How are REITs structured and why is it important for the investors to know? According to MoneySense, when a company decided to launch a real estate investment trust, money is raised from the unit holders during the IPO offering phase. The company would use the proceeds to buy a pool of real estate assets.
Sometimes, the REIT might even finance the purchase of assets through debts. The assets are held by an independent trustee who is responsible for safeguarding the interests of the unit holders and ensuring that the vehicle complies with the applicable laws in Singapore. Investors have to pay trustee fees.
On top of appointing an independent trustee, a REIT itself must be managed by a property manager for a fee. The management fees will be deducted from the income yield before distributions are made. As if the structure is not confusing enough, sometimes a sponsor or major shareholder might be present. This happens when the developer for the REIT choose to retain a certain amount of shares stake in the REIT itself, so as to receive income dividends.
The complicated structure means that investors need to understand the risks and rationalize whether the investment strategies are aligned to their risk profiles. This is because different REITs can have different structures, political and regulatory risks. Do not assume that REITs are low risk and that the dividend income is recurring. Always make it a point to read the prospectus and research reports to understand the business structure, dividend policy and management fees.
In 2009, the risk of bankruptcy in Singapore REITs became very high due to falling asset values caused by lower forecast on occupancies and rentals. This led to banks shunning away from giving loans to REITs and as a result, the Monetary Authority of Singapore had to intervene to prevent the situation from worsening. Therefore investors need to be aware of the leverage and refinancing risks that REITs carry. Investors need to understand that in the event of insolvency, the assets of the REIT would be used to pay off the debtors first. So investors should check whether the REIT is able to build up cash reserves after distributing the income to unit holders.
In conclusion, investors should make the effort to understand the product before deciding whether to invest in a REIT. Do not assume REITs are low risk investment products just because they distribute incomes. Understand the business, structure, fees, leverage and regulatory risks before parting away your hard-earned money.
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