When a torophy asset is sold to REIT, the REIT share would fall?

Now we have evidenced that large real estate companies have sold their assets to their REIT companies.

I would like to analyze the background and the consequence that will be seen over the middle to long term.

1 Trophy assets have been selected

2 Those assets are sold to REITs in a group company

3 Those assets may deteriorate in its cash flow

4 The dividend will decrease

5 The REIT price would fall

Let me explain those steps.

1 Trophy assets have selected

Reflecting the pandemic caused by the COVID19, working styles and office environments have been changing rapidly and dramatically. Especially office tenants have been considering their downsizing, relocating to reduce the fixed rental expense, and have cancelled the scheduled their office relocation. From owner’s view point, its better to sell the asset before the cash flow deterioration in the property becomes obvious. Some may sell that property with value drop potential to others, before the asset gets worse. The large scale of real estate companies have chosen their subsidized company or REIT as the exit. We are not sure if the proper due diligence has been carried out or not. Even if they did, it sometimes happens that the current owner remains silent about the potential tenants’ leaving.

2 Those assets are sold to REITs in a group company

As the location is good and the current tenants are all brilliant, there is no reason for the REIT not to buy that property. REIT has purchased those assets at market price assessed by valuers. This is somehow a tricky part in an appraisal. Sometimes, it is really hard to reflect the potential risks and concerns of a property into the market value. Thus, the REIT, according to the guideline, pays the “market value” and put that trophy asset into the portfolio.

3 Those assets may deteriorate in its cash flow

Needless to say, over say 3-6 months or in one year, some signs of cash inflow deterioration could appear. They may be main tenant’s evacuation, huge reduction in renewed rent, or providing incentive packages to lease up the vacant premises.

4 The dividend will decrease

As said, the rental value may drop and the rental total revenue consequently get reduced. Unless the REIT management company works hard to reduce the expense, the net operating income would keep declining. Such decreased result would affect the dividend paid to the investors.

5 The REIT price would fall

If the REIT releases the reduced dividend to investors, the REIT price would drop and the investors may sell the share. For the REIT, it may hard to rise the capital again from the public investment market.

To summarize, the current sales transactions among a business group would cause the REIT market peak out or downturn.