It would seem that no matter how we tried to improve governance to promote the healthy growth of particular sector, there may still be a way to game the system.
There have been much news by policy makers in response to better aligned REIT managers to promote the alignment of corporate business decisions made and that of shareholders interest.
One of the more prevalent one is the shift on management fee from based on assets under management, net property income to that of improvement to dividend per share.
Since what investors are looking for is the manager buying and selling properties that generates higher dividend per share and capital gains, these should be the metrics that are aligned to.
However, would this still be to the detriment of shareholders?
I notice 2 case study from 2 industrial REITs amongst my Dividend Stock Tracker that we can examine.
Soilbuild REIT acquired 72 Loyang Way, Technic’s premises for SG$97 million. The land lease was 23 years.
Viva Industrial Trust acquired their Technopark at Chai Chee much earlier. The land lease left is 17 years.
To help enabled urban redevelopment planning in the future to be better and to ensure industrialist cost of doing business is not too expensive, the maximum land lease for new properties in the future will be 30 years, so we will see more of these kind of industrial assets.
The acquisition will be justified by an accretive net property income. However, I wonder if we are being myopic here to acquire assets that are so short in terms of land lease.
Suppose an industrial property have 1 year of land lease left, the value of the property will be the rent for 1 year. The net property income yield will be a 100% return. If a property have 5 year of land lease left, the value of the property will be the discounted aggregate of 5 years rent.
Part of the cash flow return here for a property is a combination of organic rental return and capital return. This makes REIT return look far more attractive considering the REIT pays out of depreciation, and not saving much capital on the trust balance sheet for renewal (as REITs to enjoy the tax incentive have to pay out greater than 90% of their income)
The shorter land lease asset purchase is therefore cheaper to acquire, easier funded by debt, looks justifiable by net property income yield versus current portfolio dividend per share yield. Thus it will result in DPU moving upwards.
The long term ramifications if the manager takes the route of acquiring many of these short land lease properties, is that it looks good on dividend per share basis, but at some stage, in a nearer term, these assets will be worthless.
The managers gets a boost on their performance fee this way. Is this the loop hole to the change in incentive?
I suppose the counterpoint is that this trust will die sooner rather than later, and the manager may not want that to happen. However, it also means a delicate management of having longer land lease assets as a base, followed by strategic short land lease acquisition based on placement, debt funding can result in a consistent increase in dividends per share.
Every manager have an internal rate of return or IRR that they look for when making the acquisitions. Somehow, it is something that they held close to their heart what the figure is. Based on my understanding of IRR, it should provide the return on our capital put in initially and give a good idea of the discounted returns factoring assumed inflation, and not considering capital returns. Would having such a component in one of their reward metrics be a better determinant of performance?
Come to think of it that is what we want, a higher return, so why am I complaining?
This is not a complain but an exploration of thoughts. I believe in reflecting and asking questions, that way we find real issues, dismiss trivial ones and solidify what we should put our money into.