Repositioning CapitaLand's REITs

“I walked into the cinema to take a look at the [safe management] arrangement and it was okay,” says Tan. “Still, the operator would have to be on the ball though,” adds Tan, “It’s about the additional cleaning that cinemas require.”

Coincidentally, Lot One Shoppers’ Mall, CMT’s suburban mall located next to Choa Chu Kang MRT station is currently undergoing asset enhancement initiative (AEI) works.

For Lot One’s cineplex, the AEI will result in eight screening halls from four halls originally, to offer more viewing experiences.

The community library occupying Level 4 will also be expanded by one additional storey above, adding some 600 sq m (6,460 sq ft) of space. The AEI works will be completed progressively from 2H2021.

In fact, all the planning for the AEI was done before the Covid-19 pandemic struck, says Tan.

“At Lot One, we’ve started a new library expansion and remodelled the cinema. We thought about converting the big cinema space into smaller ones,” Tan indicates.

Today, with the pandemic in full stride, that decision to remodel the cinema into a multiplex appears prescient as current regulation limits gatherings in cinemas to 50 people.

And increasingly, it looks like Covid-19 could be with us for years. Even if a vaccine is found to limit its spread, it would take time to inoculate the whole population. The only way to mitigate the spread will be to observe better hygiene and safe management measures, restrict air travel and put those infected in quarantine.

Still, the current AEI for Lot One is only the first phase or Part One. “We would look at whether we want to upgrade further, in a Part Two, knowing that in 2026, the Choa Chu Kang Interchange will be operational,” Tan says.

To be sure, Lot One is just one of many assets in CMT’s property portfolio that have redevelopment potential. One of the upsides of the proposed merger between CMT and CapitaLand Commercial Trust (CCT) is greater development headroom. In January, CMT and CCT announced plans to merge with each other to create CapitaLand Integrated Commercial Trust (CICT). The managers of CMT and CCT see the transaction as a merger of equals. Technically, CMT is acquiring CCT, paying 0.72 CMT units and 25.9 cents for each CCT unit.

Redevelopment potential

If the merger is successful, CICT will have AUM of $23.5 billion, lifting its development headroom substantially. A hypothetical CICT has a development headroom of $2.3 billion based on 10% development allowance, compared to $1.2 billion each for CMT and CCT. An additional 15% development headroom for CICT works out at a further $3.5 billion, for a total development headroom of $5.8 billion. This compares with a total development headroom of $3 billion for CMT, and $2.9 billion for CCT.

According to the Collective Investment Scheme code, REITs are allowed to develop up to 10% their deposited property value. REITs can increase development value up to a further 15% of deposited property, for a total development value of 25%, provided the additional 15% development headroom is subjected to the approval of unitholders and is to be used only for the redevelopment of an existing property that has been held by the REIT for three years and which the REIT must hold for at least five years after completion.

One of CMT’s most stable malls, Bugis Junction is in a precinct which offers redevelopment potential. CapitaLand was awarded the integrated management of Bugis Village and Bugis Street by joint tender with the Singapore Land Authority, Singapore Tourism Board and Urban Redevelopment Authority, for up to 10 years, starting April 1. The proposed retail net lettable area (NLA) is about 195,000 sq ft.

The integrated Bugis Village and Bugis Street is located next to Bugis+ and opposite Bugis Junction. To improve connectivity, CapitaLand is thinking of building a new bridge between Bugis+ and Bugis Street, linking Bugis Village, Bugis+ and Bugis Junction while providing seamless and sheltered access from Bugis MRT station to Bugis Street.

“We are waiting for the revamp of Bugis Village. Holistically, it makes a lot more sense to have that interfacing so there is a clear positioning. And I would imagine it would be more vibrant. Bugis Village and Bugis Junction are quite popular among foreign tourists from Southeast Asia. Tourists from some Western countries like that local and authentic offering which is different from that on Orchard Road,” Tan says.

