On April 22, stapled security holders of CDL Hospitality Trusts (CDLHT) voted overwhelmingly to approve resolution 4, the implementation of a distribution reinvestment plan (DRP).
In a 24- page circular on the rationale for DRP, CDLHT’s manager said: “the cash which would otherwise have been payable by way of distributions may be retained for greater financial flexibility where the cash may be used to repay existing borrowings, which will further strengthen CDLHT’s balance sheet, or to fund the continuing growth and expansion of CDLHT.”
It adds: “[The DRP] will also enlarge CDLHT’s capital base, strengthen its working capital reserves and improve the liquidity of stapled securities.” Unitholders can opt for distributions in all cash, cash and units, or all units.
In July last year, unitholders of Mapletree Industrial Trust (MINT) voted overwhelmingly in favour of DRP implementation. “The DRP provides unitholders of MINT with the option to receive their distributions, either in the form of units or cash or a combination of both. This will enable unitholders to acquire new Units without incurring additional transaction related costs,” MINT’s manager had said. These transaction costs include brokerage, stamp duty and other fee-related expenses.
How does DRP affect a REIT? “The issue of Units in lieu of cash distributions under the DRP will strengthen MINT’s balance sheet, help finance the progressive funding needs of the development projects and accord MINT greater financial flexibility to pursue growth opportunities,” MINT’s manager said.
Based on MINT’s financial statement for the 12 months to March 31 (the REIT’s FY2022), it raised just under $39 million during its fourth quarter, compared to total income available for distribution of $92.66 million.
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“We had our first DRP and the take-up was 42%. In our announcement the issue of price of the units was at 1% discount to VWAP prior to closing the books and take up was very nice because we have good support from our sponsor who took up its proportionate stake,” says Tham Kuo Wei, CEO of MINT’s manager during a results briefing in April.
“We are continuing with it this quarter (4QFY2022). Our original plan was to cover the development period of Kolam Ayer, till 2023. We want to match the construction and its funding needs, and to moderate the leverage level. In the previous rounds when we did DRP, we turned it off when leverage was below 30%. We will relook at DRP when we complete the construction for Kolam Ayer,” Tham explains. MINT’s Kolam Ayer cluster is likely to cost $300 million including escalations by the time it completes.
The issue price of MINT’s DRP units was $2.508 compared to MINT’s net asset value of $1.86 (as at March 31). As such, the DRP issuance — although at a premium to NAV — is seen as accretive to unitholders in general.
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In some cases, REITs with a DRP mandate have opted to suspend it. Keppel REIT has a DRP but has suspended it because of a unit buy-back programme announced in July 2018. Mapletree Logistics Trust has DRP mandate but has not issued DRP units since FY2020 (ended March 31). AIMS APAC REIT’s (AA REIT) DRP is still in force, but the manager has not elected to issue units pursuant to the plan over the past eight quarters.
ESR-REIT’s (now ESR-LOGOS REIT) DRP was also temporarily suspended for the second quarter in FY2021 when an equity fund raising with gross proceeds of approximately $149.6 million was launched. ESR-REIT’s manager says DRP will be maintained as “ a component of longer-term capital management and to allow unitholders flexibility in receiving their distribution entitlements. The DRP provides a measured and efficient means of accessing additional equity capital from existing unitholders.”
Cost impact
DRP is not without its costs, says Robert Wong, CFO of Manulife US REIT’s manager. “We do have the mechanism and we are assessing whether it’s beneficial to our unitholders. The pick-up rate seems to be very low [for some REITs] where there is only a 5% pick up,” he adds.
Among the REITs with US properties listed on Singapore Exchange (SGX), United Hampshire US REIT (UHREIT) announced the establishment of DRP on Feb 23 this year. “The DRP may be applied from time to time to any distribution declared by UHREIT as the manager may determine in its absolute discretion,” UHREIT’s manager said. UHREIT is trading at a DPU yield of 10%, and aggregate leverage of 39%. UHREIT is in the process of divesting two of its four self-storage properties.
“DRP is usually issued at a 1% to 2% discount to unit price. To make DRP successful, the discount may need to be higher. In addition market conditions are volatile so DRP may not be the best option currently,” says Wong.
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Indeed, as with equity issuances, there are issuance costs associated with DRP. For instance, Starhill Global REIT (SG REIT), which implemented DRP in FY2020 (SG REIT has a June year-end), now pays its distributions per unit (DPU) semi-annually — down from quarterly — because of the costs associated with DRP, which can be as high as $100,000 per pay-out period.
Unlike some REITs that have to renew the DRP mandate with unitholders’ votes annually at AGMs, SG REIT’s DRP mandate is evergreen. The REIT’s manager has the flexibility of implementing it, should it need to preserve cash for AEIs and working capital, or it can opt for all cash DPU.
DRP and capital structure
Capital structure is a key part of any corporate structure, including REITs. Since REITs are incentivised to pay out at least 90% of their distributable income because of tax transparency, REITs are viewed to have a less robust capital structure than other corporates including banks. The most robust form of capital — comprising shareholders funds is retained earnings.
REITs’ capital structure does not comprise retained earnings. Usually, REITs’ capital consists of unitholders’ funds which have to match their net assets. When units are issued, the capital base gets larger. The cash that would have been paid out is retained. As such this cash could boost current assets till it is applied to working capital or AEI or to pare debt.
