The lowdown on REIT fees

As far as efficiency is concerned, size matters. In general, the largest REITs are likely to have the lowest fees as a percentage of assets within their groups. Hence, the manager of CapitaLand Integrated Commercial Trust (CICT) charged just 0.36% of deposited property in FY2020. This is partly because assets in the former CapitaLand Mall Trust which was renamed CICT almost doubled and the sponsor and manager waived the acquisition fee of more than $111 million.

The manager of Mapletree North Asia Commercial Trust (MNACT) also waived acquisition fees for its Japanese properties in December 2019 and in FY2021 ended March, the manager again waived base fees associated with those Japanese properties.

Although Ascendas REIT’s unitholders paid acquisition fees, as a percentage of assets, they were modest compared to other industrial REITs. It’s no wonder why REITs want to grow bigger. But they must do it judiciously and adeptly lest investors view these REITs as fee-generating machines for their managers.

A criticism made by a market participant to our fee table is that the Mapletree REITs have made acquisitions that drove up their fees.

To be sure, the Mapletree REITs were not the most efficient in terms of fees but since they have outperformed benchmarks including the FTSE REIT Index, the Straits Times Index, the Dow Jones Industrial Index and the S&P500 Index in the past 10 years, investors are unlikely to grumble.

ARA US Hospitality Trust was the only REIT that did not charge a base fee because the base fee was based on 10% of distributable income and the trust had no income in FY2020. Still, it can be said that the manager, ARA Asset Management, made up for it with ARA LOGOS Logistics Trust (ALOG) which is the best performer this year so its manager rightly deserves all of its more than 1% of fees paid. Interestingly, ALOG also paid ARA marketing commissions and service fees for property tax savings.

“The REIT fees have been broadly in line with the global fund management industry where the annual fees typically range from 0.5–2% of funds under management,” notes Vijay Natarajan, analyst for real estate & REITs, equity research, RHB Singapore. “The fees as a percentage of overall AUM for smaller REITs tend to be on the higher side due to the larger base fee effect and normalises as the REIT grows. That said, there is always room for a revamp of REITs’ fee structure,” he adds.

Internal versus external
Undoubtedly, the debate between whether internal versus external management continues to rage on. The answer to which is better really depends on how efficient the REITs are. Let us compare the largest REIT in Asia (ex-Japan) Link REIT, with the second-largest REIT in Asia (ex-Japan), CICT.

Link REIT is internally managed, which means the management company is owned by the unitholders. On the other hand, the owner of the CICT’s manager will be CapitaLand Investment (CLI) from Sept 20. Although Link REIT has a March year-end and CICT has a December year-end, both REITs were impacted by the pandemic, which hit our shores in February 2020.

CICT is additionally affected as it will be given as a dividend-in-specie to CapitaLand’s shareholders as part of its restructuring so there is some supply pressure in the near term on price. Operationally, CICT has navigated the pandemic, controlling costs including the cost of debt and keeping occupancy rates in the 90s.

Link REIT’s total costs, excluding impairments and non-cash items such as unrealised gains and losses such as foreign exchange gains and losses, amounted to around HK$3.7 billion ($638.6 million) in FY2021. Taking this as a percentage of its investment properties of some HK$199 billion, Link REIT’s expenses are just 1.86% of its assets. We use assets instead of revenue because we are comparing Link REIT with S-REITs, where we have compiled fees as a percentage of assets.

CICT’s total costs were $417.8 million in FY2020, including some $50.7 million in fees. Its total costs, including fees, work out at 1.89% of its assets. The difference between Link REIT and CICT is very narrow indeed. However, there are differences in the way the two REITs operate. The gearing of Link REIT is just 18.4% compared to CICT’s 40% level. As at Sept 13, Link REIT’s yield is 4.19% compared to CICT’s yield of 5.13%.

A few years ago, after analysing financial data on 18 externally-managed US REITs and 106 internally-managed US REITs, Fitch Ratings found that internally-managed REITs were not necessarily better at controlling administrative expenses versus externally-managed REITs.

As a case in point, in the past five years, there has been little to separate the performance of Singapore’s FTSE REIT Index and the MSCI US REIT Index (see chart). In fact, the FTSE REIT Index has done just as well if not better than the MSCI US REIT Index. The majority of US REITs are internally managed, with just a handful of 13% or thereabouts, externally managed.

“The debate around the relative merits of internal vs external management structures for REITs has long been resolved in favour of the internal model. A lack of alignment due to perceived conflicts of interest and questionable fee structures has been held up … against external models,” EY had said in an earlier report.

Sponsor strength and costs
However, as Emerging Markets opted for the external manager model, EY says, “For new REIT entrants and particularly those with institutional standard sponsors, there may be a reason to revisit the conversation around how to structure a REIT platform. Revised terms around alignment, and fees in particular, potentially make externally-managed vehicles more competitive than has historically been the case. This is especially the case for smaller REITs.”

