Singapore is becoming an escape for Hong Kong residents frustrated about the government’s handling of Covid-19, said Bloomberg in a March 4 report. A net 71,000 people left Hong Kong in February and there were more flights to Singapore than anywhere else aside from Shanghai, adds Bloomberg.
In February, Fitch Ratings said it had revised Hong Kong’s GDP growth forecast for this year to 1.5%, down from 3.0%. “Our revised growth projections imply that real GDP will not surpass its 2018 level — prior to both the onset of anti-government protests and the pandemic — until 2023, which would rank among the weakest recent growth performances across all Fitch-rated sovereigns and territories (110th out of 120 such entities),” says Fitch Ratings.
The Hong Kong government’s decision to further tighten social distancing measures to curb a rapidly growing outbreak of the Omicron variant of Covid-19 adds downward pressure on this year’s growth forecast, adds Fitch Ratings.
Still, Hong Kong retail sales is forecasted to increase by 7% this year to HK$378 billion ($65.94 billion), assuming the border will reopen between Mainland China and Hong Kong for three to four months in 2H2022, says Michael Cheng, PwC Asia Pacific, Mainland China and Hong Kong consumer markets leader. “Looking ahead, the city’s retail sales will still be primarily driven by local consumers this year ... due to the recent outbreak of the Omicron variant, Hong Kong continues to impose strict travel restrictions on tourists,” Cheng says.
As economies such as Singapore, Australia, New Zealand and Europe start to open up, Hong Kong and China remain subject to various measures. The new Omicron variant reported in Hong Kong at the beginning of January triggered an almost immediate implementation of short-term tightening measures by the government to bring infection rates under control, notes the manager of Mapletree North Asia Commercial Trust (MNACT) in a January business update.
This is similar to the statement by Justina Chiu, CEO of Fortune REIT’s manager. “In the near term, with the surge of Omicron variant and the fluidity of the Covid-19 situation, Hong Kong’s economic recovery is likely to experience a setback with the government having implemented its toughest social distancing measures since the start of the pandemic. The temporary Rental Enforcement Moratorium announced under Hong Kong’s 2022–23 budget may adversely affect landlord’s ability to collect rent and hence bring uncertainty to operating cash flows in the near term. We will closely monitor the implications on our business so as to react to the changing market conditions swiftly,” Chiu cautioned in a statement on March 1. Fortune REIT’s rental reversions remained negative in FY2021.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Increasingly, market watchers are expecting a recovery next year rather than this. However, retail GFA in Hong Kong is set to increase significantly next year according to a Savills report. With several large projects in the pipeline, the amount of new space for shops could quadruple from just over a million square feet this year to 4 million square feet next year, according to Savills. Meanwhile, JLL expects rents of prime shopping centres to climb by 0%–5% this year.
How value is determined
What does all this mean for MNACT whose largest property is Festival Walk in Hong Kong, which accounts for 54% of asset valuation and 49% of net property income?
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Investment properties are valued based on their occupancies and rental outlook. These are then used in a discounted cash flow model to arrive at a net present value. In addition, the income capitalisation method also uses capitalising metrics such as net property income. Hence discount rates and capitalisation rates are important data points used in valuing properties, along with rents and occupancy rates.
According to MNACT’s presentation, the capitalisation rate for Festival Walk stands at 4.15%, in line with capitalisation rates in Link REIT’s portfolio. Fortune REIT’s capitalisation rates stood at 4.3% as at the end of last December, for a largely suburban mall portfolio comprising 16 assets. Fortune REIT is trading at just 0.5x its net asset value (NAV) of HK$14.79, which is a lot cheaper than the price Mapletree Commercial Trust (MCT) has proposed to pay for MNACT, at 1x NAV.
Indeed, in the past three years and longer, Fortune REIT has traded consistently below NAV. Similarly, MNACT traditionally trades below NAV as well. Fortune REIT’s DPU yield is around 6.4%, compared to MNACT’s of around 6%.
On Dec 31, MCT’s manager announced a proposed merger with MNACT, where MCT would acquire each MNACT unit for $1.1949. The consideration would be a choice between 0.5009 MCT units plus $0.1912 in cash or 0.5963 MCT units. The issue price for the MCT units is $2.0039, the one-day volume weighted average price on Dec 27, 2021, the lowest price achieved in 2021. The proposed merger would be effected by a trust scheme of arrangement. Since the merger announcement on Dec 31, 2021, MCT’s unit price has declined by 10.5%, but this is partly related to sentiment around the Russo-Ukraine war and partly by investors divesting MCT.
Naturally, MCT unitholders are concerned as many have invested in MCT because of its single-jurisdiction focus in Singapore, which gave the REIT one of the lowest cost of capital among the S-REITs. Now though, MCT unitholders are paying NAV for MNACT, whose largest asset is in a jurisdiction where REITs and developers often trade at discounts to NAV.
