REITs continue to be bankers’ best friends. Of course, investors would prefer REITs to be investors’best friends. At any rate, as of Dec 8, REITs had raised more than $5 billion in equity and quasi-equity such as perpetual securities (see Table 1). Despite Covid-19, which has been largely controlled within Singapore’s borders, it was a banner year for fundraising and acquisitions by S-REITs.
The three largest equity fund raisings were from Frasers Centrepoint Trust (FCT), Ascendas REIT and Mapletree Logistics Trust (MLT) which raised $1.3 billion, $1.19 billion and $600 million respectively. Mapletree Industrial Trust (MINT) raised a modest $309.6 million amount to acquire the remaining 60% stake in a portfolio of data centres in the US, transforming increasingly into a data centre proxy for investors. The acquisitions by FCT, MLT, MINT and Ascendas REIT were mainly accretive.
FCT acquired five retail malls and an office tower from its sponsor Frasers Property and its accretion to DPU depended on how the pro forma data was used. For instance, based on FY2019 data, the transaction accretes 8.59% to DPU based on a pro forma basis, while for nine months to Sept 30, the accretion is just 0.4%. It was a brave move given that retail malls are experiencing challenging times. Still, according to FCT’s manager, footfall and tenant sales are approaching pre-Covid levels based on their assessments following their 4QFY2020 results for the 12 months to Sept 30.
The best transactions
For investors looking for a slice of action in the so-called “future economy” and the properties of tomorrow, look no further than MINT, which acquired more data centres. It is a portfolio MINT is familiar with as it already owned 40% prior to buying up the remaining 60%.
The portfolio of 14 data centres, known as Mapletree Redwood Data Centre Trust (MRDCT), is sited on freehold land, with 81.6% of the portfolio by gross rental income leased on core-andshell basis, with all tenants on triple net leases structures where expenses are borne by tenants.
Based on gross rental income, 97.8% of the MRDCT Portfolio has annual rental escalations of 2% and above, providing stable and growing cash flows. The top five tenants of this portfolio by gross rental income are AT&T, The Vanguard Group, General Electric, Level3 Communications and Equinix.
In Sept 2019, MINT acquired 10 powered shell data centres and co-invested in three fully fitted hyperscale turnkey data centres in North America via Mapletree Rosewood Data Centre Trust (MRODCT), a 50:50 joint venture with Mapletree Investments, for US$1,367.9 million ($1,829.6 million). MRODCT holds an 80% interest in the three fully-fitted hyperscale data centres in North America, with Digital Realty holding the remaining 20% interest.
As at Sept 30, data centres account for 38.7% of MINT’s AUMs totalling $6.6 billion. Of this, data centres in Singapore and the US contribute 6.5% and 32.3% of total AUM respectively.
Proxy for ecommerce
MLT owns a portfolio of logistics assets valued at $10 billion, taking into account its acquisitions of a portfolio of modern logistics warehouses in China, Malaysia and Vietnam which were completed on Dec 1. China — an economy which was the FIFO (first in first out) of Covid — has resumed activity to almost pre-Covid levels.
In Asean, Vietnam is seen as a beneficiary of new supply chains while Malaysia is seen as the economy closest to Developed Market status after Singapore and Brunei.
MLT acquired the portfolio of modern Grade A logistics facilities for a consideration of $1,090 million, of which $600 million was raised in a combination of placement and preferential equity fund-raising, comprise.
The facilities are equipped with features such as high ceilings, strong floor load, wide column space, modern loading docks, and ramps for multi-storey warehouses that provide greater accessibility and efficiency. These logistics capabilities are in demand by third-party logistics service providers (3PLs) and e-commerce players.
According to independent market research consultants cited by MLT’s EGM circular, the supply of modern logistics properties in China, Malaysia and Vietnam is still relatively low, compared to other developed markets such as the US. Only 7%, 11% and 21% of total stock across China, Malaysia and Vietnam respectively are Grade A specifications. The scarcity of Grade A warehouses in these countries has enabled them to command a sizeable rent premium which averages 20% over traditional warehouses.
Post-acquisition, developed markets account for 76% of MLT’s AUM compared to 84% pre-acquisition, and developed markets should contribute to 71% to gross revenue post-acquisition compared to 81% before the acquisition.
In addition, the acquisition diversifies and expands MLT’s tenant base and increases its network effect across the region. MLT was one of the five REITs that gained in price this year (see Chart 1).
