Property developers: A work in progress

Over the past six decades, CDL has transformed from an unprofitable company into a global industry forerunner, growing its assets from $18 million in 1972 to $31 billion, according to a press release.

Deputy Prime Minister and Minister for Finance Lawrence Wong was the guest of honour at the event. In an impromptu speech, Wong said in the past 60 years, CDL — like Singapore — has overcome huge odds to turn “every challenge into an opportunity and every vulnerability into strength and that is how CDL has developed, grown and transformed”.

Wong describes CDL as a leader in sustainability, “showing the way to many of us in our green transition, especially for the urban environment. CDL today continues to break new ground in urban concepts”.

Wong recalls his first encounter with a CDL person back in 1998 was none other than executive chairman Kwek Leng Beng. The government had then set up a committee to look into Singapore’s competitiveness after the Asian Financial Crisis.

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Sitting on the committee too were then trade and industry minister George Yeo and banker Peter Seah. “None of them will remember me. I was a newly-minted young officer on the secretariat team taking notes,” says Wong who was a 26-year-old at that time, drawing laughter from the crowd.

“I was very impressed by Mr Kwek’s business sense. He spoke directly and candidly, and gave us very useful suggestions,” he adds.

In their speeches, group CEO of CDL Sherman Kwek and his cousin and group CIO Kwek Eik Sheng recalled the vision of Kwek Leng Joo, CDL’s late deputy chairman, who believed in sustainability and the greening of the environment back in the 1990s, long before the term ESG was coined.

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During the evening, executive chairman Kwek also recalled CDL’s early beginnings when he and his father Kwek Hong Png acquired a block of CDL shares from a group of professional architects.

In the last decade, CDL has embarked on a journey of renewal and transformation, with a strategic diversification push to build its overseas property development and asset management platforms. It now has a presence in Australia, China, Japan, the UK and US, and Vietnam. Beyond geographical growth, the group has also expanded into new asset classes, including rental apartments, student accommodation, dormitories for workers and business parks, and is also steadily growing its fund management business.

Financing costs surge

Since the end of the pandemic, CDL hasn’t been spared the challenges faced by developers and S-REITs — chief of which was the surge in finance costs that impacted the real estate sector. The US Federal Reserve’s interest rate hike cycle that took the Fed Funds Rate from near-zero to 5.5% in the space of 18 months caused interest costs to surge.

In 1HFY2023 ended June, CDL’s interest costs surged to $220.5 million from $99.5 million in 1HFY2022. UOL Group’s interest expenses doubled to $93.8 million in 1HFY2023 ended June from $46.6 million in 1HFY2022. CDL and UOL are comparable based on the size of their balance sheets and market caps. As at June 30, CDL has $23 billion of assets compared to UOL’s $22 billion. CDL is capitalised at $6.1 billion versus UOL at $5.4 billion.

Standing above the fray is Frasers Property (FPL) which has an established and growing fund management business. Its interest expenses in 1HFY2023 ended March rose just 25.5% to $249.1 million from 1HFY2022.

Elsewhere, Ho Bee Land’s finance costs more than doubled to $76.3 million in 1HFY2023 ended June from $33.2 million in 1HFY2022. GuocoLand’s interest expenses of $89 million in 2HFY2023 ended June were significantly higher than the $54 million in 2HFY2022.

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Singapore’s largest real estate company, CapitaLand Investment (CLI), which is now a real estate investment manager or REIM, has a market cap of $16.3 billion. Relative to the other developers, CLI managed to fare slightly better as interest costs in 1HFY2023 ended June increased by just 21% to $239 million.

Despite the surge in interest costs, most developers continued to report earnings although names such as CDL, UOL and GuocoLand recorded a decline in earnings compared to a year ago. Ho Bee Land and Hotel Properties (HPL) both announced net losses.

