In our year-end REIT round-up, we usually take a light-hearted look at REITs as bankers’ best friends because of the copious amounts of capital they raise from equity fund-raising (EFR) and loans they take to finance their “accretive acquisitions”.
However, the main focus in 2023 for all the REITs was to navigate higher interest rates. Declines in property valuations affected loan-to-value (LTV) ratios and in some cases financial covenants. In 2022, most of the REITs had warned of the impact on their distributable income and distributions per unit (DPU) through various sensitivity tests. DPU in FY2023 are likely to be lower than DPU in FY2022, based on estimates done by UOB Kay Hian (see Table 1).
Table 2 shows the results of three REITs and trusts with September year-end that bore the full brunt of higher interest costs. They are Frasers Centrepoint Trust J69U (FCT), Frasers Hospitality Trust ACV (FHT) and Frasers Logistics & Commercial Trust BUOU (FLCT).
In 2023, REITs raised $1.72 billion from a combination of placements and preferential EFRs but excluding property sales (see Table 3). This is more than the $1 billion raised in 2022 but a fraction of the $4.5 billion raised in 2021. Based on data from the Singapore Exchange S68 , REITs spent around $3.38 billion (see Table 4) buying properties.
Only the REITs sponsored by CapitaLand Investment and Mapletree announced both acquisitions and EFRs.
As a result of the interest rate cycle, REITs appeared to be reluctant to raise too much capital from EFRs and chose to divest properties to fund acquisitions. Mapletree Logistics Trust M44U (MLT) divested properties during 2023 in addition to raising equity. For the 12 months to Sept 30, MLT had completed or was about to complete the divestment for two properties in Malaysia, a property in Japan and 8 Loyang Crescent. Since then, MLT’s manager has divested 10 Tuas Avenue 13.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
One REIT, ESR-LOGOS REIT J91U , raised capital via a placement, preferential equity fund-raising and asset sales but has not made any purchases.
In general, REIT managers were a lot more cautious with both acquisitions and capital-raising than in years past. A couple of REITs decided to divest properties to fund acquisitions. Frasers Centrepoint Trust acquired 50% of Nex for $652.5 million and then divested Changi City Point for $338 million.
Lendlease Global Commercial REIT (LREIT) acquired 10% of Parkway Parade for $90.5 million. The CEO of its manager has articulated that he is looking to divest Jem office tower and possibly Sky Complex in Milan should LREIT’s manager and unitholders decide to buy the rest of Parkway Parade.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Unmoved by acquisitions
Some REITs that made acquisitions funded in part by EFR underperformed compared to peers in their sector. One name stands out, CapitaLand Ascott Trust HMN (CLAS). During the year to Dec 8, the FTSE REIT Index declined 5.3%. CLAS fell 7.6% in the same period when peers such as Far East Hospitality Trust Q5T and FHT rose, with FHT recording a double-digit gain.
CLAS’s manager appears to have upset its retail investors with the announcement of an acquisition of a hotel each in London and Dublin, and a serviced residence in Jakarta for the equivalent of $530.8 million. CLAS raised $200 million in a placement and a further $100 million via a preferential EFR which had a low subscription rate of 64.7%.
CLAS was doing well in the first eight months of the year. When The Edge Singapore met the CEO Serena Teo of CLAS’s manager in June, she said her focus was on distributions per stapled security (DPS) and not AUM (assets under management). Barely two months later in August, CLAS’s manager announced the acquisition of two hotels and a serviced residence for more than half a billion dollars and an EFR.
CLAS’s stapled security price had moved up back to $1.12 in June following a decline after an acquisition and EFR in 2022. As at Dec 8. CLAS is trading at 97 cents, a commendable recovery from a low of 84.5 cents.
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In general, hospitality trust managers do not find it in their stapled securityholders’ interests to acquire either with debt or a combination of debt and equity. “There is no point at the moment. We have a negative carry,” one REIT manager tells The Edge Singapore.
Defaulting REITs
There is something to be said for strong sponsors. The CapitaLand and Mapletree REITs were able to raise equity and make acquisitions with support from their sponsors. Herein lies the main issue with externally managed REITs — that they are only as strong as their sponsors.
Case in point: At least one REIT and one business trust are facing defaults. Two REITs have introduced restructuring plans to recapitalise themselves — Manulife US REIT (MUST) and Lippo Mall Indonesia Retail Trust (LMIRT). They are putting their fate in the hands of unitholders and bondholders.
As at Dec 14, unitholders of MUST voted in favour of three resolutions that are part of a recapitalisation plan. They are to sell Park Place to the sponsor for US$98.7 million ($131.2 million), get the sponsor to provide a shareholder loan of US$137 million at a cost of 7.25% a year with a success fee of 21.1% and divest four non-core properties for a minimum of US$328.7 million. The resolutions were interdependent.
Dasin Retail Trust, a business trust which is in default, has also proposed a restructuring. But an EGM with a proposal to internalise its trustee-manager has been requisitioned and this could muddy the waters.
