SINGAPORE (Apr 3): A large diversified tenant base, long weighted average lease expiries (WALEs), and manageable aggregate leverage levels — coupled with a degree of geographical diversifica-tion with assets that require limited human in-tervention — are likely to be the most defensive among the REITs.
In this respect, Keppel DC REIT springs to mind. Most of its properties are leased on a core and shell basis which is equivalent to double or triple net leases. As the population in developed markets and places like China work from home (WFH) and broadband us-age increases for video-conferencing and tel-ecommuting, Keppel DC REIT’s tenants will benefit from the higher usage trend rather than the REIT itself.
Similarly, Mapletree Industrial Trust (MINT), which now has around 26% of its portfolio by value in data centres, has these mainly tenant-ed on a core and shell basis. Its tenants could benefit from more use of data centres, and the data centres have a longer WALE than MINT’s multi-tenanted business parks and flatted factories. Its data centre portfolio is 7.7% by value in Singapore, and 18.5% in the US. Ascendas REIT’s IT and data centres account for 17% of value, 12.4% of net lettable area and 11.2% of gross rental income.
The big three – Ascendas REIT, Mapletree Logistics Trust (MLT) and MINT – are probably the most defensive along with Keppel DC REIT. Ascendas REIT has 1,490 tenants, with the top 10 tenants contributing 17.9% to gross rental income (GRI) or gross revenue and a WALE of 3.9 years. MINT has an even more diversified tenant base — 2,200 tenants, with its top 10 tenants contributing 28.5% to GRI. Its WALE is also 3.9 years. MLT has a WALE of 4.4 years, 670 tenants and a geographically diversified portfolio of logistics properties in nine countries. Its largest tenant is CWT which accounts for 9.5% of GRI. (CWT is part of the troubled HNA Group.) Geographically, MLT’s largest contributors to revenue are Singapore (36%), Hong Kong (23.6%) and China (10.1%).
Impact of Covid-19 on valuations
The truth is, we just do not know how Covid-19 will affect valuations. During the 2007–2008 global financial crisis (GFC), the valuations of the individual properties of both Ascendas REIT and MLT did not fall. Still, both REITs announced equity fund raising. Ascendas REIT announced a $400 million placement and preferential equity fund raising in 2009. MLT announced a rights issue in July 2008 to raise more than $600 million to fund acquisitions and refinance debt. As at June 30, 2008, MLT’s gearing was at 56.3%. In those days, rated REITs could have gearing ratios of 60%.
Other than drawing on our experience with the GFC, we should get clarity in the last two weeks of April, when MINT, MLT, Mapletree Commercial Trust and Mapletree North Asia Commercial Trust announce their financial year-end results – as well as property valuations – for FY2019/2020.
Valuation metrics consider not just current rents and master lease rents, but also the out-look for rents. Valuers usually use master lease rents to value properties with master leases without considering the market rent should these properties be over-rented, or the credit-worthiness of the sponsor. At some point, perhaps valuers will assess the strength of the spon-sor, following the problems with Eagle Hospitality Trust (EHT). Because of an unknown sponsor, EHT’s manager should have taken a leaf out of EC-World REIT’s book. EC-World REIT provided valuations of its properties both with and without master leases.
Covid-19 is a black swan that has taken the global economy by surprise — a pandemic (which Bill Gates has warned about since 2015 and for which Singapore was well-prepared) that came upon the world suddenly. The global economy has virtually shut down and governments, including the Singapore government, have issued safe distancing measures to limit the number of people in community and public spaces including malls.
“We are living through one of the most challenging and uncertain times in recent his-tory,” says Nicholas Talbot, chief executive of the International Valuations Standards Coun-cil (IVSC). “As the global Covid-19 pandemic advances, governments, scientists, health-care professionals, businesses and the public at large are having to respond in real time to new and often untested information and ad-vice. The challenges ahead apply to every as-pect of society.”
Economies are also facing enormous upheaval. Stock markets are being tested with huge daily volatility and businesses of all siz-es have been affected in myriad ways. “For valuers, the uncertainty which permeates all markets will inevitably lead to challenges, not just in terms of carrying out valuations and determining value, but also in the reporting of those values in a way that is both helpful and informative to users,” Talbot adds.
IVSC does not give investors visibility on whether valuations could fall. Instead, the latest edition of IVSC draws reference to “uncertainty” under Sections 101–105’s “General Stand-ards”. Section 105’s “Valuation Approaches and Methods” says that valuers should consider the use of multiple approaches and meth-ods during times of uncertainty. “Where two or more alternative scenarios are possible, the valuation should be based on the most likely scenario,” IVSC says. “Where non-financial assets are subject to significant valuation uncertainty, it is more likely that there will have been reliance on unobservable inputs that cannot be easily or accurately quantified, and to which statistical analysis can-not be reliably applied.
