This commentary was published in The Business Times Singapore on 25 November 2024.
Traditionally, Singapore-listed REITs (S-REITs) have been managed by external managers owned by sponsors. This model is favoured by sponsors because it allows them to recycle capital, retain control over properties, and earn recurring income through management fees. Unitholders accept this model as sponsors provide a pipeline of properties for the REIT to acquire and help secure better financing terms. Over the past 20 years, many S-REITs have grown significantly due to the efforts of their sponsors.
However, the external manager model is not without its flaws. It raises several questions, such as the alignment of interests between unitholders and managers regarding fees, the structure of these fees (whether based on distribution per unit or net property income), and concerns that managers might engage in mergers and acquisitions (M&A) to benefit their sponsors or earn more fees. These issues have been present for some time, and the option of internalisation has always existed. So why are we seeing internalisation efforts now?
Three factors account for this trend:
- Emphasis on Enhancing Unitholder Value: There has been a growing focus on enhancing unitholder value, particularly in this region. We at Singapore Exchange Regulation (SGX RegCo) have recognised this demand, which is why our recent regulatory emphasis has been on what we call value focus initiatives to facilitate enhancing shareholder value. Unitholders want to see more value from their sponsors and managers, in return for the fees they are paying.
- Rising Interest Rates: Higher interest rates make financing conditions difficult, leading unitholders to scrutinize costs more closely. They question whether external managers and sponsors add enough value to justify their costs. Internalisation allows unitholders greater control over the manager and potential savings on fees, reflecting a broader desire for direct oversight and accountability.
- Growth of REITs: Unitholders of big REITs feel they may no longer need to depend on sponsors for properties and can secure good financing terms independently.
Internalisation as one form of market discipline
The implications of these trends for externally managed REITs are three fold.
As stock markets mature, investors develop stronger views and are more willing to voice them and vote. This trend is unlikely to diminish and regulators encourage it as it promotes market discipline. Active investors and effective market discipline can drive REITs to improve their operational performance and returns to unitholders.
Unlike companies, sponsors appoint all directors to the boards of external REIT managers. In some REITs, unitholders may confirm the directors. But in most cases, unitholders have no control over the directors. This lack of control can lead to unintended consequences. When unitholders want change but feel powerless, they may resort to the nuclear option of removing the REIT manager altogether. This drastic step, often due to limited intermediate options, can push unitholders to internalise the REIT to express their displeasure.
Regulators aim to encourage and enable market discipline. That is why SGX RegCo has proposed to make it easier for shareholders and unitholders to call for general meetings to bring about desired changes. But market discipline must cut both ways. It is not only about punishing companies for poor performance but also rewarding them when performance is good. We as regulators also want to facilitate this upside of market discipline. That is why we have fine-tuned our surveillance system to reduce our trading queries when share prices move. This allows Reits that enhance unitholder value to fully reap the benefits of their efforts and fully enjoy the upside of market discipline through an unfettered increase in share price.
As for SGX RegCo’s stance on internalisation versus external management, the decision lies with unitholders. Regulators support the process once unitholders have made their decision. Internalisation is a new development, and the process is still being refined. Suggestions include having a single voting exercise for all necessary changes and ensuring unitholders are well-informed before voting. Collaboration with fellow regulators is essential to improve the process.
Conclusion
What then should external managers do in the face of internalisation becoming a possibility in the S-Reit sector? It follows that if internalisation is one form of market discipline, then perhaps keeping unitholders happy would be the one way to respond. Here are some possible suggestions for external managers:
First, in respect to questions about fee structure and whether interests of external managers and unitholders are aligned, external managers may wish to consider these issues and how to communicate clearly to unitholders their thinking and how they are ensuring that interests are aligned.
Second, sponsors may also wish to consider intermediate options for unitholders to express their views. Unitholder engagement is a good start and some Reit managers facing macroeconomic headwinds are doing so. Another way may be to give shareholders a say in the appointment of directors. Some Reits for example, are giving unitholders a confirmatory vote on the appointment of directors to the Reit manager.
Finally, and most importantly, sponsors should signal very clearly their commitment to creating value for unitholders. For instance, developments have shown sponsors should avoid having Reits with overlapping mandates or anything at all that may lead unitholders to question their commitment to the Reit or to one Reit over another. More positively, recent articles in the local media have highlighted how our Reits have been active in their portfolio management activities to pursue growth.
Tan Boon Gin is CEO of Singapore Exchange Regulation (SGX RegCo). This commentary is adapted from a speech he delivered on 20 November 2024 at the REIT Association of Singapore Annual Conference 2024.