Investing in properties of tomorrow
Of the $1.19 billion Ascendas REIT raised, $390 million was used to partially fund two properties in San Francisco, $614 million to partially fund a data centre portfolio in Europe, and $180 million for a suburban office in Australia. The US acquisition increases the REIT’s exposure to US technology cities and diversifies Ascendas REIT’s portfolio.
The properties also have high occupancy rates, long remaining lease tenures and annual rent escalations. This increases the proportion of freehold land and strengthens the US tenant base and, of course, the acquisition is DPU and NAV accretive.
“We will invest in asset classes that support the economy of a country, in business parks or tech offices. It’s a growth engine in the US and when we stepped into the US [in 2019] the first acquisition was in tech office. In UK it was logistics, given that logistic support for the growth of ecommerce in the UK is strong,” William Tay, CEO of Ascendas REIT’s manager, said in an analysts’ briefing in November this year.
In Australia, Ascendas REIT has invested in both logistics and suburban offices. “Business parks or campus offices in the UK is also a target class as we explore further opportunities in the UK.”
For investors, the potential European acquisition looks more interesting as it appears to be more DPU accretive, and it’s a data centre portfolio.
According to an Ascendas REIT announcement, the potential acquisition is a portfolio of large scale European data centres located within Tier 1 data centre hubs across Europe. The portfolio comprises a mix of triple net powered shells and turnkey data centres. Information is limited as the transaction has yet to complete. Since the portfolio comprises triple net leased powered shells, these are likely to have long-term leases.
“The data centre portfolio includes core-and-shell and triple net leases as well as a turnkey portfolio across tier-1 cities in Europe. We want to gain a foothold and this [acquisition] gives us scale to enter into the European data centre market, and we can scale up and make it more meaningful, ” Tay said.
Based on the announcement, the portfolio is likely to be acquired at attractive property yields, and distributable income is likely to increase.
Data centre has proved to be a resilient asset class for S-REITs. Growth in demand for data centres is underpinned by growth in data creation and traffic,increasing adoption of cloud computing and e-commerce, continuing trend of data centre outsourcing by companies and increasing data security requirements imposed by regulators. Even when Covid-19 recedes, data centre demand is likely to persist, consultants say, especially in view of limited supply.
The pro forma DPU accretion of the US acquisition is 0.85%. For the pro forma DPU of the US and European data centre acquisition, accretion rises to between 2% to 2.5%. “For equity fund raising, the $1.19 billion of equity should help us maintain gearing of around 37% to 38% and maintain A3 credit rating,” Tay adds.
The worst transactions
It is difficult to decide which is worse. Is it the proposal for Eagle Hospitality Trust (EHT) revealed in a circular on Dec 8 or Lippo Mall Indonesia Retail Trust’s (LMIRT) dilutive transaction to raise equity and acquire Puri Mall? Most likely it is EHT. The third worst deal is not so much a transaction, but renewal of master leases that are likely to cause declines in DPU as is the case in First REIT.
To give a quick rundown and updates on EHT, based on its Dec 8 circular, stapled security holders get to vote on resolutions 1 to 4, or resolution 5. None of the resolutions are friendly to minority stapled security holders. The choices are stark. In Resolution 1, EHT’s trustee (which is DBS Trustee) proposes SCCPRE Hospitality REIT Management, owned by SC Group, be appointed as the new manager. Resolution 2 is a vote to change the trust deed so that SC Group can get a base for FY2021 and FY2022.
EHT’s base fee was originally 10% of distributable income of which there is none. The trust deed changes the base fee to a minimum of US$4.5 million ($6 million) or 10% of distributable income whichever is higher. Resolution 3 is to appoint a new trustee manager of EH Business Trust. Resolution 4 is related to resolution 2 and asks security holders for permission to issue 140 million new stapled securities — which is around 16% of EHT’s stapled securities in issue. The Issue price would be based on the NAV of EHT per stapled security which was US$0.171 as at Sept 30, if EHT remains suspended. The 140 million stapled securities will be for the payment of base fees to the SC Group and the new trustee manager (also SC Group) for FY2021 and FY2022.
Resolutions 1 to 4 are interdependent and if any one resolution does not pass, then stapled security holders get to vote on resolution 5, for a voluntary winding up of EHT.
