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[SINGAPORE] More stable interest rates should bring much cheer to real estate investment trusts (Reits).

All things being equal, a Reit’s distributable income rises when borrowing costs decline. Also, as low-risk alternatives such as Singapore dollar fixed deposits or Treasury bills (T-bills) issued by the Singapore government begin to offer less attractive returns, yield-driven investors may increasingly have to look at Reits. 

The cut-off yield for the latest six-month T-bill issued on May 13 was 2.3 per cent per annum, substantially below the 3.7 per cent per annum of the six-month T-bill issued on May 14, 2024.

However, seasoned investors might still be wary of raising their exposure to Reits.

Certainly, Reits tick many boxes for investors looking to build passive income to help fund retirement needs. Strict guidelines govern how much Reits can borrow. These trusts generally pay out nearly all their distributable income. Some Reits own high-quality assets that fetch good rentals and enjoy high occupancy levels.

In addition, various trust managers have solid track records in driving organic growth from underlying properties and extracting value through asset enhancement initiatives.

Dilution from equity fund raisings

Still, a retiree investing in a Reit might be concerned if a Reit would raise equity, thereby diluting an existing investor’s stake in the trust.

With a more favourable interest rate environment, Reit managers might step up on buying assets to grow the trusts’ portfolios. As Reits have to adhere to borrowing limits, asset purchases may need to be funded by raising fresh equity.

If Reits raise additional equity via private placements, existing unitholders’ stakes get diluted automatically. Worse, such placements are often done at a discount to market price and could cause prices of the Reits to weaken in the immediate aftermath.

Should Reits launch rights issues to raise equity, an existing investor can avoid dilution by injecting cash to subscribe in full to his entitlement.

With Reits that raise equity via a mix of a private placement and a preferential offering, an existing investor may mitigate the prospect of dilution by taking up his share of the preferential units for cash.

What is clear is that when a Reit raises equity, an investor who does not commit any additional funds will see his stake in the Reit diluted.

Should potential Reit investors view dilution risk as a deal breaker? Arguably not.

Reit managers should exercise discipline in portfolio management. For example, they could sell properties with limited scope for growth and recycle proceeds from asset sales into buying assets that have greater growth potential.

Nonetheless, timing gaps may exist between the sale of existing properties and the purchase of new ones.

Benefits of acquisition-led growth

Crucially, a Reit’s unitholders can benefit from a Reit manager pursuing a combination of organic growth, asset enhancement initiatives and net additional asset acquisitions.

Investors may rightly be sceptical about the motivations of Reit managers in buying assets. Many managers earn fees when they acquire assets. Also, a manager who is paid based on size of assets under management or net property income, will earn higher recurring fees by increasing the size of a Reit’s property portfolio. And, managers of Singapore Reits are typically Reit sponsors and not the trusts’ unitholders.

Still, investors, including retirees, need not avoid Reits because of the dilution risk from equity fund raisings.

With rights issues or preferential offerings of units, a retiree can potentially sell some of his existing units to raise cash to subscribe for the rights or preferential units.

Importantly, being diluted is no bad thing. The Lien family exchanged a much bigger percentage share of ownership at Overseas Union Bank (OUB) for a substantially smaller share of UOB when UOB took over OUB in 2001. 

Fast forward to today, while the Lien family may have seen their shareholding in a major local-listed bank diluted significantly, they are likely doing fine given UOB’s generally strong financial performance over this century to date.

Indeed, Reit investors should welcome Reits raising equity to buy more properties so long as Reit managers make good asset purchases that help grow distribution per unit (DPU) on a sustainable basis. 

Take a retiree holding 50,000 units of a Reit which has 200 million units in issue. Assume this Reit doubles its units in issue to 400 million after 10 years. In such a scenario, the retiree who continues holding 50,000 units of the said Reit sees his percentage interest in the trust fall from 0.025 per cent to 0.0125 per cent.

Meanwhile, if the Reit’s DPU grows from S$0.20 to S$0.30, after increasing DPU by about 4.1 per cent per annum over 10 years, the annual distributable income the retiree receives will grow from S$10,000 to S$15,000.

In short, what should really matter to investors when Reits raise equity to fund new property purchases is whether the Reit is making a good buy. Is there room to grow the net property income (NPI) of the new acquisition? How does the Reit manager plan to raise the newly acquired property’s NPI? 

While any investor may loath having his stake diluted, a Reit that raises equity successfully could over time attract a stronger market valuation. 

A private placement of new units draws in new institutional investors. Increasing the size of a Reit’s property portfolio and the trust’s number of units issued could result in a higher free float and greater trading liquidity, which in turn would enhance a Reit’s prospects of being included in various equity indices and covered by equities analysts.

Ultimately, investors need to carefully study proposed new purchases by Reit managers to ensure good assets are being bought on attractive terms.

For example, Frasers Centrepoint Trust’s purchase of retail asset North Point City South Wing at an agreed property value of S$1.13 billion, a deal that involved a large equity raising, is hopefully an acquisition that benefits investors, including those whose holdings in the trust are diluted.

May Reit managers exercise care in raising equity to buy assets so both new and existing investors prosper from such exercises.