CDL focuses on traditional fund management for recurring income as its three PPS wind down

“The rationale for investing in IREIT Global is to help us build recurring income and increase exposure in continental Europe. It also gives us the ability to recycle capital. We can buy value-add properties, fix them and inject them into the REIT,” Khoo explains. The short-term challenge is twofold. First, commercial properties in Europe are in demand, with the shift of headquarters following a no-deal Brexit; thus, accretive acquisitions are difficult to do. Second, IREIT Global itself has been under the radar. “The short-term challenge is, we are trying to help IREIT Global raise its profile and grow its AUM,” says Khoo.

A short-term target for IREIT Global is to achieve a portfolio value of at least $1 billion. CDL’s ability to backstop fundraising is an advantage that IREIT Global lacked previously.

Last year, CDL acquired two freehold Grade-A commercial buildings in London. In September, the developer bought Aldgate House, adjacent to Aldgate Underground Station, for £183 million ($328 million), or £867 psf. It has an NLA of about 211,000 sq ft, comprising Grade-A office, retail and ancillary spaces. The building’s committed occupancy rate is now 88%, with a passing net yield of about 5%. According to CDL, close to half of the office rents in the building are significantly below the market rents in the Aldgate area, and there is strong potential for positive rental reversions. CDL is exploring the possibility of an asset enhancement initiative to add value to the property.

In October, CDL acquired 125 Old Broad Street, a freehold Grade-A office tower in the City of London, for £385 million, or £1,170 psf. It has an NLA of 329,200 sq ft and is fully tenanted, with a passing net yield of 4.7%.

In 1QFY2019, CDL secured a mandate with an Australian trustee to jointly manage an office asset on the fringe of Sydney’s CBD. The A$305 million ($287 million) office building is 100% leased to a single tenant.

Multifamily opportunity in Japan

In July, CDL acquired a rental housing property in Osaka for ¥2.01 billion ($25 million). The property is in Nishi-ku, Central Osaka and near four train stations, with Dotonbori and Shinsaibashi about 1km away. The entry property yield is 4.5% a year.

“We are buying at 4.5% yield, interest rates are negative (the Bank of Japan’s short-term rate is -0.1%) and cash-on-cash [yield] is at 6%, so we are really taking advantage of the low interest rate to buy,” Khoo says. “In Japan, we have made the decision to go more into multifamily, but instead of paying someone a premium to put the portfolio together, we have decided to put the portfolio together ourselves. So, it’s going to be a bit painful and a bit slower.

“The millennials will continue to rent instead of buying, and with residential prices going up, this is becoming an affordability issue with them. Our strategy is to buy directly from the developers, and we are prepared to buy forward. For instance, if the small developers lack capital, we can provide them with capital.”

According to CDL’s announcement, the units at the Osaka property are currently rented out below market rent. Thus, there is potential to increase the value of the property via rental uplift. “Tokyo and Osaka are our main focus, because that’s where we continue to see population growth. But if I were to pick a city, it would be Osaka because of the World Expo in 2025 and a high probability of its getting an [integrated resort and] casino licence,” Khoo says.

In 2014, CDL acquired a 180,995 sq ft freehold site in Shirokane, Tokyo. “Prices continue to move up. We have not done anything and are still exploring [our options]. We might not develop the site, but just sell it,” Khoo discloses.

PPS2 and PPS3 yield high returns

On the weekend of July 20 and 21, CDL announced that it had sold 16 units at Nouvel 18 at an average price of $3,300 psf. Nouvel 18 is the main asset in PPS3, set up in 2016. It comprises a special purpose vehicle called Green 18, whose shareholders are high-net-worth Singaporeans and companies wholly-owned by Singaporeans, such as Tecity. These shareholders own ordinary and preference shares in Green 18, which allows them to enjoy a preferred 5% annual internal rate of return (IRR) and any upside beyond that, less any incentive fees payable to a unit of CDL that manages the PPS.

PPS3 valued Nouvel 18 at $965.4 million, or $2,750 psf, based on its saleable area of about 351,000 sq ft. The outlay from Green 18’s shareholders was just $102 million, with the rest of the PPS financed by bank debt from DBS Bank and United Overseas Bank, and mezzanine debt from DBS Bank and CDL.

Think of it this way — PPS3 was the equivalent of financing luxury property with 90% debt and 10% equity. If CDL sells all 156 units of Nouvel at an average price of, say, $3,200 psf, the returns to the shareholders of Green 18 are likely to be outsized, at more than $200 million, since at this price, the development would be valued at $1.123 billion before expenses.

But, not so fast. PPS3 is set up like a private equity fund. That means it needs to follow the distribution waterfall. “PPS3 follows the waterfall — the banks have to be paid first. So, I need to sell enough to pay the bank loans, then the bondholders,” explains Yiong Yim Ming, CDL’s chief financial officer. Because PPS3 is set up like a private equity fund, all the units in -Nouvel 18 need to be sold before the monies are returned.

