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Are externally managed REITs the best model for Singapore?

IF Hong Kong-based fund manager Victor Yeung had his way, all real estate investment trusts (REITs) in Asia would be managed internally rather than by an external manager that is often owned by a large property group. "There is strong evidence that internally advised REITs are stronger," says Yeung, who is managing director and deputy portfolio manager for Asia at LaSalle Investment Management (Securities).

Yeung has the weight of history behind his view. "In the US, REIT legislation started in 1960, but legislation for internally advised REITs were introduced in 1986." In 1991, Kimco Realty, the first internally managed REIT, was launched and it eventually became the structure adopted by most of the REIT market. The reason was simply because an internally managed structure was what investors wanted.

"The shareholders want a per share return," Yeung explains. By contrast, external managers are more likely to pursue asset growth rather than shareholder returns. "The REIT may buy something that is too expensive." Indeed, an externally managed REIT might be unwilling to sell underperforming assets because it would shrink the portfolio and the fees that the manager stands to collect, he adds.

That accounts for the somewhat different behaviour of REITs in other markets. "In Australia, you have REITs buying back shares in the last two years. Share buybacks only work for the manager if they are evaluated on a total-shareholder-return basis, because the portfolio would have to shrink if there is a share buyback, as the manager would have to sell weaker buildings to raise cash. That is why we think an internally advised structure is better. It allows the manager to manage the REIT on a total-shareholder-return basis," Yeung says.

Patrick Lecomte, an academic at ESSEC Business School, who has been studying the Singapore REIT market closely, says the external-manager model might be more suitable for the local market even though it has been displaced elsewhere. "We cannot apply corporate governance designed in the US on Asian companies," he says. In fact, when he took a scorecard designed by a company specialising in corporate governance in the US and applied it to the S-REITs, the results were meaningless. "It didn't take into account the idiosyncrasies of the market. There is no more idiosyncratic market than real estate."

The way Lecomte sees it, Singapore is a small market and the developer-sponsors have disproportionate access to funding as well as assets. "The market is aware of it. Usually, developer-sponsored REITs tend to perform better during IPOs because investors are aware these REITs have access to property and support, knowledge and expertise," Lecomte says.

Moreover, the developer-sponsors have proven themselves willing to support their REITs during the global financial crisis in 2008/09 when credit markets froze up. For instance, both Keppel Land and CapitaLand undertook to subscribe to their pro-rata allotment and any further unsubscribed units in 2008 and 2009, when their REITs needed to raise capital. "The REIT platform is fundamental to the success of our capital-recycling model," says Arthur Lang, chief financial officer of CapitaLand. "In Singapore, the externally managed model has worked successfully."

Eng Seat Moey, managing director and head of asset-backed structured products at DBS Group Holdings, says the key to overcoming the potential conflict of interest inherent in externally managed REITs is transparency, disclosure and good corporate governance. "Investors like the idea of a developer-sponsored REIT because you have the developer fully behind it and their interests are aligned," Eng says.

To be sure, many of the major developer-sponsored REITs in Singapore have performed well over the past decade. Yet, getting rid of an external manager isn't easy. In the wake of the credit crunch, the management of a number of REITs changed. Among them were what are now Starhill Global REIT, Frasers Commercial Trust, AIMS AMP Capital Industrial REIT and Cambridge Industrial Trust. However, in each case, the management changed through the sale of the existing management company for a hefty price. "Investors would like more transparency in the management agreement, and the cost of removing the manager," Lecomte says.

Regardless of the potential risks and conflicts of interest, Singapore's REIT sector has gained a broader investor following recently, because of low interest rates and equity-market volatility. The FTSE S-REIT Index, which fell 17% in 2011, is up 21% so far this year, outperforming the Straits Times Index's 13% gain.

As more international investors pour funds into the S-REIT market, will they continue their calls for a shift to internally managed REITs? "Singapore has one of the stronger REIT markets in Asia," Yeung of LaSalle acknowledges. Yet, he still believes that the city-state will eventually move towards the internal model because of investor demand. — The Edge Singapore

This story appeared in The Edge Singapore on Aug 6, 2012.

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