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REITs: Simply explained?

Saturday, September 11, 2010

The diversity of opinions in this world is what makes it colorful and interesting.  Everyone is free to express his opinions on diverse subjects.  We should remember, however, it is not just what is said which is important.  Of equal importance is how it is said.

I have been following a series of posts on the subject of REITs by a certain local blogger. Are his posts on REITs objective? I don't think so but I respect the blogger's right to express his opinions and I am sure readers will arrive at their own conclusions.  However, I do hope that this blogger would exercise restraint and not make insinuations beyond what is civil.

In his latest post, he took a quote from the writings of another blogger:

"For those existing investors who could raise the capital to subscribe for their rights, they are returning most (if not all or more) 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." -Lion Investor

The blogger whom I am taking issue with went on to say:

I can't agree more with the truth on "the discounted price fool" as I recently overheard some joys near the Temple of Cows over AIMS AMP Capital Industrial REIT's right issues - discounted price fools?

Firstly, Lion Investor was expressing an opinion about how we should exercise caution and not let discounted price of rights fool us into thinking we are getting a good deal.  The word "fool" is used as a verb.  The blogger in question has twisted it and used it as a noun. Calling people names isn't very nice, is it?

Secondly, going beyond language, let us objectively evaluate what Lion Investor has said and consider the proposed rights issue by AIMS AMP Capital Industrial REIT in the same vein.  Are we paying more money just to maintain our "percentage shareholding in the REIT"? 

In the case of AIMS AMP Capital Industrial REIT's rights issue, the objectives are clearly communicated. 

We are putting down more money to participate in the REIT's income accretive activities which would benefit us as unit holders. 

We are paying more money but NOT just to maintain our percentage shareholding in the REIT. 

See: AIMS AMP Capital Industrial REIT: Rights issue.

At a level that is of greatest importance to most, unit holders could choose to participate and enjoy a higher yield in future or unit holders could choose to sell away their nil-paid rights when they start trading

This was what I said:

REITs are income instruments.  Therefore, we must remember that we are investing in REITs for regular income.  The DPU per unit would decline from 2.15c to 2.08c, post rights.  This is a DPU loss of 0.07c a year.  It is not dramatic.  We would also be able to sell away the nil-paid rights when trading starts.  At an exercise price of 15.5c and with expectations that price would see a modest decline to 21c per unit, post rights, we can expect the nil-paid rights to trade at around 5.5c each.  Selling these away would bag 30 months' worth of DPU (post rights) straightaway!  Now, is that such a bad thing?

On top of that, our current investment would still make an annual DPU of 2.08c!  This is provided that everything remains constant, of course.

Accept and pay for the rights or sell away as nil-paid rights, either way, unit holders end up winners.  There will always be detractors but as long as we are clear headed and know what to do in any given scenario, we will be fine.

Unit holders could sell away their nil-paid rights as compensation for dilution and their remaining units in the REIT would still enjoy a very high yield.  

Unit holders who choose to accept and pay for their rights would see their future income increase in dollar terms and at a higher yield.  They are paying more money for greater returns.

Respect has to be earned but sometimes we accord respect to people based on seniority.  Respect should also be reciprocated. Being civil is a great way to start.

Related post:
AIMS AMP Capital Industrial REIT: Sell the rights.


Anonymous said...

I don't quite understand how does subscribing for rights (even if I can't sell it) would be a subtle form of returning my dividends ? Such a term can only be used to describe a business trust which uses its equity/debt to fund its dividends. Such a trust will see its equity declining with time and will need a massive dose of recapitalization. If it doesn't happen, then the trust share price falls to zero and the dividends gained would (hopefully) be sufficient to compensate the unit price purchased.

But I don't see it happening locally. Most local REITs do experience growth in their equity as their asset value rises. Even shipping trusts like PST and Rickmers are experiencing book value growth due to their low dividend payout ratios. Hence these companies are using their cash generating abilities to fund the dividend payouts. Hence I do not see my share price depreciating with time.

Lets pen out 2 scenarios -

Trust A:
Purchase $100 asset which yields $$15/day and depreciates entirely in 10 days. A pays out everything to its unit-holders. So after 10 days, the investor of A gets $150 but the Trus raises a rights issue to raise another $100 to purchase the depreciated asset. In this case, I would agree that the rights issue is simply a return of dividend (though it must be noted that the dividend is nothing more than the Trust's own equity).

Trust B:
Purchase $100 asset which yields $$15/day and depreciates entirely in 10 days. B pays out $4/day to its unitholders. After 10 days, the Trust has $110 which it uses to purchase another asset. But the Manager decides it is best to raise another $40 to purchase a similar asset at %50 and yielding $7.50/day. After the issue was completed, the Trust has $150 assets and yields $22.50/day. In this case, even though all of the $40 is returned back to the Trust originally, we notice that the Trust has actually grown in size. The Trust can continue to grow since it can retain even more income (from $1 to $1.5). Hence surely, this is a case of the Trust making use of equity to compound its growth further.