Great expectations

In terms of earnings, in 1HFY2023, CDL reported a profit before tax (PBT) of $217.3 million, up 48% y-o-y, although this excluded divestment gains and impairment losses. Residential development, investment property and “others” contributed $190 million, $10 million and $19 million respectively while the hotel segment made a loss of $10 million. In the absence of divestment gains, CDL’s patmi in 1HFY2023 fell to $66.5 million from $1.1 billion in 1HFY2022.

OCBC Investment Research notes: “If we exclude divestment gains and impairment losses, adjusted patmi would instead have inched up 1% to $104.3 million. This fell short of expectations, with adjusted patmi forming 27% and 24% of ours and the street’s FY2023 forecasts respectively. CDL declared a special interim dividend per share (DPS) of 4 cents, lower than the 12 cents DPS declared in 1HFY2022 as there were proceeds received from significant divestment gains then.”

In 1HFY2023, CDL made a divestment gain of $16 million from the sale of units in Tanglin Shopping Centre. On the other hand, CDL’s UK investment properties announced an impairment loss of $34 million. There was also a fair value loss on property-linked notes for an Australian project.

CDL’s group CEO Sherman Kwek says: “The impairment losses were on UK investment property. UK investment properties are going through a very rough time. We suffered a 30 bps–50 bps cap rate expansion. Occupancy rates and rents are strong but with cap rate expansion, there was a drop in valuation. Hopefully, that’s temporary and we see bright prospects in future.”

Kwek adds, “All companies and REITS have been hit by financing costs. Despite our efforts to lock in financing costs, our net financing costs have gone up four times since a year ago but we see things stabilising.”

CDL values its properties at cost. Based on historical cost, its gearing would be in the 90s. However, based on the market value of its portfolio, its gearing is about 57%. Notably, its interest cover ratio (ICR) is at 2.8 times which is well within its covenants. Developers do not have specific regulatory ceilings on gearing and floors on ICR. The ICR floor of 2.5 times that regulators have guided for REITs with aggregate leverage of more than 45% provides investors a benchmark with which to gauge other corporations as well.

Undoubtedly, CDL is impacted by its UK investments. Singapore comprises 44% of CDL’s $23 billion of assets, followed by the UK at 19%, China at 14% and the US at 8%. The remaining 16% is from other parts of Asia Pacific and Europe.

Caution in the balance sheet

Interestingly, UOL, arguably CDL’s closest competitor, has an ICR of five times and a gearing ratio of 26% as at June 30. In 1HFY2023, UOL’s cost of debt was 3.46% compared to CDL’s 4.1%. In 1HFY2023, UOL reported a PBT of $273 million, down 56% y-o-y, and a patmi of $135 million, down 64% y-o-y largely because interest costs had doubled in the first half.

UOL’s 1HFY2023 revenue declined 11% y-o-y to $1.37 billion due to a dip in revenue from its property development segment although this was offset by a 66% rise in revenue from its hospitality segment.

In an update after UOL’s results on Aug 10, OCBC Investment Research says: “[Patmi] missed our expectations as it accounted for 38% of our initial FY2023 forecast.”

Like most developers (see story on page 13), the difference between UOL’s last traded share price of $6.43 and both its NAV of $12.45 and NTA of $12.41 (UOL has $38 million of intangibles) is vast.

In addition, like most developers who ventured abroad, UOL is facing headwinds in the UK and Australia, but to a smaller extent compared to CDL. UOL’s overseas investment properties are offices, comprising 110 High Holborn and 120 Holborn Island in London, and 72 Christie Street in Sydney.

UOL’s financial statement says: “There was the recognition of net fair value gains of $44.6 million based on valuations as determined by independent professional valuers as at June 30, 2023, where the fair value gains from Singapore office properties due to positive rental reversion more than offset the fair value losses from properties in the UK and Australia.”

In Singapore, the increase in investment properties arose mainly from costs capitalised for properties undergoing redevelopment or asset enhancement initiatives including Clifford Centre and Singapore Land Tower, both held under Singapore Land Group, and Odeon Towers at 333 North Bridge Road. These were partially offset by the transfer of Faber House to property, plant and equipment (PPE) with the commencement of redevelopment works to a hotel in June.

