ESR-Logos REIT’s (E-Log) manager spent the first four months of this year deleveraging, raising liquidity, focusing on organic growth and stabilising its existing portfolio as it seeks to balance both macroeconomic uncertainties and opportunities. Unlike other S-REIT managers that focused their attention on acquisitions, E-Log has raised equity and cash through a combination of fundraising and divestments. For the time being, some of the liquidity has been ploughed back to asset enhancement initiatives (AEI) to revitalise some of the REIT’s dated assets.
Adrian Chui, CEO and executive director of E-Log’s manager, has articulated a 4R strategy since 2022. These are: portfolio rejuvenation, capital recycling, recapitalising the balance sheet and reinforcing sponsor support.
Each of the Rs are related to each other as proceeds from capital recycling and recapitalising the balance sheet are used for portfolio rejuvenation. The sponsor’s support for E-Log’s portfolio rejuvenation can also be seen via its visible and executable asset pipeline, as well as its financial support for backstopping E-Log’s preferential offerings over the years.
Portfolio rejuvenation is important especially for Singapore industrial assets which come with short-term land leases. E-Log’s portfolio was first put together in 2006 through the listing of the then Cambridge Industrial Trust.
“Our assets are at least 17 years old. Manufacturing technologies change rapidly which impact tenants’ demand for different building specifications to suit their business needs. Building obsolescence in industrial properties also tends to be faster due to rapidly changing manufacturing technologies and high usage. For instance, advanced manufacturing tenants require higher power loading for their manufacturing activities, and logistics operators now want ramp-up warehouses instead of cargo-lift warehouses as efficiency in the flow of goods is critical for them.”
Chui says: “Fifteen years ago, there wasn’t much talk about sustainability, harvesting solar power, installing EV chargers or monitoring carbon footprint. Today, tenants and virtually every stakeholder — investors, regulators and banks — have an interest in this. However, the crucial question is whether the property’s current specifications can accommodate all these requirements and if it’s economical to implement.”
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He adds: “Hence, we have to take a look at our portfolio to see if they are going to stay relevant because the expectations from tenants and stakeholders on portfolio quality and earnings sustainability have increased. Assets that are relevant, we keep. Assets that we can undertake AEIs and redevelop and give sensible returns, we will plan and execute. Those that are dated, obsolete and we can’t do any improvements, we will divest. Portfolio rejuvenation takes time and resources, and it’s not helpful when your land leases are short as you have a shorter runway to recoup the investments.”
Portfolio rejuvenation is evidenced by AEIs and redevelopments. For instance, the AEI at 16 Tai Seng Street will maximise the asset’s plot ratio with gross floor area (GFA) increasing by 2,798 sq m (30,117 sq ft), bringing total GFA to 22,800 sq m. The cost is around $32 million, and yield-on-cost is estimated at 6%. The AEI is expected to be completed in 1Q2024. The incumbent tenant in the pharmaceuticals industry renewed its lease in 2Q2023, achieving positive rent reversion of 40%.
An AEI at 7002 Ang Mo Kio Avenue 5 is a development of a tech-enabled high-specs industrial building in space that was previously an open-air car park. During a recent results briefing, Chui indicated that the manager is in advanced lease negotiations with a number of high-specifications tenants (semiconductors, lifestyle and industrial manufacturing), with rental rates in line with market rents. The cost is estimated at $53 million, and the yield on cost is estimated at 7.1%.
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Additionally, 21B Senoko Loop is undergoing redevelopment as a build-to-suit, high-specification facility for NTS Components Singapore for a 15-year lease with fixed annual rent escalation. The cost is estimated at $38.5 million, and yield on cost is estimated at 6.6%. Completion is scheduled for 1Q2024.
Given the continued favourable demand for logistics space, E-Log is looking at the redevelopment of an existing cold store logistics facility into a larger modern ramp-up cold storage facility by utilising the untapped plot ratio on site to create more lettable space. E-Log has announced it has a non-binding head of agreement signed with a master tenant for 20+5 years with built-in annual rental escalations, and negotiations are underway.
