With new mandate, ParkwayLife REIT readies for next growth phase

With investors waiting on the sidelines to enter PLife REIT, its recently approved general mandate provides an opportunity to invest for those who felt that its yields were too low and premium to NAV too high. The general mandate also means an opportunity for growth.

The reason why PLife REIT has done so well is partly because it is in a defensive and a growth sector — healthcare. ParkwayLife REIT is unique among S-REITs in that it owns three hospitals in Singapore, and 48 nursing homes in Japan. But it has also had the same management team for a long time.

Among them is Yong Yean Chau, CEO of PLife REIT’s manager, who joined the company in 2008, and has overseen its performance for 12 of the past 13 years.

“We stressed to investors we need to recognise that our end goal is to make sure DPU is sustainable and gives a growth story. But the priority is sustainability of distributions and that drives our strategies including capital management,” he tells The Edge Singapore in a recent interview.

“We see acquisition as a means to achieve an end and not the end goal. It must serve to add to the resilience of cash flow and increase DPU, and is not for increasing our assets under management,” he adds pointedly.

This approach sets PLife REIT apart from many S-REITs, where sponsors and managers have encouraged acquisitions to increase AUM, arguing often that size matters.

To recap, PLife REIT listed in August 2007, with a gearing ratio of 4%. Within two years, it had acquired its first Japanese nursing home portfolio. As at June 30, PLife REIT owns Mount Elizabeth Hospital, Gleneagles Hospital and Parkway East Hospital. In Japan, PLife REIT has over the years acquired 48 nursing homes, and a pharmaceutical product distributing and manufacturing facility in Chiba Prefecture. It also owns strata-titled units in MOB Specialist Clinics Kuala Lumpur in Malaysia.

In his unassuming manner, Yong says the reason for the REIT’s performance is a focused strategy in three key areas. “We adopt a very targeted approach in investing and we have a clustering approach where we focus on growing within a market, for example Japan, where we have reached a stage where we can enjoy scale and cost savings,” he explains.

Secondly, the REIT manager works proactively with the nursing home operators if there is a need for asset enhancement initiatives (AEI) to improve revenue and bottom line. Yong is careful about choosing these nursing home operators. “With stronger operators, our tenant default risk will be much lower and over time rentals would increase,” he says.

The third principle is, of course, capital management. PLife REIT uses long-term debt and natural hedges in Japan to mitigate forex risk, and adopts cash flow hedges so that DPU remains stable.

While its gearing ratio is around 38%, PLife REIT has the highest interest cover ratio (ICR) of 15.8 times. This is a new metric required by the Monetary Authority of Singapore (MAS). In 1HFY2020 ended June, PLife REIT’s revenue from the Singapore hospitals was $34.6 million, 1.8% higher than in 1HFY2019, while the Japanese nursing homes recorded revenue of $24.5 million, up 10.4% from 1HFY2019. These took total revenue — including a small contribution from Malaysia — to $60.1 million, up 5.1% from a year ago. In its first full year after IPO, PLife REIT reported revenue of $53.9 million, of which only $5.2 million was from the Japanese properties.

The nursing home operators have signed long master leases for PLife REIT’s Japanese assets. For instance, in December 2019, when PLife REIT acquired three nursing rehabilitation facilities with experienced operators for JPY3.7 billion ($46.3 million), they came with long-dated master lease agreements of 20 years. The acquisition lengthened its Japanese WALE (weighted average lease expiry) to 11.56 years as at June 30.

Most of the Japanese properties come with an “up only” rental review provision. This usually means that the rent payable can only be reviewed upwards, and not downwards. Of the 48 Japanese nursing homes, 40 properties comprising 81.8% of Japanese gross rental income have market revisions with downside protection; seven properties have revisions every two-three years subject to lessor-lessee lease agreements; P-Life Matsudo is on a fixed rent for 10 years, and one property has rents linked to the Consumer Price Index (CPI), which measures inflation.

