As The Edge Singapore launched its first issue, the fabric of property development started to change. The financialisation of real estate helped to lighten balance sheets, burdened by debt and high gearing ratios.
First was CapitaLand with CapitaMall Trust, followed in swift succession by the IPO of Ascendas REIT, also in 2002. Cheung Kong Holdings (now CK Asset Holdings) became the third Asian developer to list a REIT when it became sponsor to Fortune REIT.
REITs were a need, not a want. In 2002, indebted developers such as the newly formed CapitaLand, and Keppel Land, had to figure out ways to deal with high gearing levels on their balance sheet, yet work out ways to keep their Grade-A and trophy buildings within their control.
Keppel Land divested Capital Square into a fund. K-REIT Asia, now Keppel REIT, was a dividend-in-specie to Keppel Corp and Keppel Land shareholders, and listed by way of introduction in 2006. It held Keppel and GE Towers, Bugis Tower, and had a pipeline of properties in the new Marina Bay area, which it eventually acquired.
In those far-off days, REITs were blamed for raising rents to satisfy distributions to their unitholders. But the trend is unstoppable. From just one REIT in 2002, Singapore Exchange now boasts 37 REITs, and three property trusts. Securitisation of property is likely to continue apace — what could change are the properties themselves.
Institutional investors are — unsurprisingly — focused on modern warehouses and data centres, with retail and office somewhat out of fashion. Increasingly, rental housing is becoming popular. Whether people are buying online, or zooming, they have to do it from somewhere. If it’s not the office, it’s a WeWork type space, or WFH (work-from-home). In many developed markets, some 50% of the population rent the homes they live in.
Rise of the REIMs?
Constant change in the way real estate is approached continues, embodied most recently in the restructuring of CapitaLand, once the largest property company by shareholders’ funds and market capitalisation in Asia ex-Japan, into CapitaLand Investment (CLI), a real estate investment manager (REIM).
Elsewhere, ESR Cayman — which like CLI is a hybrid REIM — is acquiring ARA Asset Management in a largely share transaction valued at US$5.2 billion ($7 billion) based on a price of HK$27 ($4.69). ARA is a pure REIM.
Elsewhere, traditional developers such as City Developments plan to build a funds management business. The smaller, mid-sized developers have less compunction to change a model that has kept them on even keel for the past 40 years. Many of them are family-owned, without activist investors who would encourage their management to narrow the discount between their listed share price and NAV.
For instance, during a recent results briefing, Liam Wee Sin, group CEO of UOL Group, said when asked if he had plans to change the business model to narrow the discount between share price and net asset value: “We have very strong recurring income and our residential development boosts revenue and profit. The current Covid pandemic is pretty disruptive and there is not much clarity. We are looking at usage of various asset classes, AEI (asset enhancement initiatives) and redevelopment of our assets, and what is their best use. As to whether we are interested in fund management, it is premature to make any statement.”
The attraction of fund management, and being a REIM, is to trade at a premium to NAV; to have a relatively light balance sheet; and to deliver higher ROEs which are usually likely to be at a premium to cost of capital.
Pure REIMs such as ARA rarely use their own capital for growth. For instance, ARA puts in little or no investment in the private equity funds it manages for third parties, or in the REITs it manages.
Unlike developers, REIMs partake in developments through funds in which they hold a modest stake, with capital partners. The REIM manages the fund, leases the properties when ready, and eventually exits the fund along with its capital partners. At each stage of the fund cycle, the REIM is likely to get a fee — a development fee, management fee, leasing fee, and a promote on exit should the fund meet its hurdles.
But REIMs cannot just be fee machines. In Singapore, with the external manager REIT model, REIMs are required to be responsible sponsors to their REITs, providing them with a pipeline of properties through their funds, supporting the REITs during capital raisings, and observing regulatory code and abiding by ESG (environmental, social and governance) principles.
Both Andrew Lim, CFO-designate of CLI, and Jeffrey Perlman, chairman of ESR Cayman, have articulated that they will support their respective REITs.
Financialisation of real estate The biggest opportunity for REIMs is likely to be the accelerated financialisation of real estate in Asia. In the early 2000s, CapitaLand recognised this and financialised retail and commercial assets in Singapore and China. Subsequently, CapitaLand’s fund management business spread to other parts of Asia such as Japan, Vietnam and more recently, South Korea.
The acquisition of Ascendas-Singbridge in 2019, just before Covid, e-commerce and data centre trends accelerated, gave CapitaLand “New Economy” assets, and additional funds and REITs.
In the past five years, a number of Asian jurisdictions have introduced REIT regulations, and these are likely to provide more opportunities for REIMs. The first REITs were listed in India in 2019, in Philippines in 2020, and in China in June this year.
“Financialisation is supported by two important drivers: the support of new REIT legislation in China, South Korea and India, and the growing need for professional management and institutional real estate in Asia. We are more convinced of the size and opportunity as each day passes,” Perlman says.
On the capital partners front, global investors are increasingly consolidating their relationships towards a limited number of large-scale managers and allocating more capital to a smaller roster of platforms.
