SINGAPORE (Feb 19): Much has been written about the future of retail, including digitalisation and the challenges brick-and-mortar malls face. Managers of retail real estate investment trusts have to juggle several balls such as tenant mix, tenant sales, shopper traffic and operating costs at the same time. The biggest challenge appears to be keeping malls relevant in the age of digital disruption. And, at the end of every six months, the REIT has to announce a distribution per unit (DPU) that has to be stable. At the end of every year, investors scrutinise its balance sheet for declines or increases in the valuation of the portfolio.
REIT investors buy these instruments largely for the yield. But as with all investors, capital preservation — at the very least — should be paramount. No point getting a yield while the capital value of your investment falls.
Shopping malls are valued based on their rental outlook, which in turn depends on occupancy rates, rental reversions, tenant sales and so on. For CapitaLand Mall Trust, which owns 14 malls and meaningful stakes in a further two, its 30% interest in Westgate posed a problem last year. The property’s valuation fell $29.7 million, or 9.3%, to $289.5 million. This is despite a compression in its capitalisation rate of 5.2% to just 4.75%. If not for that, its valuation would have fallen further.
For FY2017, the value of CMT’s portfolio rose 3.9% to $8,671 million. Total assets stood at $10.5 billion and net asset value per unit was $1.92, up 3.2% y-o-y.
Cap-rate compression cycle continues
CMT could have experienced negative revaluations if the cap-rate compression did not happen. “Valuers were looking at lower rental growth and marked [rental growth] down because competition in that sub-market is keen,” says Tony Tan, CEO of CMT’s manager, referring to Westgate. Rents are likely to experience low-single-digit growth, he adds.
Bedok Mall — which CMT acquired in 2015 for $780 million — is also facing challenges. Its valuation has barely budged and stood at $781 million as at Dec 31, despite a cap-rate compression to 4.75% from 5.2% a year ago. At the time, its net property income yield stood at 5.1%. As at Dec 31, Bedok Mall’s NPI yield was 5.03%, based on its NPI of $39.3 million, which was down almost 8% y-o-y.
“Bedok Mall’s valuation also reflected lower reversion, but its [rental] growth rate is about the same y-o-y [as 2016’s],” Tan says. He acknowledged that of the two, the outlook is more negative for Westgate. Both malls reported negative rental reversions for FY2017. Westgate’s rental reversions fell 10.2%. In 2017, 76 leases occupying 79,719 sq ft, or 19.4% of the property, were renewed. Rental reversions fell 6.5% at Bedok Mall last year. A total of 81 leases, occupying 102,335 sq ft, or 46% of the property, were renewed.
With risk-free rates expected to rise — the yield on the 10-year Singapore Government Securities is up 15% to 2.3% year-to-date — investors are asking if the cap-rate compression cycle has run its course.
“There is still liquidity. Based on what we see, there is still demand for real estate in Singapore,” Tan says. CapitaLand Commercial Trust, CMT’s sister REIT, divested a 50% stake in One George Street at a cap rate of 3.2%, and the entire stake of Wilkie Edge, a fringe-area property, for a cap rate of 3.4%. It bought Asia Square Tower II, a trophy Grade A+ building, at a cap rate of 3.6%.
Consultants use the Asia Square transaction to demonstrate that the office market is in recovery mode. Asia Square Tower II was acquired at $2,689 psf, a relatively modest compared with Chevron House’s, for which Oxley Holdings paid $2,526 psf. Chevron House is older, and is seen as a premium Grade B building. Yet, within a couple of months after the completion of the Asia Square transaction, Chevron House was sold at a seemingly rich valuation.
The largest mall transaction in 2Q2017 took place at a cap rate of 4.2%. Jurong Point, the largest suburban shopping mall in Singapore, was acquired by NTUC social enterprise Mercatus Co-operative. The valuation is seen as a record high for a large suburban mall.
“My sense is the Singapore market will stay very attractive for investors because it’s very transparent and there are good-quality assets,” Tan says. Valuers know that Singapore real estate is not expensive relative to Hong Kong [or other global cities].” Hong Kong’s cap rate for commercial and retail property is lower than Singapore’s, while cap rates for premium retail property in Europe are below 3% (see table).
“Singapore is not expensive. When a few transactions happen, valuers have to mark down the cap rate. At the same time, they know the retail tenants face competition, so they mellow down their assumptions for rents,” Tan says. For CMT’s portfolio, valuers have been lowering rent assumptions. “You have to leave some headroom for valuation decline. It’s a constant battle between reversionary rent and cap rate,” Tan says. If this is the trough for cap-rate compression, it would imply negative revaluations in the future.
