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JUST over four years since CapitaMall Trust (CMT) pioneered the creation of Singapore’s real estate investment trust (Reit) sector with its successful listing in mid-July 2002, there appears much to cheer in this sector.

Today, Singapore has Reits owning foreign properties and Reits owning properties outside traditional sectors such as retail, office and industrial, and in areas like hotels and service apartments.

The capital market fund raising activities and property acquisitions carried out by Reits have given investment bankers, real estate agents, real estate valuers, property owners and a host of professionals much to cheer about. Policy makers and regulators can point to Singapore being a hub for Reits.

But even as the sound regulatory environment, the critical mass of Reits and the demand for yield plays from an ageing population all point towards continued growth in Singapore’s Reit sector, danger signs are appearing.

When entities go for initial public offerings (IPOs), pricing should be such that the entity trades, upon listing, at a reasonable premium over the IPO price such that IPO investors will support future equity raisings of the entity in question.

A look at the trading debuts of recently listed Reits shows a cloudy picture.

Disappointing performance

Cambridge Industrial Trust (CIT), which made its trading debut last month, closed at 65.5 cents yesterday, down from its IPO price of 68 cents.

CIT’s unit price performance post-IPO is disappointing despite the trust raising its initial forecast distribution yield, mainly through higher borrowings, when the IPO was relaunched after an earlier aborted attempt.

Both Fraser Centrepoint Trust (FCT) and CDL Hospitality Trusts, which also listed in July, have fared somewhat better. FCT ended at $1.06 yesterday, compared to its IPO price of $1.03 apiece. CDL Hospitality Trusts closed at 92 cents, compared to its IPO price of 83 cents apiece.

However, when CMT and Ascendas Reit listed in 2002, they were offering IPO investors initial forecast yields of 7 per cent and 8 per cent respectively. Their initial yields compare well with those of recent IPOs.

In contrast, yield on the five-year government bond then was less than 3 per cent compared with over 3 per cent today, and gearing of Reits then was lower than what it is today.

Still, there is little to blame property vendors for having certain price expectations when selling assets to a Reit today.

The danger is that when a Reit fails to convince investors of its ability to grow through acquisitions, the price heads south thereby driving up its distribution yield, which, in turn, makes it difficult to find yield-accretive acquisitions.

What stands out, however, is not that Reits are being priced at lower spreads to the risk-free rate as represented by government bond yields but that this has happened as the risk profile of Reits in general has increased.

These trusts continue to be backed by income streams from legally enforceable leases. But their borrowing levels have increased. More trusts are going overseas, which means exposure to foreign currency fluctuations and to risks of owning properties in jurisdictions with typically less robust laws than Singapore’s.

Income streams from assets like hotels have greater volatility given that their business caters to a transient clientele. Also, Reits are competing among themselves to buy assets, thereby putting upward pressure on asset prices.

Let’s focus on the path breaker for CMT. Pua Seck Guan, who was with CMT at its inception, continues to be its manager. Under his leadership, this Reit has done much on the asset enhancement front. CMT’s malls are actively managed for optimal rental returns.

But the risk profile of CMT is increasing. Gone will be the days of CMT providing investors access solely to retail income from well-known Singapore shopping malls, with a focus on those located in densely populated suburban areas.

Greater exposure

CMT’s acquisition of Raffles City complex (which has office, retail, convention and hotel space), together with CapitaCommercial Trust, exposes it to sectors beyond retail.

CMT looks set to own up to 20 per cent in a Reit by CapitaLand, which will own retail assets in China.

Another CMT growth strategy is to invest in Singapore development projects. Farewell then to the concept that investors wanting potentially exciting but risky gains from development projects can park their monies in CapitaLand while those wanting more secure but less exciting returns associated with investment properties can park their monies in CapitaLand’s Reits?

Singapore’s Reits may be a victim of their own success in that investors now have high expectations that Reits can grow their distribution per unit at fairly impressive rates.

This, in turn, puts pressure on Reits to go down riskier paths to fulfil those expectations - be it more borrowings, buying overseas or taking on exposure to development projects.

Recent results posted by Reits have been good but investors should be wary of the heightened risk profile of these vehicles.

Reits must be mindful that they do not take on too much risk such that they lose their unique position in the investment spectrum of being defensive equity plays, which sit between bonds and most other equities.

Source : Business Times - 8 Aug 2006