On Aug 23, words by Jerome Powell, chairman of the Federal Reserve, echoed globally. He said: “The upside risks to inflation have diminished. The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.”
Analysts have chorused that S-REITs, which have had a moribund two years, are beneficiaries. The immediate impact is on unit price, which is rebounding given lower cost of capital and lower risk-free rates and their impact on the yield spread. To compensate for lower risk-free rates, unit prices of S-REITs are rising.
Any S-REIT is a candidate for compressed yields. The immediate reaction is for the US-based S-REIT to rebound the most as they had fallen the most due to Manulife US REIT’s troubles.
Global investors, including institutional investors, will likely take a second look at Singapore-focused S-REITs. Among them, CapitaLand Integrated Commercial Trust C38U (CICT), with its A3 rating, one of the highest among the S-REITs, is a clear favourite.
As one of the top-five REITs by assets under management and market capitalisation in Asia-Pacific (ex-Japan), an important component of the EPRA NAREIT Developed Market Index and a major component of the Straits Times Index, CICT owns many properties — office, retail and integrated developments, a phrase promulgated by CapitaLand more than a decade ago.
According to a report by Morningstar dated Aug 27, CICT owns 15.10% of Grade A Singapore office held by S-REITs, more than any other REIT, and 6.35% of the retail stock held by S-REITs, also more than any other REIT.
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Its properties are among the most well-known, visible and well-patronised in Singapore. Offerings within them range from the up-market Jaan at Level 70 of Swissotel to the Food Junction foodcourts in suburban malls such as Junction 8 and Lot One Shoppers’ Mall. Swissotel is part of Raffles City Singapore, an integrated development comprising an office tower, two hotels and a mall atop City Hall MRT Station, an interchange station.
Nearby and linked to the same MRT station is Funan, an integrated development comprising an office tower, a serviced residence and a mall. The idea of integrated development is for the office and other parts of the development to support the mall and for the mall to provide services such as a supermarket and other amenities for the offices, serviced residences and hotels.
Based on CICT’s portfolio valuation of $24.5 billion as at end-December 2023, 93.7% is in Singapore, 2.7% in Germany and 3.6% in Australia. Office assets comprise the largest portion at 39.4%, followed by retail (30.2%) and integrated development (30.4%).
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In total, CICT owns 10 office properties: Asia Square Tower 2, CapitaGreen, 70% of CapitaSky, Capital Tower, Six Battery Road, 21 Collyer Quay and 45% of CapitaSpring in Singapore. In Germany, CICT owns 95% of Gallileo and Main Airport Center. In Australia, CICT counts 66 Goulburn Street and 100 Arthur Street as office properties. Additionally, CICT owns 50% of 101-103 Miller Street and Greenwood Plaza, an integrated development in Sydney. CICT also owns Raffles City Office Tower, Funan’s office tower and Atrium @ Orchard’s two office towers, which are part of integrated developments.
Acquisition target?
CapitaSpring is an integrated development. It includes an office tower, a serviced residence and some retail. CICT has a call option to acquire the 55% of CapitaSpring it does not own, but the serviced residence is not part of the call option. “A potential acquisition could be the call option exercise for the remaining 55% stake in the iconic CapitaSpring — the funding for which could come from the divestment of some of CICT’s mature/non-core assets; for example, Bukit Panjang Plaza, 21 Collyer Quay, and Citadines Raffles Place,” says Vijay Natarajan, vice-president, real estate and REITs, RHB Bank.
“We estimate a $230 million–$250 million valuation for Citadines Raffles Place. If proceeds are utilised to repay debt, we anticipate a decline in gearing of 0.3 percentage points (ppts) from the current 39.8% level and a mild accretion of 0.1% to distributions per unit (DPU). We are positive on the potential divestment, but anticipate greater impact from the divestment of larger assets such as Bukit Panjang Plaza or 21 Collyer Quay,” writes JP Morgan in a report dated Aug 24.
“We don’t necessarily have to own 100% of everything; 45% is quite a significant stake. The call option gives us the option to see how things progress. I don’t think we need to rush in,” says Tony Tan, CEO of CICT’s manager, in a recent interview.
Office properties have the tightest capitalisation rates and lowest yields among Singapore’s asset classes. The traditional view among analysts is that S-REITs’ cost of capital is higher than office cap rates and net property income yields. Hence, it is likely to be challenging to acquire a low-yielding office asset.
“As a portfolio in our office categorisation, the passing yield is not so low. It’s around 4%. It is not a negative carry currently,” explains Tan. In 1H2024, CICT’s average cost of debt was 3.5%, and Tan and his team were guiding for around 3.5% in 2H2024 before the Fed announced its pivot.
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The office sector will remain quite stable in Singapore, given the limited supply in downtown CBD, he adds. New supply is coming from old stock, Tan adds, referring to Keppel South Tower in Tanjong Pagar and the Shaw Tower Redevelopment on Beach Road. “We understand that there isn’t much supply from government land sales,” he says.
