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Does short land lease acquisitions by REITs game the revised performance fee structure?

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.

To get started with dividend investing, start by bookmarking my Dividend Stock Tracker which shows the prevailing yields of blue chip dividend stocks, utilities, REITs updated nightly.

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James K

Monday 8th of June 2015

Dear K,

I have been a a strong supporter of REITS as it fufils me of being a shadow landlord. 2 things I would need your advice:

1. If REITS need to beef up their assets, can they only do so via cash calls from the stakeholders themselves? Dont they have remaining of 10% which goes into their war chest for such purposes?

2. Even when REITS purchases new properties regardless 10 or 30 years balance LH, this will amend the average leasehold of their PF, which I am the shareholder, I shall track if the PE is lesser than the overall average LH. Isnt this safe enough such that the price I paid today will be returned before the PF matures?

Please pen your critical comments on my naive thoughts.



Thursday 11th of June 2015

Hi James,

1) the 10% do go to retained, but bear in mind many from time to time do distrbute 100% and as such there is no avenue to beef up. I suppose debt is out of the equation since it puts the balance sheet in a worse off position. thus they can do a placement when the share price is high to acquire, or they could dilute and do a preference share issue, which is somewhat like a hybrid debt/equity issue. either way it depends on whether the manager do something for our good, or they dunno what they are doing. some of these are financial engineering which can be to our advantage and disadvantage.

2) i think PE is not a good guage consider part of depreciation is paid out. Price to RNAV and debt to asset, debt to cash flow are good gauge. the problem is that if you want safe, you have to appreciate the asset or RNAV.a price ot RNAV might look very lor or at a discount, but if the RNAV is at a euphoric time, then in actual fact you do not have a discount at all. in this case you were thinking u are safe, but turns out you are not, which is a shock factor that is amplified.


Sunday 7th of June 2015

This is the reason I do not invest in REIT whose properties have mostly short land lease (less than 30 years), as they smell too much of financial engineering, offering higher short term returns at the price of falling NAV (and most likely, regular cash calls to renew the property portfolio).

I'd rather take a 7% return with freehold properties than 9% with 20 yo land lease...


Sunday 7th of June 2015

Hi Betcour, thanks for your point of view. To be fair in a recent the edge properties article, it does show that perhaps we are a bit over the top on free hold versus leasehold. The premium of freehold does fluctuates but is around 14%.

Having said that, i am puzzled if if i view each property purchase in terms of IRR, buying short lease properties is justifiable.

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