Today, the Business Times published an article titled, "Reit distributions to fund your retirement may be less than what you anticipate" [news]. The article cautions investors who use S-Reits to fund their retirement.
Reits, by their structure, are required to pay out 90 per cent of their distributable income to unitholders. Such income comes through the rent Reits collect from their tenants. As we know, properties are capital intensive. Most - if not all - Reits borrow money to fund their real estate acquisitions. However, there is a limit to how much leverage Reits can utilize. Hence, there are times when Reits have to raise equity from existing and new investors via right offerings and new unit issuance.
Moreover, all forms of borrowing have a maturity date, unless it is issued as a perpetual security. This means when the deadline approaches, Reit managers will have to raise new debt to repay the old. The debt amount does not decline - think about it, if a Reit has to pay out 90 per cent of its distributable income, how much debt principal can it repay? The only way the debt level can be pared down is when a Reit manager sells a property at a price more than what it had paid for. The old adage applies: Buy Low + Sell High = Profit.
Smart Reit managers will be quite vocal about making only 'accretive' acquisitions. This means these managers will only purchase properties that increase their net distribution per unit (DPU). But what is conveniently left out of the picture is that rental income is CYCLICAL. In good times, Reit managers can afford to increase their rental rates (the so-called positive rental reversion), which helps to boost the income and hence a higher DPU. But when the economy hits a recession, businesses earn less and correspondingly, rental rates have to decrease. (Otherwise, you will be left with an empty property, which is worse.)
When Reits raise equity in good times, this means there are more unitholders sharing in the income. But the number of unitholders does not decrease in bad times! In short, there are more hands dipping on a shrunken pie, which means less pie (money) for everyone.
Additionally, some Reit Trust Deeds mandate that the Reit managers collect annual management fees in the form of new units rather than upfront cash. This means REGARDLESS of how the economy performs, the number of units issued rises every year. So unless you keep buying new units on the market, or take part in every equity offering, your percentage share of the distributable income declines.
This is the main reason I decided to pivot away from S-Reits in my portfolios. I now look for listed companies with high profit margins, high return on equity (ROE), little or no debt, strong branding or diversified streams of revenue (geographical / sectoral). Market leadership, a high barrier of entry and shareholder-aligned management are a bonus.
Now, there is no doubt that companies can suffer losses in bad times too, and they can choose not to pay out dividends so as to conserve cash. But if the companies you choose have the above advantages, they should be well poised to go through the economic valleys and emerge stronger when the situation improves. In fact, downturns may present opportunities for those cash-laden companies to acquire targets on the cheap.
So my friends, if you are still keen to fund your retirement with S-Reits, do note my above caveat and opt for only those S-Reits managed by well-established and reputable managers.
Reits, by their structure, are required to pay out 90 per cent of their distributable income to unitholders. Such income comes through the rent Reits collect from their tenants. As we know, properties are capital intensive. Most - if not all - Reits borrow money to fund their real estate acquisitions. However, there is a limit to how much leverage Reits can utilize. Hence, there are times when Reits have to raise equity from existing and new investors via right offerings and new unit issuance.
Moreover, all forms of borrowing have a maturity date, unless it is issued as a perpetual security. This means when the deadline approaches, Reit managers will have to raise new debt to repay the old. The debt amount does not decline - think about it, if a Reit has to pay out 90 per cent of its distributable income, how much debt principal can it repay? The only way the debt level can be pared down is when a Reit manager sells a property at a price more than what it had paid for. The old adage applies: Buy Low + Sell High = Profit.
Smart Reit managers will be quite vocal about making only 'accretive' acquisitions. This means these managers will only purchase properties that increase their net distribution per unit (DPU). But what is conveniently left out of the picture is that rental income is CYCLICAL. In good times, Reit managers can afford to increase their rental rates (the so-called positive rental reversion), which helps to boost the income and hence a higher DPU. But when the economy hits a recession, businesses earn less and correspondingly, rental rates have to decrease. (Otherwise, you will be left with an empty property, which is worse.)
When Reits raise equity in good times, this means there are more unitholders sharing in the income. But the number of unitholders does not decrease in bad times! In short, there are more hands dipping on a shrunken pie, which means less pie (money) for everyone.
Additionally, some Reit Trust Deeds mandate that the Reit managers collect annual management fees in the form of new units rather than upfront cash. This means REGARDLESS of how the economy performs, the number of units issued rises every year. So unless you keep buying new units on the market, or take part in every equity offering, your percentage share of the distributable income declines.
This is the main reason I decided to pivot away from S-Reits in my portfolios. I now look for listed companies with high profit margins, high return on equity (ROE), little or no debt, strong branding or diversified streams of revenue (geographical / sectoral). Market leadership, a high barrier of entry and shareholder-aligned management are a bonus.
Now, there is no doubt that companies can suffer losses in bad times too, and they can choose not to pay out dividends so as to conserve cash. But if the companies you choose have the above advantages, they should be well poised to go through the economic valleys and emerge stronger when the situation improves. In fact, downturns may present opportunities for those cash-laden companies to acquire targets on the cheap.
So my friends, if you are still keen to fund your retirement with S-Reits, do note my above caveat and opt for only those S-Reits managed by well-established and reputable managers.
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