“Our preference is to have a master tenant with a long-term lease that includes annual escalations, but the terms and design must be right for us. Given the favourable demand-supply dynamics for logistics space, especially for modern cold store facilities, we are confident of filling up the space even if we decide to go multi-tenanted,” Chui says. He is unable to share more as there are non-disclosure agreements. It makes sense to redevelop the existing facility as its land lease runs till 2065 and E-Log can tap the unutilised plot ratio to create more lettable space.
Recycling and recapitalising
For recycling, E-Log has divested properties that were once part of the Cambridge Industrial Trust IPO portfolio. These include assets which have dated specifications, short land leases and/or are relatively small in size with limited capacity for rejuvenation.
Short land lease for Singapore industrial assets is a major risk to a property’s value and its ability to obtain financing. As the land lease tenure runs down, the rate of decline in value of properties will accelerate exponentially, Chui reasons. “If concerns arise on the preservation of property value for HDB flats with 50 years of land lease remaining, one can appreciate the greater impact of a property with less than 25 years of land lease remaining.”
On June 23, E-Log announced the divestment of 22 Chin Bee Drive and 51 Musgrave Road (Australia) at 6.2% and 2.4% premium to valuation, respectively. E-Log also announced the divestment of a portfolio of five non-core assets for $313.5 million, representing a 5.1% discount to valuation. In total, E-Log raised $337 million from these divestments.
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“The assets are non-core. They have contributed well to the portfolio earnings in the past, but they have limited rejuvenation opportunities because the weighted average land lease is around 25 years. By the time the assets are rejuvenated, the average land lease will approach 20 years. Selling the assets and using the proceeds to reinvest in better opportunities, and more modern assets with longer land leases, makes more sense from a property value preservation and growth perspective,” Chui says.
He adds: “There have been suggestions that we could wait till interest rates come down to seek better pricing. The key question is: When is interest coming down and to what level? In the meantime, the land lease gets shorter and property value continues to decline.”
“We have proper evaluation criteria and process,” he explains. “There will be assets in the portfolio that are sold above or below valuation depending on the asset type and who the buyers are. From our experience, end-users tend to be willing to pay more because they want to use that space for their business needs compared to financial investors. But end-users’ size appetite is limited, and they tend to focus on $20 million to $40 million priced properties while financial investors have a larger cheque book. We must remember that these are non-core assets.”
Chui states that the sale process was transparent. CBRE, the appointed manager, identified over 35 potential buyers, including real estate investors and end-users. Notably, JTC’s regulations narrow down the group of buyers of Singapore industrial assets. These stipulate that buyers must be either end-users or third-party facility providers that are: (i) an entity that builds and leases a facility to an industrialist; or (ii) REITs, investment funds or trusts with a Trust Business Licence or a Capital Markets Services Licence issued by the Monetary Authority of Singapore; or (iii) developers with established and credible track record in real estate development; or (iv) provider supported by the Economic Development Board or Enterprise Singapore, as criteria for owning industrial properties on JTC land.
“The pool of potential buyers is smaller as compared to other sectors such as office, retail, hotel or residential properties,” Chui adds. Subsequently, eight investors participated in the non-binding expression of interest exercise for the portfolio. According to an E-Log announcement, the sale criteria included the sale price, funding certainty of the buyer, track record of investing in Singapore industrial assets and deal certainty.
Chui’s rationale is to dispose of non-core assets and recycle the proceeds towards modern and in-demand New Economy assets via AEIs, redevelopments and acquisitions of assets with longer land leases.
In order for tax transparency, S-REITs are required to distribute at least 90% of their distributable income. “REITs don’t retain money, especially those with a large proportion of Singapore assets, as it impacts tax transparency. The only way to get funding is to raise equity or sell assets. We have done both,” Chui says.
Earlier this year, E-Log raised $300 million from an equity fundraising which was made up of a private placement of $150 million, and a preferential offering of $150 million, which was underwritten by its sponsor, ESR Group. The private placement was three times subscribed. The preferential offering was completed in April.
