SINGAPORE (Sept 17): Rising interest rates have caused the cost of debt for real estate investment trusts to rise, but the amount remains manageable. Ironically, the cost of debt has fallen for some REITs, notably Parkway Life REIT. This is because it took on yen debt for its Japanese acquisitions. CapitaLand Mall Trust’s (CMT) cost of debt is down 10 basis points from last December to 3.1% as at June 30. This is without giving up its weighted average debt to maturity, which stays at 5.2 years, and is the longest time frame among the REITs. The cost of debt of both Ascendas REIT and CapitaLand Commercial Trust (CCT) remains the same.

Highly rated REITs can still get competitive costs of debt. On Sept 4, RCS Trust’s trustee issued $150 million notes due in September 2024 at just 3.06%. The notes carry an A-rating by Standard & Poor’s. RCS Trust, which holds Raffles City, is 60% owned by CCT, and 40% by CMT. The pricing of RCS Trust’s notes indicates that demand for investment-grade credit exists.

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In general, though, REITs are yield instruments, which are sensitive to interest rates — when rates rise, REITs’ unit prices usually fall. S-REITs have stayed resilient in the face of this headwind. During the year, and despite two rate hikes by the US Federal Reserve, unit prices of S-REITs have fallen less than the blue-chip sector, as evidenced by the performance of their respective indices. The FTSE ST Real Estate Investment Trusts Index has fallen 7.6% this year, compared with the Straits Times Index, which has lost 8.6% this year (as at Sept 11). One of the reasons for the stability experienced by the ­REITs is the fact that yields of 10-year Singapore Government Securities, the equivalent of local risk-free rates, have stayed remarkably stable in the face of the Fed’s rate hikes (see chart). The 10-year bond yield, currently at 2.43%, is down from a high of 2.65% in May.

This could have emboldened several key REITs to make acquisitions to boost distribution per unit. In the past three weeks, three REITs have either raised equity or are planning to raise equity following acquisitions and the announcement of acquisitions, or could be planning an equity issue. Increasingly evident is the likelihood that none of the acquisitions are going to be particularly accretive to DPU in the immediate term, but investors appear willing to fund these purchases.

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(In order to keep gearing below 40% and net debt/Ebitda (earnings before interest, tax, depreciation and amortisation) to below seven times, the acquisitions have been or are likely to be funded by a modicum of equity.)

Ascendas REIT in the lead

Ascendas REIT was first off the block. It issued 178 million new units to institutional investors in a placement, at $2.54 each, raising $452.1 million. In August, it acquired a portfolio of 12 logistics properties in the UK for £207.27 million ($371.24 million). The portfolio has a long weighted average lease expiry (WALE) of 14.6 years and is largely comprised of freehold land.

When Ascendas REIT announced its UK purchase, it said it was likely to be yield-accretive. The annualised pro forma financial effect of the acquisition on the FY2017/18 DPU of 15.743 cents would be an improvement of 0.1944 cents to 16.182 cents if fully funded by debt, the REIT stated. The acquisition is expected to generate a net property income (NPI) yield of about 5.32% pre-transaction costs in the first year (5.22% post-transaction costs), Ascendas REIT added. WALE for the entire portfolio is raised to 4.4 years from 4.2 years as at March 31 (the REIT has a March year-end), and the proportion of freehold properties by asset value will increase from 16% to 19%. The triple net lease terms for the British portfolio means that tenants pay for expenses such as utilities, security and maintenance.

Out of the proceeds of the placement, $250 million is being used to partially fund the UK properties, $109 million will be used to partially fund the development of a build-to-suit facility in Singapore; and $3.9 million is to pay for the fees and other expenses from the private placement. The remaining $87.4 million will be used for debt repayment and future acquisitions. Gearing is likely to be 37.7%.

On Sept 7, Ascendas REIT announced the completion of the purchase of Nos 1 to 7 Wayne Goss Drive in Brisbane, for A$30 million ($29.4 million). Once the UK acquisition is completed, the UK and Australian properties will account for 20% of the portfolio’s value.

Different views on the placement of Ascendas REIT’s shares have emerged. Moody’s Investors Service sees it as a positive development. “The transaction is credit-positive because the equity proceeds will be used to pre-fund planned capital investments, thereby alleviating the need to rely on fresh borrowings. Ascendas REIT also indicated that it may use part of the proceeds to reduce debt.”

Deutsche Bank, however, sees the placement — which is about 5.7% of the pre-placement issued share capital — as mildly DPU-dilutive. In a recent report, it says: “We see potential dilutions to the REIT’s DPU in the near term. [The] impact to our FY2019/FY2020/FY2021 DPU is estimated at -1.5%/-0.5%/1.2% [respectively].” Ascendas REIT’s DPU for 1QFY2019 was 4.002 cents, down 1.2% y-o-y because there was a one-off distribution a year ago.

CMT to acquire remaining 70% of Westgate

On Aug 27, CMT announced the planned acquisition of the 70% of Westgate it does not own, for $805.5 million. Of this, unitholders will pay a $7.9 million acquisition fee to the manager in units. The property valuation agreed upon by CMT and CapitaLand is $1.128 billion, or $2,746 psf. The cash component is likely to be around $406 million and CMT is likely to assume debt of $392 million. At the agreed-­upon valuation, the NPI yield is 4.3%, according to the CMT announcement. The valuation of Westgate is up 14% since end-June.

