Link REIT spreads its wings: What’s next for Link REIT after acquiring the Mercatus Co-operative assets?

First off, Link REIT is the only Asian REIT that is internally managed. That is, the asset management, property management companies and the properties themselves are owned by Link REIT and its unitholders. Investors of S-REITs will be aware that for S-REITs, the asset management and property management companies are usually owned by the sponsor of the REIT, which also has a significant stake in the REIT.

The second difference between Link REIT and the other Asian REITs is its size. It is Asia’s largest REIT in terms of market capitalisation and assets under management (AUM, in HK$). CapitaLand Integrated Commercial Trust (CICT) comes a distant second.

A third difference between Link REIT and S-REITs is its much lower aggregate leverage. As at Sept 30, 2022, Link REIT’s 2HFY2023 aggregate leverage was 22.7%, and it had HK$13.2 billion ($2.3 billion) of undrawn committed facilities and HK$2.1 billion cash and bank balances. (Link REIT has a March year-end)

The Singapore portfolio, for which Link REIT was the successful bidder, comprised Jurong Point to be transacted at $1,988.90 million, and Swing By @ Thomson Plaza (formerly Thomson Plaza) for $172.53 million — or $2.161 billion in total. The acquisition is likely to be financed by Link REIT’s cash and debt facilities.

See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM

“We’ll still use Singapore-dollar loans for this asset, for a natural hedge. We tend to do that for our overseas assets,” says George Hongchoy, CEO of Link REIT, in a recent interview.

“Our overseas acquisitions and investments are principally funded by local currency borrowings as natural hedges where feasible and cost-effective. For the [distributable] income, when we sign off our budget in March, we’ll forward-hedge for one year. At least then, we know there is no volatility in terms of currency, but volatility always comes from the business side,” Hongchoy explains.

DPU-accretive acquisition

See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM

Ng Kok Siong, Link REIT’s CFO, indicates that the REIT has access to Singapore dollar funding at 4.2%. The portfolio’s net property income (NPI) of $106 million on a historical basis, including property tax but excluding income tax, translates into an NPI yield of 4.9%. As part of the transaction, Link REIT will manage AMK Hub. Also, as part of the transaction, the REIT takes on board around 140 staff of which around 100 are operational staff at the property level.

Based on the NPI yield of Jurong Point and Swing By @ Thomson Plaza, the accretion to DPU is likely to be around HK$0.04 while the fee income, less costs for AMK Hub, is likely to add a further HK$0.02 to DPU, Ng says. In 1HFY2023, Link REIT distributed HK$1.551 per unit.

On the other hand, Ng is quick to acknowledge that the Singapore portfolio’s NPI yield is historic and hence the NPI does not fully account for the rise in utilities during the year. “The 4.9% headline yield is based on the historical preceding 12 months. Utilities has come up quite a fair bit since the end of the Energy Market Authority [with energy price liberalisation]. There’s wage inflation. So there’ll be some pressures on direct costs. But overall, even 4.9%, including all the costs, is pretty competitive,” Ng says.

For the six months to Sept 30, 2022, Link REIT’s borrowing costs were 2.5%. However, this is set to rise. Before the announcement of the Singapore acquisition, UOB Kay Hian forecasted a funding cost in FY2023 of 3%, and for total interest expense to increase by around 50% y-o-y. In 1HFY2023, interest expense was HK$665 million, up 29% y-o-y. Interest expense in FY2022, for the 12 months to June 30, was HK$1,002 million.

In December 2022, Link REIT issued HK$3.3 billion of five-year convertible bonds at 4.5%. The strike price of the bonds is HK$61.92 versus Link REIT’s current price of around HK$63. In Nov, when the bonds were first announced, China had not given any indication of lifting its zero-Covid policy, and Link REIT was trading at around HK$53. If prices continue to rally with China’s re-opening, in particular after peak-Covid, a full conversion of the bonds would dilute Link REIT’s unitholder base by around 2.5%, Ng says.

The convertible bond issuance is not connected to the Singapore acquisition. “We separated the two decisions. We didn’t know [whether the Mercatus transaction] would happen until the second half of December. When we did the convertible, it’s just purely a window of opportunity to tap the liquidity, and pricing being fair, we just raised HK$3.3 billion and paid down existing loans,” Hongchoy says.

A new model for Link

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In a statement, Link REIT says it is exploring the introduction of joint-venture partner(s) before completion for co-investment in the two properties. “We are targeting capital partners to take on a partial stake and strategic partnerships with reputable like-minded investors and to manage gearing levels and to have an optimal capital structure,” Hongchoy had said during an analysts and media briefing on Dec 28 last year.

“We are working on a variety of possibilities, including a sale and bringing in capital partners in some of our existing assets. With this project, we may end up completing this deal without investing 100%. There are a few balls in the air we need to finalise.”

When pressed on who could be potential capital partners, Hongchoy indicated they are likely to be longterm investors including sovereign wealth funds. “These two assets are core with a very small plus. We’ve been looking at capital partners along those lines. Examples would be some of the family offices, insurance and pension funds and hopefully these capital partners would be familiar with the asset class,” Hongchoy had said on Dec 28.

