2 Ways a REIT Can Achieve Yield-Accretion Through Acquisitions

Acquisition announcements usually produce excitement and optimism for shareholders. This can be in the form of a real estate investment trust (REIT) purchasing a new property to add to its portfolio or a company acquiring a competitor or a related business to expand its operations.

However, not all acquisitions can benefit the shareholders and the company. Sometimes a company may purchase another firm that is a drag on profits or may overpay for an acquisition. In the case of REITs, it is common to find acquisitions funded by secondary offerings or rights issue diluting unitholder interest in the process.

Therefore, as investors, we should try to assess for ourselves if an acquisition is beneficial to us in the long-term. In this article, I will focus on two ways that a REIT can create value for unitholders through an acquisition.

Using existing funds and debt to fund an acquisition

The easiest way a REIT can make yield-accretive acquisitions is by putting unused capital to use or by making use of loans.

When a REIT purchases a new income-producing asset with its existing capital, it will inevitably increase the property income for the REIT. Unlike raising funds through a secondary offering, whereby money is raised through the sale of new units, this method of acquisition does not have a dilutive impact on existing unitholders.

At the same time, a REIT’s ability to borrow money to fund its acquisitions is limited by the cost of borrowing and the gearing ratio. In Singapore, REITs have a regulatory gearing limit of 45%. This means that for every dollar of asset, a REIT can only borrow 45 cents. Because of this, only REITs that have debt headroom can use this method of funding an acquisition.

Purchasing a higher yielding asset than its current distribution yield

A REIT can still achieve yield accretion by purchasing a new property through funds raised from a rights issue or secondary offering. This happens when the increase in income produced by the new asset is higher than the dilutive effect due to the enlarged unit base.

For instance, a REIT that has a distribution yield of 5% and a gearing ratio of 45% decides to purchase a new asset that has a property yield of 6%. It cannot take on more debt because it has reached its gearing limit. However, because the new asset yield is higher than its distribution yield, the new acquisition will still be yield accretive even if it is fully funded by equity raised through the sale of new units.

The Foolish bottom line

As an investor, I am always looking for REITs that have the means to enhance unitholder value through acquisitions. A trick to spot a REIT that can achieve this is by looking at its track record of recycling capital and making good acquisitions. I also often try to invest in REITs that have low leverage, which allows them the option of making acquisitions through debt.

Meanwhile, there are 28 surprising and important things we think every Singaporean investor should know--and we've laid them all out in The Motley Fool Singapore's new e-book. Packed with information and insights, we believe this book will help you be a better, smarter investor. You can download the full e-book FREE of charge--simply click here now to claim your copy.

Also, like us on Facebook to follow our latest news and articles. The Motley Fool's purpose is to help the world invest, better.

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