SREITs – OCBC
Our wish list for 2010
2009 has been an interesting year for the S-REIT sector, with the Great Financial Crisis exposing weaknesses in a structure many thought of as invulnerable. Keeping both the S-REITs’ strengths and weaknesses in mind, here are a few changes we would like to see in 2010…
(1) Increased alignment of incentives. Most REIT managers are currently earning fees based on asset value and on net property income (NPI). Historically, S-REITs have relied heavily on acquisitions to grow both NPI and portfolio size, especially with the added kicker of acquisition fees. Depending on the pricing and financing structure, these two metrics can be increased with no net benefit (or even a cost) to unitholders. A recent RiskMetrics report1 suggests pegging a substantial part of manager fees to total shareholder return. No fee structure is perfect but we feel this issue warrants further attention and discussion.
(2) More transparency of relationship with sponsor. The S-REIT sector has traditionally had a bias towards developersponsored REITs. These REITs are inextricably tied to their sponsors on several levels including property management, REIT management and through acquisition pipelines. In the current de-leveraging environment, we believe several sponsors will sell their assets to their REITs. Pipelines can be a competitive advantage – ultimately an investor may be buying access to quality assets. But pricing and strategic benefit to the REIT is always a concern. We would like to see increased transparency of the acquisition decision-making process that goes beyond a comparison of the acquisition cost versus the independent valuation of the target property.
(3) Renewed focus on value accretion. We expect REITs to return to their growth-via-acquisition strategy. We note that historically the market has focused primarily on yield accretion, which may be more a function of the amount of leverage used to make the purchase than anything else. Third-party or pipeline-driven, we would like to see more attention on the value-add of the proposed acquisition. The market needs to ask harder questions including: Why is the REIT making this purchase? Does this purchase enhance the overall portfolio? What are the strategic considerations behind this decision? Is this a good buy on an un-leveraged basis?
Valuation. Our key ratings drivers in 2010 are 1) earnings trends; 2) leverage and outstanding issues; 3) manager commitment to protecting and creating value; and 4) relative valuations. We maintain our NEUTRAL rating on the REIT sector. Mapletree Logistics Trust [BUY, FV: S$0.78] and Ascott Residence Trust [BUY, FV: S$1.25] are our top picks for the sector.