Kwa Beng Seng, group CFO of UOL, says: “We recorded significantly lower fair value gains in 1HFY2023 compared to 1HFY2022. As a result of interest rate hikes in the UK and Australia, we actually saw capitalisation rates expand. This explains why among our properties in Australia and the UK, we’ve registered close to $70 million in revaluation losses that offset the gain that we have in Singapore, resulting in $44.6 million of fair value gains in 1HFY2023.”

OCBC Investment Research says: “We believe UOL is in a solid position to pursue inorganic growth opportunities. Management highlighted that its priority would be to expand its presence in existing markets and the office sector in Australia and London could present interesting opportunities in the months ahead. While there is still a valuation gap between prospective buyers and sellers, this is narrowing. The increase in Government Land Sales tenders would also provide opportunities for UOL to replenish its Singapore landbank, with management interested in mature estate sites. After some adjustments, our fair value estimate is reduced from $8.26 to $8.15.”

Both CDL and UOL are redeveloping properties in Singapore as a way of unlocking value. CDL announced the redevelopment of Fuji Xerox Towers into Newport Residences. The main difference is that UOL is a lot more cautious when venturing into new sectors, which results in a lower gearing level compared to CDL.

In the past two years, CDL has created the equivalent of $1.7 billion of AUM in purpose-built student accommodation (PBSA) and private rental sector (PRS) in the UK, Australia and Japan. This includes GBP636.8 million ($1.08 billion) of PBSA and PRS in the UK, A$412.2 million ($361.4 million) of PRS in Australia and JPY24.3 billion ($226 million) of PRS in Japan. As at June 30, CDL has a pipeline of 2,400 PBSA units and 1,300 PRS units. CDL also wrote off close to $2 billion in 2020 for an investment in China-based Sincere Properties.

Other business models

With the privatisation of Keppel Land in 2015 and the privatisation of the CapitaLand Group’s development arm CapitaLand Development (CLD) in 2021, investors lost two large property companies. Keppel Land is now subsumed within Keppel Corp which itself is transforming into an investment manager of real assets.

The only listed part of CapitaLand is CapitaLand Investment (CLI), which is a REIM rather than a traditional property developer. CLI takes stakes in development projects through its REITs and private funds.

Says CLI’s group CEO Lee Chee Koon during its results briefing on Aug 11: “When we restructured the business to split the development business and the asset management business, we were really positioning the company for growth. At this point in time, the big environment is one where we are dealing with rising interest rates, a very difficult geopolitical environment, and the uncertainty of where things will lead.”

CLI had ambitious AUM targets which would have led to the growth of its fund management fee-related earnings (FM FRE). While FM FRE growth was not possible in 1HFY2023, it might still be possible in 2HFY2023.

Most recently, CLI announced a business park development fund CapitaLand India Growth Fund 2 (CIGF2) with a target fund size of $525 million to invest in Grade A business parks in prime locations across gateway cities in India.

CLI secured $263 million from a global institution for a 50% stake in the fund’s first closing. CLI intends to maintain a sponsor stake of 20% in the fund, in line with its asset-light strategy to grow its funds under management (FUM) while keeping strong alignment with its investors and partners. Including CLI’s equity contribution for the 20% stake, the total equity commitment for the first closing totalled $368 million. This is expected to add approximately $700 million to CLI’s FUM.

In 1HFY2023, CLI announced a patmi of $351 million, down 19% y-o-y. Operating patmi, excluding non-cash revaluation gains and losses, was 1% lower y-o-y at $344 million. Improved operational performance, particularly from CLI’s lodging business, was offset by higher interest costs and the absence of performance fees from funds.

Says CLI’s CEO Lee: “We’re looking at many deals and debating on many deals. We are not doing some of the deals because we are just not happy with the terms of pricing. We want to make sure that we can deliver consistent high-quality earnings for our unitholders, shareholders or LPs (limited partners) in the various funds. If you can’t deliver the returns, there’s no point in pursuing growth for growth’s sake.” He adds that a signal for liquidity returning would be narrower bid-ask prices.

