Not all REIT’s are created equal!

September 1 '2005.  Released for all to see on October 10 '05

Not all REIT's are created equal.  (As always these are my own views).

Investors in REIT's here in Thailand (as elsewhere) must be careful not to get into a possible long term "investor trap" of leased rather then owned properties. Where the lease contract of properties held by the fund does not have a "sinking fund" provision. Some REIT’s long term lease rather then own the properties. So what happens at the end of the lease contract?

Again, this could happen if the properties held by an REIT fund are in the form of a long term leasehold, rather then outright ownership.

If the properties are held say in a 30 year lease, then clearly every-year "the time clock is ticking". Meaning, that in 30 years nothing would be left when the lease expires! (If the lease is renewable the renewal terms must be understood). To account for this, such an REIT should actually have a sinking fund established, where part of the monthly income is set aside to allow for the return of original capital at the end of the lease period.

I do not think/see how or where the latest largest listed REIT CPNRF has this? Am I missing something?

The prospectus I saw is in Thai language, so I can't tell for sure but we are checking into this. I took a look for example at BOAAPF, where this is already happening. This fund is making a loss - i.e. the write-down is higher than current income - but is continuing to pay out full dividends. While this is not a concern with the TFUND, my preferred REIT, I am wondering about some others and hope to check more in to this. Any thoughts or feedback by members on this issue are most welcome.

After investigating some more, here are some further thoughts on this:

CPNRF does indeed do not have a sinking fund to support the renewal risk. However, in this case the land on the 30-year lease is actually owned by CPN (who has 33% stake in the fund itself) but they decided to lease it to their fund CPNRF (rather than selling it) so to save some transaction costs (1% transfer fees and some other special business tax and duties). This is all clearly stated in the prospectus.

Also, renewal terms are often never stated in a long-term lease agreement in Thailand. It's generally a preferred right to the tenant to renew the lease once it is expired. However, almost all institutional investors who considered this investment discussed in detail the difference on with and without a sinking fund -and hence should be valuing it accordingly. The valuation that the different underwriters did is based on no sinking fund, hence no terminal value, just valuing the contracts based on the life assuming no renewal.

Lastly, the BOAAPF is a single asset REIT and that asset was bought from Natural Park which has a recorded (by the SEC) history of questionable actions. I haven't looked at where the losses are actually coming from at BOAAPF but I wouldn't be surprised if the asset was sold a slightly high price and now they are marking it down? Not sure about this as I have no interest in BOAAPF anyway.

It is noteworthy that TFUND has a considerably higher yield (around 7.5%) on current market price, vs. around 6.4% for the much CPNRF fund on the current market price of 11. At the offering price the yield of CPNRF was at 7.2%.

Hence one can see again the steep premium one pays for liquidity here and how such liquidity often gives the investor an "inferior" asset play, viewed from the lack of a "sinking fund" provision in a fund which has leased not owned properties.

Below are some more details, as was reported in their selling memorandum. (Note the full prospectus is in Thai language only).

Regarding the CPNRF Fund profile

The CPN Retail Growth Property Fund (CPNRF) is a fund for public offering (PFPO), or a Type I property fund—similar to an American Real Estate Investment Trust (REIT). CPNRF is to focus on the business of developing retail space for rent. It has initially acquired two shopping centers from Central Pattana (CPN): Central Plaza Rama II and Central Plaza Ratchada Rama III. It was set up as a closed-ended indefinite life fund with an initial size of Bt12bn.

My Notes: acquired? More like long leaseholds.

Although there are some property funds that offer dividends at around this level, the risk associated with the retail sector is lower than for other types of property development. When compared with other asset classes (Figure 11) that have similar income streams, CPNRF offers a higher yield.

MY Notes: Hmm. .lower risk? And what is this statement about CPNRF offers "higher yields" ? As TFUND offers a higher yield, especially now (post IPO), after the CPNF fund increased to 11 Baht and TFUND’s is still at 10 Baht.

Risks and concerns:

Leasehold land of Central Plaza Rama II

Investors should realize that they have claims on earnings from the management of Central Plaza Rama II for only 20 years of operations. Thus the value of the unit tends to decline over time to the expiration of the lease agreement. From our valuation, the value of the unit will start declining on the eleventh year of holding.

My Notes: Yes, sir and this is a key difference to be understood.

Terrorism and infectious disease

In recent years, there have been concerns about terrorism and infectious diseases.

Shopping centers are public places and likely to be priority targets of terrorists, thus the management of shopping centers should pay attention to safety and security measures. We have been informed that CPN has established a comprehensive plan to protect its stores from terrorism and also to closely monitor all news and information about infectious diseases in order to quickly set protection plans in place. Moreover, the firm has an insurance policy to cover losses from terrorism.

My notes: Perhaps here the risk level is so higher, yet it states it is lower then the other funds.

Some key information about the CPNF fund:

Fund manager : TMB Asset Management Company Limited (TMBAM)

Property manager : Central Pattana Public Company Limited (CPN)

Assets : Central Plaza Rama II and Central Plaza Ratchada Rama III

Appraisers : CB Richard Ellis (Thailand) Company Limited

: Amarican Appraisal (Thailand) Company Limited