EHT’s equity as at Sept 30 stood at US$148.9 million, as total liabilities and total assets stood at US$630.0 million and US$778.9 million respectively. According to the circular, the net proceeds from a sale of assets at the very best would be US$0.171 per stapled security. The breakeven discount is 11.9%, which means if the assets are sold below book value, stapled security holders could get nothing. While nothing is certain, as a caveat, if the US hospitality sector recovers after Covid is tamed and the new manager turns the portfolio around, the hotels could fetch more than EHT’s latest NAV of $0.171 per stapled security.
LMIRT’s unitholders stuck between rock and hard place
Among the REITs, the most dilutive transactions this year is likely to be LMIRT’s. Puri Mall is a fantastic asset, but is it the right fit for a struggling S-REIT?
With a market capitalisation of $241 million, LMIRT’s rights issue raised $281 million in equity. The 160 rights units for 100 existing units at 6 cents apiece resulted in an additional 4.68 billion units. Since the rights issue is more than 50% of units outstanding, unitholders got to vote on the acquisition which is an interested party transaction, the non-renounceable rights issue, interested party vendor financing and a whitewash waiver.
As an indication of how initially value destructive the transaction is, pro forma DPU dilutes by more than 50% and NAV is diluted by almost 50%. No surprise then that many unitholders are unhappy about the dilutive transaction and requested for the EGM to be postponed to a date not earlier than three months from Dec 14. Undoubtedly, the manager declined this request.
Despite the dissatisfaction, at the EGM, unitholders voted overwhelmingly in favour of all the resolutions including the rights issue, the acquisition and vendor financing.
Fitch Ratings reckons that enough guard rails are in place to protect investors. “LMIRT has the right of first refusal over Lippo Karawaci’s malls and bought a large portion of its malls from its sponsor. However as a Singapore-listed REIT, LMIRT is subject to stringent regulations that require two independent valuations and minority unitholder approval for related-party transactions. We think these rules adequately mitigate the risks such transactions pose to minority unitholders,” Fitch Ratings says in a Nov 4 report where it downgraded LMIRT’s ratings to BB– from BB.
The conundrum for investors is over valuations. Back in 2006, when LMIRT listed, and investors were newly introduced to the concept of master lease valuations, LMIRT had master leases that valued the malls at higher valuations than they otherwise would have because of relatively higher rentals. In addition, these rentals were paid in Singapore dollars while the Indonesian Rupiah weakened. This has become apparent over the years as master leases fall away amid continued weakness of the IDR against the Singapore dollar. Valuations have fallen despite regular acquisitions of more malls with master leases that have higher rents than market rents.
For the purposes of the dilutive rights issue, LMIRT’s assets were revalued downwards, causing aggregate leverage to rise to more than 42%. This could ease to around 40% with the rights issue, according to the EGM circular.
In its Nov 4 report, Fitch Ratings says, “We believe the acquisition will have a neutral impact on LMIRT’s rating, as the incremental cash flow net of cost of debt drawn to finance acquisition is not sufficient to offset weakness in the rest of the portfolio, and lost cash flows from two divested assets in 2020. We assume Lippo Karawaci will cover any shortfall to the guaranteed minimum net property income of IDR340 billion, at least over 2021–2022, as it has sufficient liquidity and has set aside funds to complete the transaction. At end-June 2020, Puri had average occupancy of around 90% and a weighted-average lease expiry of 3.4 years.”
Fitch’s downgrade of LMIRT’s debt to BB– is because it believes “LMIRT’s financial metrics will remain weak for a prolonged period, as the recovery in Indonesia’s retail sector is taking longer than we had estimated. LMIRT’s 3QFY2020 results show continued weak retail operations, even after the government eased strict nationwide coronavirus pandemic-related movement restrictions imposed in 2QFY2020”.
Moreover, LMIRT’s reported net property income of $13 million was 20% below Fitch Ratings’ forecast. “We expect the funds from operation (FFO) fixed-charge coverage ratio to dip below our negative sensitivity of 1.5 times until at least 2021 and do not expect Ebitda to return to pre-pandemic levels during this time,” the ratings agency says.
LMIRT’s balance sheet may be weaker than it initially looks because Fitch treats its $260 million of perpetual securities, issued in 2016 and 2017, as 100% equity due to strong going-concern and loss-absorption features. This also factors in LMIRT’s intention to maintain the securities as a permanent part of its capital structure by replacing them at their next call date with similar instruments or common equity. But continuing with distributions — and it can skip them — may be a challenge.
