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1 Change That Needs To Be Made To How Singapore REITs Are Managed

The Motley Fool logo The Motley Fool 12/3/2019 Jeremy Chia
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Singaporeans love investing in real estate. As such, it is no surprise that since debuting in Singapore’s stock market in 2002, real estate investment trusts (REITs) have skyrocketed in popularity.

Besides giving investors exposure to a variety of real estate at a low minimum capital outlay, REITs also provide comparatively consistent and high yields relative to stocks.  All these characteristics make REITs a great alternative to investing in your own property. As an investor of REITs myself, I am very happy with the returns that my investments have provided so far.

However, there is a problem about the way REITs are managed that needs to be addressed, and I want to highlight it.

The problem

In my view, there is one fundamental problem with how many REIT Managers are paid in Singapore: They are paid based on the value of a REIT’s property portfolio and are also paid acquisition and divestment fees whenever a property is bought or sold.

An example is KEPPEL REIT (SGX: K71U). The REIT Manager’s fees are calculated by adding (1) a base fee of 0.5% per year of the value of all its assets; and (2) 3.0% of the net property income of the trust. KEPPEL REIT’s Manager is also entitled to receive an acquisition fee at the rate of 1.0% of the acquisition price of a property, and a divestment fee of 0.5% of the sale price.

To me, this compensation structure incentivises Keppel REIT’s Manager to grow the REIT’s asset base, sometimes at the expense of minority shareholders’ interestThe table below shows KEPPEL REIT’s manager fees over its past few fiscal years, in comparison with the REIT’s distribution per unit (DPU).

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Source: Keppel REIT annual reports

We can clearly see that despite Keppel REIT’s DPU declining each year, the Manager’s fees have increased. This illustrates how misaligned the incentives of Keppel REIT’s Manager are. To earn a higher fee, the Manager simply needs to increase the asset size of the REIT and to recycle its assets frequently. In this case, the growth-at-all-cost strategy of Keppel REIT’s Manager has resulted in a decline in the REIT’s DPU in each year for the period I’m studying because of the dilution of unitholders’ stakes in the REIT through equity offerings. 

Keppel REIT is by no means an isolated case. Many REITs in Singapore compensate their Managers in a similar manner, and the incentive structures drive their Managers to pursue growth in their asset base, sometimes at the expense of shareholders’ returns.

The fix

As the example of KEPPEL REIT shows, misaligned Manager incentives are clearly a major problem for shareholders of REITs.

To fix this problem, alignment of Manager incentives with shareholder interest is needed. One way to achieve this is to compensate a REIT’s Manager based on the REIT’s DPU, instead of basing the compensation on the size of the REIT’s asset base and net property income. This is because a REIT’s DPU is what really matters to shareholders. The DPU not only affects what shareholders earn as distributions, but it also has a direct impact on the share price movement of the REIT.

In addition, a REIT Manager’s compensation should have less emphasis on fees that are linked to the purchase and sale of properties. I recognise that the process of acquiring or disposing of a property can be a grueling task for REIT Managers and they need to be fairly compensated. However, the compensation should be done in a way that does not incentivise the unnecessary recycling of assets that may not benefit shareholders.

The Foolish Conclusion

Don’t get me wrong. Singapore-listed REITs have delivered exceptional returns in the past and at current prices, they seem well-placed to continue to do so even if no changes are made to the compensation structure for REIT Managers. However, misaligned manager incentives are certainly not ideal for shareholders and this misalignment has already led to decisions being made that ultimately do not benefit shareholders.

Hopefully, this article of mine shines light on this long-standing problem and reforms can finally start to be made.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Jeremy Chia owns units in Keppel REIT.

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