Standing the test of time

Two decades later, CICT is the largest REIT by market capitalisation and asset under management (AUM). Including distributions, the REIT has returned to investors 688% in those 20 years, or equivalent to about 11% a year. CMT was listed at 98 cents while its descendant, CICT, closed at $2.20 on June 30.

S-REITs, especially those with foreign sponsors, should take note of the journey taken by CMT, CCT and now CICT, in terms of risk management, property management, sponsor support, alignment of interest and capital management, given the current interest rate cycle.

CMT and CCT were merged to widen the focus of CICT to include retail, office and integrated developments. This provides more options for growth and enhanced resilience and stability through market cycles, says Tony Tan, CEO of CICT’s manager. The year since the merger has been an uphill battle against the effects of the pandemic and various measures to control it.

Tan, who was formerly CEO of CMT’s manager, recalls the challenges of the past two years in a recent interview: “The year 2019 was the peak before the onset of Covid and 2020 was a watershed year. We went through a lot of challenges, supporting tenants with $129 million [in rent support]. Protecting the entire system is more important [than profit].”

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

In April 2020, Singapore’s Covid-19 “circuit breaker”, its version of lockdown to halt the community transmission of the raging virus, was triggered. The safe management measures continued through most of 2020 and a large part of 2021. “We had different measures but we’ve seen an improvement from the pandemic,” Tan says.

From March 29 this year, masks were made optional in an outdoor setting. From April 26 onwards, TraceTogether tokens and SafeEntry procedures were no longer required. Gradually, travel restrictions have been lifted as well.

However, Interest rates are rising. This is a negative for REITs’ valuations, operations and capital management. Higher interest expenses, in addition to higher operating expenses and energy prices, would raise the utility costs of REITs and also impact distributable income, and hence DPU for unitholders.

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

Although the headwinds will hit every sector, Tan says “we are comforted we’ve done a bit of work by stabilising operations. Occupancy is picking up, borders are reopening and restrictions are lifted”.

Reasons for merger

REITs need to provide investors with income stability and growth where possible. This is achieved through portfolio and capital management. The S-REIT structure of externally managed REITs relies heavily on the strength and reputation of the sponsor as the management company is owned by the sponsor. While some investors prefer single asset-type REITs, REITs with strong sponsors and mainly Singapore assets have often commanded the lowest cost of capital.

Investors like their S-REITs to stay Singapore-focused but with a measure of diversification. No surprise then that CMT and CCT unitholders voted overwhelmingly for the merger, as the manager has indicated that 80% of assets and net property income (NPI) will be from Singapore.

“We see the greying of lines between the use of properties. CCT had other components and we built Funan into a mixed-use property,” Tan says, pointing out that most commercial government land sale sites are designated for mixed-use developments.

Ironically, both retail and office properties were impacted by the circuit breaker. In FY2020, CICT’s DPU fell to a low of 8.95 cents, down from an all-time high of 11.97 cents in FY2019. DPU has since recovered to 10.4 cents in FY2021 (see table 2). CICT has a December year-end.

To stay ahead of Singapore and the region’s corporate and economic trends, click here for Latest Section

As Tan sees it, scale is important to keep the cost of capital low and for sufficient liquidity. “Trading liquidity is a clear manifestation of the amount of interest and liquidity begets liquidity,” he says. As the second-largest REIT in Asia by market capitalisation and AUM, CICT’s unitholders do not really have to be too worried about liquidity. Moreover, CICT is a constituent of 12 indices including the Straits Times Index.

Since the CMT-CCT merger, the question that has often been asked is: Do mergers create value for unitholders? “In our case, it was quite clear that an overlapping mandate was happening in Singapore and we are the two largest S-REITs. This combination allows the synergy to surface,” Tan says.

The sharing of resources, from procurement and manpower to operations, and the synergies that can come from outsourcing, do lower costs. In addition, Tan cites cross-marketing as another aspect that benefits from the merger, where retail managers can market offices to bigger companies that own the retailers.

For instance, CICT’s CapitaStar programme attracts its tenants by promoting sales. In addition to tenants from the shopping mall, retail tenants in CICT’s office properties have also adopted the CapitaStar platform to promote sales. “Your outreach pool increases,” Tan says.

Ultimately, the merger diversified risk because no tenant contributes more than around 6% to gross rental income.

“The merger allows for greater stability and diversification reduces single-asset risk. The merger aims to ride through cycles, increase resilience, DPU and NAV, and unitholders also want income growth,” Tan says. “The job of a REIT manager is to grow the income because growing income will translate into growth in DPU. But as a larger platform growth in DPU will be more difficult because of the larger base as the rate of growth will slow.”

