REIT Unit Buybacks has been a recent topic of debate.
In Hong Kong, Link REIT created minor controversy in 2018 by buying back units from the open market to boost DPUs to existing shareholders following the sale of some of its properties.
Closer to home, Keppel REIT initiated the first unit buyback programme among all the S-REITs in Singapore. They have also been quite active in exercising their buyback mandate in the market in recent months.
Lastly, I recently received the notice for AGM for Capitaland Mall Trust in the mail. I read through the document and was mildly surprised to see that there was a tabled ordinary resolution as follows:
So does it make sense for a REIT to perform unit buybacks? Let’s explore this today.
What are share buybacks?
Let’s begin by explaining what are share buybacks.
A buyback essentially means that the company goes out to the open market and uses its money to buy shares in itself. Buybacks are an indirect way to return cash to shareholders.
By buying back shares, you reduce the share count in the company. For the same amount of earnings divided by the smaller number of shares, you increase the earnings per share of the company.
This in turn drives share price increases, dividend increases and shareholder value.
Main motivations for share / unit buybacks
There are several reasons for why management do share / unit buybacks:
- The stock / REIT is undervalued.
- Signalling effect to the market that management feels that the stock / REIT is undervalued.
- Tax efficiency of buybacks vs paying out dividends (not very relevant to Singapore)
- Lack of better investments in the market
Good and Bad Buybacks
Buybacks done right
Legendary investor Warren Buffett believes that opportunistic buybacks are often the best use of a company’s cash. Also, buybacks are best done below “intrinsic value”.
This means that management should only buy back shares that are below what they are actually worth. Paying $0.80 for $1 worth of stock is certainly value creating in the long run.
Where buybacks can go wrong
Harmful buybacks is often the result of management myopia, where they are singly focused on buybacks as a driver of short term shareholder value at the expense of long term value.
They may cut capital expenditure and synergistic acquisitions required to grow the business. Or even worse, borrow money to fund share buybacks.
As such, share buyback programmes can be a double edged sword if not managed properly.
What about REIT buybacks?
With the basics of buybacks out of the way, let’s specifically examine REIT buybacks.
REITs are a unique class of equities that have special restrictions on what they can do. They are mandated to pay out at least 90% of their distributable income to unit holders. They also have a much more limited scope in business activities than normal companies – they can only predominantly make money from rental from a portfolio of real estate.
Given these limitations, REITs face a situation where they have limited cash on hand and limited things they can do with the cash.
While REITs have limited capital management choices, the principles of good buybacks are still very much applicable. If administered correctly, REIT buybacks can create value for unitholders.
To determine if REIT buybacks make sense, let’s look at 2 case studies of REITs with buyback mandates mentioned earlier – Keppel REIT and Capitaland Mall Trust.
Keppel REIT
Keppel REIT is a Singapore focused Grade A Office REIT with some Australian office exposure. It owns premium CBD office buildings like Ocean Financial Centre and One Raffles Quay.
As a Singapore focused office REIT that trades below book value ie Price to Net Asset Value (NAV) < 1, it faces some tough investment decisions. It is difficult for management to find accretive acquisitions as their cost of equity is high and Singapore properties are expensive. Offices and Industrial buildings don’t have much scope for asset enhancement initiatives (AEIs) unless they have been inefficiently designed previously. Debt levels usually are manageable and well hedged.
While choosing to do nothing and maintain the status quo is fine, the REIT is essentially stagnating till market conditions change. Not exactly what a growth oriented investor has in mind.
In such situations, instituting a buyback programme can make sense and offer REITs a way out. With the REIT’s units trading below NAV, buying back units in the REIT is essentially the REIT making a value accretive acquisition. Investors benefit as they own more of the REIT without any cash outlay and their DPU goes up as a result.
This appears to be what Keppel REIT has done as the REIT was trading at about 0.8 Price to NAV when they began their share buyback programme. While Keppel REIT’s management has had a controversial history, I feel they deserve at least some recognition for having the vision to do this.
Whether the programme is successful or not is up for debate. I’ll leave you with an observation from their latest results – NAV per share dropped from $1.40 to $1.39 despite repurchasing 28.1 million shares during the year.
Capitaland Mall Trust
As many of you know, Capitaland Mall Trust (CMT) is owns retail malls predominantly in Singapore, with a small portion of its income coming from China, by virtue of its stake in Capitaland Retail China Trust.
It’s management has a solid reputation in delivering unitholder value and rising DPU. As a result, CMT trades at a premium to NAV at 1.16. This allows them to raise equity cheaply should they need to acquire new malls. As a retail mall REIT, it has ample opportunities to perform AEIs at its malls to increase Net Leaseable Area and grow rental income.
CMT is facing the exact opposite of what Keppel REIT is facing. As such, it doesn’t make sense for CMT management to perform unit buybacks despite having the mandate to do so.
As an investor in CMT, not buying back units despite having the mandate to do so only enhances my trust in CMT management.
FYI – REITs with Buyback Mandates
Intrigued by CMT’s buyback mandate, I trawled the Notices of AGM / Prospectuses of all 39 REITs in Singapore to see which REITs had buyback mandates. Here is a summary of my findings:
Looking at this table, you can see a trend emerging. REITs managed by Keppel, Capitaland, Ascendas and ARA Asset Management are more open to the idea of REIT buybacks.
Time will tell if more REITs will join the bandwagon.
Final Thoughts
The principles that govern good share buybacks also apply to REIT buybacks. If managed appropriately, REIT buybacks can be a driver of shareholder value in the long term and should not be dismissed out of hand. Whether a buyback programme is successful or not is very much dependent on the opportunities avaliable and quality of REIT management.
Bonus Read
Buyback statistics in the US – respected NYU valuation professor Aswath Damodaran compiles data about US buybacks and shares his interpretations of the data. A deep and insightful view on buybacks.
Other opinion pieces you might like:
Why you can’t totally trust independent valuation reports
Dual class shares and their implications
REITs vs SG Properties – 7 reasons why REITs are better
In case you missed my previous post:
Why I won’t invest in Starhub at the moment
Happy Hunting,
KK
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