A model that works

In a wide-ranging interview recently, Eng-Kwok Seat Moey, managing director and head of equity capital markets at DBS Group Holdings, recounts her experience with the very first REIT listing in Singapore, the different parts that need to come in place for a listing and the opportunities ahead. CapitaLand Mall Trust’s first attempt to list as Singapore Property Trust was not successful. SPT was eventually listed in 2002 as CMT, with three malls — Tampines Mall, Junction 8 and Funan — valued at $895 million, a far cry from its current asset size of $10 billion. At its IPO price of 96 cents, its distribution per unit (DPU) yield was 7.66%. One of CMT’s largest assets, a 40% stake in Raffles City, was acquired after it was listed. CMT’s sister REIT, CapitaLand Commercial Trust (CCT), owns 60% of Raffles City.

Since then, DBS has been at the forefront of the S-REIT sector in bringing REITs to list and helping them raise equity for acquisitions. This year alone, its market share of secondary equity raisings was around 90% and that of IPOs was 100%, with the listings of four REITs, three of which were those with US assets.

A frequently asked question is: Why do REITs with foreign sponsors want to list in Singapore? Is it because of the fees from the external manager model?

The answer is in the affirmative. “The external manager model motivates sponsors to set up REITs on the Singapore Exchange. When S-REITs [were first introduced], each REIT was relatively modest in size compared with global peers. We needed the external manager model to provide incentives for sponsors, especially if they are property developers, to continue to inject properties into the REIT and grow the vehicle post-IPO,” Eng- Kwok explains.

Much of the credit for the success of Singapore’s REIT market — with a market cap of $107 billion as at Dec 16 — goes to Eng- Kwok. For this reason, she is known locally as the REIT Queen.

The S-REIT model

The Singapore model comprises a developer- sponsor such as CapitaLand, Mapletree Investments or Frasers Property listing its REIT with a portfolio of income-producing properties. The developer then supports the REIT by taking up a stake in the REITs that ranges from more than 20% to 40% or more in some cases. Equity raisings by the REIT for acquisitions are supported by the sponsor with a “backstop”: The sponsor commits to taking its pro-rata allotment and sometimes underwrites the capital raising.

The problem with the external manager model is that fees are tied to the size of the REIT. In more than 50% of the REITs, base fees are a percentage of asset size. Over the years, the external manager model came in for some criticism when retail investors realised that their REIT managers were buying assets to increase asset size and management fees with little regard for creating value.

Eng-Kwok, however, disagrees that managers buy properties solely to increase asset size. “There are checks and balances in this model. The REIT manager’s fee is largely based on the REIT’s performance. The market expects acquisitions to be accretive and fundraising to make commercial sense so that investors will support the transaction,” she says.

In December 2016, Sabana Shari’ah Compliant Industrial REIT announced a dilutive rights issue that was within the REIT’s general mandate. It then announced three dilutive acquisitions, of which one required unitholders’ approval because it was an interested-party transaction (IPT), as one of the properties was from Vibrant Group, Sabana REIT’s sponsor. In 2017, minority unitholders requisitioned an extraordinary general meeting to remove the manager. The resolution was not passed, but in April 2017, unitholders voted against giving the manager a general mandate, without which the latter would have been unable to raise equity. Earlier this year, Vibrant Group sold its stakes in the manager and in Sabana REIT to ESR Cayman.

“The REIT structure aligns interests and instils discipline in the REIT manager and sponsor to act in the best interest of unitholders. This has helped to make our REIT market an attractive listing destination for international sponsors [and] S- REITs an attractive investment product for investors,” Eng-Kwok says. When the sponsor plans to inject a property into the REIT, it is an IPT and needs to be approved by unitholders, but the sponsor cannot vote. This means it is an arm’s length transaction, she notes.

US REITs here not just for the fees

The US REIT managers claim their reason for listing in Singapore is not just for the fees. According to the manager of Manulife US REIT (MUST), the first REIT with US assets to list locally, it did it to have a better profile in Singapore and Asia because sponsor Manulife planned on increasing its presence in Asia. In 2015, Manulife signed a US$1.2 billion bancassurance deal with DBS. MUST’s IPO failed to take off on its first attempt because of insufficient investor interest and it was eventually listed in May 2016. It quickly doubled its asset size with acquisitions and equity raisings.

Howard Wu, co-founder of Urban Commons, sponsor of EHT, says he wanted to list EHT in Singapore because of the availability of Asian capital. EHT was listed on the SGX hot on the heels of ARA US Hospitality Trust’s listing earlier this year. The listings were followed by that of Prime US REIT.

Of the trio, both ARA US Hospitality Trust and EHT missed their net property income projections for 3QFY2019 soon after listing. ARA US Hospitality Trust’s NPI was 22% lower than the projections in its prospectus, issued in April.

EHT missed its revenue projections by more than 10%, and its NPI projections by a smaller 2.7%. This is because operating expenses were 57% below forecasts. Visitors to EHT’s properties have indicated that the hotels appear to be cutting costs. Still, they meet the minimum standard required of their management contracts with brands such as IHG, Hilton and Marriott. As for its controversial property, the Queen Mary Long Beach, a retired cruise liner that is moored in Southern California and operated as a tourist attraction, the management company is not a global brand that is familiar to investors.