Eye on keeping A2 rating
CMT’s issuer rating is A2, the highest among the Singapore REITs. Tan says this is important because it enables CMT to obtain lower funding costs and term out its debt through long-dated notes and bonds. Its average term to maturity is 4.9 years, the longest for a Singapore REIT. Because of its long-dated debt, its cost of debt is higher than those of its peers such as Frasers Centrepoint Trust and SPH REIT, the two pure-play retail REITs.
“You can’t measure our cost of debt of 3.2% against our peers. Their cost of debt and term to maturity are lower. If you want to have a manageable maturity tower, you will need to renew $500 million to $600 million on an annual basis. Your average term to maturity will run into six to seven years,” Tan explains. CMT’s gearing is 34.2%.
Its A2 rating also provides a natural gearing limit for CMT. “If we hit 40% gearing, [rating agencies] will be nervous about our A2 rating. Now, we’re at 34% and one or two notches below 40% is where the sweet spot is. We need to have a buffer just in case valuation suffers,” Tan says.
Demand and supply
Managers of retail REITs are readying for a spike in supply this year and next. Northpoint City and Paya Lebar Quarter have opened and Changi Jewel is likely to open either at year-end or early next year. Meanwhile, the absorption rate is likely to be tepid.
Demand is seen as weak, with landlords balancing occupancy rates with rental. For instance, CMT’s occupancy is at 99.2%, but rental growth has been flat and rental reversions fell 1.7% last year. Frasers Centrepoint Trust’s portfolio occupancy for 1QFY2018 was 92.6%, but it had positive rental reversions of 1% during the October-to-December quarter, after a superlative 5.1% rise in reversions for the 12 months to Sept 30. FCT’s occupancy is in line with the vacancy level of 7% in the suburban area as at Sept 30.
According to URA data, islandwide net absorption has been somewhat anaemic since 2015. As at September 2017, shop occupancy rate across the country had fallen to 91.7%, from the high of 95.5% in 2013.
“We’re looking at leases in a different manner and not going for the highest rent,” Tan says. “Over the years, we’ve been paring our exposure to fashion, although fashion-related tenants pay more rent. The tenant is also under pressure. There’s a certain threshold of rent tenants can pay because of margin dilution, so we have to be circumspect. It’s our job to ensure they trade well,” he says. “We have some positive examples — tenants that we brought in with lower rents that trade very well where gross turnover rent covers the lower base rental.”
Proptech, e-commerce trials
If you can’t beat them, join them. CMT’s sponsor and major shareholder CapitaLand launched an online mall on Lazada Singapore last year. “As a landlord, it’s useful to be seen in this space even though it’s a CapitaLand-Lazada collaboration. Allowing our space to be more creatively used will help increase our exposure. I do not expect high revenue generation from this, but I want to increase our exposure to the online consumer. That in itself is a positive value-add to the mall,” Tan says.
CMT has two click-and-collect lounges — in Bugis+ and Plaza Singapura. “We have a lounge and a fitting room. You can collect your product, try it out; if you don’t like it, you can return it there and then. If needs be, we can expand the offering. It occupies only 200 sq ft now,” Tan says.
According to Zebra Technologies’ 2017 Retail Vision Study, more than 80% of respondents dislike the process of waiting for a delivery. Providing customers with a choice of collection from stores or pick-up points forms a critical part of the overall omnichannel experience, observes Alan Cheong, director of research at Savills. “These experiences lead to a retail transformation called ‘new retail’, which involves shopping online, experiencing in stores, making a purchase and finally, delivering at shoppers’ convenience.”
CMT is also part of one of the largest rewards programme in Asia called CapitaStar. Through this, the CapitaLand group has collected reams of data that is used for target marketing, cross-selling and rewarding shoppers.
Headwinds ahead
CMT is likely to face a tough 2018. It plans to carry out an asset enhancement initiative (AEI) on Lot 1 in Choa Chu Kang because of the relocation of a bus terminal. The relocation places Lot 1 in between the MRT-LRT interchange station and the bus terminal. Tan reckons that the mall could get a lift in shopper traffic once the bus terminal is completed. Elsewhere, CMT is readying Tampines Mall and Bedok Mall for competition from Changi Jewel.
“The economy is recovering. Confidence is back and money is flowing to Asia. Towards the end of last year, our properties started doing a little bit better, which is why we clocked $232.4 million in valuation gain. But valuers will continue to take a cautious outlook on the rents,” Tan says.
