SINGAPORE - The time has come for real estate investment trust (Reit) managers here to seriously consider buying back some of their issued shares given the sector's depressed valuations, Religare Institutional Research suggested in its recent initiation report on Singapore Reits.
Some Reits are now trading at 20-30 per cent below their book values. Compared to buying properties at high prices and compressed cap rates of 4-5 per cent, Religare sees a stronger case for managers to buy their own shares which are yielding 7-9 per cent, depending on the sector.
Analyst Pang Ti Wee told The Business Times in a call: "Share buybacks might become the best kind of investment from the manager's point of view, as opposed to taking some money out to buy another hotel (as an example), because the yield is higher."
He believes that the S-Reit sector is oversold. He sees other benefits in share buybacks for unitholders. "For one thing, it shows confidence to the market that you as a manager are saying that this stock is undervalued."
For another, buybacks shrink the issued unit base and so boost distributions per unit (DPU). In some way, share buybacks also help to support their trading prices.
Since Reits do not hold much cash in hand, there are three ways they can finance their buybacks:
1) by selling their underperforming, lower-yielding assets;
2) by using debt - which is trickier because the Monetary Authority of Singapore (MAS) has enforced a 45 per cent leverage limit and managers generally like to also keep some debt headroom; and
3) by issuing perpetual debt, which no Reit has used before to fund buybacks. The good thing about this method is that MAS treats perpetuals as equity for the purpose of Reit leverage rules, so this does not affect their leverage limits.
Mr Pang agreed that it may seem counter-intuitive to be paring down one's own portfolio instead of growing it. There may even be resistance from Reit managers who stand to enjoy higher management fees when their portfolios are larger.
"But buying back shares would show the market that they have good corporate governance, that they are thinking on behalf of and aligning interests with unitholders. Management would be returning capital to investors by taking advantage of a low interest rate environment before the opportunity vanishes, while boosting DPU," he said.
He, however, qualified that: "To be fair to managers, on the longer-term basis, buying properties should still be the underlying fundamentals for Reits to grow the portfolio. Buying back shares is opportunistic."
Currently, S-Reit yields are at a spread of more than 400 basis points above interest costs, he said. Interest rates are at 2-3 per cent, while Reits are yielding 7-9 per cent across the board.
Meanwhile, all perpetual debt previously issued in the S-Reit industry is at less than 5 per cent interest rate.
Mr Pang said that if some Reits (such as those in the industrial sector) are trading at a high yield and large discount to book value, issuance of perpetual debt at 5-6 per cent to buy back shares could also potentially result in a positive carry spread of 300 basis points or more, as well as a higher DPU if the shares bought back are retired.
There would also be minimal impact on the leverage ratio, given that perpetuals are viewed as equities by MAS.
"Having said that, we believe this exercise is more feasible for some of the larger Reits that have higher trading liquidity," he qualified.
This is because buying back shares of an already illiquid Reit would leave it even more illiquid, and may also risk pushing up its price too drastically.
This article was first published on Jan 28, 2016.
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