Since it’s been almost exactly a year since I made this post, I thought that an update would be in order. I did end up investing money in REITs and have been very impressed with the results. Perhaps too much so. My average returns are close to 20%, which is too frothy for my tastes. Of course, most of this is due to the economic recovery. Like everything else, REIT prices were somewhat down in 2008 and this is just a return to par value. Going forward, I don’t expect to see returns of more than around 7-8 percent a year.

Most of the investing public still don’t seem to have clued in on REITs yet, but clearly they’re getting hot. Sunway’s recent launch seems to be one of the most attention-grabbing IPOs so far this year and more are in the offing, such as the one from CapitaMalls Asia Ltd., apparently with a substantial stake in Sungei Wang Plaza. This makes now a good time for me to raise some of my concerns about them.

1. Quite a few of the REITs currently listed in Malaysia are linked to larger companies. For example, Starhill, UOA and AmFirst have obvious links to the far larger groups they’re named after. The new Sunway REIT will be another example. This is bad for the minority investors in them. AmFirst’s properties for example are mainly rented out to AmBank, its parent company. This is a clear conflict of interest as it calls into question how fairly the rental rates for the properties are assessed. I believe that the market has taken these factors into account and this is why Axis is one of the most valued REITs in the country, because it has no clear parent company and its shares are widely dispersed amongst different owners, including KWSP.
2. Many of the property acquisitions and disposals that the REITs have conducted are with their related party companies. It’s especially bad when the REITs have to raise new capital to acquire new properties from related companies but only offer the new shares, which are always at a discount to the current market price, to private parties instead of the open market. This of course dilutes the shares of the other shareholders. Independent valuers are supposed to ensure that the purchases are being done at fair market value, but who trusts this kind of stuff in Malaysia?
3. Strangely enough, the new REITs being announced have predicted yields that are substantially lower than just about all of the REITs already on the market. Both Sunway and the expected REIT from CapitaMalls are supposed to have yields of only around 6.8%. Take a look at the current yields for the various REITs in the country. Axis is considered to be slightly overvalued now but its yield is still better than the proposed IPOs. I predict that the share prices for these IPOs will tank. Actually, REITs in Malaysia do have a history of trading below initial prices after being launched. Since the total valuations for the REITs are still quite low, this makes me curious about why their prices are being traded up and their yields consequently depressed. The only explanation I can offer is that as trading volumes for REITs are very low, you’d have to increase your bid prices very quickly if you were looking to accumulate a substantial stake in any one of them within a reasonable time frame.
4. The only advantage that I think of that the new REITs have are their more diversified portfolios of property. Al-Aqar for example has only one tenant, the KPJ hospitals. Similarly Atrium has very few properties and consequently tenants. So even though REIT prices so far have been very stable, in theory, it doesn’t take much to cause them to wobble if one of their tenants have problems with rental payments. The newer REITs have lower yields but should in theory be less risky.

Anyway, sorry for the somewhat rambling nature of this post but perhaps there will be readers out there who might be interested in my thoughts on them. Be sure to check out the REITs discussion thread on LYN. It’s a fantastic resource on the subject.