Reits not sure-win investments

Source : Business Times - 15 Apr 2009

THE Saizen Real Estate Investment Trust (Reit) saga should dispel several widely held myths about the Singapore Reit sector - that the trusts are no-brainer investments; that they are duty-bound to pay out dividends; and that the most important thing to consider when assessing whether a Reit is worth putting your money into is the possible returns from the trust’s portfolio.

Saizen Reit, which in February said that it was not going to pay a distribution for Q2 2009 in order to conserve cash and pay off its loans, has more recently said that it aims to resume payments as soon as possible. But investors may have to wait as long as June 2010, which is when the Reit said it expects to resolve its funding issues.

Prior to those announcements, the trust, which gets its income from residential rental properties in Japan, put out a proposal that would allow it to pay dividends in the form of Reit units - rather than cash - but later said it would not proceed with the plan after deliberations with the Singapore Exchange.

For unitholders, this means that they may not get any income from their holdings in the Reit for more than a year. These investors, who probably bought into the Reit to be ensured of a stable source of income, could now have no such income until mid-2010.

The most important thing for a newcomer to the sector to note is that Reits are not required by law to pay out dividends. Singapore-listed Reits have to distribute to unitholders at least 90 per cent of their distributable income, in order to enjoy tax transparency - which means exemption from paying corporate tax at the Reit/vehicle level on the portion of income they distribute.

But this tax break only applies to those Reits with assets based in Singapore. Reits such as Saizen, which have all of their properties in Japan, do not qualify for the above-mentioned tax transparency treatment. This means that they do not have the same incentive to pay out 90 per cent of their distributable income that Reits with all their assets based in Singapore do.

The Reit sector here has been drawing investors by advertising high yields (which have gotten even higher as Reit stock prices have fallen by quite a bit over the past year). But these yields - as Saizen Reit has proven - are not always guaranteed.

The other thing that this whole saga has highlighted is that when evaluating whether a Reit is worth putting your money into, it is not enough to just consider the viability of the Reit’s business. One must also look at how the trust initially financed its property portfolio.

By all accounts, Saizen Reit’s income stream seems to be stable. The trust, which has a portfolio of 166 buildings with 6,000 rental homes in Japan, said rents and occupancies across its largely mass-market properties have remained stable since the current crisis began.

Rather, the problem is with the way those properties were financed when they were acquired. When building up its portfolio in the years leading up to its 2007 listing, Saizen relied solely on commercial mortgage backed securities (CMBS) loans to finance its buying. But the CMBS market all but shut down at the beginning of 2008.

The trust had already changed some of its loans to traditional bank loans by then, but the crisis meant that bank loans dried up, leaving it with six CMBS loans worth some 20.15 billion yen (S$303.8 million) in all - which Saizen couldn’t refinance.

Now, the trust has to draw on cash reserves, proceeds from a $41 million rights issue, operating cash flow and a short-term bridging loan to pay off five of these CMBS loans worth some 12.2 billion yen in all.

For the sixth CMBS loan, worth 7.95 billion yen, Saizen is looking for refinancing through a possible syndicated loan. In the worst-case scenario, if no refinancing can be found for the sixth loan, the trust may have to forfeit properties worth 10.3 billion Japanese yen, which were used as collateral for that CMBS loan tranche.

High yields and capital gains in the initial years of the sector’s growth have spoilt Singapore Reit investors, or worse still, lulled some into thinking Reits are sure-win investments. What happened at Saizen, hopefully, will serve as a wake-up call.