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Monday, February 4, 2013

Reits hold allure but beware potential risks

Goh Eng Yeow

INVESTORS have been getting next to nothing on their investments if they have held cash over the past five years, so it is not surprising to find that real estate investment trusts (Reits) are coming into their own.

Reits are now among the hottest financial assets to have for risk-averse but yield-hungry investors, thanks to their returns of 5 per cent to 6 per cent.

That easily beats the offerings from banks, where interest rates have been driven down by central bankers around the world printing tons of new money.

Reits are "closed-end" funds which operate in a similar manner to unit trusts. But unlike unit trusts, which raise funds to invest in shares, Reits specialise in income-generating real estate assets such as shopping malls, offices, industrial buildings, warehouses or even hospitals.

A Reit gives an investor exposure to a basket of investment properties which are leased out, producing rental income that gets distributed back to investors as dividends or distributions.

The biggest attraction is the tax-efficient structure. Reits do not pay income tax at the corporate level, while individual investors are also exempt from paying any taxes on the dividend income received, although corporate investors are not.

Reits can also offer high yields because they have to pay out at least 90 per cent of their income as dividends in order to qualify for the tax breaks.

Since January last year, the FTSE ST Reit Index, which tracks 24 Reits, has risen by 41 per cent, outperforming the benchmark Straits Times Index, itself no slacker with a gain of 24.2 per cent.

Small wonder then that in the post-global financial crisis world, Reits have become the perfect corporate structure for companies that have steady income-generating businesses but lack sexy growth stories to go with them.

All a company has to do is admit that it does not have the opportunity to invest for growth, offer to pay out at least 90 per cent of its taxable income as dividend, and it can produce a Reit out of almost any of its businesses.

After all, as some Reit fans will point out, even a company like fast-food giant McDonald's can be turned into a Reit, since it is nothing but a landlord that rents out space to franchisees that happen to run restaurants. McDonald's sits on US$23 billion (S$28.5 billion) in properties and generates a steady income which makes yield-hungry investors salivate.

So it is not surprising that the most successful listings in Singapore in recent years have been Reits.

Indeed, the hottest initial public offering (IPO) hopeful being touted around in the Singapore market at the moment is the proposed massive US$1.5 billion flotation by the Temasek-linked Mapletree Group of its commercial properties in China and Hong Kong.

And why not? Besides offering investors a steady income - some are eyeing a yield of 5 per cent to 6 per cent - there is even a sexy story to sell: The Reit can grow its business as China's rapidly expanding consumer market demands bigger and better malls.

Mapletree's previous three Reit offerings have produced astounding returns: Mapletree Logistics Trust is up 73 per cent since its debut in 2005, Mapletree Industrial Trust has risen 52 per cent since going public in October 2010 and Mapletree Commercial Trust is up 42 per cent following its IPO about two years ago.

But there is a snag. As Reits pay out most of their income, they rely on bank borrowings to finance their growth through the purchase of more shopping malls, commercial buildings, factories or hospitals.

With the credit crunch that accompanied the global financial crisis in 2008, the inability to refinance bank loans was a very real risk for some Reits and nearly caused them to collapse.

Five years is a long time for interest rates to stay at abnormally low levels, and it is only a matter of time before the world's central banks start to shrink their bloated balance sheets.

So after the heady gains made by the Reits last year, some research houses have advised investors to go easy on them. Maybank Kim Eng's Mr Ong Kian Lin, for example, believes 2013 will be a year of consolidation, as yields for Reits are depressed by a further 0.3 to 0.4 percentage point.

"We also see limited opportunities for further positive rental revisions, as rentals face downward pressure in 2013, following looming supply and softening of business sentiments," he said.

In case there is a credit crunch as central banks pull the plug on the massive liquidity now flooding the financial system, it may be advisable to stick to Reits with strong corporate parents with the financial means to bolster their balance sheets.

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