Morningstar expects CBD office rents to stay flat as limited office supply offsets weak office demand. “Beyond that, we think that interest rate cuts by the Fed will stimulate business expansion activities and drive up office demand. With projected supply staying tight for the next three years, we think any strong pick-up in office demand will push up office rents, benefitting CBD office landlords,” the Morningstar report dated Aug 27 says.
AEI, redevelopment to underpin DPU
Tan and his team have a timetable of asset enhancement initiatives to support growth as they identify properties with redevelopment potential.
“The reason why we can redevelop is because we can identify the best use for the real estate location. From a timing perspective, a few things have to be taken into consideration. The decision must coincide with a major tenant expiry or a major overhaul of mechanical and electrical (M&E) equipment. We are likely to take longer to decide and the plan must be endorsed by the authorities,” Tan says.
CICT resulted from the merger of CapitaLand Commercial Trust (CCT) and CapitaLand Mall Trust (CMT). CCT redeveloped CapitaGreen from a carpark back in 2014 and started to redevelop Golden Shoe Car Park into CapitaSpring, which received its temporary occupation permit at end-2021. The 280m 50-storey CapitaSpring cost $1.82 billion (all-in), with a yield-on-cost of 5%. As at Dec 31, 2023, CICT’s 45% stake was valued at $918.9 million.
“The lead time for any redevelopment is quite lengthy. We are talking about two to three years, which will take time to materialise. An acquisition is an opportunity. Sometimes, we give acquisitions a pass because we don’t think we need to jump into it. But if a certain opportunity is compelling enough, we may consider it,” Tan says.
Asset enhancement initiatives (AEIs) are usually ongoing and provide higher returns than acquisitions. CICT commenced AEIs on Gallileo, a 38-storey Grade A office tower in Frankfurt’s banking district, in February. CICT will be spending EUR180 million ($262 million) on AEIs. The AEI will occur in three phases, primarily focusing on fulfilling the tenant’s building requirements. Additional efforts will be undertaken to improve the mechanical, electrical and building automation systems, making Gallileo more environmentally and operationally efficient. On the ESG front, Gallileo will likely obtain a minimum green rating of LEED Gold.
In March, CICT announced the European Central Bank (ECB) signed a lease agreement with CapitaLand for 10 years. The ECB will occupy around 93% of the building’s total net lettable area (NLA). Starting from the second half of 2025, CapitaLand will progressively hand over the leased area to the ECB after completing the building’s AEI. CapitaLand is also expected to conclude a lease agreement soon with the City of Frankfurt for the basement space in the Gallileo to be used by the English Theatre Frankfurt. With the ECB and the City of Frankfurt as tenants, the building’s committed occupancy is expected to exceed 95%.
In 2018, CICT spent the equivalent of $569.6 million to purchase Gallileo. By end-2023, the property had been revalued down to $339 million.
“Management guided healthy double-digit rent reversion for the new leases. Rental income from the asset is expected to progressively kick in from 2H2025 onwards. Overall, we see this deal as a positive one, which should result in a good valuation uplift for the asset during the year-end revaluation,” Natarajan says regarding Gallileo.
Predominantly Singapore
On the retail front, CICT owns Bedok Mall, Bugis Junction, Bugis+, Bukit Panjang Plaza, CQ @ Clarke Quay, IMM Building, Junction 8, Lot One, Plaza Singapura, Tampines Mall and Westgate. CICT’s retail portfolio can roughly be equally divided into suburban and downtown.
Given S-REITs’ somewhat chequered track record with overseas assets, Tan reassures that the REIT will remain mainly in Singapore.
“We will continue to be predominantly Singapore-centric, with a small amount of optionality overseas. Over time, the composition of these segments may change depending on the opportunity. I won’t say there will be a specific ratio that will be ideal,” Tan says.
“For investors who want good exposure to Singapore, we still present the best platform for commercial space that includes retail, office and integrated developments,” Tan says. “As an investor, you have good exposure to the unique, evolving consumption pattern in Singapore. This can be downtown or [suburban],” Tan says.
“The construct in the portfolio is very important. No specific ratio of retail, office or integrated development will be ideal. In our experience, mixed-use integrated assets will be much more resilient through cycles. The portfolio may involve a little repositioning or even redevelopment,” Tan shares. His view is that mixed-use and integrated developments are likely to provide more value to investors because they have an “internal ecosystem” where office workers and visitors can access the mall’s amenities.
However, if the portfolio is tweaked or repositioned, Tan has to balance short-term stable distributions to investors vis-a-vis a long-term plan. More importantly, Tan and his team have to time AEIs and redevelopments so they do not disrupt investors’ DPU expectations.