On December 14, after LMIRT’s EGM was over, its manager announced that it may not be paying distributions to its perpetual securityholders and unitholders. “LMIRT is only permitted to make distributions of up to US$5.0 million for the remaining life of the 7.25% US$250 million guaranteed US$ bonds. Any further distributions, beyond this US$5.0 million limit, to either holders of perpetual securities or unitholders is subject to (i) US$ Noteholders’ consent or (ii) new equity injection,” the manager said.
For the nine months to Sept 30, LMIRT’s income available for distribution to unitholders and perpetual securityholders fell by 72% to $17.8 million. OCBC Credit Research points out that its amount available for distribution in 3QFY2020 to unitholders and perpetuals fell 89.5% y-o-y to $2.36 million. This is insufficient to cover the distribution required for the $140 million 7% perpetual securities which would require $9.8 million a year, and the $210 million 6.6% perpetuals which would require $7.92 million a year. The 7% perpetuals next distribution date is in March 2021, but the 6.6% perpetuals has a distribution scheduled for December.
A likeable deal
ARA LOGOS Logistics Trust (ALOG) announced a DPU dilutive acquisition but Karen Lee, CEO of ALOG’s manager, and analysts looking at the deal also point out it is transformative. ALOG will be holding an EGM on Dec 23, and unitholders will have to pre-register and send in their proxies by Dec 21.
On Nov 3, ALOG raised $50 million in a placement of units. On Oct 26, ALOG announced the proposed acquisition of five logistics properties located at the Port of Brisbane, Australia, including a development asset on the corner of Heron Drive and Curlew Street, all for $225.9 million. ALOG also plans to acquire a 49.5% stake in New LAIVS Trust and 40% stake in Oxford Property Fund for $178.5 million. The two funds together own five logistics properties in New South Wales and Victoria.
Altogether, including expenses, the acquisition will cost $441.2 million. The five resolutions in the Dec 23 EGM for unitholders to vote on include permission to place $70 million worth of units to Ivanhoé Cambridge China Inc, a fund manager which owns stakes in the two funds, and to place $18.7 million units to ALOG’s sponsor LOGOS. The REIT will also raise $50 million from unitholders in a preferential equity fund raising exercise, backstopped by LOGOS.
Because of the additional 332 million or so new units to be issued, the transaction is not immediately accretive to FY2019’s DPU or NAV. DPU falls by 2.3%, NAV by 3.4%, and gearing rises by 240 basis points to 42.8% compared to 40.4% as at June 30.
RHB says the Australian transaction is a good deal. “Despite a mildly dilutive transaction, we like the deal for its long WALE (11.3 years) with built-in rent escalations and tenant quality. ALOG also has a rights of first refusal to acquire the remaining fund stake, providing room for growth.”
Unhappy unitholders
Another set of unhappy unitholders own healthcare-focused First REIT, which like LMIRT is a “Riady REIT”. The manager is proposing to accept rents from the master lessee Lippo Karawaci in Indonesian Rupiah.
Since its IPO in 2006, First REIT’s rents were paid in Singapore dollars but in the interim, the rupiah has fallen by 48% against the SIngapore dollar, stressing Lippo Krawaci’s cash flow further. The new master lease agreements for the IPO hospitals, for the next 15 years to 2035, are likely to shave a third off FY2019’s NPI, causing DPU to decline by 48%. NAV also suffered a 48% decline to 51.6 cents while aggregate leverage would rise from 34.5% as at Dec 31, 2019, to 47.9%.
“The rental restructuring removes the overhang from uncertainty over lease structure although this benefit accrues mostly to First REIT’s tenants in our view, as their rental obligation will come down,” notes OCBC Credit Research.
OUE and its 64%-owned subsidiary OUE Lippo Healthcare acquired a 60% and 40% stake respectively in First REITs’ manager from Lippo Karawaci in October 2018, and the latter now does not own any stake in First REIT. OUE is First REIT’s sponsor and holds 19.7% in the REIT.
Since the reorganisation, it’s been downhill for First REIT which would be more aptly renamed Last REIT. Herein lies the risk with a healthcare REIT. As OCBC Credit Research points out, in reality, it would have been difficult for First REIT to obtain a new external tenant outside the Lippo Group, especially as the assets are specialised, limiting the pool of new tenants to hospital operators.
Those of us who have invested in ParkwayLife REIT may be lulled into the view that healthcare REITs are relatively safe. That depends on the quality of the manager and strength of the sponsor. In an externally-managed REIT sector, these two factors coupled with the attributes of the property are what investors are likely to turn their attention in a post-Covid environment.