The capital partner or partners would be participating with patient capital. “We are a REIT, and in most cases while we might do a 10-year projection we don’t have a 5- to 7-year exit plan for our assets. We want to have capital partners that are like-minded,” Hongchoy says.

In February 2022, Link agreed to enter into a joint venture with Oxford Properties Group (Oxford) in the Investa Gateway Office (IGO) venture, which consists of a prime office portfolio in Australia worth over A$2.3 billion ($2.1 billion). Link currently holds 49.9% interest while Oxford retains a 50.1% interest. The properties are in Sydney and Melbourne in the core CDB and the portfolio is managed by Investa.

“We have a lot of partners in different forms. We bought the 49% of office portfolio from Oxford in Australia. We are a capital partner in that portfolio. Having a capital partner but at the same time managing those assets ourselves, that’s something that is new and that’s something that we hope to do more of,” Hongchoy says.

Lease expiries lessen volatility

As Hongchoy sees it, commercial properties, in particular retail assets, have staggered expiry profiles. Most retail leases last for two to three years.

“When the economy is not good, rents don’t rise or fall by 100% because some leases haven’t expired and tenants are still paying. We’ve been very fortunate that our collection rate has been in the high 90s across all geographies. But at the same time, you know, when rents go up, they don’t go up immediately. Because again, we have these leases that need to expire before we can put the rent up. So it’s supposed to be a little less volatile set of investment,” he says.

Moreover, in the age of ecommerce, retail malls have focused increasingly on defensive trades — supermarkets, healthcare, children’s education, food, and in some cases, public libraries. In the portfolio Link REIT is acquiring, 60% of gross rents are from non-discretionary trades such as supermarket (6%), F&B (38%), and personal care and medicine (15%).

Bloomberg Intelligence says: “Both malls, with a weighted average lease expiry (WALE) of about two years, could offer some rental upside, given high occupancy rates nearing 100%. About 85% of gross rents will expire by 2025, including 27.8% in 2023, 27.7% in 2024 and 28.6% in 2025.”

As at Sept 30 last year, Link REIT owns 130 retail, office and car park properties in Hong Kong valued at HK$183 billion; six retail properties, five logistics assets and an office building in China; and three retail properties and six office properties in Australia, including 49.9% of an office portfolio in Sydney and Melbourne. Altogether, excluding the Singapore malls (the transaction is likely to be completed in March), Link REIT has AUM of HK$246 billion.

In 1HFY2023, its revenue stood at HK$6.04 billion, with NPI at HK$4.59 billion, translating into an NPI margin of a tad under 76%. A review of Link REIT by a BoCom International research report indicates that rental reversions rose by 8.5% in 1HFY2023 compared to 5.9% in 2HFY2022 and 3.4% in 1HFY2022. Occupancy rate was close to a historical high at 97.5%, and rental income from Hong Kong retail properties grew 3.8% y-o-y to HK$3.24 billion; tenant sales recorded a 3.8% growth y-o-y in the six months to Sept 30, outpacing just 0.8% by the overall Hong Kong market. Car park revenue posted a 12.7% y-o-y growth.

“Hourly rental has already recovered above pre-Covid levels and two acquired mature carpark centres started to contribute to the REIT’s FY2023 rental. The mainland China portfolio held steady. Despite the CNY24 million [$4.6 million] rental concessions incurred in 1HFY2023, rental from the mainland still managed to increase by 3.3% y-o-y to HK$789 million, thanks to several earlier acquisitions,” BoCom International says.

An operating platform in Singapore

Referring to the sale of Jurong Point by Guthrie GTS and Lee Kim Tah to Mercatus for $2.2 billion, Hongchoy jokes: “We were looking at Jurong Point in 2016–2017 before Mercatus bought it. We couldn’t afford the price.”

At the time, CFO Ng, who was previously at CapitaLand, had not joined Link REIT. Ng knows a thing or two about mall management and managing property funds for capital partners.

The reality of not acquiring Jurong Point in 2016 is more mundane. Owning one asset — especially a suburban retail mall — did not make commercial sense to Link REIT. “If you don’t have a team and if you only have one asset, it’s a long way to fly to look after one asset. This is a chicken -and-egg situation. Do you get the asset first and hire people or do you hire a bunch of people first? At that time, the proposition was different. With this transaction, which started off with four assets and a team, we removed the chicken-and-egg dynamic,” Hongchoy says.

According to him, the seller changed their mind about selling four assets. “In some ways it’s a smaller package but it didn’t change some of the points I made. We can get a good team to join us, and we have a platform from which we can continue expanding in this part of the world,” he adds.

The fourth property in Mercatus’ original sale portfolio is Nex, which is 50% held by Mercatus and 50% by a PGIM fund. Nex is managed by PGIM.

The other reasons for the Singapore move are obvious: robust regulatory framework, rule of law, political stability, low unemployment, its triple-A rating, and of course, importantly for disposable income, Singapore is one of the wealthiest countries globally by GDP per capita. In addition, Singapore generally weathered Covid without major issues. The tax transparency issue that makes S-REITs attractive does not apply to Link REIT’s acquisitions as Link REIT is not listed here.

