In the initial years, when Singapore’s REIT sector took off, master lease agreements or MLAs were a popular way for owners to monetise their assets. Property owners could sell a property into the REIT with a sale-and-leaseback agreement. The lease terms — including rents and weighted average lease expiry — would determine the pricing, which is essentially the value of the property. So the higher the rent and the longer the lease, the higher the valuation. This enabled companies like Vibrant Group and CWT to monetise their properties at higher valuations than they otherwise would have.
Of course, there comes a time when the master lessee exits the lease such as at the end of the master lease period. When this happens, the REIT manager has to find new tenants. Or, if the master lessee had sub-tenants, the REIT and property managers would have to negotiate with the sub-tenants. Vibrant Group remains an important tenant for Sabana Shariah Compliant Industrial REIT. CWT was the former sponsor of Cache Logistics Trust, which has been renamed and rebranded as ARA LOGOS Logistics Trust (ALOG).
Among the S-REITs, master leases are present in healthcare REITs ParkwayLife REIT and First REIT. What was less apparent, and came to light in 2017, was the way in which these master lease agreements boosted valuations of properties artificially. This is now a glaring problem in First REIT which owns 11 Indonesian hospitals.
Also, in 2020, the full extent of master lease financial engineering came to light in Eagle Hospitality Trust (EHT), where an overseas sponsor monetised assets at inflated values and defaulted on master lease agreements, causing the trust to also be in default. EHT owns 17 hotels and a ship.
Apart from inflating capital values, master leases provide stable cash flows for a fairly long period. Income stability is after all the raison d’être of a REIT. Unfortunately, master leases are now viewed with trepidation and as a form of financial engineering following negative experiences with First REIT, EHT and earlier in 2017, Sabana REIT, which still owns industrial property that it bought at artificially high prices.
Of course, the advantage of a long lease can extend a REIT’s weighted average lease expiry, one of the numbers bankers look at when disbursing loans for investment properties. Karen Lee, CEO of ALOG, draws a distinction between single-tenanted properties where the tenant is the end-user and master lease properties such as those with CWT as tenant. “Our exposure to CWT is down to 5.8%,” Lee indicates.
Since master leases are long — typically over periods of five to as many as 15 years — the buildings may age and could become outdated or obsolete at expiries. The REIT manager would have to rejuvenate the building with expenses borne by the REIT. In addition, if market rents are lower than expiring rents , rental reversions would decline. If the master lessee has financial problems during the course of the master lease as has been the case with EHT and First REIT, value would most likely be destroyed.
A report from Lighthouse Advisors, based on 3Q2020 announcements by the REITs, highlights the challenges and dangers of investing in healthcare REITs which rely on master lessees and operators for their rental income. Ideally, healthcare REITs should be highly attractive assets, “since demand for healthcare is usually considered to be stable and inelastic, which means the operators should enjoy steady cash flows, making them ideal tenants. Yet, a closer look suggests things are not so wonderful,” Lighthouse Advisors observes.
Healthcare REITs are not like commercial, retail or industrial REITs, where the landlord can decide whether to retain or change tenants. “When a healthcare operator has financial difficulties, the landlord may have no choice but to share the pain, because changing to a new operator is even more costly and risky,” Lighthouse Advisors points out.
As the report tells it, the healthcare REIT is more like a junior unsecured lender, who is entitled only to a fixed payment and is subordinate to the tenant’s operating needs. This has been the unfortunate case with First REIT, where the master lessee and operator — Lippo Karawaci and Siloam International Hospitals who are both related parties — unilaterally announced a change in the conditions of the master lease before the master lease term expired, hence breaking its contract.
“When the operator does well, it pays the REIT its dues, and keeps the surplus. When it does poorly, the REIT must cut its rent to save the operator,” says Lighthouse Advisors, describing First REIT’s unfortunate experience with Lippo Karawaci perfectly.
Lighthouse Advisors foretold of First REIT’s dire choices last year. It points out that First REIT’s experience with Sarang Hospital, its Korean asset, where the operator defaulted two years after the hospital was acquired, does not bode well for its Siloam-managed hospitals. And sure enough, that is now the case. “REITs are captive landlords beholden to their tenants, not the other way around,” Lighthouse Advisors says.
First REIT’s unitholders will probably be wary of investing in any of the Riady REITs following their current experience, and could probably steer clear of any other listed entities controlled by the Riadys. A quick look at the Riady entities (see charts) shows them at either multi-year or all-time lows, which may be tempting for a punt. But are they worth it after these experiences?
