SINGAPORE (July 17): In a webinar held by The Edge Singapore and EdgeProp on July 11, Wong Yew Kiang, head of research at CLSA, gave a quick rundown of the Singapore REIT (S-REIT) sector and his view on virus-resistant REITs. They are, in order of resilience: Healthcare; industrial, in particular data centres; followed by logistics; then office; retail and hospitality REITs.
“Healthcare REITs are the most resilient because most are master-leased with very long leases and with rental agreements where they are stepped-up and inflation-linked,” Wong says.
There are winners and losers among the industrial REITs. “Data centres are benefitting the most because of cloud computing and higher data usage. Logistics properties are benefitting from e-commerce and because habits of shoppers have changed. So logistics REITs could benefit,” Wong suggests.
Among the industrial REITs, CLSA, in a report dated July 13, upgraded Ascendas REIT (A-REIT) and Mapletree Industrial Trust (MINT) from “outperform” to outright “buys”.
CLSA has assigned a valuation of $3.85 to A-REIT, using a country-weighted average risk-free rate assumption of 2.1% and a 6.0% equity-risk premium, with a long-run risk-adjusted average beta. “We have assumed a terminal growth rate of 1.5%, which is higher than the usual 1% as its overseas markets have rental escalation of 1–3%,” the CLSA report says.
The main risk factor to buying A-REIT is a prolonged Covid-19 which can impact earnings and asset values negatively. A sharp slowdown in regional trade for Singapore could result in lower demand for industrial space and, hence, lower rents. Acquisition of Australian, UK and US assets now expose A-REIT to foreign exchange risk, CLSA says. On the other hand, upside surprises can come from policy relaxation in Singapore or a reduction in industrial land supply.
Data centre plays in focus
MINT is the first REIT this year to test the equity market. It had raised $410 million from a placement of 146.4 million units at $2.80 per unit. Some $302.6 million of the monies raised are to fund the acquisition of approximately a 60% stake in a portfolio of 14 data centres in the US held by sponsor Mapletree Investments. The remaining $100.9 million is being used to pare debt and fund future acquisitions, and $6 million was used for fees and expenses.
In 2017, MINT entered into a joint venture with Mapletree Investments to acquire the portfolio with MINT holding 40% and Mapletree Investments holding 60%. The acquisition — which required an EGM — increased MINT’s exposure to data centres from 31.6%1 to 39%. The acquisition is mildly DPU-accretive and NAV-accretive.
The Covid-19 crisis has provided favourable tailwinds for the data centres segment. Cloud providers have reported strong demand for data centre space during the pandemic, and they are likely to lease data centre space, rather than build, in order to expand quickly to meet customers’ requirements. The global revenue for cloud computing is expected to grow at a CAGR of 14.0% from 2018 to 2024 according to a forecast by 451 Research.
During the pandemic, the data centre segment experienced strong leasing demand from content, social media, e-payment, software-as-a-service and other information technology firms during the pandemic. In addition, data centres were identified as essential infrastructure in North America during the pandemic and had remained open during the lockdown period.
Kepple DC REIT (KDC REIT), a pure-play data centre REIT, has the lowest yield among S-REITs, and it is trading at a significant premium to its book value. Hence CLSA has an “underperform” rating on the REIT. Although data centres are in demand, KDC REIT is trading at a yield of around 3.6%, the lowest among the S-REITs, and its unit price is more than twice its book value.
Other REIT sectors under pressure
“Office REITs are relatively insula-ed in the near term because of their lease structure but in the longer term with work-from-home and decentralising trends, you could see core CBD rents softening,” Wong indicates. He adds that the two most negatively impacted REITs currently are in retail and hospitality. The retail industry is hit by high rental waivers and a growing preference for online shopping, he says, while the hospitality industry is currently the worst impacted with low earnings visibility.
“Hospitality REITs are the most interesting because most are impacted by the circuit breaker, and valuations are likely to have taken a hit, and the last sector to recover,” Wong says.
CLSA has a “sell” rating on Ascott Residence Trust (ART). On July 13, ART’s manager announced that the global environment and Covid-19 have impacted its Revenue per available unit (RevPAU) negatively.
