CorrespondentDebt-laden Chinese developers have been quick to spot the beeline yield-hungry investors here have been making for real estate investment trusts, but they may not find it so easy to cash in.
It makes sense for these developers to spin off their assets into a Reit but there is a big snag: the accounting scandals triggered by S-chips some years ago are still fresh in the minds of investors and this understandably makes them look at Reits launched by mainland firms with a wary eye.
Indeed, BHG Retail Reit - a China retail Reit sponsored by Chinese retail operator Beijing Hualian Department Store - is languishing at 14 per cent below its listing issue price since it debuted last December.
This is despite other Singapore Exchange-listed Reits gaining an average 10 per cent since January.
Of course, there may be extenuating reasons for BHG's underperformance but it sure doesn't encourage investors to pile into other China Reits that may come their way unless they can offer a much higher dividend yield as an inducement.
That said, one question that crosses my mind is whether the framework created for Singapore-based Reits ought to be modified for the foreign ones coming here to list in order to win investors' trust.
Before examining the issue more closely, it is important to understand how Reits are structured in the first place.
These are "closed end" funds that operate in a similar manner to unit trusts. But unlike unit trusts, which invest in shares, Reits specialise in income-generating real estate assets such as shopping malls, offices and industrial buildings.
And like unit trusts, a Reit's assets are held by an independent trust with a separate management firm appointed to manage the assets.
That makes Reits the perfect vehicle for companies that want to divest themselves of real estate assets that produce a steady income but lack a sexy growth story.
In such a case, a company may set up a Reit to hold the assets it is selling. The Reit then finances the purchase of the assets through an initial public offering with the original company keeping a stake as the Reit's sponsor.
Once the Reit is listed, the sponsor's role is reduced to that of a shareholder and, like all other investors, it collects income in the form of dividends.
In other words, it is exonerated from all responsibilities regarding the running of the Reit.
That works out fine if everything runs smoothly. But what happens if the Reit gets mired in a corporate scandal? There is no recourse to the sponsor and the only redress an aggrieved investor can seek is from the firm set up by the sponsor to manage the assets.
This is not an ideal situation because Reit management firms are thinly capitalised, with many having a paid-up capital of only $1 million even though they may be managing assets worth $1 billion or more.
For Reit managers, which enjoy the ultimate backing of big-name sponsors such as CapitaLand or Temasek-owned Mapletree Investments, the relatively low paid-up capital does not pose a concern to investors.
But Chinese Reits feature sponsors with unknown names. The financial capacity of the Chinese Reit sponsors is also a mystery to many investors here.
Another worry is the level of commitment they have to the Reits they sponsor. One concern is that a company may use a special purpose vehicle as the sponsor to get a Reit off the ground then wind it up after it gets the IPO proceeds.
The redeeming feature, as one market watcher points out, is that property development firms in China are quite well policed with strict provisions on the use of client funds.
Associated with the question of the sponsor's commitment to the Reit is the income support built into the structure of many Reits in order to sustain the promised IPO dividend yield.
A typical way of going about this is to get the sponsor to sign up long leases offering rental guarantees that may well be above market rates.
But if a Reit has assets mostly outside Singapore and a sponsor which is located overseas, it is difficult to assess whether the sponsor is in the financial position to sustain the income support guarantee and that it will not walk away if it finds the arrangement untenable.
Surely, there must be a way to make the sponsor more committed to the Reit, like requiring it to hold a certain minimum stake for a specified period of time, or, better still, furnish a banker's guarantee to back up its rent support commitment.
Of course, you may even ask if income support should even be allowed at all since it distorts the yield offered by the Reit, even if it is clearly stated in the prospectus and the risks are spelt out.
Another question to ask is why the Reit management firm should still deserve to earn a fat management fee if the bulk of the income is due to support offered by the sponsor.
Will internalising the Reit's management, instead of having it run by an external firm, help to solve the problem?
One merchant banker said that internalising the management within a Reit will enable investors to enjoy a higher yield, since an external Reit management firm will charge management fees as well as acquisition and disposal fees.
In that sense, from a cost angle, an internal structure is superior, especially in Reits where a big part of the income still comes from the rent support offered by its sponsor.
Under such an arrangement, the people managing the Reit assets will become employees with their pay determined by the board, rather than according to some prescribed fee formula.
But from a governance perspective, the worry is that this structure is even more prone to abuse, as there is no extra pair of eyes - in this case the Reit trustee - to ensure that the income earned is properly distributed as dividends.
However, a corporate lawyer noted that in the case of Croesus Retail Trust - a business trust - which has internalised its management, the existing business structure stays in place.
Ownership of the trustee management firm, which manages the trust, passes to Croesus' unitholders who appoint a trustee to hold the management firm's shares on their behalf.
Will a similar arrangement apply if Reits internalise their management if only to keep the existing checks in place?
Like unit trusts, Reit management firms need a special licence from the Monetary Authority of Singapore to operate. Will the Reit manager still need this special licence if the Reit is internally managed? These questions need to be answered.
With sponsors of diverse backgrounds making their way here to spin off their assets as Reits, these are some of the recurring issues which regularly crop up. It is surely time to do some soul-searching and see how they can be resolved. Food for thought.
This article was first published on August 1, 2016.
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