Keeping gearing low as rates stay elevated
Recapitalising its balance sheet will bring aggregate leverage down to 33.6% on a pro forma basis, making it one of the lowest geared S-REITs.
To fend off inflation, central banks, in particular the US Federal Reserve, have been raising policy rates at an accelerated pace. Discount rates and capitalisation rates, which are used to value investment properties, are only just beginning to expand in places like Australia.
The general consensus among economists, including the management of Singapore’s local banks, is for rates to reach a plateau this year. But they are unlikely to come down. “How long will rates stay elevated? Macro data like inflation appears to be coming down. The signal is that rates may peak in September or October, but the key question now is: How long will it stay
before rates drop?” Chui reckons.
Central banks’ targeted inflation rate is 2%. The US reported CPI of 3.2% for July. Geo-political risks are also unlikely to abate soon. These include the US-China trade and technology disagreement, and the Russia-Ukraine war.
“All these may mean that asset repricing may continue and capitalisation rates could expand, causing valuations to come down. Declining valuations in turn impact gearing and net asset values,” Chui adds.
If rates stay elevated, loans expiring in 2024 and 2025 are likely to be repriced at significantly higher costs. Some industrial REITs have already experienced that. E-Log currently has no refinancing needs for the remaining of 2023 and has indicated that it will be using its divestment proceeds to pare down some of its debts that are expiring in 2024.
“If the economy slows, then there is pressure on NPI (net property income), cap rates, valuation and gearing,” he continues. The second punch is distribution per unit, he indicates, because interest costs may doubly affect distributable income.
So far, industrial REITs’ rental reversions — which impact future NPI — remain positive. In 1H2023, E-Log’s rental reversions on average rose by 11.6% y-o-y. The 40% rise in rental reversions for 16 Tai Seng Street is a one-off, Chui acknowledges. Sustainable double-digit gains in rental reversions are likely for logistics properties this year, and E-Log has 50% of its logistics portfolio up for renewal.
Sponsor support
A sponsor’s support is critical to the growth and going concern of a REIT. The three critical factors sponsors bring to their REITs are:
1) The ability to provide an assets pipeline for portfolio rejuvenation and growth;
2) The ability to secure financing at favourable terms — during both good and uncertain times;
3) Provision of a full-value chain real estate operations platform, for example, property development, leasing and marketing, and property management.
Hence, increasingly, there is a differentiation between developer-sponsors with assets pipeline and operating platform, and financial-sponsors.
ESR Group underwrote E-Log’s preferential offering in April, a demonstration of financial support. ESR is arguably the largest developer of New Economy assets in Asia. In Singapore, it holds more than $1 billion of logistics assets with land tenures of around 40 years which forms part of E-Log’s pipeline. “These are the ones we could potentially look at, obviously, because it’s a rarity. We’ve also got to make sure that we can afford them, and the returns make sense,” Chui says.
As capitalisation rates expand and valuations decline, Australia remains an attraction as it is a transparent jurisdiction. In Japan, where ESR has a significant presence, yield spreads are positive, cost of debt remains low, and the Japanese economy is rebounding. In 2Q2023, Japan stunned economists with an annual GDP growth of 4.8%, underpinned by export growth and tourism.
In 2022, E-Log acquired ESR Sakura Distribution Centre in Chiba for the equivalent of $183.5 million excluding costs, and $187 million including costs. The cost translates into an NPI yield of 4.2%. The property is freehold and was completed in 2015.
“ESR Group is in Japan and Australia with full-fledged on the ground teams. In addition, we have good lending relationships with banks who understand our risk profile and credit metric, and hence we are able to get good financing terms especially on an unsecured basis because of the family name,” Chui adds.
Geographically, 75% of E-Log’s AUM is in Singapore, 20% in Australia, and 5% in Japan. In the short term, Singapore is likely to remain a major part of E-Log’s business even as it diversifies geographically.
“There are opportunities in the market. We have $500 million to $600 million we can spend. We need to rejuvenate the portfolio with modern, in-demand properties with long underlying land leases,” Chui says.
