Tan Tze Wooi, CEO of the manager of CapitaLand China Trust (CLCT) , had a busy month traversing China earlier this year following the lifting of zero-Covid measures by the Chinese government, checking on the retail properties under his watch.
“I went to 11 cities. Among them, the malls in southern cities like Guangzhou, Changsha and Chengdu were less impacted by Covid. One of them which did well is Rock Square in Guangzhou. The ones in the northern were hit more badly,” says Tan, because the malls in northern China were closed for more days during the pandemic than their southern counterparts. Provincial governments in the south are also more business-minded, he suggests.
“If you look at our portfolio data points, our northern malls were asked to shut for more days than the southern malls. The biggest part of our retail portfolio is in Beijing, Harbin and Inner Mongolia, and these cities were asked to shut down more,” Tan says.
Watershed year
In 2019, CLCT raised $279.4 million via a placement and preferential EFR to partly finance the acquisition of three retail malls from sponsor CapitaLand, which was before it was restructured into CapitaLand Development and CapitaLand Investment (CLI). These were Aidemendgun and Xuefu in Harbin and Yuhuating in Changsha.
In 2020, CLCT’s malls in China entered what was its darkest time when Covid-19 hit. Hospitality, tourism and retail were hit most by measures to curb the runaway virus.
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“Crowds and trades were not able to operate per normal, including enrichment classes for kids. These are the content that retail malls are able to capture spending from. We went through a difficult period when tenants were not able to operate and landlords had to support tenants through rent relief. The year 2020 was probably our lowest point,” Tan recounts.
In September 2020, CLCT broadened its investment mandate from owning just retail assets in China to holding New Economy assets such as business & technology parks, logistics parks, data centres and integrated developments.
That year, CLCT raised $326 million from a placement and preferential equity fundraising (EFR) to partly fund five business & technology parks from CapitaLand. CLCT also acquired the remaining 49% of Rock Square it did not own from its sponsor. In 2017, CLCT took a 51% stake in Rock Square, Guangzhou, in partnership with CapitaLand.
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In 2021, CLCT bought four logistics parks from unrelated third parties. Since its IPO, CLCT, formerly known as CapitaLand Retail China Trust, has divested five retail malls. Three of these were master-leased, Minzhongleyuan was sold to a city authority while Saihan in Hohhot was partly exchanged for Nuohemule which happens to be atop a metro interchange.
Since IPO, CLCT has acquired a total of 18 assets of which 10 were from the sponsor and eight from third parties. With hindsight, the 2019 acquisitions probably stressed the portfolio because of the unforeseen pandemic in 2020 (see Table 1).
However, the five business & tech parks in 2020 and logistics parks in 2021 stabilised the portfolio when China had various Covid lockdowns.
Still, China recovered in 2021. Although borders were closed, the Chinese government managed to suppress Covid. But as the Omicron variant spread in 2022, the economy recovered in fits and starts a couple of times until the zero-Covid policy was implemented. After the National People’s Congress meeting in November, the government suddenly lifted all measures. Following the more recent March meeting, more business-friendly measures have been introduced by President Xi Jinping’s new government.
“In 2022, when Shanghai was in lockdown for over two months, our business suffered. Things started to improve in 3Q2022, then weakened a little bit in 4Q2022. They then had to turn off the zero-Covid policy. If you look at our business, the worst is probably over,” Tan says.
Looking back, he believes that the 2020–2021 move into New Economy assets was timely despite the impact it had on distributions per unit (DPU) (see Table 1).
“A couple of things happened because of the CapitaLand-Ascendas Singbridge merger in 2019. CapitaLand was very heavy on traditional assets such as residential, retail and lodging. In China, Ascendas had been involved in the G2G (government-to-government) Suzhou Industrial Park (SIP),” Tan recalls.
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“We did not need an EGM to change the investment mandate. An EGM is needed within three years of the IPO, to change the IPO investment mandate. We have gone beyond that horizon. We had to make the announcement of investment mandate expansion, rationale for doing so and give the REIT a month to initiate the change,” Tan explains.
Since CLCT’s IPO in 2006, China itself has taken steps to remake its economy. “There are more asset classes in China’s own real estate markets that are REIT-able,” Tan says.
In 2020, China started pilot schemes for C-REIT structures which were mainly for infrastructure, industrial property and rental housing. In March this year, retail was included.
A more diversified portfolio
“With China spearheading infrastructure like digital, data centres and cloud-based technologies, it makes sense for us to broaden our mandate. We’ve inherited solid and mature business parks. Some of them were on [CLI’s] balance sheets and some were in private funds. If you look at fund life, 2020 and 2021 were fund maturity or liquidity windows. These are some of the considerations that went through our mind when we expanded that mandate to create that new growth catalyst for CLCT,” Tan says.
Previously, CLCT was spread thinly across various Tier 1, Tier 2 and Tier 3 cities. “Over time, we got to know the market better and to be more selective. We decided to concentrate around [CapitaLand’s] five core city clusters — Shanghai (east), Beijing (north), Guangzhou-Shenzhen (south), Chengdu (West) and Wuhan (in the centre),” Tan says.
Based on CapitaLand’s regional focus, business & technology parks are in Xi’an, Hangzhou and Suzhou. CLCT’s logistic park acquisitions are in Chengdu, Wuhan, Shanghai and Kunshan (a satellite town connected to Shanghai by the metro).
