UNDERSTANDING THE IMPACT OF FINANCIAL ENGINEERING ON S-REIT INVESTORS' DECISIONS

Abstract

In recent years, Real Estate Investment Trusts (REITs), real estate Business Trusts and real estate stapled trusts, collectively termed as S-REITs, have increasingly employed fi-nancial engineering to increase distributions to unitholders. However, there is a lack of awareness of the effects may have resulted in a penalisation of Price/NAV by investors, which is unfair towards the REIT managers. On the other hand, interest of the investors may also be compromised via lower distribution per unit due to the presence of agency cost. The above problems motivated this study on financial engineering; including four main methods: income support arrangement (IS), management fees paid in units schemes (MGT), Distribution Reinvestment Plans (DRP) and Distribution Entitlement Waivers (DEW). Suitable hypotheses were developed and after performing panel regressions on 42 S-REITs, the impact of the four financial engineering methods - IS, MGT, DRP and DEW – on price-to-NAV (P/NAV) were quantified and explained. This was further reinforced by sec-ondary analysis which dissected the impact of income support and effects of its expiration. There are several key findings. Firstly, there is a positive relationship between IS and P/NAV and IS has negative effects on P/NAV during market downturns and upon its expi-ration. Secondly, MGT also has a positive relationship with P/NAV but immediate disposal of units received from MGT by managers are not penalised by the market. Thirdly, a concave-shaped quadratic relationship was found between DRP and P/NAV which signals that the additional capital raised must be well-supported with a value proposition. Fourthly, DEW, whose application is discouraged, is identified to be a highly manipulative tool which contradicts with its rationale of supporting pre-stabilised assets. Last but not least, it was asserted that that the utilisation of any IS must be well-bolstered by corporate objectives and supported by property trends and cycles to attest that the amount of support is not excessive and unnecessary. This paper ends off with proposed regulatory improvements such as the introduction of a new metric and disclosure requirements in hopes of increasing transparency levels and preventing abuse of financial engineering.