Sunday, November 27, 2011

Return on Capital for Reits

Return on Capital
Given the propensity for cashcalls (i.e. Capital Outlays) in SG Reits, the correct metric for a Value Investor, should not be the dividend yield but the ROC ( return on capital).
Teh Hooi Ling of BT's, "Show Me the Money" series, did a calculation for the ROCs of 22 Reits listed on the SGX .

On that metric, of the 22 that she studied, only 17 made it to positive territory.
She did not state the date for the prices she used. But if we take her "prices today" (as at 25/11/2011), then we are taking prices at quite a trough, given current bear market conditions.

KReit Asia Positive ?
For the emblematic KReitAsia, which has been the most prolific in issuing rights, the surprising outcome is that it still managed to eke out a positive return on ROC, even tho the rights issue (at 85c) has pushed prices on that day to 86.5c.
So Reit, has a place in a value investor portfolio, just as Ben Graham, advocated in his book "The Intelligent Investor". Better still if they are trading below intrinsic book value.

But, the issue as highlighted in the EGM is the timing and frequency, with which the cash calls are made. In effect, the sponsors have abused the Reits vehicle, so that their interests (to monetise the assets at their  timing to recycle cash for sponsor use)  have been done at the expense of unitholders who are subjected to nasty surprises of cash calls, at a time when the markets are on the precipice  of falling and huge opportunities for purchases of  contending "stocks' could be on the horizon.

Against Sponsor's own interests
As pointed out in the EGM, these nasty surprises, if repeated often, work against the long term interests of the sponsors. Such frequent calls necessitate sponsors having to underwrite to take up any excess rights, reducing trading liquidity as the shares are concentrated in the hands of the sponsors. Loyal unitholders and IIs (institutional holders) with high stakes have to rejig and make sudden changes to their "Portfolios"; including selling in a distressed market to cough out the cash. Worst still, retirees and Mom N Pop investors who buy the Reits for dividends only (i.e. defensive plays) may not be able to cough up the extra cash at such short notice, leading to dilution or a need to sell their rights/shares at  "rights"-depressed prices. Other Unitholders, tired and fed up with the frequent and hasty cash calls, will sell.
In the end, the Reit vehicle which is the last piece in the food chain for the "asset recycling model" may fail, much to the detriment of the sponsors own interests.

MAS must act
Growth should never be the over-riding aim of a Reit; and growth for the sake of growth must never be the excuse for any acquisition.
As I have highlighted many times, accretive  property acquisitions ( to DPU) should only be made when it is certain that the property market has more or less bottomed (test is that valuations  are less than NPV for DCFs) or when the property market is stable; not anticipating a fall. The Reits biz model have that luxury to wait  and the regulators (MAS) should see to it that the sponsors stop ramming their cash calls down unitholders throats as and when they fancy!!
The Reits must be  a vehicle where the recurrent incomes have stabilised; those that have not stabilised must be incubated at the Sponsor level, NOT Reit level. Rental support is a gimmick and must be stopped.
Incentives for Reit Managers must be aligned with unitholders, NOT sponsor's interests!!

I have excerpted some of  Teh Hooi Ling's article here....
and recategorised her writeup in terms of the respective Reits.

.......But you know what? That Reits are good income-yielding instruments is but a myth. The thing is, whatever they pay out in dividends, they will take back - all and more - a few years later in the form of rights issues.

Here's what I found. Of the 17 Reits which have a listing history of at least four years on the Singapore Exchange, only three have not had any cash calls or secondary equity raising. The remaining 13 have had cash calls, and many had raised cash multiple times. One had a few rounds of private placement of new units which diluted the stake of existing unitholders somewhat.

For many of these Reits, the cash called back far exceeded the cash received. So, the myth of Reits as almost comparable to a fixed income instrument is really busted.