CDL has also articulated the need for a fund management platform although its initial target of US$5 billion has been deferred to next year from this year.

Frasers Property is the other developer likely to have a significant fund management platform. In August 2022, Frasers Property announced the formation of Frasers Property Capital (FPC) with Wong Ping as its CIO. She reports to Chia Khong Shoong, FPL’s group chief corporate officer. FPC has a mandate to coordinate capital partnerships with investors keen to take part in the company’s growth as it pursues investment opportunities aligned with its strategic objectives.

At that time, Chia said: “Real estate is a capital-intensive industry. To maximise the value generated by our platforms and capabilities, we need a strong capital base and diversified capital sources to execute on our strategic priorities. We believe long-term strategic institutional investors who share our vision and appreciate the capabilities of our established real estate platforms in our chosen markets. Forming Frasers Property Capital now to work with aligned partners, as part of our wider asset and capital management strategy, is a natural evolution in our journey.”

So far, FPC has not announced any deals but it could be interesting to investors if Frasers Property wasn’t so illiquid. The AUM of its REITs — of which three are S-REITs and two are Thai-listed REITs — is around $17.8 billion. Its major shareholders TCC Group and Thai Beverage hold around 88% of FPL.

Another developer with trapped value is GuocoLand. In a recent report, DBS Group Research suggested the potential securitisation of GuocoLand’s income-producing portfolio or conversion into a “stapled security” could be a significant share price catalyst, with potential upside ranging from 50% to 100%. As at June 30, GuocoLand’s NAV stood at $3.85 versus its recent price of $1.54.

DBS Group Research says: “The group’s $6.2 billion portfolio of investment properties now accounts for about 60% of its asset profile, with high occupancy rates across the properties. We like the group’s mixed-use developments Guoco Tower and Guoco Midtown in particular, due to 1) Quality: Grade A office, floor plates that are easy to restructure, and flexible spaces for tenants and 2) Amenities: A direct indoor link to the MRT, retail shops and F&B outlets in the area that are open even till late at night, and green spaces. As a result, we saw bulk renewals in FY2023 for Guoco Tower with double-digit rent reversions.”

Little to show for share buybacks

To date, only CapitaLand has been able to narrow the discount between its share price and its NAV through the restructure which produced CLI.

Hongkong Land, which is the second-largest real estate company on the Singapore Exchange with a market capitalisation upwards of US$8 billion, chose to attempt to narrow its P/NAV discount in a traditional way — through share buybacks.

Since Hongkong Land announced a US$1 billion share buyback programme in September 2021 and July 2022, it has invested US$599 million as at June 30. Following the cancellation of these purchased shares, the total issued share capital has been reduced by 5.1%.

Some Hongkong Land investors believe the share buybacks haven’t produced much benefits, saying a special dividend would have been better use of the US$1 billion. Hongkong Land continues to trade at a significant discount to its NAV of US$14.51. As the share capital is reduced, its share price has fallen while the discount to NAV has remained more or less the same. Still, as at June 30, Hongkong Land’s net debt fell due to net cash inflows from trading activities. Net gearing stood at 17%, unchanged from end December 2022.

During CDL’s results briefing, when asked about its share buyback programme, group CEO Sherman Kwek said he “struggled with whether to initiate our buyback programme. I wasn’t able to see the floor at that point and the share price kept plunging over a certain period of time. If I do a share buyback, it’s not so much because I wanted to help the share price but more because it’s good value for me to buy back shares at that price”.

During CDL’s 60th anniversary dinner, the group CEO thanked his colleagues “for their passion, dedication and support that has given us so much to be proud of. When the various business units work together as one in a cohesive manner, that’s when we can truly deliver the best outcomes for CDL and our customers. We must never rest on our laurels and should always strive for continuous improvement.”

CDL’s investors, including Sherman and his family, are hoping that would also translate to the developer’s share price too.