REITs – BT

Examining the house that Reits built

Recent property deals rekindle debate over fees, independence, minority protection

Calls for reform in the real estate investment trusts (Reits) market here have taken on fresh urgency, as questions resurface about the possible conflict of interest when Reits acquire assets from their sponsors.

This comes after the Monetary Authority of Singapore (MAS) said last week it may offer more regulatory guidance to the industry and urged boards not to take ‘an overly technical approach’ in following governance rules.

The spotlight has swung sharply on the manager/ trustee model and fee structure that Reits operate under, as well as whether there is enough independence on Reits’ boards.

The murmurs grew louder after the sale of Keppel Land’s 87.5 per cent stake in Ocean Financial Centre to K-Reit Asia for $1.57 billion was approved last month at the shareholders’ meetings, despite criticism from minority unitholders over the price and timing.

Singapore and Hong Kong Reits tend to use the manager/trustee model, which has the Reit manager appointed by the sponsor – and often the controlling shareholder – of the property trust. The directors of the Reit manager are also appointed by the sponsor. Reits are managed by the managers, and managers are paid according to the size of the portfolio they take care of.

An earlier report by CFA Institute had already highlighted that one way to better protect Reit unitholders is to ensure most directors on the boards of Reit managers are independent. It noted that the inter- relatedness between the sponsor and the manager increases the risk that they would act in their own interest, at the expense of minority unitholders.

The bulk of Reits do not have independent directors making up the majority of their board, though this is in line with the practice of most listed firms here.

‘The conflict of interest can be avoided if the sponsor appoints a Reit manager that is not related to the sponsor or its group of companies,’ Lee Kha Loon, head of the Standards and Financial Market Integrity division of CFA Institute for the Asia-Pacific region, told BT in an interview.

The other option is to use a corporation model that has investors voting for the appointment of the directors, including independent directors – a practice that is more common in Australia, he added.

Mak Yuen Teen, associate professor at NUS Business School, called the governance of Reits ‘problematic’, since the board of directors is the board of the Reit manager and owes fiduciary duties to the manager, not the unitholders.

Under recent revisions of the Code of Corporate Governance, a director is not independent if he is or has been directly associated with a substantial shareholder of the company in the current or any of the past three financial years.

Professor Mak noted that K-Reit manager’s chairman Tsui Kai Chong is classified as an independent director, though he has been an independent director of Keppel Land since 2001. Another K-Reit independent director, Lee Ai Ming, is also an independent director of Keppel Land.

At Reits such as CapitaMall Trust, CapitaCommercial Trust and CDL Hospitality Trusts, the chairmen – who have links to the sponsor – are not labelled independent.

BT reader Bobby Jayaraman recently wrote that Reit managers should be paid based on a combination of growth in distribution per unit and market valuation of the Reit.

He argued that current rules are not robust enough to ‘prevent unscrupulous Reits from taking advantage of minority shareholders’. ‘The major culprit is the incentive system for Reits, which does not always align with shareholder interests,’ he added.

Mr Lee noted that in Singapore, the fee structures of S-Reits are skewed towards performance fees paid based on net property income. Of the 22 S-Reits that the CFA Institute reviewed in January, 64 per cent of them used this approach.

‘This excludes interest charges; therefore gearing charges have not been deducted in computing performance fees for the manager,’ said Mr Lee.

‘A more equitable form of compensation would be a combination of factors, based on an index and growth in distribution per unit.’

Also, independent financial letters issued to minority shareholders of both Keppel Land and K-Reit do not express an opinion of future prospects, Mr Lee noted. Analysts have noted the deal came at a time when macroeconomic conditions are turning grim.

In addition, Mr Jayaraman noted that independent valuation reports – done in accordance with MAS rules to safeguard investors’ interests – do not consider potential changes and risks to the commercial property market.

Mr Lee said: ‘If there can be additional information that can help minority shareholders to evaluate the impact of the acquisition, it will be a research report issued by a research house. However, this will likely happen only if there is sufficient institutional ownership.’

An idea to have a tender process for such property transactions has also been mooted. One senior lawyer supported this but cautioned that sponsors could control the timing and know the information better, making it hard for third parties to have the same assessment of the values.

Reits are currently excluded from the annual ranking for the governance and transparency index, which highlights the best and the worst among listed companies in corporate governance standards, noted Prof Mak.

‘They are just a completely different animal.’