Take CapitaMall Trust (CMT) which was listed in July 2002. Assuming that Ms Retiree bought one lot or 1,000 units at the initial public offering (IPO) for a total sum of $960. For the whole of 2003, she received $57 in dividends. However in that year, CMT also had a one-for-10 rights issue. To subscribe for her entitlement, Ms Retiree would have to cough out $107.

In 2004, she would received $89 for the total number of CMT units she owned. That year, CMT had another rights issue, also one-for-10. The exercise price was higher at $1.62. To subscribe, Ms Retiree would have to fork out $178.

In 2005, CMT again had another fund raising exercise via rights issue. Ms R would pocket $124 in dividends but in that same year, had to return $282 back to the Reit.

In the next three years - 2006 to 2008 - Ms Retiree felt rich and happy. She merrily banked in her quarterly distributions which amounted to $404 for her holdings of CMT. Her one lot, after three rights issues, had grown to 1,331 units.

In the following year, another $175 was distributed. But CMT wasn't going to let Ms R be happy for long. It launched a big one - a 9-for10 rights issue. To fully subscribe for her entitlement, Ms R had to empty her bank account of a whopping $982.

And you know what, the cash call came in March 2009, when the Straits Times Index fell below 1,600 points, and many retirees were dismayed to see their investment portfolios plunge by half or more. Many fret if they would have enough left in the pot to sustain their lifestyle. Having to cough up more money for a Reit was the last thing that they wanted to do!

Negative cash flow
And here's the final tally. Since its IPO until today, a holder of one lot of CMT would have received $1,264 in cash distributions. However, in all, he or she had to return $1,549 back to the Reit so as to subscribe to their entitlement of new issues. That's a net outflow of $284 per lot......

......But while Reits may not be the perfect income yielding instrument that they are made out to be, they have proven their capacity for capital appreciation. Relative to the capital ploughed in, CapitaMall Trust has rewarded its unitholders with a return of 127 per cent. Most Reits have yielded positive total returns......

KReit Asia

......It's the same story with K-Reit Asia, Capitacommercial Trust, Frasers Commercial Trust, Mapletree Logistics, First Reit, Lippo Malls Indo Retail Trust, AIMS AMP CAP and Saizen REIT in that what was taken back from investors was more than what was given out.

K-Reit has been one of the most aggressive fund raising Reits. Had you started with just one lot when it was listed in April 2006, you would have to dish out $8,399 to subscribe to your rights issue. Distributions amounted to $1,110, resulting in a net outflow of $7,289.....

....Reits are managed by managers, and managers are paid based on the size of the portfolio that they manage. So the incentive is for the managers to continue to raise money and expand the portfolio size. Sometimes this is not done in the best interest of unitholders.

The most recent controversy was over K-Reit's purchase of Ocean Financial Centre (OFC) from its sponsor Keppel Land. K-Reit has launched a 17-for-20 rights issue to pay for the purchase which was deemed by the market to be expensive at a time of uncertain outlook and when office rental is expected to ease.

BT reader Bobby Jayaraman argued that rather than be compensated based on factors such as the value of assets, net property income and acquisition fees, Reit managers should be paid based on a combination of growth in distribution per unit and market valuation of the Reit.

'If Reit managers were paid on the basis of distribution per unit and market valuation growth, would K-Reit have bulldozed its way through the OFC acquisition like they have done?

'The day K-Reit announced the OFC acquisition, its stock price fell close to 10 per cent and has continued sliding. Yet, its Reit manager will take home significantly increased management fees while shareholders would have lost a good chunk of their capital even as they bear significantly more risk in the form of higher leverage and potential property devaluations given the uncertain environment,' he wrote to BT......

Other Reits

.....For Reits with at least four years of track record, only Fraser Centrepoint, Parkway Life and CapitaRetail China have not had any cash calls.

Instead of a rights issue, Suntec Reit raised funds by issuing new units to some institutional investors at a slight discount. Existing unitholders don't have to cough out additional cash, but they would have their share of earnings diluted somewhat......


qiaofeng said...

