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Friday, October 5, 2012

There's money in recycling

5 October 2012
Tan Chin Keong

When real estate investment trusts (REITs) in Singapore need capital for an asset acquisition or expansion, they normally turn to the equity market to raise funds through a secondary share placement or a rights issue. For this reason, REITs have earned the reputation for asking back what they have given to shareholders.

REITs are highly sought-after investments because they generate high dividends. For their continued sustainability, REITs need to be generous with these dividends. To qualify for their tax-transparent status, Singapore REITs have to disburse at least 90 per cent of their distributable earnings to shareholders. While this makes them a reliable source of income, the downside is that REITs hardly retain any of their earnings for future capital expenditures, so they - especially those with high levels of debt - tap the equity market. This in turn dampens their share prices.

The good news is that alternative ways of fund raising have emerged as the REIT sector begins to mature.

One of these is the perpetual bond market that was established in Singapore earlier this year. As I highlighted before in this column, REITs can now issue perpetual bonds to finance a potential acquisition instead of issuing new ordinary equity. In doing so, they avoid diluting shareholders and causing a near-term share-price overhang. This option makes all the more sense given that a perpetual bond is also considered a form of equity but is cheaper to finance than ordinary equity.

Other than perpetual bonds, an increasingly popular way for REITs here to raise funds is asset recycling. When REITs are in acquisition mode, they normally look for property whose rental values can be boosted through asset-enhancement initiatives, such as redevelopment, provision of new facilities and improving the tenant mix. But once these assets have reached their full potential, it may be time for the REITs to recycle them.

Asset recycling involves divesting selected properties that have sat for a while on the REITs' balance sheets and have little residual enhancement potential, then using the proceeds for newer assets with better enhancement potential. We understand that this is an established practice in some of the larger and older REIT markets such as Australia. We began to notice such asset-recycling activities in Singapore in 2010 from some of the office REITs, continuing last year up to the present.

Indeed, the practice has spread into other property sectors. Some of the industrial and retail REITs in Singapore are taking advantage of the current buoyant markets in their segments by recycling and divesting some assets in their portfolio for a profit. We believe these activities will continue to gain in popularity as the REIT sector matures - in other words, as some of the REIT assets age - and as long as the property market remains buoyant.

All this is part of the evolution of the REIT sector in Singapore. As the market develops, players will find new and different ways of financing their asset acquisitions and expansion. Whether it is through perpetual bonds, asset recycling or some other source of funding that does not involve tapping the secondary equity market, it could help lower REITs' equity capital-raising risks and remain a viable investment option for investors with a lower risk appetite.

Tan Chin Keong is an analyst at UBS Wealth Management Research.

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