It has not gone unnoticed that S-REITs with a Singapore focus have fared a lot better in terms of maintaining distributions per unit (DPU), occupancy and rents than those with an overseas bias. As a result, valuations of those with a local focus are also better than those with an overseas bias. The exception could be CapitaLand Ascott Trust HMN (CLAS), which has mainly overseas assets.
““Singapore has solid attributes of being a safe haven. It's a double-edged sword. It's a benefit in the sense that we've seen inflows to physical property assets. As a result, Singapore property values have been pretty well supported in an environment where global property values have come under quite a significant amount of pressure, especially in Europe, and to some extent in the US. As late as mid last year, you saw family offices buying buildings here for cash. On the flip side, with REITs’ cost of capital having risen substantially amidst the selloff in equities and higher interest rates, the sticky property values have made it now that much harder for them to acquire assets accretively,” notes Koh Shern Ling, portfolio manager of Principal Asset Management.
Currently, S-REITs appear a little stuck because valuations in Singapore remain robust while capitalisation rates remain relatively compressed compared to other developed markets. As a result, S-REITs cannot acquire Singapore properties because asset value yields are well below funding costs, which means S-REITs cannot grow inorganically. Meanwhile, Singapore’s GDP growth is muted, so they cannot grow organically either. In Koh’s view, the upshot of all these is that S-REITs face challenges growing both organically and inorganically.
Koh also notes that S-REITs went overseas probably at the worst possible time, “Singapore-focused names have generally done better. Many of the foreign focused names are facing challenges. If I had to scope out the challenges, going overseas was one of the big issues," Koh says, adding that the time to go overseas is perhaps now in 2024 as interest rates peak and start falling, as in the case of Europe.
Where do S-REITs go from here?
The cost of debt and equity are high. Koh suggests that s-REITs cannot do much about the cost of debt, but they can bring down gearing. For instance, Mapletree Pan Asia Commercial Trust N2IU (MPACT) is divesting Mapletree Anson for $775 million, $10 million above its March 31 book value of $765 million and $95 million higher than the REIT’s purchase value.
See also: ESR-LOGOS REIT divests 81 Tuas Bay Drive for $35 mil
“This is expected to lower MPACT’s aggregate leverage from 40.5% (as of March 31) to 37.6% on a pro forma basis and improve the adjusted interest coverage ratio from 2.9 times (for FY2023/2024) to 3.3 times on a pro forma basis,” MPACT’s manager says.
“The problem is, it is currently easier to sell Singapore assets than overseas properties. But many SREITs that need to degear their balance sheet are reluctant to part with their prime Singapore assets, and do not want to book a loss to sell offshore assets below book value," Koh concedes. “In the environment that we're in where the Singapore safe haven status is sharply in focus, I think many people would prefer to see many of these diversified REITs sell the marginal assets overseas if they can," he adds.
Many S-REITs may be asking themselves whether they had a comparative advantage in going overseas. For instance, Keppel REIT and Suntec REIT ventured into Australia in 2010 and 2013, respectively. Finally, CapitaLand Integrated Commercial Trust C38U (CICT) acquired Gallileo in 2018 when it was still CapitaLand Commercial Trust. At the time, 100% of Gallileo’s value was equivalent to $577.4 million, translating into a purchase price of $547.9 million for CCT’s 94.9% stake. In 2019, CCT acquired 94.9% of the Main Airport Center from CapitaLand for the equivalent of $387.1 million. As at Dec 31, CICT’s stake in Main Airport Center was valued at $333.6 million.
See also: CICT: All ready for a Fed pivot
Interestingly, Gallileo will be the new headquarters of the high-profile European Central Bank while 8 Chifley Street in Sydney is the headquarters of the Reserve Bank of Australia. The Chifley Street property is owned by Keppel REIT.
Deciding whether to go overseas or not requires S-REITs to do some soul-searching about their strategic focus, Koh points out. The REITs, which owned Singapore properties, had a lower cost of capital and, often, debt. That made it “accretive” to acquire an overseas property with a higher yield. Moreover, even before the interest rate cycle, it was tough making Singapore office buildings accretive, despite a low cost of debt as capitalisation rates were and still are, in many cases, below 4%.
Nonetheless, Koh believes that S-REITs could be better off refocusing on their domain knowledge. Geographically, this is Singapore. S-REITs should continue to take advantage of the externally managed S-REIT structure. As such, the sponsors of S-REITs often own major stakes in their REITs and support their REITs with both a pipeline and financing and management services.
Moving into developments for higher returns
With the cooperation of sponsors, some of the larger S-REITs could go up the risk curve, Koh suggests. “Sponsors could step up their game to provide more support for their REITs though working on developmental opportunities together as these have higher returns and can leverage the balance sheets of the sponsor. Many sponsors have big stakes in their REITs so it can be win-win. In addition to redevelopment of older assets that REITs or sponsors own, there are also many incremental development opportunities in Singapore driven by government planning, Eg Jurong, Paya Lebar, the Southern Waterfront. Sponsors can co-develop such projects with their REITs." With development, REITs would be able to get higher returns. It is not that much higher up the risk curve as the development is being done in Singapore where the sponsor has legacy assets.
