Last November, Han Khim Siew was appointed CEO of OUE Commercial REIT’s (OUE C-REIT) manager before he took up the post in February. If a new broom truly sweeps clean, investors in OUE C-REIT should experience an overall more stable phase for the REIT.
One of the first tasks that Han undertook was the issuance of $150 million five-year 4.2% fixed rate notes. “We tapped the bond market. We launched a $150 million five-year note with a 25 bps stepdown if we get an investment-grade rating. We printed 4.2%. With a 0.25% discount, it [can potentially] go to 3.95%. We caught the timing. After that, the Fed kept pushing rates higher,” Han says in a recent interview. “At that time, the objective was getting the timing right and lower rates.”
A second major transaction undertaken by Han is the unsecured $978 million sustainability-linked syndicated loan announced in August. This implies that the majority of OUE C-REIT’s debt in 2023 and 2024 has been refinanced in advance, leaving only 12% of borrowings or $283 million to be refinanced in September 2023. As Han tells it, there were three tranches of debt to be refinanced — this year, next year and 2024.
“We looked at the market after the bond issuance. In May, we felt we should get this refinancing done and take out the whole tranche since 2023 would be challenging. What made it harder was moving from secure to unsecured. A lot of the loans were on a secured loan basis. They are cheaper until you unencumbered the whole lot,” Han continues.
The banks that provided the syndicated sustainability-linked loan were OCBC Bank, Maybank, CIMB and Standard Chartered. The maturities are in 2025 and 2026.
“When we talked to the banks for moving from secured loans to unsecured, with cheaper and bigger refinancing, we ended up with 19 banks [who offered to refinance] and who understood the journey. We did not promise immediate growth but accretive growth, growing to benefit unitholders,” Han says.
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Han is pleased with the refinancing which included a large sustainability-linked loan that could lower the cost of debt subject to certain sustainability targets. The refinancing exercise increased the percentage of unsecured debt from 30.9% to 70.1%, extending its weighted average debt maturity from 2.7 years to 3.1 years.
Cost of debt and gearing inched up quarterly, with 69.2% of its borrowings on fixed rates as at Sept 30 compared to 76% as at June 30, and slightly below its 70%–75% target.
Accretive versus dilutive
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Growing accretively is important for unitholders. And in this respect, OUE C-REIT has not been able to meet expectations.
When asked about OUE C-REIT’s dilutive acquisitions, Han says: “As long as you think it’s going to yield up and it never materialises, then that is a poor analysis of the acquisition. If it’s clearly a case where tenants are committed but they haven’t come in, [the property] can yield up. The ideal acquisition would be accretive from day one, and it should keep yielding up.”
Since its IPO in 2014, OUE C-REIT has made two major property acquisitions and both were initially dilutive. OUE C-REIT acquired a 67.95% stake in One Raffles Place (ORP) in 2015 for $1.1 billion, funded by a ninefor-20 rights issue raising $218.3 million and issuance of $550 million worth of convertible perpetual preferred units (CPPU). Based on the funding, ORP’s acquisition was dilutive to DPU to the tune of double digits. Since then, 75 million CPPUs were redeemed in 2017, 100 million in 2018 and 155 million in 2022 leaving 220 million CPPUs outstanding as at November.
The most recent $155 million redemption was funded from the divestment proceeds from the partial divestment of OUE Bayfront to a fund managed by Allianz Real Estate in 2021 at a premium of 26.1% over the purchase consideration of $1.005 billion. The net proceeds from the divestment were $262.6 million.
In 2018, OUE C-REIT acquired OUE Downtown which was around 4.3% dilutive to DPU based on the outstanding CPPUs to be redeemed rather than converted. OUE Downtown’s net property income (NPI) was supported by rental support of $60 million for up to five years. Han says that the $60 million has been fully utilised.
In 2019, OUE C-REIT announced a merger with OUE Hospitality Trust. The circular indicated that the merger is around 2.1% accretive to OUE C-REIT’s DPU. However, Covid hit and OUE Hospitality Trust’s income was based on the master lease income which comprised $45 million from Hilton Singapore Orchard (formerly Mandarin Orchard) and $22.5 million from Crowne Plaza Changi Airport. “The point of entry becomes quite important and you need to get that right, otherwise you are pushing water uphill,” Han says.