Overall, 95% of PLife REIT’s Singapore and Japan portfolios have downside revenue protection and 59% of the total portfolio is pegged to a CPI-linked revision formula.

General mandate wins favour

Since its IPO in 2007, the number of PLife REIT units outstanding has stood at 605.02 million. That is because PLife REIT was the only REIT that did not have a general mandate to issue new units. However, as gearing inched towards 38.2%, PLife REIT held an AGM in June to ask unitholders to approve a general mandate. Under the general mandate, the REIT can issue units up to 20% of the units outstanding in a given year. In a pro-rata situation which would involve equity fund raising or rights issue, the REIT can issue up to 50% of units outstanding in a calendar year. As expected, unitholders voted overwhelmingly in favour of a general mandate.

“Over the last few years, investors and different stakeholders have asked when we were going to do the first equity issuance. Since IPO, we have not done equity issuance because we started off with a gearing of 4% and there was no need to tap equity. In Japan, cheap cost of debt also meant it did not make sense to fund acquisitions with equity,” Yong explains. “We may not activate the general mandate, but it gives us the flexibility.”

Following a well-defined growth strategy, Yong is looking to expand into a third market, with PLife REIT well anchored in Singapore and Japan contributing to 41% of revenue. Earlier this year, at the height of Covid-19 pandemic in Asia, one of PLife REIT’s Japanese properties reported a confirmed Covid-19 case. The operator stepped in quickly to quarantine the staff and residents. Subsequent testing showed them negative. Operations have stabilised, but PLife REIT retained $850,000 as part of the $1.7 million set aside to help tenants contain and manage Covid-19.

“As a landlord, besides cash flow and rental relief, we look at how we can help tenants to contain and manage the current situation,” Yong says. “That explains why a third key market is important over the longer term and why a lot of focus is on development and establishing a foothold in it,” he explains.

More likely than not, PLife REIT’s third market is likely to be a developed market with a focus on an operator with strong credit metrics. “The operator is a particular focus and must be strong, and preferably with the opportunity for further synergies, someone we can potentially partner with, not only for acquisitions but for a pipeline,” Yong says.

Yong outlines a few conditions for potential moves into a third country. Ideally, the lease should be long, with downside protection such as an inflation-linked increase in rental every year. “In Europe, we see a lot of lease structures that are downside protected, that come with CPI-related increases. The occupancy cost should not be too high though,” Yong adds.

Since DPU sustainability is key to the strategy of PLife REIT, asset valuation and DPU accretion would also be a focus. “During Covid-19, all these measures are important for sustainability of revenue. It is also important not to be too urgent in search for growth, but to focus on the fundamentals. The last thing to do is to buy overvalued assets. We took pains to build [our portfolio] over the last 12–13 years and diversifying to a third market serves to strengthen the resilience of our cash flow,” Yong explains.

“Developing a third key market is mission-critical, while looking at incremental acquisitions in Japan to give yield accretion in the next 1–2 years. The general mandate came in, and that would enable us to come up with a more optimal capital structure,” he adds.

Mount Elizabeth Novena

The most interesting part of having a general mandate would be to make a transformational acquisition. PLife REIT’s sponsor is IHH Healthcare, which is dual-listed in Singapore and Malaysia and owns Mount Elizabeth Novena which opened in 2012. As at December 2019, Mount Elizabeth Novena has a valuation of RM3.9 billion ($1.27 million).

When asked about Mount Elizabeth Novena, Yong says: “The hospital remains a good potential pipeline subject to agreement in terms of pricing and valuation, and is something PLife REIT would be keen to look at, but would depend on whether the sponsor is ready to sell the asset.”

And despite plans for a third market, Singapore will still remain a core market, Yong confirms. “PLife REIT’s strategy is to buy a good yield-accretive asset, and this would be a good potential, but it would depend on IHH Healthcare. Hopefully, over dialogue we can work something out,” he adds.