“Our portfolio is a good mix of different vintages. We plan our AEI timing carefully. We don’t want to disrupt our DPU on a y-o-y basis, but we must make plans for future cash flows. Each AEI upgrade gives us value enhancement. Hence, it’s making sure we plant different flags at different milestones to derive more revenue streams for CICT,” Tan elaborates.
A beneficiary of the RTS
IMM, a popular outlet mall near Jurong East Interchange, is undergoing a $48 million AEI lasting from 1Q2024 to 3Q2025. Phases 1 and 2 of level 1 are in progress and on track to meet the target ROI of 8%. Both phases have a committed occupancy of 98.7%, and the new tenants are expected to start operations in 4Q2024.
“IMM is quite unique to Singapore. It is the largest location, where you have the most outlet offerings and a one-stop location for both locals and tourists. We want to further strengthen IMM,” Tan says.
When the rapid transit station (RTS) between Woodlands North and Bukit Chagar stations is up and running, IMM may benefit. Its only competition at present is Johor Premium Outlets in Kulai, which is accessible only by car or coach. Even with cross-border travel made easy by the RTS, it would still take an additional journey to get to Johor Premium Outlets for car-lite Singaporeans.
IMM is readily accessible by public transport and it has several hundred carpark lots available.
“We want to further anchor IMM as a regional outlet mall where even Johoreans living close to the border may find it even more convenient to come over. If the RTS is open, IMM will be a more convenient destination by MRT,” Tan says. “We have the largest regional offering of outlets, and hopefully, we can extend the concept beyond Singapore. We want to enlarge our lead further, which is why the AEI is important, to free up space for more outlets. Our outlet mall is about accessibility and convenience, and the basic infrastructure is very convenient for foreigners and visitors,” he points out.
CQ @ Clarke Quay reopened in April after a $62 million AEI. CICT did not reveal the ROI of the AEI. Although the AEI is completed and Fort Canning MRT serves the property on the Downtown Line, Tan points out that CQ @ Clarke Quay is unlikely to attain its full potential till 2026. CanningHill Piers, which comprises two residential towers, a Moxy-branded hotel and a Somerset-branded serviced residence, provides the “ecosystem and catchment” for CQ @ Clarke Quay and will be ready in 2026.
“It’s a holistic precinct. The full micro market is anchored by the product (CanningHill Piers) coming onstream. The curation of the tenants is very important. Not all tenants will perform well between the completion of AEI and 2026,” Tan observes.
However, Tan is not keen on CQ @ Clarke Quay being wholly reliant on night activity, which was the case before the AEI. “People beget people. Once you draw in the crowd, we need to convert the footfall into sales,” Tan says.
The conversion of visitors into tenant sales has yet to materialise. For the time being, tours and visitors remain “transient”. The precinct’s early 20th-century warehouses are a popular backdrop for Instagrammers.
CQ @ Clarke Quay’s slow 1H2024 performance was the reason for CICT’s anaemic tenant sales, which crept marginally higher by just 0.1% y-o-y in 1H2024 despite a 3.2% y-o-y growth in shopper traffic. “Management attributed the weak growth to the stabilisation of its Clarke Quay asset post-AEI, the ongoing AEI at its IMM property and outbound travel by Singapore residents. Going into 2H2024, management expects local spending to remain resilient and is optimistic that tourist arrivals for upcoming events such as the Singapore Grand Prix will support healthy tenant sales growth,” observes Xavier Lee, equity analyst at Morningstar.
Strong backbone, new trends
Aggregate leverage inched lower to 39.8% on June 30 compared to 40% on March 31. On July 10, CICT issued $300 million 10-year fixed-rate notes at 3.75%. With that, 80% of the debt due to expire in 2H2024 has been refinanced and the expected average cost of debt will likely remain around 3.5%. Although the Fed has indicated a reduction in its Federal Funds Rate, CICT will likely keep a large part of its debt fixed. In 1HFY2024, 76% of debt was fixed.
CICT was one of a handful of S-REITs, including CapitaLand India Trust CY6U , Mapletree Industrial Trust ME8U , and ParkwayLife REIT, which announced y-o-y DPU growth. Its 1HFY2024 DPU rose by 2.5% y-o-y to 5.43 cents, which, if annualised, translates into a yield of 5.12% based on the closing price on Aug 27.
In 2HFY2023, CICT implemented its distribution reinvestment plan (DRP), which could have accounted for the dip in aggregate leverage.
Looking out into the future, Tan expects consumption trends to continue to change. For now, health and wellness figures prominently for consumers. Sponsor CapitaLand Investment is managing Kallang Wave Mall. Tan is observing trends at the Sports Hub, Decathlon and Ikea. Their experiential formats are interesting, he says. “Can we find an appropriate retail mix to add to our offering? There are possibilities of collaboration with activities in Kallang Wave,” he mulls.
With the tailwind of interest rates behind it, CICT is likely to be watched closely by investors and shoppers alike for its next steps.
