Published March 17, 2009

Scrip dividends for Reits: why not?

By ARTHUR LEE

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IS THE use of scrip - instead of cash - as a way of issuing dividends to unitholders a violation of the basic characteristics of a real estate investment trust (Reit)?

One school of thought says that it is a violation as the scrip dividend scheme, if widely practised, runs counter to the objective of a Reit as a 'stable, high-payout, pass through vehicle'.

This argument has its merits. But given the current unprecedented global financial turmoil, which has made many rethink previously established financial practices, the issue deserves a look from a different perspective. This is important as, like it or not, more trusts are likely to resort to scrip dividends amid an environment of credit squeeze.

If proper guidelines are in place on how cash conserved from issuing scrip dividends should be used, there is no reason why some Reits can't take the scrip dividend route, even if it is a part scrip, part cash scheme with an opt-out option.

Given the present economic climate, asset values have dropped, sometimes in large percentages and there is very tight financial liquidity as banks seek to manage risks and minimise losses. The nature of business or life is that nothing is ever certain. We try our best to manage the challenges as they confront us.

Often times, we adapt, improvise, modify and even take a 180 degree-turn just to survive.

A Reit which had a good business model just two years ago is probably facing a different set of figures now. Falling asset values cause the net gearing to rise. Drops in consumer spending due to unemployment and other reasons bring lower yields as rentals fall. A very high degree of conservatism among financial institutions to minimise potential non-performing loans (NPLs) brings higher borrowing costs.

Taken together, these three factors threaten to sink many a less sturdy Reit. Unitholders don't want to see their Reits collapse due to refinancing failures, a view shared by those against the scrip dividend practice.

Scrip dividends have been with us for a long time. The argument is that if you bought into a business, getting a bit more of the business is often a good thing so long as sound management prevails. Though it's perhaps unfortunate that in today's context, more companies resort to it for different reasons.

Reitholders who had invested even a year ago are looking at large losses on the prices of their units. Many Reits are trading at substantial discounts to net tangible assets (NTAs) or initial public offering (IPO) prices.

Real estate is fundamentally a medium to long-term investment. From this viewpoint, the current guidelines for Reits to distribute at least 90 per cent of their distributable income to qualify for tax benefits should perhaps be re-examined. This percentage and the accompanying tax benefits could be reduced on condition that the amount not distributed as a result of a scrip dividend be set aside for paying debt. A regulatory requirement to ensure that the retained earnings are correctly deployed to mitigate the accompanying drop in cash distribution is important. Savvy long-term investors may then shift their focus on short-term DPUs (distribution per unit) to net gearing and cash balances. This allows for Reits to be built on sturdier ground to stabilise them from regular oscillations in asset values and economic cycles.

There are investors who look forward to putting their money in a Reit that has a good portfolio with very little gearing. It has to do with times past where we often looked upon debt as a burden and tried to pay cash for our purchases if possible.

A well-managed Reit that can reduce its gearing regularly over time may even end up with zero gearing or a net cash surplus position. Owning more shares in such a Reit is probably the best real estate investment one can make. It pays 'good yields' as there is little financing costs and insulates unitholders from bankers who keep the umbrella when it starts to pour. And a Reit built on 'solid sturdy ground' may trade close to or even above their NTAs in good times, a far cry from today's deeply discounted prices.