Growth was important
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“Those acquisitions were somewhat dilutive,” Han acknowledges, referring to OUE Downtown and One Raffles Place. “In 2010–2014, a lot of REITs came to market and you had a lot of subscale REITs. If you didn’t have $1 billion of AUM, you were locked out of the market. If you were stuck at that level, the REIT would have performed poorly for unitholders, hence REITs had to grow,” Han explains.
After the merger with OUE Hospitality Trust, three things happened that showed why scale matters, says Han. OUE C-REIT’s AUM grew to $6.9 billion and the REIT could recycle capital. It sold 50% of OUE Bayfront to a fund managed by Allianz Real Estate. That leads to a second advantage. With some of the sale proceeds, OUE C-REIT was able to undertake a $150 million AEI for Hilton Singapore Orchard. “Hilton Singapore Orchard’s income was $70 million a year. If you stripped out this income, you couldn’t do AEI because we would take out the main income-generating asset,” Han points out. Thirdly, OUE C-REIT was added to the FTSE EPRA NAREIT, an index many S-REITs aspire to be in.
“The acquisitions were dilutive and the merger impact was flat. But we can see the benefits of scale because index investors are the largest part of the investing universe. Allocation is based on the size of the REIT. If you are looking at smaller REITs, there are many things you can’t do and this platform allows us more flexibility,” Han says.
Boost from Hilton Singapore Orchard
The average room rates at Hilton Singapore are likely to be significantly higher than at the old Mandarin Orchard. “When we opened as Hilton Singapore, our average day rates (ADR) were $300. Then in May, ADR increased to $400 and now it is $500,” Han confirms.
The increase is not only due to the rebranding. The market has opened up and quarantine restrictions have loosened. As evidenced by the Formula One night race and the Singapore FinTech Festival, visitors were flocking to Singapore in droves. In addition, it was reported that the Grand Hyatt on Scotts Road and the old Hilton across from that Thai embassy have closed for major AEIs, taking away supply from Orchard Road at a time when visitors are flocking to the Lion City.
In addition to the macro picture in Singapore, the Hilton’s booking system is likely to be more sophisticated and far-reaching than the old Mandarin Orchard system. The profile of travellers has also changed because of the brand change. Previously, booking depended on cabin crews and tour groups from the region. Now, US travellers are among the top three groups of customers.
“The idea was to tap into direct bookings and corporate travellers. That has improved the margins and rates and reduced the amount of distribution by wholesalers. We wanted North American travellers. Now, Hilton has the largest Mice facilities [along Orchard Road],” Han says.
Once all 1,080 rooms at the Hilton Singapore are ready, its revenue could rebound to levels not experienced since 2019, before Covid. In 1HFY2022 ending June 30, OUE C-REIT reported total revenue of $115.8 million, which remains lower compared to pre-Covid levels. Hilton Singapore accounted for 18.5% of revenue while Mandarin Gallery accounted for 11.3% and Crowne Plaza Changi Airport 9.3%. In FY2018, OUE Hospitality Trust, which comprised Mandarin Orchard, Mandarin Gallery and Crowne Plaza Changi Airport), reported revenue and net property income (NPI) of $129.7 million and $112.8 million respectively, indicating upside potential.
A challenge remains
DBS Group Research is sounding a cautious note about OUE C-REIT’s prospects and recommending a hold on the stock. “Key positive catalysts that could change our view include i) a hospitality ramp-up and recovery to pre-Covid levels at full capacity, ii) the office income growth trend continuing longer than expected, and iii) China reopening,” DBS says in a recent report.
It adds that the REIT may utilise “the remaining $9 million in capital distributions after the partial divestment of OUE Bayfront to smoothen out some earnings. However, the payout will be considered at the end of the year”.
On the other hand, DBS is concerned about the remaining $220 million of CPPUs. While converting to equity is highly unlikely given the conversion price of 71 cents, DBS says that “potential redemption may require equity placement.” On the other hand, the CPPUs are perpetual at 1% and the REIT may just continue to carry them as CPPUs.
Han touched on acquisitions in developed markets such as Australia and possibly UK. At present, NOI yields and cap rates are at 4% to 5% for office assets leaving very little upside given borrowing rates of 4.5% to 5.5%.
“We are waiting for market stress to kick in. No one wants to be the first to sell below valuation and you want to be able to buy at a discount to valuation. We have consolidated ourselves this year and are in a good position to act opportunistically over the next 9–12 months,” Han says.
