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An Inherent Problem for Investors with Real Estate Investment Trusts

singapore property

Singapore can be considered as one of the more mature markets for real estate investment trusts in Asia.

The REIT sector was established in 1999 after the first set of regulatory guidelines was approved by the Monetary Authority of Singapore (MAS). Since the 2002 debut of CapitaMall Trust (SGX: C38U) as the first publicly traded REIT in Singapore, there are now 26 REITs in Singapore’s share market.

REITs are a great method for retail investors to gain access to large and very highly-priced properties such as retail malls, commercial real estate, and industrial buildings. Without a REIT structure, it might be almost impossible for a retail investor to invest in such properties unless he or she is fabulously wealthy.

That said, REITs are far from being a perfect investment vehicle for investors wanting exposure to properties. Here’s one structural issue with REITs that investors should take note of.

When income really isn’t income

The retail mall-focused REIT Frasers Centrepoint Trust (SGX: J69U) had recently completed a private placement exercise where it’s selling 88 million new units of itself in order to finance its purchase of Changi City Point. This exercise is actually emblematic of a characteristic shared by almost all REITs.

As a REIT is bounded by regulation to distribute at least 90% of its taxable annual income to unit-holders, very little is left for the REIT to engage in expansion programs. Therefore, REITs tend to require the injection of new funds from either its existing owners (in the form of rights issues) or new owners (in the form of private placements; it should be noted that a REIT could also issue new units in a private placement to a select group of its existing unit-holders) when it needs to acquire new properties.

As an investor, the implication is that investing in a REIT might require you to fork out additional capital once in a while to subscribe for those rights issues. Many investors buy into REITs for their high dividend yields for a potentially large stream of passive income. But, a REIT’s fund raising exercises might just result in an overall cash inflow that’s tiny, or in the worst case scenario, even negative.

We can use CapitaMall Trust as an example by looking at its history between 2002 (the year it got listed) and the end of 2013. Over the past decade, the REIT had raised funds through private placements almost yearly; that’s fine as a retail investor is not required to cough up additional capital.

But, the trust had a 9-for-10 rights issue in 2009 for all its existing unit-holders back then. If we calculate the cash flow for an investor with 1000 units of CapitaMall Trust that’s bought since 2002, she would have gotten S$1503.30 in distributions provided she had subscribed for the rights in 2009. However, those rights would have cost her S$738.00. This resulted in her net cash inflow for the 11 years in which she has held CapitaMall Trust to be only S$765.30 – that’s almost half of what her income from the REIT’s distributions seem.

Even though the investor would have benefitted from capital gains with a rise in price for CapitaMall Trust, the idea of investing in a REIT for income does not seem to be that effective especially when cash outlays for rights issues are considered.

Foolish Summary

All told, it is important to track a REIT’s history with issuing new units before any investment is made. In that way, investors would have a better idea on the actual return they might be getting in terms of their net cash inflow.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.