A rights issue is a way by which a real estate investment trust (REIT) can raise funds through the sale of new units to existing unitholders. It gives unitholders the right but not the obligation to purchase units at a predetermined price to add on to their existing holding. The predetermined price is usually set below the current market price of the REIT, making it attractive for unitholders to buy more units.
However, before you get too excited when you are offered a rights issue, there are a few things that you should look out for.
What is the REIT using the capital for?
A rights issue is commonly used to make acquisitions to expand a REIT’s property portfolio and increase its property income. This can be both good and bad. The rights issue can have a negative impact when the new property acquired has a lower rental yield than the REIT’s portfolio. The low yield might be a drag on future distributions.
A REIT that is in financial trouble may also use a rights issue to pare down debt. This is usually the last resort when the REIT is unable to meet its debt obligations. Investors should, therefore, avoid REITs that have a weak balance sheet.
Dilutive effect of the rights issue
Current unitholders also need to assess the dilutive effect of the rights issue. When a rights issue is offered at a much lower price than the net asset value of the REIT, it will have a dilutive effect on existing unitholders.
On the flip side, if the rights issue is offered above the net asset value of the REIT and the funds are used for yield-accretive acquisitions, the new issue may add to unitholder value over the long-term.
Is the right issue renounceable?
Some rights issues are renounceable. A renounceable issue can be sold in the market to someone else.
This option can be used when the investor needs capital. If the rights issue is renounceable, it is more sensible to sell your rights issue instead of letting it expire worthless.
The Foolish bottom line
A right issue can add value to current unitholders as they are offered at a discount to the market price of the REIT. At the same time, investors need to assess the long-term dilutive effect of the new issue. If the increased unit base ends up having a dilutive effect on earnings and book value per unit, it may be advisable to re-look into your investment thesis on the REIT.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.