Link REIT has been held up time and again as a successful REIT whose management company is internalised. Indeed, since its IPO in 2005, it has outperformed the likes of CapitaLand Integrated Commercial Trust (CICT), CapitaLand Ascendas REIT (CLAR) and Mapletree Logistics Trust (MLT).
As a REIT with an internalised management structure, detractors of the externally-managed REIT model argue that the lack of a sponsor shoving assets into Link to grow AUM and fees is an advantage — which it probably is.
In terms of valuation, Link used to trade at a premium compared to S-REITs. Over the years, as it diversified into jurisdictions such as China and recently the UK, Link has been trading at a discount to NAV. This is probably due to the market and interest rate cycles in places like the UK and Australia rather than its structure.
A quick look at its corporate structure in its latest annual report for the 12 months to March 31 shows unitholders owning both The Link Holdings, which owns the properties, and Link Asset Management, which manages the portfolio.
Ng Kok Siong, Link’s executive director, CFO and member of the board of director, recalls: “The genesis of the company was a spin-off from the Hong Kong Housing Authority (HA) in 2005. It’s a government statutory board, placing its assets into the company.”
Link Asset Management is stapled with The Link Holdings and unitholders own both companies via a trustee, HSBC Institutional Trust Services. Within Link, Link Asset Management can manage third-party properties.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
When Link acquired Jurong Point and Swing By @ Thomson Plaza, Link Asset Management signed an agreement to manage AMK Hub which is not owned by the REIT. Link CEO George Hongchoy introduced the concept of Link 3.0 during the Singapore transaction, where he articulated the idea of investing with capital partners as Link Asset Management takes a more active role in management.
Ng says: “Link was ‘born’ as an internally managed REIT. At the time of the IPO, there were many considerations as the business started rolling, including organising the management, an independent board, governance procedures, and having the independent board organise the CEO and management team and so on.”
“The advantages of internal versus external were not obvious in the beginning. However, the market has seen that over time, the cost structure is much lower, governance is stronger with fewer conflicts, and there is only one portfolio to manage,” Ng continues.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Link does not have a pipeline or a sponsor divesting assets into the REIT. “Investors are primarily focused on DPU, so they don’t necessarily care whether the REIT is internal or external, but institutional investors do differentiate over time,” Ng says.
Not about fees
Link started in 2005 as an internally managed REIT holding suburban retail property and car parks in Hong Kong (Link 1.0) in its first 10 years. It expanded its asset class (diversifying into office and logistics) and into overseas markets such as mainland China, the UK and Australia (Link 2.0).
In the Singapore transaction where it acquired Jurong Point, Swing By @ Thomson Plaza and the management contract for AMK Hub, Link’s management embarked on a fee income trajectory.
In Link 2.0, the REIT divested older assets and diversified out of Hong Kong. In addition to the two Singapore malls acquired this year, Link also owns retail assets in China such as stakes in Qibao Vanke Plaza and Link Plaza Guangzhou; it owns Link Square Shanghai which comprises two office towers; and three logistic properties in China. In Sydney, Link has a 50% interest in the Queen Victoria Building, The Galeries and The Strand Arcade which are retail properties. It also has a 49.9% stake in a trust with Oxford Properties Group, which holds interests in five office properties — four in Sydney and one in Melbourne.
In 2020, Link acquired The Cabot in Canary Wharf for GBP380 million or the equivalent of HK$3.77 billion. In the 12 months to March 31 this year, The Cabot lost 28% of its value and was last valued at HK$2.78 billion ($470 million).
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“We had to write down our UK property due to a combination of rising capitalisation rates and structural work-from-home resulting in lower demand across the office market. However, there was no conflict of interest as we acquired The Cabot as competitively as we could, and not because we bought it from a connected party,” Ng says.
For an external manager, a 20% drop in valuation would translate into many years of foregone fee income. Generally, when interest rates are low as they have mainly been from the Global Financial Crisis (GFC) to 2022, being an “asset-heavy play” is not a problem.
When the cycle turns and a REIT faces difficulties to sell assets, then capitalisation rate expansion will cause both internally and externally managed REITs to suffer write-downs. For externally managed REITs, this would impact fees paid to the manager.
As a case in point, in June this year, Australian real estate group Dexus divested a Class-A office building in Sydney at a 17.2% discount to its Dec 31, 2022 valuation. Other Class-A office buildings in Sydney, including those owned by S-REITs, will be affected and would probably result in lower AUM and associated fees.
In early 2022, CICT acquired 66 Goulburn Street and 100 Arthur Street for A$672 million from CLA Real Estate, its unlisted grandparent. The transaction was announced in December 2021. At the time of acquisition, the price for the two buildings was equivalent to $672 million.