Although CICT is the largest S-REIT, it has only just entered into the large capitalisation REIT sector which requires a minimum market capitalisation of US$10 billion ($13.9 billion). “We are the first S-REIT to achieve this,” Tan says.

But what is more important, stable DPU or DPU growth? “I won’t want to say we want to trade off one against the other. We need to grow income alongside meaningful scale. We will not grow just for the sake of size,” Tan replies. “With or without a merger, we have to deliver value but the merger should create a more resilient platform in the long run.”

Portfolio adjustments

After the merger, CICT spent a year consolidating its assets and managing the pandemic. It was only in December 2021 that CICT’s manager completed the divestment of its 50% stake in One George Street while announcing the acquisition of two office properties from its grandparent, CLA Real Estate.

"We thought it was timely to do a few adjustments. It’s a journey so it will be an effort that will be ongoing for a while as we look at appropriate opportunities to adjust the portfolio,” says Tan.

This year, with the disposals and the acquisitions, Tan says “the numbers will be quite noisy as a result of the various activities” (see table 1). While REIT managers are not allowed to give forecasts, Tan believes there could be more pluses than minuses.

Last December, CICT completed the sale of 50% of One George Street for $640 million, which translates into an exit NPI yield of 3.1%. In March, CICT completed the sale of JCube for $340 million with an exit NPI yield of under 4%. CICT also raised $250 million through a placement of 127.55 million units priced at $1.96 each.

CICT also acquired 66 Goulburn Street, 100 Arthur Street, Greenwood Plaza and a 50% stake in 101–103 Miller Street in Sydney for around A$1.1 billion ($1.05 billion) (see table 1). According to CICT, the Sydney acquisitions were made at average NPI yields of around 5.1% while CapitaSky was acquired at 4%. That would result in almost $90 million in NPI over a 12-month period.

“We will see the effect of the acquisitions from 2H2022 and we will see the full flowthrough in 2023,” Tan explains. The acquisition of the two Australian offices — 66 Goulburn Street and 100 Arthur Street — was completed on March 24, so only a quarter of the NPI impact could be recorded when CICT announces its financial results for the 1HFY2022 ended June.

In addition, half of One George Street was sold in December 2021 while JCube was divested in March. Meanwhile, CapitaSky’s acquisition was only completed in April while the acquisition of the 50% stake in 101–103 Miller Street and Greenwood Plaza was completed in June.

“There is a timing difference. JCube was sold in March and CapitaSky was completed in April. Directionally, it’s positive,” Tan says.

The boost to NPI from the acquisitions is likely to come at a time when workers are returning to their offices. Although CICT’s office occupancy in Singapore is 92.3% as at end March, its actual “return of office community” was 47% in the week ending April 22. This should be a lot higher in July, as evidenced by packed MRT trains in the morning.

Operationally and organically, consultants expect the office sector to remain resilient. CICT’s rent reversions for its office sector were 9.3% in 1Q2022 and its retention rate was 95.5%, which is high relative to peers.

Figures from the retail front are more nuanced though. Tenant sales in 1Q2022 were up 0.6% y-o-y while shopper traffic fell 5.3% in the same period. The retail retention rate of 91% was higher than peers though.

Value creation

CMT was the first REIT that introduced terms such as asset enhancement initiatives or AEIs, return on investment or ROI of AEIs, and decanting. In addition, CCT redeveloped Market Street Car Park into CapitaGreen and Golden Shoe into CapitaSpring. Ascendas-Singbridge redeveloped 79 Robinson Road into CapitaSky.

Decanting is the removal of a part of leasable space and moving it somewhere else. This happened at Raffles City where CMT created retail space at the expense of car parks.

Decantation originated as an AEI to generate new GFA (gross floor area) for properties. Junction 8 was the first mall to undertake decanting in 2004 when it transferred 70,000 sq ft of GFA from the office tower to the retail space on the basement and levels 1 and 2 of the mall. The average rent increased by about 50% between July 2002 and December 2004. The office tower was, in turn, handed over to charity for non-profit activities.

Why undertake AEIs? Tan says the average ROI of an AEI can be in double digits. For a large-scale AEI, ROIs are in the high single digits because the upgrades require M&E work. Greenfield projects take longer so ROIs are lower. “We’ve done successful AEIs with ROIs ranging from single digits to 10%, and 20%,” Tan says.

CICT’s most recent AEI was at Six Battery Road. Tan says rents have not stabilised but ROI will be in single digits. At 21 Collyer Quay, the ROI should be higher than the guided 7%.

As for the fewer car parks at Raffles City, Tan says Singapore is aiming for a carlite society. Most of CICT’s buildings in the CBD have end-of-trip facilities. These include Funan, CapitaSky, CapitaGreen, CapitaSpring and Asia Square Tower 2. “We provide end-of-trip facilities for the new builds. For the older buildings, we are looking to see whether we should convert some of the space,” Tan says.

