About three years ago, we summed up the ‘Year in REITs’ as being ‘Bankers’ Best Friends’ because of their equity raising requirements and prowess. Case in point: in 2021 so far, REITs have raised at least $1.1 billion in perpetual securities which are considered as equity under certain conditions, just under $3 billion in placements excluding First REIT, and around $982 million in preferential equity fund raising (EFR), including First REIT (announced in 3Q2020 but completed in February). Altogether, REITs have raised around $4.2 billion in equity, excluding perpetual securities.
By contrast, IPOs have only raised $1.65 billion. The largest two IPOs are Digital Core REIT which raised US$600 million ($819 million), and Daiwa House Logistics Trust which raked in $464.4 million.
Perennially low interest rates following the Great Recession had pressured the regional banks’ net interest margins. Fund raising by REITs helps to boost banks non-interest income.
S-REITs — for tax transparency purposes — pay out at least 90% of their distributable income. This is usually income after all expenses, augmented by joint ventures.
For example, Keppel REIT and Suntec REIT own a one-third stake each in One Raffles Quay (better known as ORQ), and Marina Bay Financial Centre Towers 1 and 2. CapitaLand Integrated Commercial Trust (CICT) owns a 45% stake in CapitaSpring, a 51-storey skyscraper in CBD. Elsewhere, AIMS APAC REIT owns 49% of Optus Centre in Macquarie Park Sydney.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Because REITs pay out most of their earnings, their capital structures are absent of retained earnings, or revenue reserves. Whenever REITs pay out their distributions per unit (DPU), their NAV usually declines by the payout. As a result, in order to grow their portfolios, REITs have to lean on either their unitholders, their sponsors, or investors for placements, preferential EFR and rights issues to fund acquisitions.
The requirement for funding via equity has led to the REITs’ general mandates as a key resolution that needs to be passed at annual general meetings (AGM). Over the course of the past 20 years, two REITs met with unitholder revolt, where unitholders declined to vote for the general mandates. This was Cambridge Industrial Trust, which is now ESR-REIT, and Sabana REIT.
With regular capital raisings, usually in the form of placements, the task of distributing the new units to investors often falls to banks. This year, all three local banks have been involved in some form of placement, EFR, rights or fortunately for the banks and Singapore Exchange, IPOs. JP Morgan was the joint bookrunner and underwriter (along with United Overseas Bank) for CICT’s placement on Dec 6 to Dec 7, which took place nearer the top of its indicative range.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Rate rise leads to rush to issue new units
Bloomberg reported that Federal Reserve (Fed) Chair Jerome Powell signaled on Dec 15 that inflation is now enemy No. 1 to keeping the economic expansion on track and returning the labour market to something approaching ebullient pre-pandemic levels. At 2021’s final Federal Open Market Committee (FOMC) meeting, the the Fed indicated a drawdown of its asset-purchase programme. Its dot plot has penciled in three rate hikes in 2022, two rate hikes in 2023, and a further three rate hikes in 2024.
Powell also raised the possibility that the Fed might begin to withdraw liquidity from the financial system before too long by reducing its massive balance sheet. “One of the two big threats to getting back to maximum employment is actually high inflation,” Powell said during a press briefing on Dec 15, adding that the pandemic was the other. “What we need is another long expansion, like the ones we have been having over the last 40 years.”
On Nov 14, it was announced that the US consumer price index for Oct rose by 6.2%, the highest rate in 30 years, and it became clear that interest rate hikes were a matter of time. Hence the race to raise equity.
Among the spate of placements in the space in three weeks, Mapletree Logistics Trust (MLT) on Nov 22 announced a $1.423 billion acquisition, or $1.467 billion including expenses. The portfolio comprised 13 properties in China for $870 million, three in Vietnam for $129.9 million and a property in Japan’s Fukuoka for $423.5 million. Of the 13 Chinese properties, seven are very new and come with rent support.
MLT raised $700 million, with $500 million from a placement on Nov 23 to Nov 24, and the remaining $300 from a preferential EFR which completed on Dec 14. Since both placement and EFR are at $1.88 and $1.84 respectively, and at a significant premium to NAV, the equity fund raising is most probably likely to be accretive to NAV. The acquisition is accretive to DPU under certain conditions.
In recent years, some REITs have been laser-focused on acquisitions being DPU-accretive. That is a good thing. However, immediate accretion should probably be one of a handful of factors managers should focus on. The others are financing, outlook for interest rates, hedging in the case of overseas assets, the ability to manage the property, the quality of the property, land tenure and so on.
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MLT’s sponsor has teams on the ground in China, Vietnam and Japan. If they can make the properties yield up through a network effect, growth in demand, inflation, e-commerce and other factors so that both NAV and DPU rise over time, then investors would have no qualms funding the acquisition. At any rate, the conditions for accretion based on permutations of EFR are usually written in the small print, which MLT certainly did.
