Yesterday evening, the Monetary Authority of Singapore (MAS) issued a list of changes to the regulations affecting real estate investment trusts (REITs) in Singapore.
The MAS had first announced back in October 2014 that it wanted to refine REIT regulations and had come up with a list of proposed changes. After inviting feedback from the public and thinking through them for a number of months, the MAS has settled on the changes, which were released yesterday evening.
Here’re some of the important ones (along with my comments).
On changes to the fee structure
“MAS will not intervene on the structure of fees or types of fees that Managers charge, but will require them to disclose the justification for each type of fees charged. Managers will also have to explain the methodology for computing performance fees, and justify how this methodology takes into account unitholders’ long-term interests.”
Investor maestro Charlie Munger has described incentives as one of the most important forces that can shape human behaviour. To that point, Munger once said, “I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it.”
With the right incentives in place in terms of Manager fees that are aligned with unitholders’ long-term interests, investors in REITs can thus stand a better chance of having a profitable experience.
But what should unitholders look out for? This ties back to what truly drives the economic value of a REIT and that is, growth in its per unit figures like its distributions and net asset value. Warren Buffett, Munger’s long-time business partner and an even larger investing father-figure, once said (emphasis mine), “We do not measure the economic significance or performance of Berkshire [the conglomerate controlled by Buffett] by its size; we measure by per-share progress.”
Think about it this way. Say you had 100 units of a REIT in 2010 and after five years in 2015, you still own the same 100 units.
Over that period of time, the REIT’s distributions grew by 100% from S$100 million to S$200 million; that’s a very commendable performance. But because its unit count had doubled from 100 million to 200 million as a result of private placements and the payment of management fees with new units, the REIT’s distribution per unit had stayed flat at S$1. And you, as the investor, would not have any added benefits whatsoever despite the REIT having doubled its distributions.
So, keep an eye on whether a REIT’s Manager’s fees are based at least partly on growth in the REIT’s per unit figures. If that’s not the case, then take a hard look at the justifications given by the Manager and think it if makes sense.
With all that said, it’s worth stressing that having the right incentives is no panacea for a winning investment. Hutchison Port Holdings Trust (SGX: NS8U) had fee structures which are very much aligned with unitholders’ interests. Sadly though, its total return (including gains from reinvested dividends) from the close of its first-day of trading in March 2011 to today is a negative 10.5%. There are many other important factors to consider – such as the type and quality of the properties in a REIT’s portfolio – when making an investment.
On changes to leverage limits
“The leverage limit imposed on a REIT will be increased from 35% to 45% of the REIT’s total assets, but a REIT will no longer be allowed to leverage up to 60% with a credit rating.”
REITs in Singapore have so far been rather disciplined in terms of risk-taking. When the MAS first announced its proposals to change REIT regulations last October, it mentioned that “most [REITs]… have kept their leverage ratios within 35%” even though two-thirds of them had credit ratings and could thus have geared themselves up to 60%.
But, greater leverage comes with higher risks. As such, investors may still want to keep an eye on how the balance sheets of their REITs are changing given that they now have more leeway to take on more borrowings.
On changes to remuneration policies
“Managers will be required to disclose their remuneration policy and procedures in the REITs’ Annual Reports.”
With better disclosure, investors can then make sounder judgements on whether the policies are reasonable or not. This is similar to the fee structure changes mentioned earlier in the sense that remuneration polices which are aligned with unitholders’ interests can help increase the odds that the REIT will be a good investment for the latter group.
Some yellow flags to watch out for could be remuneration policies for management personnel which does not take into account, or only gives little consideration to, growth in important drivers of a REIT’s economic value such as those mentioned earlier.
A Fool’s take
There’re a lot more to the new regulations governing REITs and here’s the complete list from the MAS. The changes to the rules will be implemented in phases starting from 2016; in particular, REITs will have to start adhering to the new disclosure standards for Manager fees by the first Annual General Meeting of the financial year ending on or after 31 December 2015.
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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 writer Chong Ser Jing owns shares in Berkshire Hathaway.