As it stands, PLife REIT’s debt headroom is around $250.1 million based on its Dec 31, 2019, valuation of $1.96 billion. If Mount Elizabeth Novena is added to the REIT’s assets, debt headroom could rise to as high as $732 million, assuming transaction price is around $1.4 billion. For a lower gearing of around 42–43%, debt headroom would be correspondingly lower. PLife REIT is trading at around 1.85 times its NAV of $1.91, and has a yield of 3.8% based on its annualised DPU of 13.44 cents.

Assuming PLife REIT would need to raise around $700 million for a 50:50 debt-equity split which would involve either equity fund raising or a rights issue, the acquisition could still be accretive due to low cost of debt as well as PLife REIT’s DPU yield and P/NAV premium.

“We are 38% geared and with our low trading yield, we want to make sure any assets we buy are good assets. We have been hesitant in doing equity fund raising because we want to show the market we will only tap your money if it’s put to good use. From various feedback, investors are comfortable for us to have a general mandate. It allows us to have the flexibility and speeds up capitalising some of the opportunities there may be in the market,” Yong says.

“To be defensive, one should not be over-geared. We are looking at low 40s at most. But not to 45%. We will remain conservative. Around 40% should be optimal. Especially during Covid-19, all the more we don’t want to over-gear, running the risk in case there are asset devaluations,” Yong cautions.

Master lease renewal

PLife REIT’s formula of the rental income for its three Singapore hospitals is tied to CPI and includes downside protection. It comprises whichever is higher: A base rent of $30 million plus 3.8% of the hospital’s revenue or [1+(CPI+1%)] multiplied by total rent payable for the preceding year. Where CPI is negative, it will be deemed as zero. The first year’s rent was $45 million.

The 14th year minimum rent is set at 1.17% above the rent payable for the 13th year on the CPI+1% formula for the period Aug 23 to Aug 22, 2021.

The initial lease term of 15 years for the three Singapore hospitals ends in August 2022. The master lessee, Parkway Hospital Singapore, a subsidiary of Parkway Pantai owned by IHH Healthcare, has the option to extend the lease for a further 15 years.

When asked if a new lease would be signed, Yong is keeping his cards close to his chest. “We engaged two valuers to help us to make sure the rates we negotiate are fair. Negotiations are underway. I don’t want to run the risk of painting too optimistic or too pessimistic a picture.” At any rate, whatever the new lease structure is, the proposal has to be approved by unitholders since it is an interested party transaction and the sponsor and manager — IHH Healthcare — cannot vote.

“It is important to stress that between sponsor and PLife REIT, we’ve enjoyed a very good working relationship over many years. When tenants’ performance improves, it benefits us, and it’s in the interests of both parties to continue this relationship,” Yong says.

And it is not just about a new lease. According to Yong, the three hospitals have been operating for many years and are quite dated. “It’s important for us and IHH, while looking at reasonable rates, to rejuvenate the assets to make them more efficient for the operators,” Yong continues. “If we can put together a package where it helps to improve the efficiency of the hospitals, that also benefits PLife REIT.”

Among the various strategies would be an IHH-funded AEI which would need landlord approval. The other model is for the REIT to help pay for the funding at certain ROIs. “The end objective is to make sure the model is a sustainable one,” Yong says.

UOB Kay Hian is pretty upbeat about the lease renewal. “The lease structure with rental escalation of CPI + 1% would be maintained. Improved profitability for private healthcare operators provides an opportunity for ParkwayLife REIT to negotiate for higher base rents.The extension of lease could be finalised by end-2020/early-2021,” UOB Kay Hian says in a recent report.

While medical tourism took a dip this year, the three hospitals were used for overruns from Covid-19. During 1HFY2020, occupancy rates hovered around 90%, similar to the levels of the past 10 years. Looking past the pandemic, Yong sees demographic trends working in the favour of the REIT with an ageing population in Japan.

More importantly, PLife REIT is the only healthcare REIT listed on the SGX to date suitable for both retail and institutional investors because of its transparency and conservative management.