While ARA US Hospitality Trust’s sponsor is known to local investors, EHT’s sponsor was an unknown at the time of its IPO in May. The retail portion of its IPO was not fully subscribed. On the first day of trading, one of the underwriters, Bank of America Merrill Lynch, sold four million units below the IPO price.

Since then, retail and institutional investors have mostly given EHT a wide berth despite a DPU yield in double digits. “Most of our S-REIT investors, including our retail investors, are very savvy. They read prospectuses and circulars and ask relevant questions in unitholder meetings. As market participants, we are also doing a lot to further educate the market through REITAS-focused forums, conferences and events organised under REITAS [REIT Association of Singapore], SGX and so on,” Eng-Kwok says.

Urban Commons had contacted DBS in 2016 to explore an IPO in Singapore soon after the listing of MUST, so it was not an overnight initiative. That year, Urban Commons was awarded the contract to run the Queen Mary, paying a ground lease of US$300,000 to the City of Long Beach.

Executives involved in the IPO say there was a discussion on which assets to inject into the new REIT. Some of the assets did not have the required yield for investors without income support. According to executives involved in EHT’s IPO, only mature assets were used for the initial portfolio. These assets had been managed by Urban Commons for close to 10 years.

Just before the IPO, six of the 18 assets in EHT, known as the ASAP Holdings assets, were sold to Urban Commons by a third party, the Yuan family. This is because the portfolio would have been too small if it comprised only the properties that were chosen for the REIT.

A final point on US REITs: Not all of them have their base fees tied to assets under management (AUM). MUST’s base fee comprises 10% per annum of distributable income while its performance fee comprises 25% per annum of the difference between the DPU in a financial year with that in the preceding financial year, multiplied by the weighted average number of issued units. According to its FY2018 annual report, there was no performance fee for FY2018, while manager’s base fee rose 51.9% to US$7.1 million, owing to a 51.9% rise in distributable income to US$71 million from the previous year.

Similarly, Keppel Pacific Oak US REIT’s (KORE) base fee is based on 10% per annum of its distributable income while its performance fee is 25% per annum of the difference between the DPU in the current financial year and that in the previous financial year. KORE also did not announce a performance fee for FY2018. Elsewhere, Starhill Global REIT, which was listed in 2005, has never announced a performance fee.

Not an income top-up

Sometimes, REIT managers negotiate for income support, or income top-ups, from the vendor of a property, and master leases with committed rents above market rents. When a building is new, income support is necessary, managers argue, so that the building’s income has time to stabilise.

Hotels are a different matter. The average length of stay in Singapore is two to three days. As a result, room revenue fluctuates and hotel revenue is not as stable as, say, that for shopping malls or office buildings, which have longer leases and stabilised income.

“The [Code on Collective Investment Schemes by the Monetary Authority of Singapore that governs REITs] requires stable income from underlying assets; therefore, a master lease together with a stapled structure (REIT+Business Trust stapled together) is quite common for hospitality REITs. The master lease arrangement, typically contracted with a sponsor entity, adds a layer of stability to cash flow and provides downside protection. The stapled structure provides the fail-safe; for example, in the absence of a master lease, the business trust can be activated for the REIT to be the master lessee of last resort,” Eng-Kwok explains. The minimum rent for a hospitality asset is not an income top-up, she emphasises.

Eng-Kwok was instrumental in introducing the stapled security structure in a hospitality trust, consisting of a REIT to hold the assets and a business trust that is usually dormant but could be activated in certain circumstances when the hotel needs to be actively managed. CDL Hospitality Trusts (CDLHT) was the first stapled security to be listed locally in 2006.

The stapled structure was also used by Far East Hospitality Trust, Frasers Hospitality Trust and Ascendas Hospitality Trust. A-HTrust activated its business trust to manage some of its hotels.

When the vendor does not want to provide a minimum rent or master lease, the business trust has to be activated, Eng- Kwok says. Similarly, ARA Asset Management did not provide a minimum rent or master lease for ARA US Hospitality Trust, and hence it is more of a business trust because the manager has to actively manage the hotels. This is because the assets were acquired from a third party and ARA Asset Management was not comfortable with providing a master lease or minimum rent for the portfolio. Instead, ARA US Hospitality Trust activated the business trust structure.

Hence, ARA US Hospitality Trust’s valuations are based on no master lease, Eng- Kwok points out. On the other hand, EHT’s valuation is based on the minimum rent, which covers around 61% of the projected revenue of US$95.43 million for 2020. CDLHT’s minimum rent covers around 35% of revenue, and FEHT’s 50%.