ART’s manager has warned that ART’s available income for distribution for 1HFY2020 is expected to reduce by 55%–65% from the $74.6 million recorded in 1HFY2019. ART’s distribution per stapled security for 1HFY2020 is expected to reduce by 65%–75% from the 3.43 cents recorded for 1HFY2019.
According to The World Tourism Organization (UNWTO), international tourist arrivals declined 44% y-o-y from January to April and plunged 97% y-o-y in April this year. For the full year of 2020, UNWTO expects international tourist numbers to deteriorate between 58% to 78% versus last year.
Internationalisation of SGX-listed REITs
The S-REIT market is the second largest in Asia, after the J-REITs (Japanese REIT sector). The main difference is that J-REITs largely own Japanese assets. Because of the limited size of Singapore geographically, S-REITs are becoming increasingly international.
“The Singapore regulators have done a good job promoting S-REITs and Singapore as a hub for international REIT listings,” notes Wong.
As at June 30, the SGX counts 44 listed REITs and property trusts, with a total market capitalisation of $73 billion. According to REITAS (the REIT Association of Singapore), as of April 2020, 86% of S-REITs are property trusts by number and 80% by market cap own properties outside Singapore across Asia Pacific, South Asia, Europe and USA. There are 17 S-REITs with real estate portfolios entirely composed of overseas assets. In terms of asset size, 62% of assets are in Singapore, 8% in Australia and New Zealand, and 6% in China, followed by Europe, Hong Kong, the US and Japan (see chart 1).
Based on asset class, office comprises the largest assets by valuation, followed by industrial, retail and hospitality (see chart 2).
All Singapore REITs use an externally managed model, where the REIT manager is paid a fee for man-ageing the REIT, and where the properties are held by the trustee who is meant to look after the interests of unitholders. While this works well in theory, practically, in at least two instances — that of Sabana REIT in 2016, and more recently Eagle Hospitality Trust — the trustees did not immediately act in the interest of unitholders. In the case of both Sabana REIT and Eagle Hospitality Trust, it was the regulators who questioned the sponsors and managers with regularity.
Financial engineering remains a problem
The main problem with REITs is the financial engineering ability of some REIT sponsors. For instance, the sponsors of First REIT and Lippo Mall Indonesia Retail Trust were able to sell properties into the REIT with master leases attached, that valued these properties are higher valuations than they otherwise would have been valued. The master leases — which were paid in Singapore dollars to the REIT unitholders — are coming to an end, and the sponsors appear not to have budgeted for renewals after 2021 and 2022.
In May 2019, Eagle Hospitality Trust was listed with its asset valuation boosted by long master leases by the sponsor. It appears increasingly likely that the sponsor did not plan to honour those master leases.
Increasingly, in the case of independent REITs — that is those whose sponsors are not the Big Four (see chart 3) — unitholders are questioning the aim of master leases by the sponsor that help to boost rents and hence artificially inflate valuations.
In addition to financial engineering, another drawback to the REIT structure is the fees charged by the manager which is owned by the sponsor. In the past, sponsors have sold assets into their REITs to raise AUMs and as a result, they were able to garner more fees. More recently, with the exception of Lendlease Global Commercial REIT, performance and even base fees are tied to DPU growth.
Still a good investment?
To the question whether S-REITs are a good investment, Wong says: “The average yield for the sector is 5.8% versus historic yield of 6%. The yield spread is 488 basis points compared to the historic average of 360 bps. This is where we see the S-REITs have the opportunity for further yield compression, and hence the opportunity for capital appreciation.”
Indeed, an investment thesis for REITs is the historic low levels of global interest rates following the US Federal Reserve’s quantitative easing to infinity. Low interest rates coupled with compressed yields are advantageous to REITs, because they keep interest costs low, while lower yields help acquisitions to be accretive.
The key REIT sponsors in Singapore — CapitaLand, Mapletree Investments, Keppel Corp and Frasers Property — have among them REITs which command lower yields, higher price to book valuations and hence lower cost of capital. These REITs are likely to find it easier to acquire properties to grow both assets and DPU. They are also the most transparent REITs and rank high in corporate governance. Investors looking for capital appreciation may want to stick with these REITs.
