The Motley Fool

3 Main Methods REITs Use to Fund Acquisitions

Many REITs grow their portfolios through opportunistic acquisitions, and the best REITs have been able to consistently grow distribution per unit (DPU) for unitholders through a combination of savvy acquisitions and organic growth (i.e., asset enhancement initiatives). As REITs have to pay out 90% of their earnings as dividends, as is required under regulations, they normally have to resort to raising funds rather than relying on internal cash flow in order to complete acquisitions.

Here are three of the main ways REITs raise funds. Investors should note that each method has implications for the unitholder and that he should read up on the financial effects in order to assess if such actions are ultimately beneficial for unitholders.

1. Loans and borrowings

The most common method for fundraising is for a REIT to tap its multiple credit lines in order to draw down on loans from banks and financial institutions. REITs are able to access multiple bank lines thanks to the many properties they can provide as collateral for such loans. These loans may be as cheap as offering just a 2% to 3% cost of borrowing, and if the acquisition can provide a net property income (NPI) yield above this, it will be accretive to DPU for unitholders.

Unitholders should note, though, that there is a regulatory gearing limit of 45% for all REITs. If a REIT already has a fairly high gearing level, approaching 40%, it may choose not to tap on more borrowings and may instead turn to equity fundraising methods. Most REITs with gearing levels in the range of 20% to 35% are able to comfortably rely on more loans to fund acquisitions.

2. Private placement (secondary offering)

Some REITs may tap equity markets to fund either all or part of the required consideration for the acquisitions. One method, also known as a private placement, or secondary offering, involves selling new shares to institutional or strategic investors in order to raise a sum of money for the REIT.

These shares are usually offered at a slight discount to the last traded market price in order to make it more attractive for the new investors. These new shares will be dilutive (i.e., the total distributable amount will now be divided by a larger pool of shares, thus reducing DPU), but the potential increase in DPU from the acquisition may offset this dilution.

3. Preferential offering (rights issue)

The third method involves tapping existing unitholders to fund part of the acquisition in what is known as a preferential offering or rights issue. Existing unitholders are given a chance to subscribe for new shares in the REIT in an agreed-upon ratio (e.g., 1 new rights share for 4 existing shares held) and also at a discount to the last traded market price.

This method offers existing unitholders a chance to increase their stake in the REIT so as to offset any dilution effects from the enlarged share capital. However, if the discount is too large, it will increase the number of shares by a significant amount, and this leads to greater dilution for the unitholder. Unitholders thus have to assess if the preferential offering is indeed beneficial to them and will not result in dilution in overall DPU.

A combination of methods may be used

Investors should note that REITs aren’t limited to one method and may use a combination of them when fundraising. In fact, it is fairly common to see REITs employ all three methods so as to utilize a variety of sources. The most important thing is for unitholders to size up the acquisition and the details of the fundraising to assess if the deal is beneficial to them or not.

Want to keep up to date with how market volatility can impact the investment landscape here in Singapore? Click here now for your FREE subscription to The Motley Fool’s investing newsletter. 'Take Stock' lets you know exactly what’s happening in today’s markets, and shows how you can protect your wealth in the years ahead by clicking here

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.