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Saturday, January 10, 2009

REITs’ high yields and risks

Investors are spoilt for choice in their search for yield as many shares and most of the real estate investment trusts (REITs) offer dividend yields in the high single digit to low teens.

Like their counterparts in the developed markets, however, they are also scared and uncertain if both the yield and capital value of REITs will hold.

A sell-down in REITs that intensified in December have pushed their unit prices lower and, therefore, lifted their yields. Axis REIT, for instance, fell from a 52-week high of RM2.00 and from RM1.20 in late November to RM1.00 less than two weeks later. It has since recovered to around the RM1.20 level.

Such price fluctuations may be the norm in these volatile markets but retail, and even institutional investors, did not expect prices for REITs to swing like that. Typically, REITs have tenancies leased for a number of years in contrast with trading businesses in which revenue varies from day to day or contract to contract.

REITs, of course, face the property market risk of tenants moving out and in the global credit crunch, the risk in rolling over their loans. Prices of REITs also fell in the general sell-off of securities by investors going into cash.

As a result, Axis REIT was carrying a historical yield of about 13% for 2008, annualising its nine-month income distribution.

REITs in Singapore and Hong Kong showed similar, or even higher, historical yields as their unit prices fell further, reflecting the greater risks in the property markets there.

Starhill Global REIT, the former Macquarie Pacific REIT, listed in Singapore, shows a historical yield of 13.6% with its units traded at 52 cents. That is still much lower than the 82 cents a unit that YTL Corp Bhd paid for a 26% stake in the REIT. Furthermore, the REIT now has the support of the very large YTL group.

On Dec 23, Starhill told the Singapore Exchange it is consulting its legal advisers to assess Future Revolution’s and Futuregement’s ability to meet their obligations to the REIT’s properties in Japan.

Future Revolution and related entities directly occupy 33% of the space in Starhill’s Japanese properties. The bulk of Starhill’s properties are, however, in Singapore.

Fortune REIT, with retail properties in Hong Kong but listed in Singapore, was yielding as high as 18% for 2008, one of the highest in the sector. The REIT is sponsored by Cheung Kong (Holdings) Ltd, the flagship company of Li Ka-shing. Interestingly, a report by Macquarie Research forecasts Fortune REIT’s high yield will be sustained this year.

A yield of even 10% is very high for any asset class and if the Malaysian REITs can sustain their current yields, this is a rich field for investors in search of income.

High yields prevent expansion

The window of expansion for real estate investment trusts (REITs) has closed for the time being as their high yields preclude the possibility of any yield-enhancing acquisitions.

When the stock market was buoyant last year, prices for the units of REITs were higher and their yields were thus lower, at around 7% and even as low as 3%.

With that, it was possible for REITs to purchase properties that yield 8% to 9% and that would increase the yield of the trust.

With current yields of about 10% in the REITs, any purchases of properties with yields below that would reduce the trust’s yield.

It appears that even where the REIT promoter thinks it will be fruitful to purchase a property with a yield lower than the trust’s, shareholders may reject it.

That happened at Atrium REIT which proposed to purchase an industrial property for RM17.8mil cash from a related party. This is not unusual because sponsors provides a pipeline of properties for many of their REITs.

However, as the property offered a yield of 8.75%, lower than Atrium’s own yield that was then about 10%, minority unitholders rejected the purchase resolution at an EGM in November.

The financing window for REITs is also, for the moment, closed. REITs need to issue new units to raise capital now and then so as to raise their borrowing capacity and to repay loans.

REITs are regulated to maintain borrowings below 50% of their total assets but they do not retain the cashflow to repay their loans. They normally pay out 90% of their income so as to qualify for tax exemption, which leaves very little for loan repayment. Some REITs have a policy of distributing 99% of their income.

With the units of some the REITs trading below their par value and a lack of institutional interest, REITs will have to wait for markets to improve before they can substantially expand their asset size.

Fundamental flaws in trusts

Real estate investment trusts (REITs) are pitched to retail investors, including moms and pops and retirees, that they are a handy alternative to owning a house or condomium for rental income.

In a REIT, maintenance and tenancies for the properties are handled by a manager whereas an individual, buying a house to rent out, has to look for a tenant, ensure rents are paid and done so on time, and he has to take care of repairs and maintenance himself. REITs are, therefore, appealing to busy investors and retirees who do not want the drudgery of that work.

The price performance of REITs last year, however, show it does not mirror that of real properties. While a house of RM500,000 has held up its value so far, the value of REITs would easily has lost 50% in the last 12 months.

The first difference is that REITs are listed in stock markets and, like all listed securities, are subject to a sell-down whenever there is fear.

Secondly, REITs in most markets finance their property purchases with short-term loans. This exposes them to risks of banks willing to refinance and higher interest rates. This is an aspect not considered by many retail investors even if the facts were made known by the REITs in their prospectuses.

Would they buy a house with a loan repayable in five years or less? Probably not, but that’s the characteristic of a REIT. In some cases, a REIT may have its borrowings due within the year.

The reason for a preference for short-term debt could be that interest costs are lower than long-term debt, which boosts the bottomline. If REIT prices move up, they can issue more units to pare down debts, or make more purchases.

Last week, investors in Singapore heaved a sigh of relief that CapitaCommercial Trust, a REIT managed by the CapitaLand Ltd group, obtained a three-year loan of S$580mil at a very favourable rate of about 4% a year to refinance a loan coming due in March. Earlier, there were concerns that banks might charge 7% or 8% which would knock off a lot of its income.

In the US, some REITs have even failed altogether. By now, retail investors are aware that investments in REITs have to be managed the same way as their equity investments, with potentially the same risks.

By The Star (by C.S.Tan)

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