Perlman estimates there is US$1 trillion of opportunities in Japan, China, India and South Korea in “institutionalisling” real estate, assuming that a public REIT market in these jurisdictions is in line with a mature market such as the US which has REIT equity market cap of 6.1% of GDP. As a comparison, Singapore’s REIT market cap as a percentage of 2020 GDP is around 22.8%, which appears outsized because of a prevalence of non-Singapore assets in S-REITs.
During the last CapitaLand results briefing on Aug 13, CLI’s Lim says that in the run-up to the launch of CLI, “in the fund management strategy, we looked at where we are historically active, and gaps of where we can go to. Our REITs and private equity funds are very focused on sectors we were strong on in the past. In CLI, in addition to ‘core’, we want to value-add, and we want to go into New Economy alternative assets, and these are large sectors presenting opportunities”.
In addition, companies are looking for capital partners, hence Lim sees opportunities galore, especially with CLI’s and the privately held CapitaLand’s ‘boots on the ground’ in Asia Pacific (Apac), Australia, Europe and the US.
Secular trends
In addition to the continued financialisation of real estate, Perlman identified two secular trends that are likely to continue for the next several years — e-commerce and the impact on modern logistics assets, and the demand for data and data centres.
The expected surge in demand for data centres is increasingly being fuelled by transferring legacy systems to the cloud, by e-commerce, videoconferencing, and the digitalisation of banking, and just about everything else.
In the last five years, data consumption in Apac has grown by four times, to 64.2 zetta bytes (or a trillion trillion terabytes). Apac is already the second largest data centre market (after the US). Apac data centre spending is expected to grow to US$35 billion by 2024, to account for 35% of the global data centre market.
Warehouses, where people once stored grain, and food for a rainy day, have become New Economy. To be sure, modern logistics warehouses are nothing like the godowns that once lined the Singapore River.
New Economy warehouses have automated systems enhanced by machine learning and AI, which can recognise items by their bar codes and QR codes. Pulley systems and robotics pick out items when needed and partially pack them for disbursement.
As an indication of demand, Perlman measures the yield spread between logistics properties and offices (see Chart 2). In the US, logistics properties are trading at tighter yields than offices. As a result, he reckons that yields for logistics assets in Apac can compress further.
Hybrid REIMs in Asia could be the future
Lim has said CLI may be a hybrid REIM in the future, holding sufficient capital and pipeline to support its six REITs. Both Lim and CLI’s group CEO-designate Lee Chee Koon have said that CLI as a committed sponsor, will continue to stand by their REITs, and support them in their respective growth trajectories.
In the past two years, three REITs have refined their assets. CMT and CapitaLand Commercial Trust merged to form CapitaLand Integrated Commercial Trust. CapitaLand China Trust has expanded its mandate to include industrial and logistics properties, business parks and data centres.
For ESR Cayman to match CLI’s success in managing its REITs, it too may have to adopt a hybrid version of REIM.
Interestingly, and unsurprisingly perhaps, CLI’s six REITs have a market cap of around $33.5 billion, compared to ARA’s listed REITs which have a market cap of just under $10 billion even including Cromwell European REIT. ESR Cayman’s three listed REITs have a market cap of $2.5 billion. ESR Cayman is a relatively young company. However, ARA has been around since 2002.
Although Suntec REIT has some $11 billion in assets, its debt-to-asset ratio is around 44% to 45%, and it has not had sponsor support for acquisition growth, in terms of equity fund raising. Its market cap is just $4.1 billion. This compares with, say, Ascott Residence Trust, whose market cap is $3.1 billion.
It started off as a modest-sized serviced residence REIT, but has expanded to purpose-built student housing and rental housing in Japan. Its manager has articulated that it would like to acquire CLI’s multi-family portfolio should it come available.
With the focus on fee income for companies such as CLI and ESR Cayman, investors may find it more lucrative to invest in them rather than their REITs.
Following the announcement of the acquisition of ARA, ESR Cayman’s share price tumbled as much as 20% from the pre-announcement price, providing an investment opportunity. ESR Cayman’s share price did not reach the benchmark of HK$21.60. At this level, the material adverse effect clause would have kicked in. Since the tumble, ESR Cayman’s share price has recovered albeit modestly. The market is often the best judge of whether an acquisition is accretive, or not.
What could happen in the next 20 years?
As ESR Cayman doubles down on fee income growth, and CapitaLand restructures into CLI, which other Singapore-listed developer is likely to form a REIM? Market watchers indicate there are a few candidates.
Shortly after Keppel Land was privatised in 2015, Keppel Capital was formed in 2016, as a REIM. With the acquisition of Singapore Press Holdings, Keppel Capital will have AUM of around $50 billion and if sufficiently sizeable, could be listed.
Elsewhere, Frasers Property has a shot at listing a REIM with three S-REITs, and two REITs listed on the Stock Exchange of Thailand. As an indication of how well the FPL REITs are managed, the market cap of Frasers Centrepoint Trust and Frasers Logistics & Commercial Trust together surpasses the market cap of ARA’s listed REITs, including Cromwell European REIT.
As the future pivots to REIMs, other small and mid-sized locally listed developers may hang around, trading at large discounts to their NAV, or at some point they could privatise in the manner of Wheelock Properties and SC Global Development.
The financialisation of real estate, which started off as baby steps 19 years ago, is likely to continue for the next 19 years.
