs the participation of all------- manager of the Reit, the Board of the Reit, majority shareholders (aka Sponsors), retail/minority Reit investors, not forgetting SGX and MAS; which encouraged and fostered the ecosystem for the growth of this important asset class.
In the Sg context, Reits can and must evolve into a class of shares in which conservative investors can look forward to regular recurrent dividends payouts (DPUs, DCFs) with relatively low risks and be de-risked from untimely "wants" for cash calls.
Note: I call it a "want" and not a "need", as it is often the sponsor/majority shareholder whom is the chief beneficiary and decides on the timing for the call. A well concieved Reit with good Reit-able tenants have the luxury of choosing the timing for acquisitions; it is the sponsor who needs to cash out at opportune situations.
Why Reits ?
The raison det're for Reits for the Sponsor/majority shareholders is that it allows monetisation of their assets and serve as a vehicle for recyling the monies; in short, as the last and most important component of the asset recycling model.
The raison det're for Reits for the minority/retail shareholders is that it serves as a defensive investment choice for regular DPUs, given that the Reits tenants are supposedly chosen to give safe recurrent incomes with locked in leases.
For the Asset recycling model to work, the Sponsors must not forget the investors at the end of the food-chain.
Hence, the Reit must acquire properties with good location, which have a stabilised portfolio of proven tenants (in terms of ability to pay), with a stabilised mix of tenants able to provide that mix of regular recurrent income net of operating expenses and interest charges which can then translate into accretive DPUs.
That said, it implies a period of incubation at the sponsor level, so that the rental profiles in terms of tenant mix, WALE, cost of borrowing and operating expenses are all quite stablilised.
As OFC is only 80% rented out at passing rentals of SGD 9psf with the remaining 20% subject to the uncertainty of the current Office rental mkts (buffeted by the woes of the Eurozone crisis), rental support is an artificiality ------- it is certainly not real as the tenants are not captured yet and is an attempt to substitute for (get around) the uncertainties with an explicit guarantee by the majority shareholders (aka Sponsors). One may ask, what if the returns that sponsor was seeking did not materialise, so that the sponsor herself falters and fails, and will be unable to cough out the guaranteed rental supports ?
Regulators may want to look at the validity and the use of such "Rental supports". How do they know that the sponsor will remain viable to keep their promissory "Rental supports"? What if the weaker sponsored Reits, also want a piece of this kind of "Rental supports" options/actions?
The issue is that the Sponsors themselves may have hidden agenda and entirely different motivations for unloading the property assets at such a time, completely unaligned to the Reit biz model.
Kepland, as the prime beneficiary could be trying to lock in the price of OFC before the downturn and eyeing the cash from the monetisation of OFC for certain "prizes" that they want to capture in a mkt downturn---- in other words, Kepland is trading and timing the buy and sell of property assets which IMHO, is fair as it is in the biz of developing and trading of such properties.
But, for the KReit management and KReit Board, which is in the biz of finding a good tenant mix and locking in good rents and rental periods so as to get positive recurrent incomes with positive reversionary outcomes, buying or selling property assets should not be happening in such uncertain periods.
Yes, KReit can cite need for growth, but growth must be from acquisitions of properties that are accretive DPU-wise and whose incomes have truly stabilised.
In this case, KReit is getting itself involved in trading of property assets risks ; as well as risks in the volatilities associated with rentals rates, borrowing costs, as well as risks of a possible rise in gearing (falling property values or NAVs may risk downgrades in debt ratings due to increased gearing; causing a rise in borrowing costs).
Growth should be according to the schedule guided, well in advance-----OFC was not due to be offloaded by Kepland until end 2012 or early 2013------ so that investors do not get nasty surprises for cash calls; cash which they can use for buying juicy assets at low low prices in these crisis driven environment.
For KReit minority shareholders (as distint from the sponsors who have a stake in OFC, the choice is between an meagre accretive 2% increase in Proforma DPU vs having to cough out 17/20 of cash for the rights issue.
3 cash calls in 3-4 yrs is an awful record for KReit, and the pliant Board is not taking good care of minority shareholder interests. The worry is in MBFC Tower 3. Will there be another cash call?
Does that mean that minority shareholders should just sell their shares and park the money in others?
To answer this Q, we come full circle, back to the issue of evolving Corporate Governance---- reporters, shareholders, corporate governance watchdogs------ by speaking up , helps to influence and shape opinions and policies in the Reit investment ecosystem.
The number of available safe haven defensive plays in the Sg mkt are few and far between.
Reits can be and should be such an asset class.
Minority Shareholders must speak up, so that the Sponsors (whether TAL for Ascott Reit or Kepland for KReit etc) realise that such practises are contrary to the practise of good corporate governance; and in doing so, help effect a change.
Make the Reits you own rise to better standards of Corporate Governance.