In private equity investing, distribution waterfall is a method for allocating the capital gained by the fund to the limited partners (LPs) and the general partner (GP). The GP usually manages the fund — in the case of the three PPS set up by CDL, it is the GP. The LPs are the investors. When distributing the capital back to the investors, hopefully with an added value, the GP allocates the monies based on the distribution method stipulated in the LP agreement.

A waterfall structure can be pictured as a set of buckets or phases. Each bucket contains its own allocation method. When the first bucket is full, the capital flows into the next bucket. The first buckets are usually entirely allocated to the LPs, while buckets further away from the source are more advantageous to the GP, as was the case in PPS2. This structure is designed to encourage the GP to maximise the return of the fund.

After paying off bank debt, waterfalls usually consist of return of capital, preferred return, catchup and carried interest.

The assets in PPS2 — Central Mall Office Tower, Manulife Centre and 7 and 9 Tampines Grande — were sold in December 2018, January and April respectively. Manulife Centre was divested for $555.5 million, or $2,301 psf, and 7 and 9 Tampines Grande were sold for $395 million. On Aug 8, CDL announced the realisation of $153.9 million pre-tax deferred gains from the divestment of Manulife Centre and 7 and 9 Tampines Grande.

In PPS2, CDL’s joint-venture partner was a fund that belonged to Alpha Investment Partners. In December, CDL acquired Central Mall Office Tower from PPS2.

The estimated returns for the Alpha Investment Partners fund are likely to have been more than 81%, according to the distribution waterfall. CDL, though, would have more than doubled its return on invested capital of $133.4 million, except that it had to also acquire Central Mall Office Tower.

The Sentosa conundrum

On Aug 8, CDL announced that it had bought back the non-residential components of PPS1, comprising W Singapore — Sentosa Cove and Quayside Isle, for $393 million. The properties were sold into PPS1 at $500 million.

This PPS was in two parts. The entire PPS comprised the Quayside Collection, comprising 204 units of Residences at W Singapore — Sentosa Cove; W Singapore — Sentosa Cove (the hotel); and Quayside Isle. After PPS1 was formed, CDL booked a gain of around $327 million.

The first part of the PPS, the residential portion, was valued at $1 billion and had a fund by BlackRock as LP investor and a CDL unit as GP. The second part of the PPS — valued at $500 million — was the hotel, W Singapore, valued at $1.65 million per key, and Quayside Isle.

CDL is buying back the hotel at $1.32 million per key, and Quayside Isle for $2,000 psf. Isn’t that lower than valuations in places such as Jurong? “Yes, because the rent [at Quayside Isle] is $6.15 to $6.30 psf a month. The retail [property] has some inherent issues, so we are looking at enhancing the entire place. Sentosa is a beautiful development, a nice story, but if you go on a weekday, the activity is insufficient to sustain high rents,” Yiong explains. “That is why chairman (Kwek Leng Beng) is saying we must reach out to the authorities. If they rejuvenate the entire place, [it would] bring more life. So, the potential is there.”

On Aug 8, CDL announced that, with the acquisitions of W Singapore — Sentosa Cove and Quayside Isle, “a net gain of about $7 million was recorded, owing to remeasurement of its existing stake in these properties at fair value”.

How does CDL buy the properties for $500 million, sell them for $393 million, and make a net gain? analysts ask. “For the interest in the part that CDL continues to own, our share is at historical cost. It’s going to be hard to quantify, but it’s quite close to the current valuation,” Yiong says. “The previous unrecognised interest [at historical] cost offsets this amount of loss. So, we have said we have no further downside on PPS instruments.” Unlike many property developers, CDL values its investment properties at historical cost less depreciation, and not at fair value.

The largest part of the PPS — the 204 units at W Residences — will be extended. Even then, Yiong claims that CDL will not lose money. “CDL accounts for [the residential portion] as an associate,” she says. CDL owned 42% of PPS1 after a CIMB fund sold down its stake in 2015. “So, the carrying value after the sale, including the residential portion, was at zero cost to CDL. CDL has totally no downside on the residential portion,” she adds.

Property prices at Sentosa Cove have sunk to post-2011 lows. Earlier this year, EdgeProp reported that a penthouse was transacted at below $1,100 psf. Yiong is looking to sell the units at W Residences at more than $2,200 psf. “If everything sells at $2,000 psf, we may not have upside,” she says. To obtain an IRR of 8% to 10%, the units would have to sell around $3,000 psf. “At $2,300 to $2,400 psf, nobody is going to lose money,” she adds.

According to Yiong, BlackRock’s levered return, based on its limited capital outlay, for the portion of PPS1 that has been unwound is likely to have been sound. “[It would be] a single-digit IRR levered return. I call it a ‘make everyone happy’ instrument,” she jokes.

Although CDL’s profit after tax and minority interest for 2QFY2019 fell 16.2% y-o-y to $162.4 million, Patmi in 1HFY2019 rose 18.3% y-o-y to $362 million, owing partly to the unwinding of PPS2. Net asset value per share rose 2% y-o-y to $11.29, and the developer announced a dividend of six cents a share, which should make shareholders happy.