Reits' asset injections: A little less action a little more discretion, please

RIGHTS issues have become a thing to fear for Reit investors.

Recent cash calls by OUE Commercial Reit, Keppel-KBS US Reit and Cromwell European Reit have all drawn negative market reactions. As one market watcher whispered in passing: You never know who's next.

Indeed, Reits have always relied on equity dilution or new debt to fund acquisitions, since the law requires them to distribute at least 90 per cent of income to enjoy tax benefits.

So Reit managers who pursue acquisitions without enough buy-in from existing unit holders are flirting with a sell-down.

Basic principle: Managers and unit holders can't go on together with suspicious minds.

To recap:

In September, OUE C-Reit announced a S$587.5 million, massive 83-for-100 rights issue to part-fund the purchase of strata office space in the OUE Downtown building, which diluted DPU (distribution per unit) yield. Analysts also sniffed at the property's short remaining leasehold tenure of 48 years and the challenge of making a major yield-accretive acquisition in the future without another cash call.

In October, Keppel-KBS US Reit announced a US$93.1 million, 295-for-1,000 rights issue to fund the purchase of a business campus in the Seattle metropolitan area that is yield-accretive on a pro forma basis.

But some were stunned that the cash call had come so soon after the Reit's initial public offering (IPO) less than a year ago. The rights were also priced more cheaply than originally forecast, while a planned preferential offering of new units to raise US$101.3 million failed to materialise.

DBS analysts reasoned that the sell-down was exacerbated by "fears that a negative tax ruling would be applied retrospectively", though in fact the US tax reforms took place late last year and this risk had been present since the Reit's listing.

Others cited Keppel-KBS US Reit's lower-quality portfolio in comparison with Manulife US Reit, and possible competition from the IPO of KBS Prime Reit.

Now, Cromwell E-Reit is in the midst of a 224.1 million euro (S$349 million), 38-for-100 rights issue, which will also fund yield-accretive new acquisitions, including three office buildings in Poland.

Some perceive the re-introduction of Polish assets as a backward step by the Reit manager. The Reit's IPO last year was shelved for a time and later downsized to remove seven retail properties in Poland that investors weren't willing to take a punt on. This cash call also comes less than a year from the IPO date.

Other factors dampening investor interest include possible market fatigue since many bigger Reits have also raised fresh equity recently.

As newcomers to the Reit scene, Keppel-KBS US Reit and Cromwell E-Reit might have fared better if they'd built up a stronger track record of good performance before re-tapping the market, suggested RHB analyst Vijay Natarajan: "My sense is that they didn't establish themselves first."

In any case, both Reits have delivered in line with their IPO prospectus forecasts, driven by organic numbers instead of financial engineering, he said. In comparison, Sasseur Reit is helped by a complex Entrusted Management Agreement with its sponsor; Dasin Retail Trust also gets income support from its sponsor.

Units of Keppel-KBS US Reit and Cromwell E-Reit both trade below their theoretical ex-rights prices, after rebounding off earlier lows.

There's also more at play here than the standard chicken and egg problem faced by Reits that want to grow their asset base in order to gain a larger investor following.

Broadly, Singapore-listed Reits have been on an overseas acquisition spree over the last year, but the market has grown more cautious of late.

From Europe to the US, people are starting to worry about a bubble in commercial real estate again.

The period of growth driven by cap rate compression - thanks to a surfeit of cash from private equity funds, the super-rich, and others who have been willing to pay a high price for a property just to generate nominal income - is widely perceived to be behind us.

While rental growth varies across geography and asset class, the general environment favours sellers rather than buyers.

So it is becoming more difficult for Reit managers to convince investors to back a new acquisition on the sole basis that hypothetical data shows the deal will be accretive.

The focus increasingly falls on finding the right capital structure to enable sustainable, long-term growth.