The IVSC report adds that valuers should not apply pre-crisis crite-ria to their valuations as this would be based on the assumption that values will return to their pre-crisis levels. Quantifying valuation uncertainty does not involve forecasting a worst-case scenario, the IVSC says. The objective is not to stress-test a valuation to an extreme case, IVSC cautions, but to provide information about the variability of value at the specific valuation date.
Significant declines before ceiling is reached
Despite the lack of guidance from IVSC in current circumstances, investors are asking valuers and analysts: What is the worst-case scenario? Vijay Natarajan, an analyst at RHB Research, estimates what it takes for industrial REITs to hit their 45% debt ceiling.
“ESR-REIT’s gearing of 41.5% is among the highest in the sector. However, asset values need to fall by $200 million or more than 7% from the current level before a potential breach of the REIT’s gearing threshold of 45% occurs,” Natarajan writes in a recent report. “Even in the worst case where such an event occurs, we believe the REIT’s sponsor will po-tentially step in and underwrite any potential equity fund raising.”
Since acquiring a controlling stake in ESR- REIT’s manager and the REIT, ESR has sup-ported ESR-REIT during fund-raisings and ac-quisitions. For this year, at any rate, ESR-REIT has secured commitments for a $160 million loan expiring at a lower interest cost, which should bring interest cost down by 20 basis points with no other debt maturity till the second half of next year.
How much would valuations need to fall before industrial REITs hit their gearing ceil-ing? The lower the gearing, the more valuations would need to decline. As a result, the decline is probably unrealistic for some REITs. For instance, Keppel DC REIT is unlikely to get to its debt ceiling. Similarly, Ascendas REIT, MINT and MLT are unlikely to get to theirs. In the unlikely event they do, their sponsors have the wherewithal to backstop any equity raising.
Perpetual securities may impact weaker REITs
Five industrial REITs have used perpetual securities, which are considered as equity un-der certain conditions and excluded from the calculation of aggregate leverage. These conditions are:
a. the securities have a perpetual term;
b. the redemption is at the sole discretion of the REIT or property fund;
c. the distributions are non-cumulative;
d. there are no features that will have the effect of incentivising the property fund to redeem its units, such as a step-up in interest rates, although a reset is permitted; and
e. the securities are deeply subordinated in the event of liquidation.
For these reasons, and the equity-like, loss-absorbing nature of REITs’ perpetual securities, the decline needed to get to 45% (see table) excludes perpetual securities for Ascendas REIT, Cache Logistics Trust, ESR-RE-IT, MLT and Soilbuild Business Space REIT. Moreover, perpetual securities – while part of unitholders’ funds, are not part of REITs’ net asset value per share.
However, in the case of Cache and Soil-build REIT, if perpetual securities were rede-fined as debt, a decline of around 8% to 10% of total assets would cause a breach of the gearing ceiling.
Retail REITs more vulnerable
According to Credit Suisse, the impact of Cov-id-19 on rentals at retail malls is not clear yet. “The market could look at the near-term rent rebates as one-off which can depend on how long it takes to contain the virus outbreak,” it says in a recent report. The government’s safe distancing rules allow malls to remain open, subject to con-trolling crowd density at the rate of one per-son per 16 sq m of usable space. The government has also advised people to avoid going to malls unless essential. “A clearer trend of new cases peaking would provide more comfort around near-term risks,” Credit Suisse says.
It calculates that for every month of rent rebates provided to retail tenants, distribution per unit (DPU) for Frasers Centre-point Trust and SPH REIT would fall by 6%, while MCT’s would fall by just 3%. This is because MCT also owns Mapletree Business City Phase 1 and 2. However, SPH REIT announced for its 2QFY2020, for the three months to Feb 29, DPU fell by 78.7% y-o-y to 0.3 cents.
As for retail REIT valuations, Credit Suisse points out they are still 15% to 30% above GFC troughs. In the meantime, the market has already passed judgement. Among the top losers this year are retail REITs, hospitality REITs, and US commercial REITs. The latter is more an idiosyncratic event based on the credit crunch in the US which is now being alleviated.
Cache, Soilbuild REIT and ESR-REIT were also among the year’s big losers. For ESR-REIT, it appears that the banks have force-sold the stake owned by Tong Jinquan down to 29.11% as at Apr 1, from 30.7%.
The year’s most resilient REITs so far are Keppel DC REIT, Ascendas REIT, MINT, MLT and ParkwayLife REIT.