“If you can strike a price that works both ways, that refocuses on potential growth and opportunities in Singapore, that signaling can help lower the cost of equity. People love the Singapore story and Singapore’s defensiveness. Development returns are higher,” Koh says, yet the risk is manageable because it is Singapore.
“If you can think of it in terms of Singapore-focused development around these areas and work with the sponsor to strike a good price, these are some of the things REITs need to be thinking about in terms of challenges: repairing the balance sheet, refocusing on your comparative advantage and leveraging on your sponsor,” Koh reiterates.
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CICT, along with sponsor CapitaLand, has made use of this model. Back in 2011, CapitaLand and the former CCT started redeveloping Market Street Car Park into a green, sustainable building, now known as CapitaGreen. The REIT obtained permission for the redevelopment from the Urban Redevelopment Authority and paid a differential premium to the Singapore Land Authority for the change of land use on the unexpired land lease. The redevelopment cost about $1.4 billion.
Since REITs had a development limit of 10% back in 2011, CapitaLand and a partner, Mitsubishi Estate Asia, took a 60% stake in the project, with CCT owning the remaining 40% stake. CCT had a call option to acquire the 60% it did not own, which it exercised in 2016. A similar model was chosen for the redevelopment of the Golden Shoe car park into CapitaSpring. As at Dec 31, CICT owns 45% of CapitaSpring.
CICT is not the only REIT redeveloping existing assets. ESR-LOGOS REIT J91U completed a new building at 7002 Ang Mo Kio Avenue 5, costing $53.3 million, with an ROI (return on investment) of 7.1%. It is also redeveloping a cold storage centre at 2 Fishery Port Road for around $200 million or so, although the exact cost has to be confirmed.
Mapletree Industrial Trust redeveloped its Kolam Ayer flatted factory cluster into Mapletree Hi-Tech Park @ Kallang Way for around $263 million. During the development period, sponsor Mapletree Investments opted for its full allocation of units under the distribution reinvestment programme. CapitaLand Ascendas REIT A17U and CapitaLand Development announced the redevelopment of 1 Science Park Drive into a life science and innovation campus for $883 million.
In 2019, CapitaLand, CapitaLand Ascott Trust (CLAS) and City Developments partnered to redevelop Liang Court into CanningHill Piers, comprising 696 units in two towers, and CanningHill Square with F&B and retail outlets, a 475-room hotel operated under the Moxy brand by Marriott International, and a 192-unit serviced residence with a hotel licence operated under the Somerset brand, managed by The Ascott Limited. For CLAS, the project development expenditure is around $300 million and ebitda yield-on-cost is estimated at 4%. Unfortunately, CanningHill Piers is one of the properties where mainland Chinese money launderers have acquired several units, which have to be resold after being confiscated.
Other forms of support
When one of Digital Core REIT’s tenants in its Toronto facility filed for bankruptcy in 2022, sponsor Digital Realty executed an agreement with DC REIT to reimburse the latter for any cash flow shortfall in 2023 related to the customer bankruptcy.
Additionally, when a second customer, Cyxtera Technologies, filed for bankruptcy protection, Brookfield, which acquired Cyxtera’s assets, had an agreement with Digital Realty and DC REIT to pay book value for DC REIT’s 90% stake in two Silicon Valley facilities, just 11% lower than their valuation during DC REIT’s IPO in 2021. Brookfield also took over a third Silicon Valley property until September, giving DC REIT time to backfill it.
“We’ve seen Digital Realty getting more involved with Digital Core REIT and that helped the REIT,” Koh observes. Digital Realty, which is also structured as a REIT, has a development pipeline as well. Digital Realty is also an operator and operates data centres as well as building and owning them. As part of the ecosystem, Digital Core REIT can act as an offtake vehicle, acquiring some of the data centres built by Digital Realty. Under this model, Digital Realty will continue to manage and operate the data centres on receiving fees from Digital Core REIT for doing so.
“Is this model likely to change? Truth be told, Singapore does need to evolve. The sponsor needs to evolve. I think the sponsors get it. Some of them may even think about stapling,” Koh says. In Australia, investors own both the REIT and the management company, which is stapled to the REIT. This is unlike in Singapore, where investors own a passive REIT with the management company outside the REIT.
“We’ve suggested considering stapled structures with a focus on overall total return akin to many of the REITs in developed markets. Institutional investors like us are happy to buy 2%-3% yielding REITs in the US and Australia where the prospect of future growth is high. We don't think just about dividend yield, we are looking at total return because we are used to investing in REITs that have both development as well as investment components. The growth from the development part is built into our future forecast. But it’s a big leap to make to get regional investors to move beyond yield to think about total return," Koh says.
By investing in US and Australian REITs, Principle Asset Management’s fund is likely to do a lot better than investing in S-REITs. As the chart shows, S-REITs continue to underperform partly due to their higher aggregate leverage levels which have impacted DPUs negatively.
