You will be able to explain why S-REITs pay out most of their income and how that limits the way they grow.
If you hold units in a Singapore REIT, you will see that nearly all of its income is paid out to unitholders, while most listed businesses hold back a good part of their profit to fund expansion. The reason is a tax rule set by IRAS. Knowing how the rule works tells you how your distributions are taxed, how a REIT pays for new buildings, and which two things deserve your attention when it does.
Darren, who holds units in a REIT, put it side by side with a property developer listed on SGX. The developer held on to most of its profit and paid only a small dividend. Darren's REIT paid out almost all of what it earned every half year, like clockwork. It struck Darren as an odd way to run a property business, and they wanted to know what it meant for the REIT's ability to grow.
A company in Singapore pays corporate tax on its profits. A REIT is set up as a trust rather than a company, and IRAS has a specific tax treatment for it. If an S-REIT distributes at least 90% of its taxable income to unitholders within the same year, IRAS can grant it tax transparency. With that treatment, the trustee pays no tax on the income it distributes, and any tax that applies is assessed on the unitholders.
The effect is to turn the REIT into a pass-through. Rental income arrives, operating costs and interest are paid, and most of the remainder goes to unitholders without first being taxed inside the trust. The conditions and finer details belong to IRAS, and you can read the current version in its guidance on REITs on the IRAS website.
Suppose a REIT has S$100 million of taxable income. It needs to distribute at least S$90 million to qualify, since 90% x S$100 million = S$90 million. Many managers distribute close to the full amount of taxable income in practice, which here would mean paying out close to the full S$100 million. The figure to carry through the rest of the course is 90%: S-REITs distribute at least that share of taxable income, and many distribute all of it.
For individuals holding S-REIT units directly, IRAS generally exempts these distributions from tax. The IRAS guidance lists exceptions, for example income received through a partnership or as part of a trade. Most people hold units in their own name as an investment, and for them the distributions normally come in tax-free.
Company dividends go through the one-tier system, which Lesson 1.3, Tax, CDP and where the cash lands, explained. REITs go through tax transparency. Legally these are separate routes, though for most individual investors the practical outcome is much the same.
If an S-REIT owns properties overseas, the income from them may already have been taxed in the country where it was earned before the REIT receives it. Lesson 6.4, Overseas properties and currency risk, deals with this.
Darren's question comes down to how much the business keeps. A developer that holds on to most of its profit can spend it on land, construction and expansion. A REIT that pays out 90% or more has very little left over. Using the example above, if the REIT distributes S$90 million of its S$100 million, it keeps at most S$10 million that year (S$100 million - S$90 million = S$10 million). One new property can cost several hundred million dollars, so retained income will never be enough to buy one.
To grow, S-REITs bring in money from outside. They can borrow, which adds debt, or they can issue new units, which adds new equity. New units come through rights issues, preferential offerings and placements. Most acquisitions are funded with a mix of the two.
A company funding growth from retained profit can lift its dividend without going to anyone for money, whereas a REIT that wants to expand nearly always has to go to lenders or unitholders.
Debt is the first thing to watch. Since REITs borrow in order to grow, three features of their loans shape how much income reaches you: the amount owed, what it costs in interest, and when it falls due. MAS sets limits on how much a REIT may borrow, and Lesson 4.4, How MAS regulates S-REITs, introduces them. In Module 5 you learn to read gearing, interest coverage and the debt profile.
New units are the second. Each issue divides the REIT's income among a larger number of units. When the new property earns enough, distribution per unit goes up. When it earns too little, distribution per unit goes down, even though the REIT has grown in size. Module 7 covers rights issues and placements and how to judge them.
For an income investor, the payout rule is a benefit, since it accounts for the size of S-REIT distributions. The same rule leaves a REIT's growth dependent on borrowing and on raising fresh money from unitholders and other investors.
Each S-REIT sets out its distribution policy in its prospectus and its annual report. The policy states what share of distributable income will be paid out and how often, usually quarterly or half-yearly. Expect a short paragraph, placed either in the section on distributions or in the notes.
Open the prospectus or the annual report, go to the section on distributions or to the notes, and find that paragraph. Write down two things from it: the share of distributable income the REIT commits to paying out, and how often it pays.
In the activity you will find that paragraph for one S-REIT and record what it commits to, which is the baseline you will compare its actual payouts against in module 5.
Find the distribution policy in one S-REIT's annual report. Write down what share of income it pays out and how often.
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