Not All Acquisitions Made By REITs Are Great For Minority Unitholders
Most investors will tell you that acquisition potential is one of the main things that they look out when investing in REITs. Acquisitions can help to grow a REIT’s property income and consequently, may lead to higher distributions. Unsurprisingly, the announcement of an acquisition is often met with excitement and optimism.
However, in reality, acquisitions may not always be good for unitholders. Some acquisitions may even end up having the unwanted effect of decreasing distributions per unit.
With this in mind, here are some things we should look out for when a REIT acquires a new asset.
How is the acquisition funded?
Perhaps the best indicator of accretion to unitholders is whether the acquisition is funded through debt, a rights offering or unused capital.
A rights offering is the process of raising funds through the sale of new units. It has the effect of increasing the outstanding unit base and diluting existing unitholder interest.
Acquisitions funded through debt and existing capital do not have a dilutive effect on unitholders. Therefore, this type of acquisition is more likely to be beneficial to unitholders.
What is the yield on the new property?
The rental yield is the amount of rental income that the landlord of the property can generate per year as a ratio of the purchase price. The higher the rental yield of the new acquisition, the more likely it is to have a positive effect on unitholders.
We should also compare the yield of the new property with the yield of the existing portfolio. If the yield of the new acquisition is below that of the current portfolio, it may end up being a drag on returns. This is even more so if the acquisition was funded through a rights offering.
What is the gearing ratio before and after the acquisition?
The gearing ratio of a REIT is the proportion of its total debt relative to its total assets. There is a regulatory gearing limit of 45% for REITs in Singapore.
Investors should monitor the gearing ratio levels and other debt management statistics of their investments. A gearing ratio that is too close to the gearing cap should be a red flag. A high gearing ratio may also lead to higher cost of borrowing and higher interest expense for the REIT.
The Foolish conclusion
Don’t be fooled (with a small “f”) into thinking that all acquisitions are good for unitholders. Too often, REITs may make acquisitions merely to grow its distributable income, but at the expense of current unitholders’ returns. Only by assessing an acquisition made by a REIT will we be able to get a better gauge on the net effect it can have on us, the minority unitholders.