Eng-Kwok Seat Moey, managing director and head of DBS Bank’s capital markets business, has a wish list for S-REITs on the 20th anniversary of the IPO of the very first REIT in Singapore, CapitaLand Mall Trust (CMT). Eng-Kwok, who is also called “the mother of S-REITs” because of her pivotal role in the creation of the shopping centre REIT, hopes that more S-REITs to make it to Asia’s top 10 REITs by market capitalisation (see chart 1). She also hopes for an S-REIT to make it into the global top 10.
“At this point, if you compare us, on [the basis] of average market cap to the US and Hong Kong, we are very small,” she adds. “One item on our wish list is for one of our REITs to become top 10 in the world. It’s possible.”
For her, the largest S-REIT, CapitaLand Integrated Commercial Trust (CICT), is not Asia’s largest REIT “because Link REIT is there”. In terms of market capitalisation, Link REIT is 75% larger than CICT. As shown in chart 1, the Japanese REITs (J-REITs) figure significantly in Asia’s top 10.
Big is beautiful
The conventional wisdom that bigger is better and big is beautiful has some merit to it. A case in point is the desire for local growth companies to list on Nasdaq because of its heft. Nasdaq listings have access to capital, liquidity, higher valuations and lower cost of capital. These metrics provide a tailwind for growth and S-REITs should thrive there as they are growth and yield vehicles.
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This brings us to the latest trends among the S-REITs of expanding beyond Singapore and mergers. While mergers make for interesting news angles, in REIT mergers, a little value is lost for one of the parties, which is usually the acquirer.
To reflect a different point of view, Jonathan Yap, CEO, fund management, CapitaLand Investment (CLI), points out that CICT had provided unitholders with total returns of 19.9% between its inception on Nov 3, 2020, and Dec 31, 2021. In the same period, the FTSE ST REIT Index reported total returns of 13.9%.
CICT was formed in 2020 from the merger of CMT and CapitaLand Commercial Trust (CCT) to “capitalise opportunities from the real estate trend of blurring of boundaries between office and retail developments”. CICT is the largest S-REIT, with a diversified portfolio of retail, office and integrated developments in Singapore, Germany and Australia.
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In 2019, Ascott Residence Trust (ART) and Ascendas Hospitality Trust (AHT) merged following the acquisition of Ascendas-Singbridge by CapitaLand. Although both property trusts had different mandates, ART’s serviced residences and its Japanese long-stay properties, and AHT’s hotels are both parts of the broader lodging sector.
The success of ART’s merger with AHT was partially underpinned by irrevocable undertakings from two major unitholders, French hospitality giant Accor and tycoon Gordon Tang. ART paid $1.0868 for each AHT unit. The $1.0868 price comprised $0.0543 in cash and 0.7942 new units in ART issued at $1.30. The scheme consideration was based on an exchange ratio of 0.836x, which was derived from the net asset value (NAV) of AHT of $1.02, divided by the NAV of $1.22 for ART at the time.
“In each instance, the merger structure took careful consideration of the interests of both sets of unitholders to ensure that the terms were fair and the transaction made sense to both sides. The two transactions were resoundingly approved by their respective unitholders, which underscored that REIT mergers that are backed by sound and well-articulated rationale and that enhance the long-term interest of unitholders would receive support,” says Yap, when asked whether the mergers made sense and created value.
While CICT’s price performance and DPU growth in FY2021 are obvious, ART’s performance was impacted to a great extent by the pandemic. Still, Yap points out that ART had outperformed its peers in 2021 amid a Covid-challenged environment. Shares of ART, CDL Hospitality Trusts (CDLHT) and Frasers Hospitality Trust (FHT) ended 2021 0.3%, 4.3% and 9.7% lower respectively, based on Bloomberg data.
“Investors are savvy. They make their buy and sell decisions based on their assessment of the performance and outlook of a counter in relation to their investment objectives. Hence, managers and sponsors would have to decide on the path of the REITs taking into consideration investors’ interests and views to stay relevant to the market,” says Yap.
One of the lessons learnt from mergers by the CapitaLand group is to get irrevocable undertakings from long-term unitholders who are interested in future value and accretion and who are willing to roll their units into a larger merged entity, rather than to cater to activist hedge funds that are keen on higher pricing.
Liquidity, tight yields, growth
However, a bigger question remains. Why aresome REITs a resounding success while others are unable to trade at sufficiently compressed yields to acquire properties to grow? Eng-Kwok suggests three main factors contribute to a REIT’s success: Quality of assets, strong sponsor support and a pipeline of properties.
“The key is a strong, supportive sponsor, with a good track record and the ability to generate a good pipeline for its REIT,” she says. REITs are passive investment vehicles. “A strong sponsor can support the REIT financially, provide a pipeline and the opportunity to acquire the pipeline, and provide the REIT support to close deals, which are key to the growth of the REIT,” she explains.
In the 2000s, the first batch of REITs had name recognition and good sponsors with good assets. “CapitaLand Mall Trust’s assets were the best properties. It was pure-play Singapore for the longest time,” Eng-Kwok says. Investors, particularly retail investors, can just go to the malls to see whether they are doing well.
