Take a hard look at Reit sponsors

SINGAPORE - For yield-hungry investors, the big draw with real estate investment trusts (Reits) is their headline- grabbing projected dividend yields.

But one lesson which many investors have yet to grasp fully is that the eye-catching high yields offered by Reits do not come risk-free - especially for Reits with sponsors that are relatively unknown in Singapore's corporate landscape.

Reits are "closed-end" funds that 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 and warehouses.

As a Reit is structured like a unit trust, its assets are held by an independent trustee. But the trustee does not manage the assets. That job is handled by a separate management company.

What makes Reits attractive in Singapore is their tax-efficient structure.

In order to be exempt from paying any income tax, Reits have to pay out at least 90 per cent of their income as dividends.

Individual investors are also exempt from paying tax on the dividends they receive.

That makes Reits the perfect corporate vehicle to raise cash for companies that want to divest themselves of their real estate assets, which generate steady income but lack a sexy growth story.

In such an instance, a company may set up a Reit to hold the assets it is selling.

The Reit will then finance the purchase of those assets through an initial public offering (IPO), with the original company retaining a substantial stake as the Reit's sponsor.

But here lies the catch: As far as some Reit sponsors are concerned, they are simply shareholders like any other investor, collecting income from the Reit in the form of dividends.

If the Reit gets mired in any corporate malfeasance, the only possible recourse for an investor is to seek redress from the management company set up by the sponsor to manage the assets.

However, Reit management companies are often thinly capitalised, with many having a paid-up capital of only $1 million each.

This is unlikely to be an issue for investors in Reits that ultimately enjoy the backing of well-known sponsors. CapitaLand and Singapore Press Holdings are among the Reit sponsors included in the Straits Times Index of blue-chip companies.

But as more and more Reit IPO hopefuls make a beeline here, with the bulk of their assets outside Singapore's jurisdiction, some market watchers would like the sponsor - rather than the Reit manager appointed to manage the assets - to be ultimately answerable for any mis-steps that may occur.

This is to safeguard the sterling reputation that Reits have painstakingly built up here, turning Singapore into a destination of choice for investors planning to invest in such instruments.

One corporate lawyer noted: "A number of transactions now have sponsors with unknown names with no financial substantiveness relative to the size of the IPOs which they have launched."

Another worry is that a company may use a special purpose vehicle as the sponsor to get the Reit off the ground, only to wind it up after it distributes the IPO proceeds to its shareholders.

The lawyer said: "Surely this isn't the best position for the retail investor. For corporate governance and investor protection, the sponsor who reaps all the benefit of the IPO should step up and be liable for any misrepresentation that may occur."

This harks back to a point often raised in this column - that investors should look beyond a Reit's mouth-watering yield and check out its sponsor's financial health and ability to inject fresh money into the Reit if it is hit by a credit crunch.

Sure, Reits are enjoying a boom right now, with high rents and low loan-servicing costs.

But there was a brief period in 2009 when there was a real worry that banks might be unwilling to roll over the huge sums owed by Reits to finance their property purchases as the global credit crunch hit Singapore.

Since then, Reits have not become any less immune to such a threat. In May, their share prices fell by as much as 18 per cent on concerns that the US central bank might tighten the ample credit it has unleashed on the world's banking system.

As such, it may be timely for investors to tackle the question of whether sponsors should take on more accountability for their Reits, rather than being merely passive shareholders.

engyeow@sph.com.sg