But why should a REIT/Trust make acquisitions in the first place ? Reason: It is in the unit-holder's interest for a REIT to continue making acquisition. As a retail unit-holder, we often what things to be simple - standard dividends and no material changes. I am quite certain that many of us will be happy if First REIT kept on paying us S$0.019 dividend per quarter for eternity or AIMS maintaining their 2.12 cents payout annually. But this isn't an ideal world. A trust must always expand outwards to spread out its risk. By acquiring more assets, it reduces its exposure to any single counter-party and diversifies its geographical spread. Some may even acquire a totally different asset class so as to avoid any disproportionate impact from a downturn in a particular segment. In short, a larger (and more diversified) business trust will be far more attractive investment. This is a long term project and it deals with the Manager's ability to purchase assets which are of good quality and can appreciate with time both in valuation and its rental income.

In some sense, I would be concerned about companies which continually raise rights or placements but pay a pittance to their shareholders :)

Cheers !

Disclosure: I am vested in both business trust and companies so my views are biased.

Createwealth8888 said...

Sorry about it. I didn't realize verb and noun make so much different and "fool" is just such a sensitive word even in the investors and traders mind

I always thought investing or trading is part of Greater Fool theory. A theory that states it is possible to make money by buying securities, whether overvalued or not, and later selling them at a profit because there will always be someone (a bigger or greater fool) who is willing to pay the higher price.

AK71 said...

Hi Nick,

A really well considered and well written piece. I have come to expect nothing less from you. :)

I believe this comment deserves to be a proper blog post. ;-)

Thanks so much. Much appreciated. :)

AK71 said...

Hi CW,

Hey, thank you very much for taking the time and trouble to explain yourself. I want you to know that I really appreciate it as do some other readers, I'm sure.

You are a veteran investor and trader and your views are useful references for many. I will continue visiting your blog and I hope you will continue visiting mine too.

Thanks again. :)

mark said...

I personally feel that not all rights issue are equal. Rights are issued for various reasons. The exercise price is important to find out if we are getting a good deal. Another important aspect is to figure out what the funds raised are for. I agree REITs need to continue to 'trade'. Ideally there is no need to buy and sell assets, save on the cost of doing so and just generate a stable yield forever. The world doesnt stay the same forever. With a large portion of the income distributed via dividends, REITs simply dont have the funds to make accquisitions. Question is, do we agree the accquisition they are interested in, is in good taste and value? If I deem so, I dont see a problem in supporting the rights issue. If I dont let go of 10c, how to gain $1? That is not to say that all rights issues are worth me putting up that 10c.

So I feel it is inaccurate to downplay rights issue as a return of dividends. While partially true,there are some deals where I would like to pay them back some dividends so that they can grow and get more dpu for investors. On the other hand if they make a 'hopeless accuisition' where I cannot see how my 10c can be made to work harder to generate that $1 then I will not support it. I may sell the rights, and/or I may let go of the entire stake I own even.

Taking it one step further, a rights issue gives me a choice. A placement to a private investor(s) gives me zero choice and I cannot help but watch my stake get diluted . This is where I may get a little annoyed.

It is inevitable rights issue (and in some cases placement) is a way of life in REITs and companies looking to expand their business. All are not equal and investors have to figure if the company is doing the right thing, at the right price, and ultimately, at the right time too (market sentiment).

As for the word 'fool' I suppose it can be subjective depending on the context used. An investor, whether buying it at a cheap or overvalued price is a fool or not, could depend on many factors. Could we be fools who over analyze? Could we be fooling others and ourselves, with our own biased opinions? Fool or not, the market is the only one who is right.
One of the lil quotes that I like - "Listen to your heart. It is on the left, but it is always right'.
I prefer to think (as a trader and investor) if I profit after selling something and the price continues to head up, I just take it as its for someone else to profit. One of my own strategies is to take partial profit along the way up. This makes me a winner regardless of the price action thereafter.

Just my 2 cents worth from my very limited knowledge. I hope to learn over the years.

-- charlesming

Anonymous said...

Thanks to both parties for this discussion. Again, it has help novice & newbies, like me, to clear the air & arguements.


AK71 said...

Hi Mark,

Your comments are rare gems because you hardly blog these days. So, it is always a treat to hear from you here in my blog. :)

I read every single word of your comment carefully and found myself agreeing with everything you have said. Balanced and objective, that is what I have come to expect of you.

As per our conversation yesterday over lunch, I hope to see you blogging again soon. :)

AK71 said...

Hi JimmyN,

I am happy if my blog has helped in any way. It would have been nice if I had a mentor to help me shorten my learning curve when I first started investing so many years ago.

Through blogging, I hope to share my own experience and views with anyone who might be interested. Thanks for visiting. :)

Vin said...

Dear Bro AK,

I'd like to ask how we can determine if a REIT is a "good buy" or not? Or in other words, how do we know at what price is good to buy a REIT at? Thanks!

AK71 said...

Hi Vin,

Not an easy question to answer not because it cannot be answered but it is too complex. However, if we want a quick scan, look for the following:

1. Low gearing.
2. High distribution yield.
3. Discount to NAV.

Other questions such as when are the debts due, interest cover ratio, quality of assets, quality of tenants, quality of management, WALE (weighted average lease expiry), strength of sponsor etc should be considered too. No simple answer.

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