Even with the pandemic now, suburban malls still remain popular. Tony Tan, CEO of CICT’s manager, says Bukit Panjang Plaza (BPP) performed better than it did in 2019 before Covid-19 struck. BPP is situated near the last stop on the Downtown Line and within a suburban catchment.
“You are buying a part of the mall and paying CapitaLand to run the mall. It’s very transparent and the fees are all stated in the trust deed. The expenses are locked and the bulk is in management fee and interest cost,” Eng-Kwok says.
Investors are guaranteed at least 90% of the distributable income. For retail malls, leases are usually locked in for around three years. Hence, investors have income and growth stability when the REIT acquires a new asset and have the financial support from the sponsor in the event of capital raising.
Boots on the ground
“CLI operates in markets where we have localised resources to originate deals, manage and lease projects. Our strong asset operating platforms, including lodging, retail, commercial, industrial & business parks, logistics and data centres, are key to enhancing asset value in the long term. These set us apart from other REIT sponsors and managers,” says Yap.
CICT and Ascendas REIT — CLI’s industrial REIT — trade at around 5%, lower than the average yields in their respective sectors. Mapletree Commercial Trust (MCT) and Mapletree Logistics Trust (MLT) trade at tighter yields; MCT is pure-play Singapore while MLT is pure-play logistics. Yap attributes the tight trading yields to sponsor support.
“We are committed to support the continual advancement of our REITs and develop them into robust growth engines, with a view to preserve long-term value for and deliver sustainable returns to all unitholders,” he says.
“We hold meaningful stakes in and are the single largest unitholder of all our sponsored REITs. This demonstrates our alignment with the interest of investors and confidence in the strategy of our REITs.
“In addition, we have offered relevant assets owned by us or our private funds for investment by our sponsored REITs,” Yap elaborates.
Lack of liquidity, support
Smaller sponsors and unknown sponsors started to list their REITs after the first flush of success for the developer-sponsored REITs. For instance, Freightlinks (now Vibrant Group) listed Sabana REIT in 2010, with what appeared to be over-rented properties.
As an example, Sabana REIT’s Chemical Logistics Hub was sold into the IPO portfolio at $78.9 million and was last valued at $40 million. The current manager is in the process of repairing the REIT but is being thwarted by a large unitholder.
In December 2020, Soilbuild Business Space REIT’s (SB REIT) manager cited low trading volume, low liquidity, low analyst following and high trading yields that make it difficult to grow. These were the key reasons SB REIT’s sponsor privatised the REIT in early 2021 after an IPO in 2014.
Recently, some of the highest trading yields were recorded by S-REITs with US assets. They need to get to more compressed yields so that acquisitions can be more accretive. Still, that has not stopped three US S-REITs announcing acquisitions in 2021.
United Hampshire US REIT acquired two properties for US$78.25 million ($105 million), financed by debt and US$30 million raised via a placement. The acquisition accreted 1.75% to DPU on a pro-forma basis.
Keppel Pacific Oak US REIT (KORE) acquired two properties for US$105.1 million, financed by debt and US$65 million raised in a placement. The acquisition’s accretion to DPU was less than 1%. KORE’s FY2021 DPU rose by 1.8% y-o-y to 6.34 cents, partially underpinned by the acquisitions.
Because of certain regulations that include a widely-held rule, for Singapore investors to benefit from full tax transparency, no single unitholder can hold more than 9.9% of US S-REITs. As a result, sponsors are unable to support these US S-REITs to the same extent that the likes of CapitaLand, Mapletree, Frasers Property and Keppel Corp can support their S-REITs.
This lack of sponsor support, higher leverage and an external model accounts for the higher yields that US S-REITs trade at compared to their US-listed peers, market observers note.
US S-REITs have delivered in operating performance and what they had promised during their IPOs as well, Eng-Kwok points out, blaming the pandemic for their poor performance. “When the pandemic hit, physical occupancy in offices reduced and yields shot up,” she says. “Previously, there was a lot of focus on trophy and class-A assets. With the new reality of the pandemic, they’ve become more open to suburban and campus-type office assets which have higher yields.”
No sponsor? Internalise
What then happens to REITs without a sponsor? “A strong sponsor provides a pipeline on an ongoing basis and name recognition for the financial backing for fundraising. If the REIT does a rights issue or preferential equity fundraising and if you don’t have financial backing, you might as well internalise the manager. That’s our advice to potential sponsors with no backing or track record here. You can still be CEO there and run the internalised REIT,” Eng-Kwok says.
For example, even though Manulife has a presence here and plans to increase its footprint in Asia, because of regulatory reasons, it cannot provide Manulife US REIT (MUST) with greater support.
In December, MUST had to issue units at the low end of its range for a placement. This is in contrast with MLT and CICT which issued units nearer the high end of its indicated range. All three REITs made acquisitions and raised equity via placements last November and December.
“The external manager framework works for Singapore because we had just started S-REITs and we needed to give a lot of incentives to the sponsors to list here. The incentive was not just to set up the REIT but for an ongoing pipeline,” Eng-Kwok says. Since REITs in Singapore are still growing via acquisitions, a sponsor with interests aligned to the REIT is necessary.