However, the AUD has since weakened against the SGD, which means the price is now equivalent to around $606 million; capitalisation rates have risen; and valuations have fallen. CICT values its properties once a year, so its 1HFY2023 financials are unlikely to reflect a valuation write-down.
In Europe, as at Dec 31, 2022, the value of CICT’s 94.9% stake in Galileo, an office building in Frankfurt, was written down to $370.2 million compared to its acquisition price of $577.4 million. Here, too, the impact included a currency impact from the Euro and the outlook for rents as the tenant is vacating the building in January 2024.
During 2022, CICT continued to acquire assets such as the Australian properties and 70% of CapitaSky. It has a call option to acquire the 55% of CapitaSpring's office and retail portions that it does not own.
CICT also divested its 50% stake in One George Street and JCube. Divestment fees are usually 0.5% of property value compared with the acquisition fee of 1% of the property value. In FY2022, CICT’s acquisition and divestment fees amounted to almost $13 million, excluding base and performance fees which were an additional $87.9 million.
It must be noted though, that CICT’s fees were not the highest as a percentage of AUM. That prize goes to the smaller S-REITs.
Ng says: “The external management model does potentially create conflicts from divestments, as the sponsor loses the AUM and the associated fees. We buy and sell assets to refresh the portfolio and to create long-term value. For us, management does not get paid for acquisition or divestment.”
No sponsor, no fees, no AUM focus
The big positive for local investors looking at Link is that it does not have a sponsor pressuring the REIT with AUM growth. “Due to our cost recovery model, we don’t earn fees as a percentage of AUM, so we don’t have to hug AUM,” Ng says. “Acquiring an asset from the sponsor could create governance issues. For example, did the sponsor sell the asset too cheaply to the REIT? What if you are only a shareholder of the sponsor? Would it complicate the valuation down the road if the REIT acquired it with structured features like rental support? And are you a shareholder of the REIT?” Ng continues.
In addition, the REIT’s manager has to hold an EGM to get unitholders’ approval if the asset is from the sponsor.
Over the past 20 years, there have been concerns over income and rent support compared to the pricing of the asset. If the asset’s yields are not accretive, could the sponsor have lowered the price?
Well-known examples of forms of income support include One George Street, acquired by CapitaLand Commercial Trust with yield protection; Ocean Financial Centre by Keppel REIT and OUE Downtown by OUE Commercial REIT, acquired with rental support; and One Raffles Quay and Marina Bay Financial Centre, acquired with income support.
Other forms of financial engineering include master leases where assets are sold into a REIT at higher valuations based on the discounted cash flow calculations of rental income. Hence, master lease rents for these assets can be higher than market rents.
EC World REIT, for instance, receives more than 80% of its rental income from its sponsor and related units. In this example, the same entity is the manager, the sponsor and the tenant.
Sometimes, S-REITs raise AUM by buying yield-accretive properties where land leases are short, say around 20 years.
In August 2022, CLAR announced the proposed acquisition of Philip APAC Center for $104.8 million. The property had only 20 years of land lease left. In September 2022, CLAR announced the proposed acquisition of a cold storage facility in Buroh Lane for $191 million. The land tenure for this property was also around 20 years.
Earlier this year, CLAR acquired The Shugart for $191 million. The building sits on land with a remaining tenure of 20 yHong ears. In 2021, CLAR acquired a data centre portfolio in Europe, which included a data centre in the Netherlands that also sat on land with 20 years of remaining lease.
The advantage of acquiring buildings on land with 20 years left is the higher yield. However, since the lease is running down, part of the yield also consists of a capital return. Some market observers have indicated that JTC or SLA will only extend the land lease for end-users.
Another issue for externally managed REITs and sponsors is their multiple funds and REITs. If all the REITs need help with financial support, can the sponsor cope? During the GFC, this was put to the test. Both CapitaLand Mall Trust and CapitaLand Commercial Trust had rights issues, as did their sponsor CapitaLand. Elsewhere, MLT had a rights issue. The ultimate parent Temasek had to step in to support CapitaLand with its rights issue.
In 2021, CapitaLand restructured such that the listed entity, CapitaLand Investment (CLI) is a real estate investment manager (REIM) in the manner of Brookstone, Blackstone and BlackRock. Eventually, CLI is likely to hold lower percentages of its REITs and funds than it had done as CapitaLand. Instead, CLI is focusing on AUM growth and fee income.