I used to subscribe to the thinking of sell and buy another asset/share, if you disagree with management.
But lately, I have another view------Don't just take the easy route of selling, which will in the end limit the number of types of shares of the different assets classes available for investments on the SGX----Speak up and stand up for better Corporate Governance.
Inherently, Kreit and most of the Temasek linked Reits vehicles have very good sponsors (Keppel Corp, FNN, Capitaland etc) and a robust biz model. But, as with every situation when the majority shareholders have complete dominance, minority rights can get overlooked and if undefended, trampled.
Complacency creeps in and the laxity can fester into a downward loop.
This BT article has done good by creating awareness of the Corporate Governance issues and make the regulating bodies be mindful of the possibilities of the next wave of potential problems.
Hence, the issue here, is not really the quality of Kreit, as one may argue that Kepcorp and even Temasek will come in to help even if Kepland should inexplicably fail (which is unthinkable to many given Kepland's pristine record).
The issue is about fostering an environment, an ecosystem, that is conducive to the evolving Reit class in Sg.
Yes, in terms of size, with 23 listed Reits and mkt cap of SGD 34b, SgX listed Reits has got the heft, but Corporate Governance is a process, more correctly an evolving process and as minority shareholders, we must support, speak up and stand up --- for it is only when we do so, that the media, NGO watchdogs and regulatory bodies will sit up, listen and act!!
LETTER TO THE EDITOR,
posted here as it cannot fit into the comments page due to length....
Regulations governing Reits should be reviewed
I REFER to the commentary 'Don't let Reits be the next wave of governance lapses' by Wong Wei Kong (BT, Nov 15) and the letter 'Tie Reit managers' pay to DPU, valuations' (BT, Nov 16)__________________
The S-Reit market has done well since its inception in 2002. However, I agree that it is time for the Monetary Authority of Singapore and the Singapore Exchange to review the regulations governing the industry.
First of all, the appropriateness of having S-Reits governed by the Collective Investment Scheme (CIS), which was designed to regulate unit trusts, should be reviewed.
While Reits are a trust, they are fundamentally different from a typical unit trust in that Reits are landlord businesses with physical business operations while unit trusts generally trade in securities on stock exchanges. There are potential conflicts of interest in the operations of unit trusts and they are adequately addressed by the CIS regulations.
However, as Reits are physical landlord businesses, the externally managed arrangement of outsourcing the fund-management and property-management functions to external managers opens up many new areas of potential conflicts of interest which are not adequately covered by existing regulations. Examples of these potential conflicts of interest are:
a) The marketing and leasing of space by the property manager, which is usually owned or related to the sponsor - the same team may be responsible for both the properties owned by the Reit and its sponsor.
b) Similarly, the property manager may be managing both the properties owned by the Reit and its sponsor and potential conflicts could arise with regard to, for example:
i) cost being fairly allocated between the Reit and the sponsor's properties; and
ii) some costs incurred by the property manager are reimbursed by the Reit, which creates the risk of the property manager loading tasks and headcounts to the Reit which rightfully should be costs borne by the property manager.
c) Incentives or performance fees earned by the fund manager (based on gross or net revenue, for example) are not in line with the interests of shareholders.
In most cases, the fund manager and the property manager of a Reit are two sister companies owned by the sponsor of the Reit. My understanding is that each has its own profit and loss responsibilities.
The fund manager may not have control over the property manager as it is considered an outsourced party and therefore does not have managerial control over the property manager's staff, as would be the case in a normal corporate structure.
Also, because both entities belong to the sponsor, the fund manager may not be free to terminate the services of the property manager if the latter is not performing. In this scenario, the minority shareholders of the Reit would suffer if the property manager does not perform well.
In the past, investors could trust boards of directors of the fund manager and the sponsors of Reits to have good corporate governance and treat minority investors fairly. However, recent events show that this trust may not be justified.
The argument that the directors of the fund manager will protect the interests of minority shareholders may not work in practice, as all the members of the board of directors of the fund are appointed by the major shareholder of the company which is usually the sponsor of the Reit.
One obvious solution to the above governance issue is to review the wisdom of prescribing an externally managed Reit model. Would it not be more appropriate to require S-Reits to be internally managed which would eliminate most of the conflicts of interest?
The Reit could acquire and 'internalise' the management business based on a proper and fair valuation of the management business. Also, the board of the Reit should be truly independent of the sponsor and the members of the board should be elected by the Reit's shareholders at its annual general meeting.
The 2 activities:- 1) Fund Management (FM) and 2)Property Management (PM) services should reside within the REIT vehicle itself, rather than be outsourced to an external party.
Conflict of interests occur when the managers appointment are made by the sponsor (aka majority shareholders) or are staffed by the sponsors ----- then they cannot be considered independent!!
PM, FM, Board,IDs,IFAs etc they should ALL be independent !!