During a recent conversation with Yong Yean Chau, CEO of Parkway Life REIT’s manager, following the announcement of the REIT’s acquisition of 11 nursing homes in France for EUR111.9 million ($160.2 million), Yong was quick to emphasise that Singapore will always remain core to the portfolio and that the acquisition is likely to be more accretive than the 1.6% stated in the initial announcement.
”Singapore will remain the core and more than 60% of the portfolio because this forms the backbone of Parkway Life REIT. By 2026, the rental income will increase, and the assets will be revalued upwards with income and asset size growth. I think it is important to reassure and inform investors of this just in case investors are worried that our big move into Europe and Europe plus Japan will become bigger than Singapore,” Yong says, referring to the new master lease agreement that boosts income and valuation of the portfolio.
In 2021, Parkway Life REIT and sponsor IHH announced a new 20-year lease for the three hospitals — Mount Elizabeth Hospital, Gleneagles Hospital and Parkway East Hospital — with a 20-year master lease agreement and the option to extend for 10 years. The rent uplift comes with rent rebates with a full rent uplift in FY2026.
Yong says: “We have adopted a few key prongs in our strategy. We continue to foster closer collaboration with the sponsor and work together on many things. The new 20-year lease agreement is a result of this. The asset enhancement initiative [AEI] of Mount Elizabeth is also a function of closer collaboration, and the right of first refusal [ROFR] for Mount Elizabeth Novena has been executed. Other collaborations are underway, including deepening our presence in Singapore and collaboration with the sponsor.”
Among the collaborations is a possible AEI at Gleneagles Hospital. The new master lease agreement for the three hospitals comes with the ROFR for Mount Elizabeth Novena for 10 years.
The other part of the collaboration with the sponsor is the formation of teams by both Parkway Life REIT’s manager and IHH Healthcare Q0F to study opportunities where Parkway Life REIT can support IHH Healthcare in its growth journey. “Dr Prem Kumar, the new group CEO of IHH Healthcare, has been very supportive, and Parkway Life REIT can help support IHH Healthcare in its growth journey. So we have formed a task force evaluating the possible options for cooperation,” Yong says.
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Dr Kumar’s growth strategy includes having IHH Healthcare “continually review its assets to improve performance and operations, helping them to maximise their full potential”.
Market observers have indicated that Parkway Life REIT and its sponsor have formed joint teams tasked to identify a structure, including the timing of the possible acquisition of Mount Elizabeth Novena. At this junction, there is yet to be a commitment to the timing because there are still fundamental things that the two entities need to iron out so that IHH Healthcare and Parkway Life REIT can move forward. Market observers say that the management of both Parkway Life REIT and its sponsor is putting a lot of resources into focusing on the end objective of the next big acquisition.
In IHH Healthcare’s FY2023 annual report, Mount Elizabeth Novena and the adjoining medical centre units are valued at RM4.5 billion ($1.36 billion). Parkway Life REIT’s investment properties were last valued at $2.2 billion. This implies that Mount Elizabeth Novena would be a sizeable investment requiring equity fundraising. Parkway Life REIT is trading at an annualised yield of under 4% based on a projected DPU of 15.08 cents. IHH Healthcare says the capitalisation rates of its investment properties range from 4.2% to 6.4%. This suggests that Mount Elizabeth Novena, being the newest hospital, could be valued nearer the 4.2% rate.
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Analysts believe that the timetable for acquiring Mount Elizabeth Novena will likely lead to an agreement in around two years, long before the expiry of the ROFR. A report by SAC Capital earlier this year put the timetable for acquiring Mount Elizabeth Novena in five or six years and in two tranches.
If that is the case, the acquisition of 11 nursing homes in France from DomusVi Group, announced on Oct 22, could be a stepping stone to a larger size. Although Parkway Life REIT could have made the acquisition with debt, the manager decided to fund the acquisition fully with equity, raising $180 million from a placement of 47.37 million units at $3.80 apiece.
The placement is Parkway Life REIT’s first equity fundraising since its IPO in 2007. This was partly because the REIT did not have a general mandate until 2020.
Why Europe and why now?
Japanese nursing homes form a significant part of Parkway Life REIT’s assets, contributing around 28% to net property income (NPI). The remaining NPI is mainly from Singapore hospitals.
