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The Pros and Cons of Rights Issues in Reits

The Pros and Cons of Rights Issues in Reits

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Published by Kyith

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Published by: Kyith on Dec 03, 2011
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12/03/2011

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Investment Moats
 – 
Income Investing, Cash, Money and Life
 
www.investmentmoats.com 
The pros and cons of rights issues in Reits
 From our research, investors who opted not to participate in the rights issues havecome out ahead 
By TEH HOOI LINGSENIOR CORRESPONDENT
 
 
Investment Moats
 – 
Income Investing, Cash, Money and Life
 
www.investmentmoats.com 
I RECEIVED quite a number of e-mail and text messages in response to my article last week which talked about how it is a myth to expect real estateinvestment trusts (Reits) to be a steady income yielding instruments.The fact is, Reit managers are always on the lookout to expand theirportfolio under management. The bigger their portfolio, the moretransactions they carry out, the higher their fees.But there is no denying that some managers do have the contacts andexpertise to bag the right acquisitions at the right price, hence benefitingunitholders who chose to pump in more money to participate in thecontinued expansion of the Reits.One of the most common questions that I received in response to last week's article was: What would the return be if I don't subscribe to therights?
Does it pay to subscribe?
I decided to tabulate all the cash flows of the Reits with at least four years'track record. For one set of cash flows, I assumed that the investorsubscribed to his or her entitlement of rights shares. For the other set, theassumption was that the investor didn't subscribe and didn't sell the rightsshares in the market as well. Some rights shares have market value, andsome, like the recent K-Reit rights have zero market value. That's becausethe exercise price for the rights is almost equivalent to the market price of K-Reit, hence there is no privilege to owning the rights.Based on the cash flow stream, I then calculated the internal rate of return(IRR) for each strategy.This is the definition of IRR from Wikipedia: 'The IRR on an investment orproject is the 'annualised effective compounded return rate' or 'rate of return' that makes the net present value of costs (negative cash flows) of theinvestment equal to the net present value of the benefits (positive cashflows) of the investment.
 
 
Investment Moats
 – 
Income Investing, Cash, Money and Life
 
www.investmentmoats.com 
'Internal rates of return are commonly used to evaluate the desirability of investments or projects. The higher a project's internal rate of return, themore desirable it is to undertake the project. Assuming all projects requirethe same amount of upfront investment, the project with the highest IRR  would be considered the best and undertaken first.'A firm (or individual) should, in theory, undertake all projects orinvestments available with IRRs that exceed the cost of capital. Investment,however, may be limited by availability of funds to the firm and/or by thefirm's capacity or ability to manage numerous projects.'So how did the Reits do when we take into consideration additional capitalinjections? And would investors be severely punished for not taking uptheir rights entitlement?Out of the 18 Reits, 13 chalked up positive IRRs, but some just barely.Seven managed to reward investors with IRRs of more than 10 per cent. Ascott Residence and Ascendas Reit are among the top performers. Andcuriously, it is investors who opted not to participate in the rights issues who have come out ahead. And if these investors managed to sell theirrights entitlement in the market, their return would have been even higher.By not participating in the rights, an investor in Ascott since its IPO days would have registered a 17.2 per cent IRR. For those who forked outadditional cash to take up their rights issues, their IRR worked out to 13.4per cent.I reckoned that this happened because the appreciation of Ascott's shareprice has not been as steep since its latest round of cash call last year. Andalso, very importantly, Ascott's rights issues weren't that dilutive in that theexercise price of its rights was only a slight discount to the then marketprice of its units.This was similar for Ascendas Reit, although the difference wasn't thatgreat. The cash calls of Ascendas Reit have been relatively small.

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