If fully debt funded, the acquisition could add around 1.1% to FY2017’s DPU, and gearing would remain relatively modest at 35.9%. However, net debt/Ebitda would rise to 6.9 times, putting it on watch for a downgrade, according to a Moody’s report. Hence, the general view is that CMT is likely to issue sufficient units to keep its net debt/Ebitda ratio reasonably below seven times, as its A2 rating is very important to the REIT. CMT’s manager has left the method of funding flexible and has the option of using debt and equity.

OUE C-REIT’s rights issue the most dilutive since Sabana REIT’s

On Sept 11, OUE announced the planned divestment of the office portion of OUE Downtown to OUE Commercial REIT (OUE C-REIT) for $908 million, subject to unitholders’ consent. OUE also needs approval from the Singapore Land Authority. The purchase is likely to be part-funded by an 83-for-100 rights issue, at 45.6 cents, or a 31% discount to Sept 10’s price of 66.5 cents, making the entire transaction unabashedly dilutive. OUE C-REIT’s announcement says “the proposed acquisition is not immediately DPU yield-accretive”.

The rights issue should raise $587.5 million. OUE C-REIT — which had a gearing ratio of 40.3% as at June 30, the second highest among the S-REITs — will take on $361.6 million in debt to fund the acquisition. The REIT will also issue $6.8 million in units to pay its manager for acquisition fees. Of the $587.5 million, $550.1 million will be used to part-finance the office portion of OUE Downtown, $6.9 million will be used for costs and expenses, and $30.5 million for stamp duty and fees presumably to bankers, underwriters and sub-underwriters.

Given the equity raising, gearing could fall to 39.8% according to the OUE C-REIT rights document. Since the rights issue is underwritten, the manager will be issuing 1,288.4 million rights units, or 83% of the existing units.

There is an irrevocable undertaking by OUE to subscribe for its 55.9% stake. It is also sub-underwriting 66% of the total number of underwritten rights units for a 1.8% fee. The total cost of the acquisition is $955.9 million. The additional 5.27% is for the acquisition fee of $6.8 million payable to the manager, and $41.1 million for debt and equity financing-­related costs, stamp duty, professional and other fees and expenses incurred or to be incurred.

To recap, on Dec 20, 2016, Sabana Shariah Compliant Industrial REIT’s rights issue was offered to unitholders on the basis of 42-for-100 at 25.8 cents apiece, which at the time represented a 48.9% discount to its price of 50.5 cents on Dec 19. While Sabana REIT’s price represented a larger discount, nothing quite beats OUE C-REIT’s ratio. Since the rights issue is larger than OUE C-REIT’s general mandate allows, the rights issue is subject to unitholder approval. An extraordinary general meeting is scheduled for Sept 28.

What are OUE C-REIT’s unitholders buying?

Unitholders will get Grade A office space on the 35th to 46th storeys of OUE Downtown 1 and Grade A office space on the seventh to 34th storeys of OUE Downtown 2. According to OUE C-REIT’s document, “the properties enjoy an established blue-chip tenant base which includes reputable insurance, financial, information and technology, media and telecommunications companies and multinational corporations”.

The purchase price works out to be $1,713 psf for the property’s 48-year lease, or a hypothetical $2,234 psf if the lease is topped up to 99 years, according to the rights document. Income support of $60 million over five years comes along with the property. At the purchase price and with income support, the NPI yield is 5%, which is higher than the 4% of OUE C-REIT’s existing portfolio. Without income support, the NPI yield is 4.02%, according to the rights document.

The rationale for income support is that most of the committed leases were negotiated and signed between 2015 and 2017, when the office market was soft, the rights document says. The document cites market research by Colliers, which estimates that rent for the Shenton Way/Tanjong Pagar area is now $8.43 psf, which is above the average monthly gross rent of $7 psf for OUE Downtown as at June this year. The rental support is based on a target base gross rent of $8.90 to $9.40 psf between 2018 and 2023 (see Table 3).

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The proposed acquisition is expected to increase OUE C-REIT’s assets under management by about 26.2% from $3.515 billion (as at end-2017) to $4.435 billion.

Safe harbour for investors

OCBC Investment Research says the average DPU growth of the 23 S-REITs under its coverage for 2QCY2018 fell 0.8% y-o-y, compared with a decline of 2.6% y-o-y for 1QCY2018. “Looking ahead, we are projecting stable DPU growth (market-cap weighted) of 1.7% for the current financial year (FY2018 and FY2019) and 1.6% for the next financial year (FY2019 and FY2020),” the OCBC report says. It has highlighted REITs such as Mapletree North Asia Commercial Trust, Keppel DC REIT, Frasers Centrepoint Trust and Frasers Logistics & Industrial Trust as its favourite REIT picks.

DBS Group Research likes CCT and says it is undervalued at its current price because of a “multi-year upturn in office rents in Singapore”. The full benefit from the acquisition of Asia Square Tower 2 late last year, and Gallileo early this year, have not been realised. Also, its property valuations are below physical market transactions.

Supported by a resilient yield of around 5.5%, CMT is a safe harbour for investors, DBS says. While the acquisition of Westgate is not hugely yield-accretive, there is upside to Westgate’s NPI. The CEO of CMT’s manager, Tony Tan, has said that he sees no reason why Westgate’s NPI cannot rebound to $56.3 million (recorded in FY2015) from $49 million in FY2017. Tan has also articulated that CMT is likely to continue focusing on Singapore for the time being, removing any currency risk the REIT might face. And of course, CMT has the most robust capital management among the REITs — it has a relatively low fixed rate of debt, with a weighted average debt to maturity of 5.2 years.

As debt costs inch higher, highly rated REITs offer safe harbour

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