Small REITs without a strong sponsor end up having higher costs in terms of debt, capital, and also operating costs. As can be seen in the example of Link REIT and CICT, there isn’t much to separate them in total costs including fees, despite the different models. However, Mapletree Commercial Trust (MCT) — which is by no means small but a lot smaller than Link REIT — has total costs including fees amounting to 2.5% of its assets.

Instead of debating over internal or external management, how REITs are managed is more important. In a recent interview, Ng Hui Min, portfolio manager with Manulife Investment Management, says she likes REITs with strong sponsors. “History has taught us that strong sponsors matter in terms of capital strength and relationship with bankers which brings about more efficient and cheaper costs of borrowing. Sponsors with very strong development pipelines are able to bring good deals to the table which are quality assets, accretive to shareholders of the REIT,” she says.

In addition, sponsors must be able to support the REIT during its equity fundraising exercise. And, of course, the stronger the sponsor, the less the likelihood of “financially engineering” a higher DPU or valuation through income support or higher rents during acquisitions.

Andrew Lim, group CFO of CLI, which is the sponsor of CICT, says that CLI is committed to supporting its REITs. “As a committed sponsor, we intend to stand by our REITs and continue to support them in their respective growth trajectories. We have no intention to deviate from this commitment, as our REITs form a key pillar for CLI’s continued growth going forward,” said Lim time and again when meeting analysts, media and investors ahead of CapitaLand’s restructure.

Similarly, the Mapletree REITs have been the best performers over a 10-year period with Mapletree Logistics Trust, Mapletree Industrial Trust and MCT all up more than 300%. Using the same metrics such as performance including dividends reinvested, Link REIT is up 278% in the same period.

Robust regulation
Fitch believes that stock ownership, corporate governance, potential conflicts of interest, allocation of investment opportunities and management time are still the greatest risks faced by externally-managed REITs. Ensuring alignment of interests between investors and management is the key aspect of enhancing investor trust and support for externally-managed REITs, the ratings agency says. Most externally advised REITs fall short on at least one of these items, Fitch suggests.

In Singapore, based on the Collective Investment Schemes (CIS) code, REIT managers and their directors have a statutory duty to prioritise the interests of unitholders over those of the REIT manager and its shareholders, in the event of a conflict of interest.

In 2020, as MAS allowed REITs to raise their debt to asset ratio to 50%, REIT managers are also required to disclose their interest coverage ratios.

These days, the practice of financial engineering are confined to a few poorly-managed REITs. This is because managers who adopt these controversial practices have to disclose them clearly and retail investors are also cognisant of them.

Fees to incentivise performance
Increasingly, the interests of REIT managers are being aligned with those of their unitholders with performance fees linked to DPU growth.

In 2015, after much introspection among REIT managers, coupled with proposals from the REIT sector, the Monetary Authority of Singapore (MAS) made some recommendations and changes to the CIS code. For fee structures, the recommendation is for the performance fee to be “linked to an appropriate metric which takes into account the long-term interest of the REIT and its unitholders such as net asset value per unit or distributions per unit”. The performance fee should be “crystallised” once a year and should not be linked to gross revenue.

With a couple of exceptions, REITs that listed since 2015–2016 have linked base fees to distributable income. Cromwell European REIT and Lendlease Global Commercial REIT followed a percentage of deposited property, as they wanted to be assured of a fee. Often, when DPU growth may not have materialised, REIT managers have resorted to acquisitions. Investors should check whether their REIT manager regularly acquires and divests for the sake of fees or to sustain higher DPU for unitholders.

During feedback from the REIT sector in 2015, some market participants suggested that acquisition and divestment fees should be on a cost-recovery basis. This was not adopted because of the difficulty of implementing cost-recovery. Instead, REIT managers are required to disclose the justification of each type of fee charged. Interestingly, Link REIT charges its unitholders fees on a cost-recovery basis.

“Over the years we have seen positive changes to fee structure driven by REIT managers (example Far East Hospitality Trust) and unitholders, as well a change in performance fee structure tied to DPU growth rather than distributable income. As the REIT industry matures with the growing competition we believe this trend is likely to continue with REITs delivering the best value in terms of DPU/NAV growth gaining more traction and thus outperforming,” Natarajan of RHB says.

MAS requires REIT annual reports to contain disclosure of the total operating expenses, including all fees and charges to be paid to the manager, in both absolute terms and as a percentage of the REIT’s net asset value (both as at the end of the financial year). Some REITs still do not itemise their property management fees as separate items. But over time, it is hoped all REIT managers will disclose fees as a percentage of the REIT’s NAV and AUM, as Ascendas REIT has done in great detail in its annual report.

As other jurisdictions in Asia such as India and China implement their own REIT frameworks, Singapore’s disclosure-based standards and strong local sponsors should continue to set the standard for fee-based alignment between manager and REIT in Asia.