Elsewhere, a joint venture between City Developments (CDL) and CapitaLand acquired Liang Court in May 2019 and were permitted to top up the lease of the site to 99 years. The site will be jointly redeveloped into an integrated development, which will comprise about 700 residential apartments, a commercial component, a hotel, and a serviced residence with a hotel licence. Upon completion in 2024, the CDL-CapitaLand joint venture will own the residential and commercial components while Ascott Residence Trust (ART) will own the 192-unit serviced residence. CDL Hospitality Trusts (CDLHT) will own the hotel under a forward purchase agreement with sponsor CDL.

Because of zoning restrictions, the redevelopment of Liang Court is conditional on a 60% residential portion, with the rest commercial. As a result, ART and CDLHT will reduce their portion of GFA in their respective strata segments while CDL-CapitaLand will increase theirs for the residential units. Last year, analysts at DBS Group Research and Credit Suisse estimated the land cost at $1,000 psf, or $1,400 psf including top-up premium for the 99-year lease. They have estimated a value of $2.9 billion for the completed development. Most of the gains would probably be from the residential units, the analysts say.

The rejuvenation of Liang Court near Clarke Quay implies the latter could well be remodelled in the next few years. “Liang Court is a repositioning; we know Clarke Quay has operational constraints because of the Ministry of Health ruling. It’s timely we relook at Clarke Quay with reference to having a better interface with Liang Court,” Tan says. Clarke Quay is focused on entertainment and F&B which have been impacted by Covid-19.

“We’ve been studying ways to make Clarke Quay stand out other than just being a place associated with night activity. That thought process is ongoing,” Tan adds.

Capital Tower redevelopment

Tan lets on that discussions on a CMT-CCT merger started well before January. Moreover, he indicated that the stock prices of both REITs were “trading well” at that time.

At any rate, CMT is no stranger to integrated developments. CMT and CCT jointly own RCS Trust which holds Raffles City, the integrated development comprising retail, office and hotel. Another is Funan, previously an IT mall which is now an integrated development with retail, office and lodging. Plaza Singapura and Atrium Orchard has a combination of retail and office but plans are afoot to transform Orchard Road into a “lifestyle destination with innovative and unique non-retail offerings” which could incorporate Plaza Singapura and Atrium.

“If you see where the government is moving, the trend is clear,” Tan says. In March 2019, URA introduced a set of incentives to encourage the conversion of existing, older, office developments into mixed-use developments to help rejuvenate and reposition the CBD as a 24/7 mixed-use district. In August, URA released further details on how these redevelopments could take shape. The incentives are applicable to sites within Anson, Cecil Street, Robinson Road, Shenton Way and Tanjong Pagar. The old developments must be at least 20 years’ old, be predominantly office and have a minimum site area. With these qualifications, older office buildings can be redeveloped with 25% more GFA.

In the Robinson Road, Shenton Way and Tanjong Pagar sub-precinct, commercial with 40% non-commercial uses such as residential would provide the development with 25% more GFA. Among the properties that would qualify is Capital Tower, one of the major buildings owned by CCT, which contributes 13% to CCT’s net property income (NPI). As part of CICT, loss of NPI would still be meaningful, but not as painful as that experienced by a smaller REIT.

Tan sidesteps a direct question on Capital Tower saying instead, “the government-incentivised trend will accelerate, and the government is trying to revitalise the CBD. Some landlords have put up plans and we will relook [at our assets] once we clear Covid-19.”

In the same area, Perennial Real Estate Holdings has announced the potential redevelopment of AXA Tower, and CDL has indicated that it plans to redevelop Fuji-Xerox Towers.“Because of the pandemic, a larger base and a more diversified platform, in the long run, will be a lot more resilient,” Tan notes. “When Covid-19 hit, the impact was felt first by retail. When things started to stabilise, people started to look at how real estate would be affected post-Covid, which reinforced the point that we need to get the [merged] platform up,” he explains.

Limited accretion for CMT but CICT gains

Based on distributable income for the latest 12 months to June 30, including distribution of retained income, the CCT-CMT merger should be DPU-accretive for both CCT and CMT.

CMT’s DPU in 1HFY2020 fell by 49.6% to 2.96 cents and the retail REIT has retained $46.4 million of distributable income in the first six months. CCT’s DPU in 1HFY2020 fell by 24.1% to 3.34 cents, with $7.5 million retained from its 60% share in RCS Trust.