The Edge Singapore took a closer look at MLT’s acquisition portfolio in issue 1012 dated Nov 29, in the piece titled Asian logistics assets in focus as Daiwa House Logistics Trust debuts, MLT acquires.
Equity is the best form of capital, but at what price?
As always, shareholder equity and retained earnings — in the case of REITs, unitholders’ funds — are the best form of capital. As a case in point, banks report their common equity tier 1 capital in their Pillar 3 disclosures on a quarterly basis. No surprise then that during a period of rising interest rates or rising risk-free rates in the form of 10- year government bond yields, that REIT managers decided to opt for equity.
On Nov 30, Manulife US REIT (MUST) announced it had placed out 154.084 million units at US$0.649 per unit, at the low end of its range guide of US$0.649 to US$0.674 to partly fund the acquisition of three properties which cost US$201.6 million excluding expenses. As at Sept 30, MUST’s NAV was 68 cents so the placement was possibly dilutive to NAV.
The properties, according to Jill Smith, CEO of MUST’s manager, are in “high growth, magnet cities”. MUST needed a placement because the pro forma aggregate leverage post-acquisition would have been 43.8%. Its interest coverage ratio (ICR) as at Sept 30 was 3.3 times so it has more leeway than REITs with ICRs below 3 times (section on perpetual securities).
MUST is now taking its time attempting to rise from near a one year low as the advanced DPU for unitholders is likely to be at 2.16 US cents for July 1 through to Dec 1. In 1HFY2021, MUST’s DPU was 2.7 cents.
The largest placement and EFR — excluding perpetual securities — was undertaken by Mapletree Industrial Trust (MINT) as it ramped up its data centre portfolio. It acquired a portfolio of data centres for around US$1.244 billion. MINT raised around $500 million through a placement, and the remaining $300 million from a preferential EFR (see table).
The transaction cemented MINT as the largest owner of data centres in Asia Pacific taking its US AUM to US$4.6 billion. According to 451 Research, data centres in the US are expected to benefit from both: (i) Existing demand drivers which continue to grow, which include cloud computing, e-commerce, e-payments, big-data analytics, online gaming, video streaming and social networking, and (ii) Nascent trends with enormous potential, which include the rollout of 5G networks, the proliferation of internet-enabled devices or Internet of Things (IoT), autonomous vehicles (AV) and AI. These trends could outlast a temporary rise in interest rates, say market watchers.
Perpetual securities
In October, Cromwell European REIT issued $100 million of perpetual securities at a coupon of 5%. “For the perps at 3.55%, we entered into currency swaps to convert the Singapore dollar perps into Euro at 3.55%. They are considered as equity and accretive for perp holds because in Singapore dollar they can get 5% yield so REIT is not taking any Singapore dollar risk,” explains Simon Garing, CEO of Cromwell REIT’s manager. “We have done the first green forex swap with OCBC and we get lower interest rates should we hit green related milestones,” he adds.
In June, Suntec REIT issued $150 million of perpetual securities priced at 4.25%, In May, Lendlease Global Commercial REIT issued $200 million of perpetual securities priced at 4.2% to partly fund the acquisition of a stake in Jem. Along with the debt, the stake in Jem is accretive to DPU to the tune of 3.6%. The net property income (NPI) yield of Jem based on the agreed price of $2.077 billion is 3.9%.
In August this year, AIMS APAC REIT announced the issuance of $250 million of perps (on Sept 1) priced at 5.38% to partly fund the acquisition of Woolworths Headquarters in Sydney, Australia. AA REIT issued $125 million of perps at 5.65% in August 2020, weakening its capital structure.
Perpetual securities or perps are useful as they do not add to aggregate leverage, and they do not dilute the sponsor’s stake. If a sponsor needs to maintain its stake in the REIT but is reluctant to stump out monies for placements to fund acquisitions — as in the case for Cromwell REIT — then a perp is the answer.
Of note is that from Jan 1, 2022, the aggregate leverage for REITs will be capped at 45% if the adjusted interest coverage ratio (ICR) is less than 2.5 times, or capped at 50% if the adjusted ICR is equal to or above 2.5 times. While the REITs’ perpetual securities are not treated as debt for the computation of REIT’s aggregate leverage, the computation of adjusted ICR considers interest payable on perpetual securities. As long as the perpetual securities can meet these criteria, it will not count towards the aggregate leverage cap.
The REIT that is closest to the regulatory limits — excluding its perps — is Suntec REIT, which has an aggregate leverage of more than 44% as at Sept 30, and an ICR of 2.7 times.
S-REITs’ unitholders are well aware that REITs are yield instruments. To expect growth, investors need to fund that growth. It is highly likely for REITs to remain bankers’ best friends, despite a possible temporary hiatus to allow interest rates to rise and stabilise.