Equity under certain conditions

While there is some ambiguity on whether perpetual securities should be defined as debt or equity, for REITs, the regulations set out in the Code on Collective Investment Schemes by MAS are quite clear. Treatment of perpetual securities is also clearly stated in the annual reports of REITs that have issued them. Ascott Residence Trust’s annual report states that its perpetual securities do not have a maturity date and distribution payment is optional, at the discretion of the trust. “As the trust does not have a contractual obligation to repay the principal nor make any distributions, perpetual securities are classified as unitholders’ funds,” ART says. ART’s perpetual securities do not have a step-up feature.

A perpetual security is a hybrid security. For a perpetual issued by a REIT to be treated as equity and not aggregated as debt for the purpose of the gearing limit, the security will have to meet certain conditions, such as being deeply subordinated, with non-cumulative distributions and no step-ups, says Eng-Kwok.

For REITs, the advantage of issuing perpetual securities is that they are cheaper than equity, and do not affect the gearing cap. “These features, particularly no step-ups, differentiate REIT perpetuals from those typically issued by companies,” says Eng-Kwok.

Ascendas REIT, ART, Cache Logistics Trust, ESR-REIT, First REIT, Frasers Hospitality Trust, Keppel REIT, Lippo Malls Indonesia Retail Trust, Mapletree Logistics Trust and SPH REIT have issued perpetual securities.

For index inclusion, big is beautiful

An increasing number of S-REITs have become members of the FTSE EPRA NAREIT Developed Market Index. On Dec 23, MUST will become the 12th REIT to be included in the index (see table on Page 19), and 15th Singapore listed entity to be part of the 334-member index. The main requirements are that more than 50% of earnings before interest, taxes, depreciation and amortisation (Ebitda) have to be from a developed market, and the free-float market cap has to be above US$1.3 billion.

Being in the index gets the REIT noticed by institutional investors. The manager of Frasers Logistics & Industrial Trust (FLT) cited a higher weightage in the FTSE EPRA NAREIT Index as one of the reasons to merge with Frasers Commercial Trust (FCOT). Together, they would have a higher free-float market cap than that of FLT alone.

ART will complete its merger with A-HTrust by end-2019 and is also looking to be included in the FTSE EPRA NAREIT Index. ART alone has already met the main requirements for inclusion in the index, as more than 50% of its Ebitda is derived from developed markets. At its pre-merger market cap of $2.88 billion, and based on CapitaLand’s 45% stake in ART, it would have qualified for the FTSE EPRA NAREIT Index, based on the required $1.7 billion of freefloat market cap.

After the merger, ART’s free-float market cap rises to $2.4 billion and its combined AUM rises to $7.6 billion from $5.7 billion pre-merger. It is likely to be included in the index at the next quarterly review. If so, ART would carry a higher weightage than Keppel DC REIT, MUST and CDLHT.

“We want to make sure our REITs are growing responsibly, buying good yield-accretive assets and delivering value to unitholders,” said Lee Chee Koon, CEO of CapitaLand, during CapitaLand’s investor day on Dec 6, when management fielded questions from investors and analysts.

One of the questions was: Why were Mapletree Investments’ REITs trading at a higher valuation than CapitaLand’s REITs? “We have a very clear, decisive execution plan and the REITs will play a big part; maybe in the past, we’d not been decisive. Our REITs are all in very strong positions,” answered Andrew Lim, chief financial officer of CapitaLand.

“We need to make sure that we are able to drive NPI growth. And there is only so much [that can be done] for stabilised assets,” Lee said. He pointed out that CapitaLand’s very conservative capital management strategy — as a rule of thumb, CapitaLand REITs opt for longer-term debt — also had an impact on DPU. As always, there is a trade-off between being low risk — with high ratings from the rating agencies, which allow for lower borrowing costs — and having a more aggressive capital management strategy, which could deliver higher DPU with shorter-term debt. CapitaLand’s REITs, with their long-term debt and fixed-rate strategy, are less susceptible to external shocks.

Still a young market

US REITs are a new asset class for local investors, and the learning curve is likely to be steep. Investors need time to assess the quality of their sponsors. Not only is Urban Commons an unknown in Asia but EHT’s manager appears reluctant to provide financial details on the sponsor despite its being the master lessee of the properties in the portfolio and hence, EHT’s largest creditor.

Also, at 18 years old, S-REITs are still young compared with those in Australia and the US. Though sizeable, on a global basis, S-REITs are small — even the largest S-REITs are relatively small. “Globally, the biggest REITs are in the US. In Asia, the big REITs are in Japan and Hong Kong (Link REIT). S-REITs are a small market,” observes CapitaLand’s Lee. CapitaLand is the sponsor of three of the largest REITs in Singapore — Ascendas REIT, CMT and CCT, in that order by size.

“Our S-REITs are still relatively modest in size compared with REITs from other developed markets such as the US. Currently, out of 44 REITs and property trusts listed on the SGX, only seven have a market cap of more than $5 billion,” Eng-Kwok notes. “There is room for growth, although at a measured pace. REITs will grow incrementally with each acquisition. The external manager model aligns the interests of the manager and sponsor to support the REIT’s growth.”

Although the S-REIT market is still young, investors are savvy enough to know the difference between a supportive sponsor and one that uses the Singapore REIT model to garner fees and monies from an IPO.