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1 High-Yield REIT to Be Wary Of

Real estate investment trusts (REITs) are growing to be one of the more popular investment vehicles in Singapore. Not only do they provide exposure to a variety of different real estate types, they also offer relatively high dividend yields.

However, not all high-yield REITs make good investments. It is more important to invest in a REIT that will likely sustain or even grow its dividend over time. With that said, one high-yield REIT I am wary of is ESR-REIT (SGX: J91U). Here’s why.

Reason 1: DPU is being artificially propped up

In the first six months of the year, ESR-REIT has also distributed a portion of capital gains made from the disposal of investment properties in prior years and ex-gratia payments received from the Singapore Land Authority (for the compulsory acquisition of land). The distribution from these gains will only likely persist over a few quarters and cannot be counted on for the longer-term.

For the first six months of the year, distribution from these gains accounted for S$5.9 million or 9% of total distributions. Once these are removed, investors may see distribution per unit (DPU) falling.

Reason 2: Recent equity fundraising will likely be dilutive

The REIT also recently raised S$100 million from a private offering and is set to raise another S$50 million through a preferential offering. 

There are a few reasons that individual investors may be irked by the private offering. First, the private placement was raised at a steep discount of 8.3% to volume-weighted average price on the announcement date of the private placement. The market clearly did not like the announcement and ESR-REIT’s unit price has fallen by close to 8% since then.

The REIT also announced that it is using S$56.8 million of the S$150 million raised to pay off existing debt. The issuance of new units to pay off debt will most certainly be DPU-dilutive. As such, I am expecting an immediate fall in DPU in the next quarter.

Reason 3: High gearing

Despite raising funds through a rights issue to pay off debt, ESR-REIT still has a comparatively high gearing ratio. 

As of 30 June 2019, the REIT had a gearing ratio of 39%, which is still relatively close to the 45% regulatory ceiling. Based on my calculations, once the REIT raises the additional S$50 million through the preferential offering and pays off around S$30.5 million in debt, it will have a gearing ratio of 38.5%. For comparison, only around four of the 40-plus REITs and stapled trusts in Singapore have gearing levels higher than 38.5%.

Its high gearing will limit the REIT’s ability to take on more debt for growth and the REIT may even be forced to raise more money through equity fundraising to lower its debt in the future.

The Foolish bottom line

Not only is its current DPU being artificially propped up by capital distributions, the recent round of equity offerings will also dilute its DPU. Its high gearing also continues to put the REIT in a disadvantaged position when making acquisitions. 

All things considered and despite its relatively high 7.7% annualised yield, I believe there are plenty other REITs in the market that have a better risk-return profile right now than ESR-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. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.