This article on Singapore Real Estate Investment Trusts (S-REITs) is long overdue as I already had plans to pen down my thoughts on this topic more than a year ago.

Initially, I wanted to title this post “The Disastrous Singapore REITs Model” but decided otherwise.

So why do I think they are a disaster?

A REIT is an instrument that allows small investors to have indirect access to real estate investment at an affordable cost. Through this investment, you will be entitled to a steady stream of dividends (distributions) from the rental income.

From the developer’s point of view, it offers them a chance to divest of their assets and recycle their capital into new projects.

REITS has been available in other more mature markets prior to the first Singapore REIT listing of CapitaMall Trust (CMT) in 2002. Ascendas-REIT (A-REIT) followed in November 2002 and this was followed by a steady stream of other REITs.

A REIT is intended to be a defensive instrument as it relies on revenues generated from income producing properties held in its portfolio. As rentals are more or less constant, investors are assured of a steady stream of dividends.

A REIT manager earns fees by charging a management fee based on the assets under management (AUM), as well as associated fees for adding/selling properties from its portfolio. The higher the AUM, the more fees he would earn. Needless to say, REIT managers are always on the lookout to grow their portfolio. Which is what many of them did.

It is only possible to justify (to investors) adding more properties to a portfolio if the acquisitions are yield accretive. This means the new properties that are being added to the portfolio must give a higher rental yield than the yield on the REIT itself (at the current stock price).

In 2004 to 2007 when the stock market was booming, many of the REITs were trading at a high valuation and had yields that were quite low. So it was easy for a lot of REITs to go on an acquisition spree using either debt or equity (or a combination of both) to finance their purchases. Some of them used too much debt which resulted in highly geared balance sheets.

As most of the REITs managers were just benchmarking their gearing levels to their peers at that time, everything seemed normal so everyone just concentrated on growing their AUM. Every acquisition was followed by a press release highlighting the good news about how so-and-so REIT has grown and is now bigger. Come reporting time, they could also put a positive spin on the results by reporting higher earnings or distributions (in absolute $ terms) even though there could be just a marginal increase in the distribution per unit (DPU).

Investors are also happy as they were enjoying both their dividends and capital gains from high valuations.

The reality check came in 2008 after Lehman Brothers collapsed. Due to writedowns on the property, many of these REITS discovered that their gearing had become untenable to the banks. It was a very challenging time for them as the debt market was practically frozen up at that time as well.

In the end, most of them with over-geared balance sheets had to raise cash in the form of equity. Raising equity at a time when the share price is low can be very dilutive to shareholders who are not part of the equity raising process.

One example is when you do a share placement to preferred investors.

Another example could be retirees who had invested all their life savings in REITs for the dividend streams and had no more money to take up their Rights issue. Perhaps some of them also didn’t really understand the implications of a Rights issue and didn’t wish to fork out more money to subscribe for their rights.

For those existing investors who could raise the capital to subscribe for their rights, they are returning most (if not all) of the dividends they had collected back to the REIT. Don’t let the discounted price fool you as you are essentially paying just to maintain your percentage shareholding in the REIT.

This is the reason is why I deem Singapore REITs to be a failure. Touted as a defensive investment with a steady income, it has failed to deliver its promise.

However, not all the REITS are failures as there are some exceptions. There are a few REITs that had kept their gearing relatively low throughout the years and did not have to raise any equity during the crisis. While investors in those REITS might have suffered a paper loss in capital value during the crisis, the prices have largely recovered by now.

Long term investors would have been well rewarded with all the dividends they had collected over the years if they did not panic and sell out at low valuations at the wrong time.

The reason why I’m writing this post now is that recently, some of the REITs have returned to the acquisition path again. As their stock prices have recovered from 2008, they can now make yield accretive acquisitions again.

Will history repeat itself?

As an investor, what I am looking for is not a REIT that keeps on growing its AUM. All I really need is one that can manage its existing assets well and not get into any (financial) trouble.

A very good site to track Singapore REITS is this website – SGX REIT Data. It is updated daily with the latest news and provides a comparison of the different REITS including their gearing, dividend yield, etc.