The merger is mildly NAV-accretive for CMT unitholders, with DPU accretion of up to 4.1%. For CCT unitholders, the merger is DPU-accretive to the tune of 7.6%, but mildly NAV-dilutive. However CCT unitholders are compensated by a cash payout. The merger and items associated with it such as trust deed amendments will be voted on in five resolutions in two EGMs on Sept 29.

The larger benefit for CMT is likely to be through CICT, if it materialises. From 2021 onwards, when office supply is mainly from the completion of CapitaSpring which would have around 647,000 sq ft of office NLA, there is limited Grade A office space in the CBD. CCT owns 45% of CapitaSpring and has a call option to acquire the stake it does not own.

Elsewhere, CCT is spending $35 million on AEIs for Six Battery Road which should be completed next year even though it was delayed by Covid-19. CCT is targeting an ROI of 8%. At 21 Collyer Quay, CCT is spending $45 million on an AEI which is underway. A seven-year lease to WeWork also starts next year. CCT is expecting an ROI of 9%.

In terms of organic growth, CICT could look to Funan, which opened in June last year but has not really had a chance to stabilise. Tan and his team are also looking at a rebound in shopper traffic and retail sales in 2H2020. In August, shopper traffic for malls like IMM have already rebounded to 80% of pre-Covid levels. On average, August shopper traffic for CMT’s portfolio rebounded to more than 50% of pre-Covid levels.

Inorganic growth for CICT is aplenty. Jewel is an amalgamation of a suburban mall for families with a supermarket, cinema, and the Canopy Park, yet it caters to jet-setters with an array of retail offerings for tourists as well as the well heeled. Meanwhile, construction of 79 Robinson Road, which was inherited from Ascendas Singbridge, appears to be completed.

Engaging unitholders

Will unitholders be patient and hold on to CICT for long-term growth? What is the probability of the merger being voted through? Investor relations teams at the managers of both REITs are working very hard to engage unitholders. “We have been actively engaging CCT unitholders since the announcement. On the whole, our investors recognise the rationale for the proposed merger and understand the merits of the transaction. Ultimately, what investors look for are sustainable returns for their investments,” says Kevin Chee, CEO of CCT’s manager.

CMT’s Tan says he and his team have also been engaging unitholders on the merits of the merger. “We’re looking at the merger from multiple angles. We have to consider the interests of both REITs. CCT has a higher accretion and a cash component. They have the option of whether they want to reinvest [elsewhere]. They own a larger vehicle with cash in the pocket,” Tan says. It is a merger of equals, he continues.

The potential CICT would also have a gearing of more than 39%. “Over time, we will look at capital management strategy and at the appropriate time, I’m sure we will be able to manage it down,” Tan says. “We think our rationale stays very strong. Following Covid-19, the rational still stays and the attributes stand out very strongly,” he emphasises.

While size is important, engaging unitholders is also a key component. This is particularly so in the wake of pushback on an unrelated merger of two industrial REITs, ESR-REIT and Sabana Shariah Compliant Industrial REIT. The rationale for the ESR-REIT and Sabana REIT merger are obvious. As a larger industrial REIT, the merged entity would have a more diversified tenant base, be able to harness a network effect, and lower cost of capital. However, two activist hedge funds who together own 10% have said they intend to vote against the merger as they would like a cash component, and this could scupper the transaction.

Still, M&As of smaller REITs are becoming inevitable as the benefits of scale are increasingly glaringly evident. “Our REITs have moved beyond Singapore. Our REIT managers look for assets globally, so you need a REIT manager who is financially strong that can have people sourcing these assets,” notes Nupur Joshi, CEO of the REIT Association of Singapore (REITAS). “With scale comes better cost of funding. There are a lot of players out there looking for assets because the macro environment has created a lot of liquidity, so your cost of funds becomes a competitive advantage. And a smaller REIT tends to have a higher cost of funds.”

With CICT at AUM of $23.5 billion and second only in market cap to Hong Kong-listed Link REIT, the largest REIT in Asia, the “big is beautiful” trend looks unstoppable. This is a trend Tan of CMT was acutely aware of when he peeked into the cinema in one of his malls.