Once the sponsor fails to show alignment, the REIT could trade at a discount to NAV and at a higher yield. In May 2020, Cromwell European REIT’s (CE REIT) manager decided to take its management fees in cash yet maintained a distribution reinvestment programme for its unitholders. Although its assets are in Europe where risk-free rates are low, CE REIT is trading at 7% because of the perception that there is less alignment between the interests of its sponsor Australian-based Cromwell Property Group and the REIT.
What will happen to a REIT without sponsor support and opportunities to grow? The REIT will be stagnant, the price will tank and the REIT will forever be trading at a discount, Eng-Kwok suggests.
Take a look at Link REIT, which is internally managed. “If you don’t have a pipeline, liquidity is important because liquidity provides the opportunity to tap investors,” EngKwok says. That is why Link REIT can continue to grow and its yields are tight.
Perhaps another reason for Link REIT’s sub-5% trading yield is its low gearing. Following a spate of acquisitions last October and November and in February, its gearing has risen to 24.6%, which is still lower than all the S-REITs. Its most recent acquisition is a 49.9% stake in an office portfolio in Australia for A$596 ($572.7) and an NPI yield of 4.4%.
Another REIT with no sponsor is Suntec REIT. It has not been as fortunate as Link REIT though. It is trading at a 25% discount to its NAV. Eng-Kwok describes Suntec City, which is an integrated property comprising retail, office and a convention centre, as a “beautiful property”.
Suntec City was built in the 1990s and owned by 16 Hong Kong tycoons, of whom one was Li Ka Shing. Li’s property vehicle, which used to be Cheung Kong Property Holdings (now CK Asset Holdings) had the second-largest stake in ARA Asset Management after founder John Lim, in the 2000s.
Eventually, the tycoons sold out of Suntec REIT. ESR Cayman inherited an 8.5% stake in Suntec REIT when it acquired ARA Asset Management in January.
Suntec REIT has one of the highest gearing levels and one of the lowest interest coverage ratios among S-REITs.
Lessons learnt
Singapore introduced the REIT framework in 1999. In 2000, CapitaLand was formed from the merger of Pidemco Land and DBS Land. In 2001, CapitaLand attempted to list Singapore Property Trust.
As Eng-Kwok says: “When we first started, everyone including the regulators was trying to understand what a REIT is all about. What’s the difference between REITs and developers?”
Everyone was suspicious, she remembers, especially the media. Eng-Kwok continues: “There were two factors against us. Property counters were trading at huge discounts. Why would anyone invest in a REIT and pay NAV? The second point is the valuation methodology. Investment properties in REITs are valued based on their cash flow, through both discounted cash flow (DCF) and income capitalisation.”
Capitalisation rates and in particular discount rates are benchmarked against 10- year government bond yields.
The third factor is the yield spread which is the difference between the REITs’ trading yield and the yield on 10-year government bonds. Adds Eng-Kwok: “We launched Singapore Property Trust at a 5.75% yield although the risk-free rate at the time was 2.75%. It’s a new product. Why are you paying a 300bps risk premium and NAV? Understanding the product is key. We underestimated the importance of understanding the valuation of the product, and explaining the difference between developers and REITs.”
In a REIT, when rents decline and cash flow falls, the valuation of the asset is likely to fall.
“You have to be mindful of the alternative investments to REITs, yields on 10- year bonds. REITs are still equities. They are not a bond that is priced based on prevailing rates,” Eng-Kwok notes.
Finally, when Singapore Property Trust was relaunched as CMT, the yield was 7%. From 2002 till November 2020 when CMT became CICT, the REIT had outperformed the Straits Times Index and almost outperformed the S&P500 Index but was pipped at the finish line because of the pandemic when tech stocks surged (see chart 3).
Rising interest rates
Since REITs are a yield product, rents, rental outlook, occupancy and cash flow are key to the valuation of their assets. Operationally, for most REITs, more than 70% of their debt cost is hedged. So interest rate movements are only likely to impact new loans and refinancing.
The trading yields of REITs do not move in lock-step with interest rates the way bonds do. In fact, the 10-year US Treasury yield started rising last year when the US Federal Reserve communicated it was winding down quantitative easing. The relationship between 10-year risk-free rates and REITs is real (see chart 2). REITs’ unit prices are inevitably impacted by rising rates. However, REITs could rally or rebound once the first two rate hike cycles are over.
Whatever the volatility of REIT unit prices, sponsors are likely to remain committed, says CLI’s Yap. “We do not take for granted investors’ confidence in us. Instead, we made it a point to maintain investment discipline in uncovering and unlocking value for investors, and are firmly committed to being a good steward of the funds that our investors and capital partners have entrusted us with. This is because we understand that only financial managers with a strong track record will continue to gain investors’ trust in today’s competitive financial markets.”
Whether the success of the S-REIT sector is repeated by special purpose acquisition companies or spacs remains to be seen. American writer Mark Twain once said that “history doesn’t repeat itself, but it often rhymes”. Regulators and investors are probably hoping that is the case.
