The Hidden Danger Of Investing in US Based SREITs Due to Shareholding Restriction.

The recent US Manulife high aggregate leverage level crisis (within a whisker of the statutory breach at maximum of 50%) due to a sharp decline in valuation of its investment properties has brought up another key risk that many retail unit-holders did not consider in-depth previously. Even during the COVID-19 crisis with global lockdown, the valuation of investment properties of most REITS were not adversely impacted. It has also been more than a decade since the 2008/2009 global financial crisis. The key risk that I am talking about is the possible failure of a rights issue exercise to raise funds due to the peculiarity of the situation of SREITs with investment properties in the US.

Why rights issue exercise may fail for SREIT with properties in US?
This is because the Sponsor may not be willing to undertake the rights issue given that they need to maintain less than 10% stake to qualify from withholding tax exemption for dividends received. If not, US withholding tax of 30% will need to be applied for all future distribution. Nevertheless, it is not the end of the world. The sponsor could still form a private equity property trust to buyover some of the investment properties at the revised net book value to provide liquidity to the REIT for reduction of leverage.

The sad thing is that if a rights issue exercise is not conducted, the alternate option via sales of investment properties to its sponsor at this juncture would still be a lower price due to bad market timing and also lead to another vex issue of cherry picking the best assets out and leaving the worst properties in the REIT. While this is better than a fire-sales at depressed pricing to non related external parties, existing unit-holders may not be happy and there would be some unit-holders who still preferred a rights issue exercise instead. 

Parting thoughts

Will a good and reputable sponsor be able to save their listed REIT from financial challenges given unit-holding consideration that hampers the prospect of the usual rights issue? The upcoming corporate action from Manulife US REIT will be a good case study on what will happen to the rest of the US SREITs like Keppel Pacific Oak REIT, Prime REIT and US Hampshire REIT in the event that they faced the same aggregate level crisis due to plunging valuation of their investment properties from higher discount rate and lower future cashflow projection. 

(P.S: Please also see my previous post: "Manulife US REIT Spectacular Self Implosion- Risk of Firesales of Office Properties Or Dilutive Rights Issue".)