Whatever happens to the retained monies, they in turn would lower aggregate leverage which is the ratio of gross debt to total assets. Note too, how NAV drops by the equivalent to the DPU after every payout. The CapitaLand REITs always publish the impact of DPU payout on NAV. In its FY2022 results, Mapletree North Asia Trust (MNACT) also highlighted a drop in NAV after DPU payout.
DRP and issuing units in lieu of, say, management fees adds to unitholders’ funds.
However, when units are issued at a discount to NAV, this can be dilutive to DPU. REITs usually emphasise the accretive nature of acquisitions on DPU, but investors should also be cognisant of whether the transaction is dilutive or accretive to NAV and DPU.
Two transactions which boosted unit prices of REITs and were seen to be positive for the REITs overall, were actually dilutive because of the impact on NAV. In 2020, ARA LOGOS Logistics Trust (now ESR-LOGOS REIT) did a transformational acquisition (announced in FY2020) to raise its portion of long-dated land tenure including freehold land. The transaction worked out well although it was dilutive to both NAV and DPU initially. Still, all’s well that ends well as the introduction of a new sponsor and a new institutional investor boosted sentiment.
Elsewhere, First REIT announced
a transformational acquisition of Japanese nursing homes earlier this year. The unit price reacted positively, but it was dilutive to NAV.
As a case in point, Sabana Industrial REIT’s merger with ESR-REIT was not voted through because it was dilutive to NAV. Charlie Chan, a unitholder of Sabana REIT, says he voted against the merger because the offer was at a discount to NAV.
At CapitaLand China Trust, the only CapitaLand REIT with DRP, $15.9 million of cash was retained due to its DRP on Sept 24, 2021 during the course of FY2021 (12 months to Dec 31). The retained cash was used for repayment of CLCT’s interest-bearing borrowings, general corporate and working capital purposes.
Enlarging the capital base
Unrelated to DRP — although MNACT has a DRP mandate which is likely to be suspended after its merger — is how a merger can enlarge the capital base. In an initial proposal on Dec 31, 2021, Mapletree Commercial Trust’s (MCT) manager made an all-unit offer and a cash-and-unit offer for MNACT.
On March 22, MCT’s manager announced an added choice of a cash-only offer for MNACT. Unitholders can choose between scrip-only, cash-and-scrip or cash only. “The introduction of the alternative cash-only consideration option gives higher certainty to MNACT unitholders … without prejudice to the interests of the MCT unitholders,” MCT’s manager said in a series of Q&A.
“The interests of MCT unitholders are safeguarded as the inclusion of the alternative cash-only consideration achieves the same pro forma financial effects as the cash-and-scrip consideration option and would have no impact on the aggregate leverage of MCT and the merged entity,” MCT’s manager adds.
This is because in all three options, MCT would have to issue around 1.1 billion new units at $2.0039 per unit to the sponsor and/ or unitholders. In the all cash alternative, should all minority unitholders opt for cash, the new units would be issued to the sponsor. As MCT’s manager points out in the Q&A, the overall quantum of the scheme consideration remains unchanged.
Since MCT’s NAV as at March 31 stood at $1.74, the transaction is accretive to MCT. Of course, it also raises MCT’s risk profile: Its DPU yield is likely to expand, and the premium between unit price and NAV could well disappear.
Mainly industrial REITs
Interestingly, the sector with the most DRPs are industrial REITs. This is possibly because industrial REITs with a preponderance of Singapore property have shorter land leases.
“We are moving into an expansionary phase. We need funding to grow. Industrial properties have short leasehold assets. Most of the leases are 30 to 35 years. Hence your land lease shortens every year and you have to replenish your capital to purchase newer property,” explains Donald Han, CEO of Sabana REIT’s manager.
Most industrial leases run for either 60 or 30 years and in many cases, 20 years. Upon the expiry of the lease term, the ownership of the land returns to the state. Hence — and as a very rough guide — for a portfolio valued at say $900 million, and assuming leases run for 30 years, the REIT will lose some $30 million a year because of falling land lease tenure.
The industrial REITs publish their remaining land leases during every financial results announcement. Some industrial REITs have extended their land leases by acquiring freehold assets overseas. These include Ascendas REIT, Mapletree Logistics Trust, MINT and AA REIT.
According to Bala’s Table — based on an older method of valuing leasehold land and published by the Singapore Land Authority — a land lease of 30 years will hold 60% of its freehold value; 20 years land tenure maintains 48% of its freehold value; at 15 years land lease, the land holds 40% of freehold value, dropping rapidly to 30% of freehold value with 10 years of lease left, 17% of value with five years lease left, and just 3.8% of freehold value at one year of land lease. The fall in value — which is similar to depreciation in the case of say a ship — is not accounted as depreciation in a financial statement. Instead, REITs publish revaluations upwards and downwards.
Some industrial REITs prepare for this falling land lease by conserving cash through DRP, and acquiring new assets with their full 30 years of land tenure.
In summary, DRP is not bullish or bearish. It is a tool that REIT managers can use should they wish, to shore up cash for AEI, acquisition, redevelopment and extending land tenure. Unitholders have a choice of cash or units. However, if units are issued at a discount to NAV, that could be dilutive immediately, but the DRP could work for the greater good eventually.