“You see us moving in areas where we can capture diversification and geography. We started heavily in the north with 70% in Beijing. It has now lightened. That ratio has come down to less than 40%. Assets are diversified with business parts and logistics where we see growth areas such as the Yangtze Delta and Pearl River Delta,” Tan adds.
During the pandemic, CLCT also took the downtime to implement AEIs on its biggest mall, Xizhimen, in northwest Beijing. Last year, Wangjing Mall in Beijing underwent some AEI. CLCT’s manager is now working on Grand Canyon Mall in southern Beijing and focusing on vacancies in the Hangzhou-Singapore Science & Technology Park.
Occupancy versus rents
What is more important to Tan — occupancy or rents? “I want both ideally. But at different stages of negotiating and sealing a deal, we have to be more strategic in thinking and more tactical. Last year — under that kind of difficult climate — if you want to raise rents, it’s difficult to do business,” Tan says.
More importantly, retailers must feel they can operate with profitability. They must have confidence in mall management — a clear direction of where you want to position your mall and footfall, Tan elaborates.
Rent is a function of sales and margins. For some businesses, CLCT has a lease structure of lower rents in the first year. “I’m ok to lower rent accommodation in the first year, but other parts of the jigsaw should be built. In the last three years, it was difficult to get positive rent reversions because of Covid,” Tan says.
Most of CLCT’s lease structure comprises the higher of either base rent or a percentage of the tenants’ sales figures. Tan indicates around 70% of lease structures are of such a nature, approximately 20% (give or take) of leases are based on fixed rents and about 5% is just from gross turnover rent (GTO).
“As a REIT, the GTO component is always very small. 3% to 5% is exposed to that, so even during Covid, with zero sales, at best/worst, the impact is contained to that level,” Tan says.
Careful capital management
CLCT’s capital management is probably a model other S-REITs with Chinese assets may decide to study. First off, around 20% of debt is up for renewal on an annual basis. This ensures that debt maturity is staggered.
“We want to make sure not more than 20% is up for refinancing so we are not subject to undue pressure when a whole basket of borrowings are up for renewal,” Tan says.
Secondly, to mitigate interest rate volatility, around 70% of borrowings are on fixed rates. The other part is foreign exchange. CLCT’s income is in renminbi but DPU is in Singapore dollars.
“Every half year we pay DPU in Singapore dollars so we’ll hedge 50% of our income,” Tan says. “These policies have been consistently in place,” he adds.
The other interesting aspect of CLCT is how it manages its capital structure. Since its IPO, the majority of its borrowings were done offshore as the cost of debt was lower. However, with the accelerated interest rate hike cycle by the US Federal Reserve and the loosening of monetary policy by the People’s Bank of China, onshore rates are either on par or lower than offshore rates.
“We’ll be reviewing the onshore borrowing to see how to make it more favourable overall,” Tan says. At present, there are constraints on borrowing and the use of bank loans by entities such as REITs and developers. For instance, it is not possible to use onshore loans to refinance an offshore loan that is expiring, despite the asset being in China.
A way around this could be for CLCT to acquire an asset onshore to be financed by an onshore loan. Concomitantly, CLCT could divest an asset and repatriate the funds offshore to settle the offshore loan. Tan is considering whether to divest Shuangjing Mall for instance, when its master lease runs off.
Separately, CLCT has $130 million of perpetual securities at 3.375%. “My pricing is attractive and it’s a small percentage of my market cap. At the time, we didn’t want our perps to go beyond 10% of our market cap,” Tan says. The call date is 2025. Once again, CLCT could acquire a property onshore and divest an asset ahead of the perps call date in 2025.
Asked if aggregate leverage or interest coverage ratios was more important to Tan, the manager of CLCT REIT has always guided on not going above 40% “on a stable basis”. “We may tactically opportunistically move it up but with a clear understanding of how to take it down. Ideally, we’d like to sell something before we buy something,” Tan says.
Inevitably, interest coverage ratio (ICR) for all the REITs have been falling because debt costs more since 2022; ICRs may continue to fall this year as debt expiries are refinanced. “We have a lot of room. Our last disclosed number was 3.8 times,” Tan says. The Monetary Authority of Singapore’s (MAS) rule of 2.5 times is only if REITs take their aggregate leverage beyond 45%. Most loan covenants require an ICR of 1.5–1.75 times.
Integrated development on the cards
According to CLCT’s latest presentation, the asset mix it would like to attain is 30% of AUM from retail, 30% from New Economy, and 40% from integrated developments. These could be two properties in Shanghai, Hongkou Plaza and Minhang Plaza, which comprise office and retail.
Hongkou Plaza is situated at the Metro station that serves the famous football stadium. The Hongkou district was originally part of the American Concession before 1949 and is now part of the North Bund. However, in FY2019, Hongkou Plaza was valued at more than RMB9 billion. Well-located properties don’t come cheap.
“Hongkou is big. It makes sense because when we grow bigger, we need to reconstitute and recycle capital from lower-growth assets. As we have more New Economy assets, our cost of capital should improve as sources of income for our DPU becomes clearer. It would make sense to address these chunky assets then. In the long term, our vehicle is meant to be a proxy to China. Domestic consumption is increasingly a big portion of the economy,” Tan says.
Thanks to Tan and his management team, CLCT is now on a stronger footing as it has a strong sponsor with the ability to support the REIT financially, a more resilient pipeline of both New Economy and integrated developments in the prime areas of Shanghai, more sources of capital, a conservative approach to capital management, and the patience and ability to combine these various aspects — all heartening news to unitholders in these uncertain times.
