Shipping Trusts and Reits - Understanding the Risks

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Real estate and shipping trusts are often viewed as a safe-haven investments, but developments in the past one year have shown that the risks of investing such trusts are not as low as they may seem at first glance.

In simple terms, a business trust is a legal entity through which investors pool their money to invest in income-generating assets, which are then managed on their behalf by trust managers. Trust managers are appointed by sponsors who are, more often than not, the majority investors of the trust.

There are several major types of risks associated with business trust operations.

Counter-party risks

Risks for Real Estate Investment Trusts (Reits) mainly relate to arrears in rental paid by tenants, while those for shipping trusts relate to charterers’ defaulting or reneging on charter contracts. This is especially true when contracts were written at a time when rates were buoyant.

Cyclical and leveraging risks

Business trusts often return what appear to be compelling yields because they are leveraged, such that assets are financed not only by unit holders, but by loans as well. Such loans are often governed by loan-to-value (LTV) covenants, whereby borrowers have to top up their loan facilities, should underlying asset values fall below a certain point.

This was the predicament faced by shipping trusts when they found their assets decline sharply in value in 2009 amid a double whammy of the drying up of trade and a glut of new vessels on the market. Waivers to these covenants, if they could be obtained at all, were often subject to the trusts agreeing to higher interest rates.

Financing risks

The recent financial crisis also exposed a new type of risk, related to liquidity of the banking system. Many banks were simply unwilling to rollover loans, leaving trusts (and businesses in general) to scramble for alternative sources of funding or even having to let purchase options expire with penalties.

Conclusion: Finding a balance between risks and returns

Well-run business trusts usually try to manage their risks by diversifying their counter-parties across sectors. They also rely on a variety of financing options beyond loans, such as the issuing of bonds, rights or new units. Just as importantly, fundamentally sound trusts maintain a low gearing to avoid being over-leveraged.

By studying the annual reports, the sponsors and past track records of these trusts, it is possible for investors to identify good investment targets which have yields commensurate with the risks that these trusts are exposing themselves to.

If a trust appears to have a higher yield than its peers, it is a reflection that the market perceives the trust to carry higher risks.

Annex: The Troubles with Trusts

The following is a list of troubles faced by Singapore-listed shipping trusts and Reits, which makes for somber reading. Some trusts came close to collapse while others remain in the doldrums.

First Shipping Lease Trust (FSLT)

Rickmers Maritime Trust

Pacific Shipping Trust (PST)

Frasers Commercial Trust (FCOT)

Capital Commercial Trust (CCT)

Suntec Real Estate Investment Trust

Ascendas Reit

Macarthurcook Industrial Reit (MI-Reit)

Lippo-Mapletree Indonesia Retail Trust (LMIR)

Saizen Reit

 

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Last Updated ( Friday, 04 June 2010 17:44 )