IPTs and EGMs

Investors trust CICT’s manager and it is unlikely that the manager acts contrary to unitholder interests. Sponsor CapitaLand Investment (CLI) owns the manager and around 20% of CICT. CLI’s CFO and CEO have said time and again that they are committed to the REITs as the REITs are an integral part of CLI’s business model. On other occasions, CLI’s management has said its best properties are offered to the REITs, and the sponsor won’t stuff its REITs.

It was interesting that CICT did not have EGMs for its recent spate of acquisitions. According to the SGX’s rulebook, an issuer must obtain shareholder approval for any interested person transaction (IPT) of a value equal to or more than 5% of the group’s latest audited net tangible assets; or 5% of the group’s latest audited net tangible assets when aggregated with other transactions entered into with the same interested person during the same financial year.

The IPTs in Australia were less than 5% of CICT’s NTA or NAV. As at Dec 31, 2021, CICT’s NAV stood at $13.67 billion. The total price paid for 66 Goulburn and 100 Arthur Street was $672 million, which is less than the benchmark of $683.5 million. In addition, based on CICT’s announcements, it took on debt of A$328 million for the acquisition, so the NAV of the acquisition would have been around A$344 million. The agreement for this Australian transaction took place in December 2021.

In March, CICT announced it had agreed to acquire 70% of CapitaSky where CLI’s stake was 35%. That would have been $441 million, which is also below the 5% threshold. Once again, CICT took on debt. Of course, the total amount paid by CICT would have exceeded the 5% threshold taken together but agreements for the transactions were recorded in different financial years.

Lessons from capital management

While every aspect of REIT management is important in creating a stable, resilient platform, during the current interest rate cycle, capital management is likely to increasingly take centre stage.

Based on recent experiences with some REITs, the first rule should be to stagger debt expiries, and not allow debt expiries to be bunched together on the same day, week or month. The second rule is to have a significant portion on fixed-rate debt wherever the REIT’s debt profile is on the interest rate cycle. Better safe than sorry.

Thirdly, CMT was first off the block to diversify sources of funding. CICT issued the first retail bonds and embarked on green/ sustainability-linked financing in addition to its other sources of funding such as medium-term notes and bank borrowings, both secured and unsecured. CICT is also targeting long debt maturity profiles with an optimal cost of debt.

CICT’s average cost of debt is 2.3%. While this is higher than say Keppel REIT’s, Keppel DC REIT’s and Digital Core REIT’s cost of debt, CICT’s portion of fixed-rate debt is at 85%, leaving just 15% on floating rates. Despite this, a 1% rise in interest rates is likely to raise interest expenses by $12.9 million a year. In FY2021, interest expenses stood at $189.7 million, up from $133 million in FY2020. This is because a full year of CMT and CCT’s interest expense was recorded in 2021 compared to 2020.

If interest rates rise by 1% a year, DPU is likely to experience a negative 0.2 cents impact for a full year, based on the number of units in issue as at March.

The NPI from the Australian properties and CapitaSky should be able to offset the rise in interest expense but whether the additional NPI can also offset the higher operational costs remains to be seen.

While gearing is likely to rise to 41% from 39.1% as at end March because of the completion of the acquisitions of CapitaSky and 101– 103 Miller Street and Greenwood Plaza, CICT’s portfolio is conservatively valued.

Asked whether he is concerned that CICT’s cost of capital could rise with its overseas exposure, Tan says going overseas gives the REIT “optionality”.

“We take pride that Singapore is a good attraction globally and investors are very interested in Singapore exposure. But things may change. Some day, if Singapore is not a desired location then every sector in Singapore will be hit. We need some diversification.”

Tan is mindful that the aim is to keep volatility in income low. “In the long run, we can grow inorganically in Singapore and organically through redevelopment,” he says because a redevelopment puts a building out of action. Capital Tower has been mentioned as a potential redevelopment theme. But its NPI yield is 6% to 7% and would impact DPU if the building is closed for redevelopment.

The Australian investments are “opportunistic”, Tan says. The construct of the portfolio could shift, with CICT deepening its presence in Australia while growing its base in Singapore.

“We started to look at redevelopment opportunities which we talked about during the merger. The planning takes time. But it’s timely to review some of the assets, to decide whether to further optimise, or whether the asset meets the best use case,” Tan says.

In the meantime, the general recovery in retail and office could give CICT a bit of a tailwind despite inflation, recession and interest rate hikes. And, as Tan often said during the interview, it’s a journey.

Happy 20th anniversary, CICT.