“We have a relatively good size, and we wanted to slow down in Japan, and the strategy is to create a third key market so that we can diversify and create a better, robust engine. Even after this acquisition, Singapore will account for 60% of our portfolio. This core has built-in good organic growth because of the CPI-linked formula for revenue of the new master lease agreement,” Yong explains.
“I can buy a Japanese asset at a very attractive capitalisation rate, and the funding cost is very low. Although stable, the challenge is there is very little growth in Japan because of a lack of CPI-linked rental growth. We need to pause or slow down in Japan. Over time, as Japan’s portfolio becomes bigger on an organic basis, it will be a threat to the overall portfolio for DPU because Singapore’s income can grow by 3%. If Japan is growing at 1%, that implies, on a weighted average basis, the growth is probably 2%,” Yong reasons.
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As it is, Parkway Life REIT’s revenue in 1HFY2024 ended June fell by 2.7% y-o-y to $72.42 million and NPI fell by 2.5% to $68.35 million. However, because of the net foreign exchange movement, the REIT had registered a realised foreign exchange gain amounting to about $4.7 million in 1HFY2024 from the settlement of Japanese yen forward contracts, accounting for the higher DPU of 7.54 cents in 1HFY2024, up 3.5% y-o-y. Distributions are net of the $3 million the REIT retains yearly for capital expenditure.
Searching for a third geography, Parkway Life REIT’s manager rejected many deals. “We chanced upon a conversation with DomusVi, which has a presence in France, Spain, the Netherlands, Ireland and Germany,” Yong recalls.
DomusVi is going down the asset-light route, and discussions with Parkway Life REIT’s manager started over 18 months ago. Based on Parkway Life REIT’s manager’s research, there is a shortage in the supply of nursing homes.
“Our biggest concern is tenant default risk. Can the tenant continue to pay the rent? This is the reason why we entered Japan. Over the last six years, whenever a tenant defaulted, we didn’t have an issue with replacement tenants. France has similar characteristics. Our other consideration is to achieve sustainable rental and growth over time,” Yong explains.
Parkway Life REIT is acquiring the portfolio at a cap rate of 6.5%, which is 150 basis points (bps) higher than other opportunities it was studying. DomusVi is the third biggest operator of nursing homes in Europe and is profitable. “We have locked in the deal at 6.5% cap, and the 12-year lease is pegged to inflation,” Yong points out, adding that the expectation of both a larger security deposit and a 3% rental growth a year, giving the REIT a 10% rental growth rate in the next three years are other safety features.
The transaction is funded by 100% equity, with a DPU accretion of 1.6%.
Mitigating exchange rate risk, shielding income from tax
Loo Hock Leong, CFO of Parkway Life REIT’s manager, says that although the European Central Bank is on a rate-cutting cycle, the Parkway Life REIT opted for a fully equity-funded deal to bring down gearing to 34.8%.
Despite this, he is confident that the structure will protect Parkway Life REIT from any risk due to a softening of the Euro despite the assets being in euros.
“To mitigate net asset value [NAV] volatility, we are putting in a cross-currency swap. We are converting our Singdollar [SGD] to euros, and we have a two-year forward contract to convert the euros back to SGD at the same exchange rate. This is a cross-currency swap by a simultaneous purchase of euros and selling at the same rate in two years to act as a counterweight to fluctuations in euros,” Loo explains.
Parkway Life REIT will also have in place long-term hedges to hedge against the euro for the cash flows repatriated to Singapore for the next three to five years. “The DPU will be locked in at least for the next three to five years, and you will no longer be subjected to any fluctuation in the forex risk,” Loo says.
Additionally, the acquisition and income returning to Singapore are relatively tax-transparent. Although Parkway Life REIT is using equity to acquire the French portfolio, the manager plans to use the thin capital rule to establish inter-company loans to create onshore debt interest expense as a tax shield.
With the thin cap rule and intercompany loans, earnings repatriated to Singapore are charged very little French tax.
The 1.6% accretion to DPU assumes a 17% corporate tax rate in Singapore. However, the manager has applied for exemptions under Section 13(12) of the Income Tax Act for foreign-sourced income received in Singapore. If granted, the accretion of the French acquisition to DPU will be 3%, making it one of the most accretive acquisitions by a REIT this year.