LMIRT’s recapitalisation plans include a haircut for its bondholders. LMIRT’s manager has obtained a new IDR2.3 trillion ($200 million) loan from a lender, subject to certain conditions. This includes redeeming a 7.25% note maturing in 2024 at 76.5 cents to the dollar and a 7.5% note maturing in 2026 at 66.5 cents to the dollar. The expiration time was at 4pm GMT on Dec 20 for both the 2024 and 2026 notes and the consent settlement date is no later than Dec 22.
As at December, MUST, LMIRT, EC World REIT and Dasin Retail Trust CEDU no longer distribute DPU.
Some REITs are in default of their financial covenants because their property values in various markets have declined, causing LTVs to breach covenants. But REITs are not the only asset class to be affected by declining property valuations.
On Dec 8, CapitaLand Investment announced that revaluation losses for assets in China, Australia, Europe, the UK and the US will cause a significant decrease in total patmi for FY2023 ended December compared to FY2022. CLI reported a total patmi of $861 million in FY2022, down 36% y-o-y.
On Nov 14, Frasers Property TQ5 announced an 81.3% decline in its patmi in FY2023 ended Sept 30 to $173 million due to “non-cash net fair value losses on the group’s commercial properties in the UK and industrial and logistics properties in Australia and the EU, mainly due to higher capitalisation rates amid a high interest rate environment,” Frasers said in a statement.
The issue with S-REIT structure
Generally, to compensate for DPU decline, REITs often made “accretive acquisitions” to boost DPU. This is not a bad thing. The Singapore REIT structure allows REITs to take on bullet loans to finance assets. Hence, as the AUM of REITs grow, so does the debt on their balance sheets and fees. The bigger the REIT, the more fees it churns.
Unlike companies, REITs are not able to have retained earnings or revenue reserves. Note that the local banks pay out 50% of the cash net profits. The remaining 50% goes to their capital. Banks follow strict global and local capital rules. To maintain their double-A ratings from the three ratings agencies, the local banks abide by minimum capital ratios which are higher than global requirements.
S-REITs have to keep to minimum LTV ratios which are termed aggregate leverage and sometimes referred to as their gearing. Strictly, gearing ratios are usually debt-to-equity (D/E) ratios. Table 1 — compiled by UOB Kay Hian analysts — has both D/E and LTV ratios.
The rough rule of thumb is that at a 50% LTV, for every 10% decline in valuation, equity falls by 20%. Against this, REITs with more foreign properties in places such as the EU, US, UK, Australia and China are likely to experience sharper declines in their unit prices to reflect the impact on equity, analysts say.
Amid Covid and the lockdowns, on April 16, 2020, the Monetary Authority of Singapore (MAS) announced along with the Ministry of Finance and the Inland Revenue Authority of Singapore that leverage limits were raised to 50% from 45% “to provide S-REITs greater flexibility to manage their capital structure amid the challenging environment created by the Covid-19 pandemic”.
Undoubtedly, S-REITs went along with the higher leverage limit. Conservatively managed REITs such as CapitaLand Integrated Commercial Trust C38U (CICT) also pushed their LTV ratios to above 40%. This move is likely to be the cause of its underperformance when CICT fell by 6.9% in 2023, compared to the FTSE REIT Index which fell by 5.3%.
Secondly, the properties CICT acquired are in markets which have seen an expansion in capitalisation rates, unlike Singapore. It acquired two properties in Australia from a related company in December 2021, just as the rate hike cycle started. Now, CICT owns four overseas office assets — two of which are in Germany — and a stake in a fifth mixed development.
The EFR that took place to fund the two Australian office properties and stake in a mixed development could have also pressured CICT’s performance. Then again, it acquired a 70% stake in CapitaSky in 2022 but divested JCube to partly pay for the acquisition. The acquisitions stressed the balance sheet as each acquisition caused CICT to take on more debt.
In other markets including Japan, commercial mortgages are amortising, unlike Singapore where REITs tend to use bullet loans. So long as the yields on their assets were higher than their cost of debt, the spreads made sense.
Nonetheless, despite the higher cost of funding and management fees, REITs were still able to generate sufficient operating and often free cash flow to provide unitholders with stable distributions although at lower levels in FY2023 than in FY2022.
Internalisation not a panacea
One of the REIT sideshows during the year was internalisation. The Edge Singapore had a cover story on Link REIT in July which highlighted the positive aspects of an internally-managed REIT. Link REIT, which was “born” internally as a result of agglomerating properties once owned by the MTR, has been a model for an internalised REIT structure.
Up to early 2023, Link was one of the best-performing REITs in Asia in terms of price growth. In addition, from 2007 to 2022, Link’s DPU grew every year (the REIT has a March year-end), giving a CAGR of 9.9%. This is unlike CICT, whose DPU CAGR growth between 2003 to 2022 was just 1.1%. On the other hand, from the start of the year to Dec 8, Link’s unit price has lost 32% while CICT’s has lost just 6.9%.
So was it the right thing for unitholders when Quarz Capital Asia took it upon itself to change the structure of Sabana Industrial REIT?
In July, Quarz requisitioned an EGM to vote out the manager and to direct the trustee to internalise the manager. Both resolutions were passed with simple majorities on Aug 8.
