An activist shareholder’s campaign to sack the external manager at a small Singapore real-estate investment trust has shone the spotlight on the industry’s East versus West split, with important consequences for future returns. REITs in most parts of Europe and North America are typically managed internally, while those in Asia prefer to outsource the job to a firm owned by their sponsors. Which model is superior?
The evidence is far from conclusive. An Ernst & Young study found 240 basis points of annual outperformance in favor of internal management, but it also said that the opposite holds true for smaller US REITs with under $2 billion in assets.
That makes Sabana Industrial Real Estate Investment Trust, which has less than S$1 billion ($740 million) under its belt, an interesting case study. Earlier this month, Swiss value investor Jan Moermann’s Quarz Capital Management Ltd. pushed for a shareholder vote on removing Sabana Real Estate Investment Management Pte., the external manager owned by the Hong Kong-based ESR Group Ltd., the REIT’s sponsor.
Handing over activities like property acquisition, disposal and redevelopment to a new subsidiary owned by the trustee will mean reductions in fees that currently flow to the sponsor, Quarz says, projecting a 7%-plus increase in dividends to unitholders. The REIT manager disagrees. The cost savings, in its view, are hypothetical, while a change in guard could trigger a mandatory prepayment of loans to creditors. Besides, the new team will need a capital-market-services license from the monetary authority. All this translates to “considerable operational challenges and potential disruptions to the day-to-day management” during the takeover, “which could severely affect the value” of the REIT, it says.
Globally, “roll-ups” aren’t that big a leap of faith. Following a crucial 1986 US tax reform, a clutch of private equity-type, limited-life investing vehicles got together and reorganized at the time of the initial public offering by internalizing their management. The Santa Monica-based Douglas Emmett Inc., a provider of nearly $10 billion worth of Class-A office properties and luxury condos in Southern California and Honolulu, began life this way. As did Empire State Realty Trust, the owner of the eponymous New York building.
In Asia, however, the prevalent model is of “captive REITs,” with administrators owned by the property developers that sponsor them. A 2017 study by researchers at the National University of Singapore cited several examples — such as a controversial 2011 purchase of an office tower by the city’s Keppel REIT from its parent — to show that related-party transactions are often of questionable quality or priced unfairly.
With Sabana, there is an obvious potential for conflict. ESR has sponsored not one but two REITs in Singapore in the same line of business. As a landlord of warehouses and other industrial property, ESR-REIT (now known as ESR-LOGOS) is nearly six times Sabana’s size. The manager says that it doesn’t swap properties with the rival trust and has robust processes to deal with interested-party transactions with the sponsor. Still, Quarz has a valid question: When ESR buys or develops a new property, why won’t they allocate the asset to the larger REIT from which they earn five times as much in fees as the smaller Sabana?
The Sabana manager has lost the battle for its perceived independence at least twice before. In late 2020, Quarz successfully persuaded investors to block a proposed all-stock merger of the industrial-property owner with ESR-REIT. Last year, the manager tried to push for the appointment of Charlie Chan, a former Credit Suisse Group AG trader, as an independent director. Quarz objected, pointing to Chan’s financial dealings with ESR in the past. Unitholders voted down that plan, too.
Regaining investor confidence has to take top priority. The manager says the landlord’s tenancy levels aren’t as poor as Quarz portrays them. While that may be true, the market price of its units is 19% lower than its net asset value, a level of discount that doesn’t plague most of its peers. Clearly, something is amiss. If it is the REIT’s suboptimal size, then ESR may need to return to the table with a fairer merger offer. If it’s a question of inefficient operations, then rolling up the manager might be a risk worth taking.
However, investors deserve to know the alternative scenario in greater detail. Although it’s hard to imagine that banks would yank away funding from an underleveraged asset owner, it would still be nice if they came out and confirmed their participation. Similarly, before unitholders are asked to vote, they ought to have the certainty that the regulator would instruct the existing manager to continue until the new internal team is licensed and ready. Otherwise, as ESR said in a letter to shareholders Sunday, Sabana REIT “would be seen to be cast adrift.”
The post-pandemic resurgence of Singapore REITs petered out rather quickly. While the past two years’ underperformance of the asset class can be chalked up to higher interest rates, the $1.8 billion of fundraising by the trusts so far in 2023 doesn’t have a good explanation. The city-state’s property-loving investors have lost an average of 49% on the last 10 REIT IPOs in the city, and yet they must keep investing in additional units just to avoid getting diluted. Ultimately it’s the sponsors who gain from bulking up. The base management fees paid by Singapore-listed REITs rose more than 30% between 2019 and last year, according to Quarz’s calculations.
The power balance at a small REIT has triggered a welcome debate about the wider industry. If the Sabana manager can be rolled up, activists might turn their attention to the bigger fish. The historical roots of developers’ sway on externally run Asian REITs may be strong, but Australia offers a template. Real-estate trusts in the nation took to self-administration after they became large and ran out of domestic growth drivers. We may see a similar shift in other parts of Asia-Pacific as well. The East-West gap may not disappear, but it might narrow.
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