This letter was published in BT in response to Teh Hooi Ling's article.....

Published November 30, 2011

CMT returns almost 130% since its IPO

WE refer to the commentary, 'The Reit Myth Busted', by Ms Teh Hooi Ling (BT, Nov 26).

Similar to other stocks listed on the Singapore Exchange, the performance of Reits should be analysed based on the total returns they give to shareholders. CapitaMall Trust (CMT) has delivered sustainable and resilient returns in the form of both regular distributions as well as long-term capital appreciation since its IPO. Over the last nine years, CMT has delivered a total return of close to 130 per cent.

Almost all of CMT's previous equity fund raisings since 2002 were to fund yield-accretive acquisitions. These acquisitions have resulted in increased distributions to unitholders and a corresponding increase in the net asset value of CMT's portfolio. This has invariably over time further boosted CMT's valuation and unit price.

The exception was the rights issue undertaken in 2009, during the global financial crisis, to strengthen CMT's balance sheet and refinance looming debts in the midst of very uncertain times that affected all businesses worldwide. In the example cited by Ms Teh, an investor holding one lot of CMT units since IPO would have paid an estimated $1,549 to subscribe for all the cash calls since 2002. Of this amount, approximately 63 per cent or $982Â can be attributed to the 2009 rights issue which was undertaken under extenuating circumstances.

Our track record also shows clearly that CMT has proven its resilience and defensiveness through time and economic cycles. These attributes are also attractive for Reit investors. Finally, as highlighted by Ms Teh, loyal CMT unitholders would be happy to note that, since its IPO, they have secured a total return (inclusive of distribution yield and capital appreciation) of close to 130 per cent over nine years, or a compounded return of 9.5 per cent per annum.

Simon Ho
CapitaMall Trust Management Ltd
Manager of CapitaMall Trus


My Thots...

Hooi Ling was NOT far off....
She calculated ROC of 127% and Simon Ho wrote in to reiterate 130%.

The point made about frequency (only once) and calling for the rights issue only under extenuating circumstances is moot.IMHO, that is the main reason why CMT is trading above NAV, most of the time and at low yields relative to other Reits.
It shows that Mr Market is cognisant of the factors he highlighted and differentiates well with their voting power!!!

Anchovies said...

Hi QF,

Hmm interesting article.
Thanks for sharing.

In this case, looks like its wiser to invest in a company than a REIT that has equal dividends, eg singpost.
(given that reits would more likely make cashcall)

Since reits capital appreciation comes from gains in property values.
(which itself is volatile rather than defensive)

This case, would REITS be even classified as defensive?

qiaofeng said...

Sorry for the late reply.
I would not generalise. Much depends on the particular Reit or biz, U are investing in.
Amongst good companies that pay good persistent dividends, they might be geared highly (such as Starhub etc)but as long as their FCF supports their payout, they can be considered defensive.

Similarly, with REITs, they can be selective --- time-wise and asset-quality wise. Growth should not be for growth sake. Reits need not grow, unless the acquisitions are DPU accretive and the acquisition targets have stabilised NPIs. That way unitholders will not lose out.
I have been very proactive in creating awareness here, writing to BT and MAS precisely because I do not want the REIT asset class destroyed. It has a place as a defensive asset. We should not let a few trigger-happy gungho REIT managers destroy the REIT asset class.

Recent REIT AGMs suggest that MAS has got the message down on the polling-- they all use the electronic polling device now.

qiaofeng said...

Regarding property values, revaluations gains are clearly defensive since they reduce gearing.

Revaluation losses in a weak economic climate is the worry.
But with the huge gap from 35% to 60% guidelines for REITs, management do have flexibilty--- they can do AEIs, sell old assets to recycle cash etc.

"Wisdom is purified by virtue and virtue is purified by wisdom. Where one is, so is the other."