Tuesday, July 30, 2013

The social cost of reits

Reits are hot hot hot. With the low interest rate environment, where investors are looking for a place to park their money to beat inflation, the yield of reits is indeed alluring. I've invested in them and they had made a fair share of profit for me. But because I've also went to the other side of the equation, I realized that there's a huge social cost in reits being so hot.

As reits are public company, they owe it to the shareholders to increase DPU year after year. That way, the managers of the reits can also get more performance fees. But who are the ones really paying for the increase in DPU? It's those people renting to do business! I've heard stories of rents increasing from 5k to 8k in those malls that are in the heartland managed by one of the listed reits. How are people going to make a living when the next time their rental are renewed, there's a jump of 30 to 60% increase? It's just not sustainable.

Even when a building is not managed by a reit, as the price of the rental in a reit manged building increases, it causes a trickle down effect to all the neighboring areas. The landlord in a non-reit managed building must be thinking that, hey, just across the road, those guys can charge so high, so why can't we do the same? So up and up the rental rates spiral, and down and down the margins of the business goes. It's just crazy when maybe 30-40% of your profits are all given to the landlord and passed on to the reits.

This will eventually end up very badly. The party will end when the rents are revised so high that few would dare to take up the space. Honest hardworking entrepreneurs who are out to make a decent living would be hard pressed to set up business. Everyone suffers. Including, eventually, the shareholders.

I know there are many ways that the reits can increase DPU without raising rental rates. I'm just ranting the pervasive idea of a reit always working to increase the rental at all cost, without regards to the human cost behind those numbers. How would you feel if your boss, in the pretext of accounting to the shareholders, decided to reduce your salary so that the company's share price can increase?


Money Honey said...

Nowadays mall management also throwing-in asset enhancement initiative (aei) works to justify rental increases. Whether this aei is able pull in more shoppers from competitors on a sustainability basis cannot really be guaranteed. Another trend surfacing now is that mall management is trying to differentiate itself from neighbouring malls ---> for example, jcube mall is trying to pull-in sports-theme tenants. But you are certainly right that shop owners will suffer if they are not able to earn much more to cover the rental increase. And if there are no new tenants willing to pay higher rental when comparing to other malls (in order to occupy the vacant shop lot) so it will eventually reduces the mall's revenue. So no matter how much was spent on the aei it could turned terribly wrong, just like all dressed up but no where to go. Thanks for this article, it's a timely reminder to myself to not overly excited investing into reits.

la papillion said...

Hi Money honey,

Usually AEI is a reason for them to increase rental and also the leasing space available i.e trying to squeeze more money from the space they have and creating more space to squeeze more money ;)

I shiver to see the reitification of Singapore. That would be fragilizing the entire retail/industrial/office landscape. Very bad when the party is over.

Weowster said...

Weow... in the absence of a REIT, the landlords would still as a whole try to get the maximum rent the tenants are willing to pay. If renting a space to run a business becomes uneconomical, tenants will have to close shop. If the asking rent remains too high, even fools will avoid jumping in. And so, the eyesore of a lasting vacant slot will force the landlord to reduce the asking rent. Thus, I think, the rent is set by the invisible hand of economics, not the REIT.

la papillion said...

Hi Weowster,

Not doubting that in theory. But in practice, for those units under reits, they are bounded by many layers of bureaucracy and the person who have the power to adjust the rents are those who are furthest away from doing the actual negotiation of the rental rates. As such, the prices are set by them from an ivory tower. If there are any changes in rates to reflect the true market condition, it will be delayed. I'm saying that such a system makes it less efficient than a system where there are many multiple landlords each negotiating directly with people who are renting the premises. Less layers, faster response to the market conditions and from my experience, they are generally more flexible because it's their money which is at stake. Employees in the reits will follow rules governed by layers of superior who are not as involved in the market that they are in.

Buggery said...

Hi LP,

What made you think about the social costs of REITs?

Personally, I've seen a number of dear neighborhood shops close down due to rental increases.

A number of corner coffeeshop stalls have also folded after the landlord jacked up their rents. Even a small coffeeshop stall along Macpherson Rd costs $3k to rent per month! It's nuts!

Have lost a number of delicious food and friendly hawkers this way. So sad!

la papillion said...

Hi bummy,

Long time no see. I made the post after I saw a number of my favourite restaurants and food stalls fold up (like you) and then I saw a lot of shops with shutters down in my favourite shopping malls, so I have a feeling it's due to the rental rates. I've also personally experienced trying to get rental space in non reits and reit managed premises and noted the difference. I've talked to countless shopkeepers who are forced to move to ulu areas so that they can continue their business because the landlord increase their rent by 40%.

The social cost of reitification is there. I'm not blaming all of it on reits, it's just that I think reits is becoming fashionable in investing. Every other people are trying to form reits and list them. Make money to be made from being the manager of one. But at what cost?

momoeagle said...

That's why some business are moving more business online...

Web space is relatively cheap compared to retail rental :)

Anonymous said...


The ice-cream shop that renovated the shop closed down, I guessed the rent increase was too high.

:( I just saw a banner "Renovation in progress -- new ice cream shop coming"


How to stop the greed?


Anonymous said...


I had jumped to conclusion! Neightbout told me the ice-cream shop "let out" to a young man, taught him how to make ice-cream for 3 days..


la papillion said...

Hi momo,

Indeed. But certain business just needs a retail space...so no choice on that. I think for bookstores, it can really be online. Physical bookstores are going the way of the dodo.

Hi HH,

Haha, wow, after 3 days of crash course he can make ice-cream to sell? :) But I think it's quite achievable. Actually it's quite easy with a machine. I made my home-made ice-cream using saturated fruit solution too :)