SINGAPORE (Jan 23): Last year, real estate investment trusts proved they remained as bankers’ best friends after raising more than $6 billion in secondary issuance alone, and excluding IPOs. In addition, two REIT mergers were completed. OUE Commercial REIT merged with OUE Hospitality Trust and is listed as OUE Commercial REIT. Ascott Residence Trust (ART) completed its merger with Ascendas Hospitality Trust on Dec 31. The mergers, acquisitions and equity issuances were all driven by the need for size.
“While lower cost of funding has undoubtedly spurred this (M&A and equity raising), we think enlarged market cap and higher trading liquidity considerations have also been significant motivating factors behind this wave of activity,” notes Wilson Ng, an analyst at Morgan Stanley. “The desire to grow larger among REIT managers, especially for smaller names looking to gain entry into the MSCI and FTSE EPRA NAREIT indices, has also manifested in consolidation within the sector, most recently between Frasers Logistics Trust and Frasers Commercial Trust (pending approval), as well as Ascott Residence Trust (ART) and Ascendas Hospitality Trust (A-HTrust) completed in December 2019.”
Ng reckons this trend is likely to continue this year. Already, market watchers including Ng and other analysts are expecting a merger among industrial REITs. The most likely combination is ESR-REIT merging with Sabana Shariah Compliant Industrial REIT given their major unitholders and sponsors are ESR Cayman.
Getting noticed
The larger the REIT, the lower the cost of capital as evidenced by compressed yields and higher price to book ratios (see charts 1 and 2). Of course, becoming a component of the MSCI and FTSE EPRA NAREIT Developed Market indices is also good for Singapore. The Lion City’s weightage has risen to 2.99% as of Jan 17, compared to 2.01% in November 2019. This is because the market cap of the largest components, CapitaLand and Ascendas REIT, have risen. CapitaLand’s market cap tops $20 billion.
Once ART qualifies for the FTSE EPRA NAREIT Developed Index sometime in the first half of this year, Singapore’s weighting in the index could top 3%. ART’s free float market cap — CapitaLand owns 40.1% — is around $2.5 billion. This would place it between Keppel DC REIT and above Keppel REIT (see table 2).
As more REITs and developers qualify for inclusion in the index, the larger the countryrepresentation, since size is one of the qualifications for getting in. This in turn could lead to a virtuous cycle of more REITs wanting to list in Singapore, to get noticed by institutions.
High yield REITs try to grow
Investors looking for higher yields need to look to smaller REITs (see chart 3). The REITs with the highest yields are those with foreign properties. Eagle Hospitality Trust is a special case. Other than that, Lippo Mall Indonesia Retail Trust (LMIRT) and First REIT stand at No 2 and 3. ARA US Hospitality Trust and EC-World REIT are No 4 and 5 in terms of trading at the highest yield (chart 3). LMIRT is also one of the cheapest REITs (see chart 4) based on its price to book ratio. The higher the yield the more difficult it is to grow because acquiring yield accretive properties becomes a challenge.
In 2018 and 2019, LMIRT’s unit price was under pressure because sponsor Lippo Karawaci had to restructured and recapitalised. Part of the restructure involved divesting Lippo Mall Puri into LMIRT for IDR3,700 billion or $354.7 million, based on $1 being equivalent to IDR10,431.47, which was officially announced in March 2019. LMIRT’s market cap is $635.3 million as at Jan 17.
Acquiring a property that is valued at half the REIT’s market cap would have required a combination of equity and debt. In June last year, LMIRT issued US$250 million of senior notes due 2024 priced at 7.25%.
Last December, LMIRT announced the conditional sale of Pejaten Village and Binjai Supermall to a joint venture between Warburg Pincus and PT City Retail Developments for a total IDR1,280.7 billion ($124.3 million). “The sale considerations of IDR997.4 billion for Pejaten Village and IDR283.3 billion for Binjai Supermall amount to a premium of 33.3% and 19.3% over the original purchase considerations of IDR748.0 billion and IDR237.5 billion of the respective properties acquired back in 2012,” LMIRT’s manager said in an announcement in December.
Loss in translation
Indeed, in 2012, LMIRT acquired Pejaten Village for IDR748 billion or $96 million and Binjai Supermall for IDR237.5 billion or $30.5 million based on $1.00 to IDR7,795.3. As at Jan 17, $1 is equivalent to IDR10,139.15.
REITs have very simple capital structures, and have little or no retained earnings. Hence, any negative (or positive) currency translation is likely to impact book values. Although Pejaten Village and Binjai Supermall are being divested at a significant premiums to their acquisition prices in rupiah, in Singapore dollars, a small loss could be recorded.
As evidenced by the acquisition and divestment of Pejaten Village and Binjai Supermall in Singapore dollars, the rupiah has probably played a part in LMIRT trading at a high yield and a low P/B.
Last September, LMIRT and Lippo Karawaci agreed to extend the completion of the Segregation Process and the long stop date to for the Lippo Mall Puri transaction to March 31 and June 30 this year. Lippo Karawaci had stated that the sale of its Lippo Mall Puri to LMIRT will be delayed to mid-2020 from the end of 2019, due to a regulatory strata-titling process.
The monies raised from the US dollar senior notes and the proposed sale of two properties should be sufficient for the acquisition of Lippo Mall Puri, observers say. If so, concerns on an overhang from equity raising should be removed.
Big is beautiful
Ng of Morgan Stanley has overweight ratings on two REITs, Ascendas REIT and Keppel REIT. Although Ascendas REIT is the fifth most expensive REIT based on P/B (see chart 2), it is likely to experience upside to its rental income from its recent acquisition of 28 tech and medtech business parks in the US. But that is not the reason Morgan Stanley likes the REIT.
Ng says that the demand-supply dynamics in its business parks in Singapore are favouring landlords. “We see a broader improvement in industrial supply-demand dynamics arresting Ascendas REIT’s occupancy slide, averaging 60 basis points higher occupancy a year over FY2020 to FY2022,” he writes in his report. A bigger boost to distributions per unit could come from the potential redevelopment of its light industrial buildings to high spec buildings, Ng adds.
Keppel REIT is this year’s dark horse. Its DPU has been sliding for six consecutive years. Of course, market watchers are wondering if Keppel REIT, once the largest commercial S-REIT, can reverse the slide this year. Morgan Stanley thinks so. Ng expects 1% to 3% p.a. growth in DPU in 2020 and 2021.