According to MNACT’s 3QFY2022 presentation, there were 49 retail leases renewed or re-let for the nine months to Dec 31, 2021 at Festival Walk. These have an average rental reversion of negative 32%, and this remains a concern for MCT’s unitholders.
Gateway Plaza, MNACT’s second largest property, contributing 19% to NPI and 18% to asset size, is also cause for concern. A major tenant at Gateway Plaza, which analysts reckon is BMW, has extended its lease for a year, up to the end of next year. BMW contributed 8% to gross rental income and is MNACT’s largest tenant.
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In replies to questions by SIAS on its two underperforming properties Festival Walk and Gateway Plaza, MNACT’s manager says, “Although short to mid-term challenges remain amidst uncertainties of recovery, we will continue to execute these initiatives in Festival Walk, capitalising on the long-term prospects of Hong Kong.”
Rents for Beijing office districts such as in the Lufthansa Area where Gateway Plaza is located and those which are nearer to the central business district areas where high levels of new supply exist, are likely to face more uncertainties.
“The strategy for Gateway Plaza is to focus on maintaining a high occupancy rate and adopting flexible leasing strategies to retain existing tenants and to attract new tenants. Over the next few years, domestic insurance, wealth management and media companies, and international tenants in the financial services and media sector will form the bulk of leasing demand at Lufthansa in line with Beijing’s opening up of the services industry, are expected to remain stable in the near-term and will likely rise in late 2022 or early 2023,” MNACT’s manager says.
The Edge Singapore understands that Gateway Plaza’s valuation is based on the assumption that the major tenant renews the lease at the end of next year. Festival Walk’s valuation is in line with consultants’ outlook for rents. The valuers have assumed no rental increase this year and a recovery in 2023, supply issues notwithstanding. While occupancy rate assumptions are high, the priority is for landlords get tenants in first as rental recovery takes time.
Based on valuers’ usual practices, one of the methodologies adopted for the valuation would include a standard renewal probability for all expiring tenants. There were no specific disclosure of tenants information and renewal assumptions in the report. Typically, valuers just assume reversion to market rents. The scheme consideration of $1.1949 takes into account the intrinsic value of MNACT’s properties, compared to other mergers which look at market price, market watchers say. The MCT and MNACT managers wanted to be fair to both sets of unitholders, hence MNACT’s valuation was based on NAV.
Elsewhere in MNACT’s portfolio, Sandhill Plaza’s occupancy is expected to remain stable as it has a more robust office market compared to Beijing, which could suffer from lockdowns.
What about MCT?
MCT owns Vivocity, Mapletree Business City I&II, mTower, Mapletree Anson and Bank of America Merrill Lynch Harbourfront. It has consistently traded above NAV because of its single jurisdiction Singapore focus. Compared to MNACT, MCT’s gearing is lower.
Interestingly, hedge fund Quarz Capital has written an open letter to everybody, asking for a better price for MNACT. Based on Bloomberg data, Quarz Capital did not figure among MNACT’s 70 or so largest unitholders as at March 4. In addition, no filing has been made of any new substantial unitholder. This, of course, could change. Quarz can emerge as an important unitholder at some point, or not.
Nonetheless, despite requests for a higher price, MNACT’s manager has not received any better offer from any third party since the merger announcement on Dec 31, 2021. However, it has stated it will consider any third-party offer for the REIT or assets which it receives. “This includes reviewing and evaluating the proposal, making the requisite announcements, and recommendations to the MNACT unitholders as may be required under applicable laws and regulations. There is also no break fee payable to MCT in the event a competing bid is successful. The proposed merger is the only offer that has been received for the entire portfolio to date and the transaction terms have been extensively negotiated,” MNACT’s manager says.
Alternatively, Cuscaden Peak is likely to be successful in its bid for Singapore Press Holdings (SPH). Possibly too, Cuscaden Peak is likely to make a chain offer for SPH REIT. Cuscaden Peak comprises Hotel Properties (40%), Mapletree (30%), and CLA (30%). Mapletree is sponsor to MCT and MNACT while CLA is CapitaLand Investment’s parent.
The assumption among market watchers is that Hotel Properties is likely to be keen on The Paragon — SPH REIT’s largest property that is valued at around $2.64 billion and the Nassim Road properties. Would MCT unitholders be interested in any of SPH REIT’s properties such as The Paragon or Clementi Mall? Would they be a better fit than North Asian assets?
It has been assumed that the suburban malls in SPH’s portfolio would be offered to CapitaLand Integrated Commercial Trust. These include Seletar Mall and Woodleigh Mall.
Both MCT and MNACT unitholders will be able to vote on their respective trust schemes in April.