“From a diversification point of view, Singapore, unlike Hong Kong, is not tied to the US,” Hongchoy says, referring to the HKD-USD peg. Although both Hong Kong and Singapore do not have independent monetary policies, Singapore has an exchange rate policy where the Singapore dollar is measured against a basket of currencies. “One of the diversification goals in investing in Singapore is [the SGD] will move slightly differently from Hong Kong,” Hongchoy points out.

From suburban Hong Kong to global REIT

Link REIT was established in 2005 when the Hong Kong government divested assets from the Hong Kong Housing Authority, including 151 retail properties in public housing estates and 79,000 car parks.

It appears that Link REIT has often come under criticism by the lower-income groups who say that retail prices rose after their neighbourhood shops were acquired by the REIT (much like the angst over retail REITs in Singapore). Unlike the retail S-REITs, Link REIT is viewed by residents in public housing estates as a public good in private hands.

According to a 2019 report in the South China Morning Post, three contentious areas that were a source of public anger were the Mandatory Provident Fund, the MTR and Link REIT’s management of properties in public estates. Hence its management has to tread a fine line between stakeholders and its unitholders.

“The way we look at it in Hong Kong, the first step, at the time when we bought those assets, people who lived above them didn’t shop there. We improved over time so there is more spending made on the mall closest to their home, and the offerings improved with better tenants. The trade mix hasn’t changed but tenants have changed, for example, better restaurants, or smaller restaurants and more cuisines,” Hongchoy explains.

Retail REITs are often focused on ensuring their tenants do well. “I like to always say to our leasing staff, for example, for restaurants, try to find better restaurants as people love to eat everywhere. For example, a better Thai restaurant replacing the current Thai restaurant; or if a restaurant is too big, it’s better to have two cuisines. The trade mix really hasn’t changed too much but the tenant mix has improved drastically,” Hongchoy elaborates.

Another strategy is to attract people from outside the immediate catchment so that tenants have more traffic. “You will have more traffic with people who tend to have a higher income level and higher household spending capacity. To draw them into spending more allows us to increase the price point of the outset,” Hongchoy continues. “The improved quality of service and product have allowed tenants to do well and we think we have the formula to make sure there are more people coming to the mall.”

Hongchoy believes that malls such as Jurong Point and Thomson Plaza can be the catchment population’s “third place” after home and work.

In 2014, Link REIT ventured into China with an initial acquisition of Beijing EC Mall, followed by two commercial buildings in Shanghai. As Link REIT expanded overseas, it started divesting some of its Hong Kong properties from 2015 onwards. Following the Singapore acquisition, Hong Kong’s portion of AUM will fall to a pro forma 74.4% from 78.3%. Singapore will account for 5% of overseas assets, taking total overseas assets outside of mainland China and Hong Kong to 11.1%, up from 6.4% as at end-September.

A REIT model for S-REITs?

While Link REIT may have come under some flack in its home market for focusing on tenants and NPI, S-REITs have nursed their own controversies. Investors have occasionally mulled over whether internally managed REITs could serve them better. Witness how some sponsors divested overpriced assets into their REITs, or requested unitholders to finance significantly dilutive acquisitions.

OUE Commercial REIT and its acquisitions of OUE Downtown and One Raffles Place come to mind. Forchn Holdings divested master-leased properties into EC World REIT in 2016 and is currently facing challenges refinancing these master-leased assets. More than 80% of EC World’s rents are from Forchn Holdings and its related units. Most recently, EC World REIT has been postponing the monetisation of two of its assets as required by its financiers as part of its loan covenants.

Eagle Hospitality Trust was suspended without distributing a cent, with retail investors losing all their investments in it. Perhaps Eagle was more a case of requiring more due diligence and disclosure in its prospectus.

“If you look at another market, which has gone through this development, it’s Australia. They used to have a lot of externally managed REITs, but over time, those became internal,” Hongchoy says.

Internally managed REITs have some advantages over externally managed REITs. First, there is no conflict of interest between sponsor and REIT. There are no base and performance-based fees, or acquisition and divestment fees. Expenses involved in acquisitions and divestments are recovered through cost-recovery.

“My salary is just cost-recovery. It’s not based on a percentage of AUM, we don’t charge an acquisition fee, we don’t charge a disposal fee. We don’t need to get the deal done so we will have a higher AUM and get an acquisition fee, as some of the external managed REITs might do,” Hongchoy points out. “That’s how we have managed ourselves since the IPO. But it is unique compared to Hong Kong, China, Singapore, and Japan.” In addition, when it does not make sense to hold an asset, Link REIT has no qualms about selling it.

While some sponsors believe in supporting their REITs, other sponsors have also stuffed their REITs with dilutive acquisitions from which those REITs have yet to recover.

Since the start of 2023, Link REIT is up 8.7% to more than HK$63, taking its unit price to a premium to the strike price of the HK$3.3 billion convertible bonds, and to an annualised DPU yield of below 5%, giving it a lower cost of capital than most of the externally managed REITs.

Link REIT’s entry into Singapore may provide new concepts and tenants for the two malls, and also for local investors.