In an extraordinary turn of events, HSBC Trust Services (HSBC Trustee), which is Sabana REIT’s trustee, announced on Dec 6 that it “disagrees with any suggestion of any wrongdoing or delay on its part” following a letter by the Sabana Growth Internalisation Committee (SGIC) believed to include Quarz, to the MAS and SGX RegCo.
The SGIC letter asks MAS and SGX RegCo for answers and guidance that the internalisation and the implementation of the specific governance rights do not necessitate any trust deed amendments. Even if an extraordinary resolution of the unitholders is required for the trust deed amendments, the sponsor and its concert and related parties are prohibited from voting on a resolution concerning any trust deed amendments to effect Internalisation. “The clear reason is their inherent conflict of interest as their fee income is directly affected by the outcome.”
Since the vote to remove the manager, Sabana REIT has three large unitholders, Quarz, Volare and ESR Group. As it stands, all unitholders are on equal footing.
HSBC Trustee dissociates itself from SGIC’s letter, adding that it is “seeking legal advice with regard to its contents and will respond at an appropriate time”.
SGX RegCo says: “The matters raised are commercial issues. SGX RegCo notes that the trustee has appointed its own legal adviser. Unitholders should await further updates on this matter by the trustee. SGX RegCo therefore has no comment.”
It is with Sabana REIT’s internalisation process in mind that several unitholders of Dasin requisitioned an EGM to internalise its trustee-manager. The Dasin requisitionists sounded a lot more conciliatory and professional than Quarz’s requisition notice and numerous open letters.
“We believe Mr Zhang Zhengcheng will continue to support Dasin Retail Trust because he continues to be a substantial unitholder in the trust,” the requisitionists say.
Zhang had given up majority shareholding control in Dasin Retail Trust’s trustee-manager in a bid to refinance Dasin Retail Trust’s loans. He still holds 43.2% of the trust’s units.
“We believe that his interests are very much aligned with the rest of the unitholders, and he and the sponsor would continue to support Dasin Retail Trust even after Dasin Retail Trust’s trustee-manager is replaced with an internal trustee-manager owned by unitholders as a whole,” the requisition notice states. Dasin Retail Trust’s sponsor is an entity owned by Zhang’s family.
The Dasin requisitionists are conscious of having to work with the sponsor, major unitholders and lenders to solve the default problem. Dasin’s recapitalisation plan includes disposing of its malls in an orderly manner in a 24-month timeframe. The lenders require the major unitholders to preapprove the sale of retail malls at or above minimum selling prices, provided requisite majority lenders approval is obtained when an offer is received and subject to the pre-approval being legal.
What is there to like about REITs?
“Lower US and Singapore 10-year bond yields by end-2024 as projected by our fixed income team are supportive of S-REITs prices. However, the upside is potentially capped with heightened competition from other yield instruments, larger valuation buffers in other regional REIT markets, relatively tight yield spreads of 296 bps or 0.6 s.d. (standard deviations) below the mean, a decline in core earnings and lingering concerns over US bond supply,” write analysts Mervin Song and Terence Khi of JP Morgan in a recent report.
The differentiator among the REITs is their property fundamentals. These include growth in spot rents, positive rental reversions, assertive DPU management and many REITs approaching peak debt costs. The y-o-y declines in DPU are likely over but FY2024 DPUs could be flat y-o-y, Song and Khi suggest.
According to the JP Morgan analysts, the 2024 outlook for every sector is positive except office. The analysts have an underweight on Keppel REIT and Suntec REIT because of negative rental outlook. On the back of healthy retail tenant sales, regional supply chain shifts and relatively tight supply, spot rentals for suburban retail, data centres and logistics should maintain their uptrend into 2024. As leases signed during Covid are renewed, rents could continue to rise.
The analysts at DBS Group Research are cautious about industrial property. Following the construction delays during Covid, DBS expects as much as 1.9 million sq m of new supply, which is the highest in a decade, coming onstream in 2024. Properties with modern specifications such as data centres and logistics could do better than those with lower specifications, DBS says.
Interestingly, ESR-LOGOS REIT divested some $400 million of “non-core” properties that were part of its IPO portfolio back in 2006. As E-LOG awaits to deploy the proceeds into its sponsor’s pipeline of modern logistics properties, it has taken to a share buyback.
DBS’s top picks are FLCT, MLT and Digital Core REIT (DCREIT) because of their focus on logistics and data centre properties. They are also positioned for acquisition growth should spreads turn positive for them.
JP Morgan’s key picks also include FLCT. Song and Khi also like Mapletree Pan-Asia Commercial Trust because it is undervalued.
Lastly, a word of caution. Rates are unlikely to move lower till the second half of next year should inflationary pressures recede. Borrowing costs remain near their highs, limiting DPU upside. The average S-REIT yield for the big caps is at 6%. “Other instruments such as bonds offer comparable yields but with lower capital risks,” JP Morgan says, adding that the Singapore banks are offering higher yields of more than 6% and with more robust balance sheets and capital structures.