Similarly, Keppel Corp changed its focus and business strategy earlier this year, to prioritise AUM growth and fee income from both real estate and alternative real assets such as infrastructure and the green economy. Both CLI and Keppel plan to create more funds which they will manage and own modest stakes. Managing the portfolio will provide fee income while exit strategies will provide extra fee income in the form of “promotes” should the portfolio outperform its stated internal rate of return.
Pipeline no longer a strength
REITs are viewed as a form of “perpetual capital” for REIMs because of the fees they generate. “Having a pipeline is not necessarily a strength or an advantage, it depends on the specific circumstances,” Ng observes. The external manager has tasted the honey of acquisition and divestment fees, he indicates.
Even if the sponsor sold the property at a relatively lower price to its REIT, the external manager, owned by the sponsor, receives 25 basis points of fees a year, Ng points out.
In an earlier interview with The Edge, Hongchoy had said: “For internally managed REITs, there is no conflict of interest. Externally managed REITs will always have fees in their cost base. For us, it’s just cost recovery. My salary is a cost recovery. We don’t charge an acquisition fee, we don’t charge a disposal fee. We don’t get the deal done because of a higher AUM. We believe the internally managed model is better. It is unique compared to the REIT structure in Hong Kong, China, Singapore and Japan.”
On the other hand, strong sponsors are often seen as having a positive impact on their REITs, especially when the REITs need to raise equity. For instance, ESR Group provided an undertaking to underwrite $150 million of preferential equity fundraising (EFR) by ESR-LOGOS REIT earlier this year. Mapletree Investments provided financial support to Mapletree North Asia Commercial Trust in 2019 and 2020.
When IREIT Global announced a $75.9 million preferential EFR, sponsors Tikehau Capital and City Developments (CDL) irrevocably undertook to subscribe to their pro-rata allotment. In addition, CDL committed to subscribing for excess units up to $40 million. IREIT Global had excess applications and the issue was 134% subscribed.
Noteworthy, though, is the lack of sponsor support for S-REITs with US assets. This was demonstrated by the reluctance of Manulife to start the process of acquiring a couple of Manulife US REIT’s buildings in December or January this year when the REIT’s manager announced that its aggregate leverage had risen to 49% because of a decline in the valuation of the portfolio.
Instead, Manulife negotiated to divest the manager to Mirae Asset Global Investments along with a preferred placement which would dilute minority and retail unitholders significantly. As it is, the transaction did not materialise, and Manulife is now committed to acquiring Phipps, an office tower in Atlanta.
Similarly, some market observers do not expect Keppel Pacific Oak US REIT or Prime US REIT to be able to rely on their sponsors for financial support should they face financing issues. Hence, market observers believe that such REITs should have been listed as internally managed REITs.
On the other hand, converting an externally managed REIT to an internally managed one is likely to be a long and expensive process, given the approvals, legal advisers, and investment and financial advisers required for the process.
Lower leverage levels
“Link does not have any sponsors to support or sub-underwrite capital raising. Compared to our peers in Hong Kong, we prefer to live with much lower gearing given the house view for higher-for-longer interest rate environment,” Ng says. As an example, he notes that Link would not be able to sustain an aggregate leverage of 35% and refinancing will be too expensive.
In March this year, Link REIT completed a one-for-five rights issue to raise HK$18.8 billion ($3.2 billion). JP Morgan, HSBC and DBS Bank were joint lead underwriters, supported by OCBC, Bank of China, Citigroup, Mizuho and Bank of America Securities.
Ng explains: “We had three Tier One banks — HSBC, DBS and JP Morgan — willing to stand by because the rights issue was at a discount that we believe is fair to allow unitholders who cannot afford to subscribe to sell the rights and while paying the banks the appropriate fees in proportion to their risk. Dilution comes with the benefit of a stronger balance sheet as we enter an uncharted and uncertain time and gives us the flexibility to protect against any further downside while capturing upside if distress deals surface.”
Link 3.0
Increasingly though, Link is beginning to look like a hybrid, or a cross between a CICT and a CLI. For one thing, in Link 3.0, Hongchoy says he is looking to grow AUM “with capital partners, looking for investment opportunities in multiple asset classes, and with different investment models and platforms”.
Capital partners reduce the funding required for each individual investment. “We aim to manage assets for our capital partners, and this enables us to grow our AUM faster,” Hongchoy had said during Link’s EFR. The move would also elevate the role of Link Asset Management, which would gain a source of fee income.
In the meantime, Link has clinched its first development project in Hong Kong with the acquisition of a non-office, commercial-use land on which it will build “non-discretionary retail” with a fresh market and car parks to serve the surrounding community. That, too, is Link going back to its roots when its initial portfolio comprised shopping centres for the community and car parks.
