Future of S-REITs lies in harnessing of technology

“Where are the smart shopping malls? How many offices are truly smart? Are REITs operating smart buildings?” Lecomte asks. “As far as retail REITs are concerned, GST on online goods will only help for a while but it cannot hide the fact that local real estate players need to be more aggressive in their approach to smart technologies and the challenges that come with new lifestyles (co-working is one of them).”

CapitaLand has taken heed of this. It is ­using the network effect and technology to future-proof its properties. The network effect is where an increasing number of participants improve the value of goods or services.

Its 29.4%-owned retail REIT CapitaLand Mall Trust has chosen “Powering Innovation” as the title of its FY2017 annual report. “By powering innovation, we open up new possibilities for the future of retail to better serve the needs of this and future generations of shoppers,” it says.

As the debate on the future of S-REITs ­rages on, CapitaLand held a programme called CapitaLand’s Retail Future (CRF) on April 5 at Raffles City Convention Centre. Raffles City is owned by RCS Trust, which is 60% held by ­CapitaLand Commercial Trust and 40% by CMT.

StarPay powered by data analytics

During the programme, Lim Ming Yan, CEO of CapitaLand, introduced a novel shopper-retailer-mall ecosystem called the CapitaLand Digital Merchant Services Suite (DMSS). It comprises a series of digital tools for retailers to digitalise interactions with shoppers in the areas of transactions, rewards and operations — all powered by data analytics.

CapitaLand also launched StarPay, an ePayment service via a single unified touchpoint that will sit inside its CapitaStar app.

“With StarPay, we will be providing all-in-one smart terminals to over 2,500 stores in 17 participating CapitaLand malls across Singapore,” Lim told a gathering of some 400 retailers. StarPay went live on April 18. Its initial payment gateways are American Express, GrabPay, NETS, DBS PayLah! and Alipay. Other payment gateways including credit cards issued by banks other than American Express will join StarPay subsequently.

CapitaStar has 880,000 active members in Singapore and 5.4 million active members in Asia. Wilson Tan, formerly CEO of CMT’s manager and now CEO of CapitaLand Malls Asia, provided further evidence of CapitaLand’s network effect when he took the stage on CRF Day. “We had 1.1 billion people walking through our malls in 2017,” he said. “In Singapore, we had more than 400 million people going through our stores.” That means that an average Singaporean would have gone through a CapitaLand mall 80 times a year, or 1.5 times a week.

“The retailers in our network had revenue worth more than $12 billion,” Tan continued. “The retailers in our 17 malls [in Singapore] chalked up more than $5 billion of sales. That’s the amount of money transacted and completed within our malls.” As at end-2017, CapitaLand’s network comprised 103 shopping malls in Singapore, China, Malaysia, Japan and India with a gross floor area of about 98.6 million square feet. Of these, 91 malls are operational and 12 are under development.

Embracing the Fourth Industrial Revolution

Unlike the banks, which are embracing fintech, developers are only just coming to grips with the New Economy. CapitaLand is among the first to pre-empt this trend. In June 2016, it launched C31 Ventures, a $110 million corporate venture fund. The fund invests in technology start-ups with a focus on innovation in energy, operations and maintenance; building and construction; design and building materials; real estate funding as well as customer engagement.

In the past five years, CapitaLand Commercial Trust tore down two old buildings. Market Street Car Park was replaced with CapitaGreen, a smart, green building. The Golden Shoe Car Park and food centre is being replaced with CapitaSpring, also a smart, green building. “Future of work” innovations and concepts will be incorporated into the buildings to enable personalisation of workspace, seamless connectivity and other cutting-edge smart-building features, CCT says of CapitaSpring in its annual report. CapitaSpring has already secured an anchor tenant.

CMT is also redeveloping an old property, Funan DigitaLife Mall, into a smart, green building simply named Funan. It will be a state-of-the-art “built environment” that is an experiment in experiential retail offerings and proptech components such as co-working space. CapitaLand has also launched a new concept, lyf, under its serviced residence arm, The Ascott Ltd (Ascott), targeted at millennials.

Tenants with a focus on corporate social responsibility and sustainability are likely to be attracted to smart, green buildings. As Lecomte sees it, S-REITs such as CCT and CMT provide a sustainable business model that developers do not. “Since the early 1990s, there has been increasing realisation that corporate real estate management can contribute to the competitive advantage of the firm, by being aligned with its corporate strategy. Noticeably, real estate can be intrinsically linked to the firm’s CSR and sustainability agenda.”

Currently, CMT owns six buildings with a Green Mark Platinum rating, three with a Green Mark Gold Plus rating, and five with a Green Mark Gold rating.

Rise and rise of proptech

Some of CapitaLand’s digitalisation process is increasingly Proptech 3.0. Proptech is a wide term that embraces the application of digital technology to real estate. In the same way that fintech is changing financial services, proptech is altering the way space is being used. Although proptech did not start with the global financial crisis, the crisis hastened the catalysts that drive proptech.

“The technological, economic, political and social changes since the global financial crisis have also fostered a different style of living,” states a report titled “Proptech 3.0” by the Said Business School (SBS), Oxford University. The report discusses some obvious trends. The internet and smartphones have changed the way people shop. Internet billing systems such as Paypal have helped build the foundation for e-commerce. E-commerce, in turn, is changing the way retail REITs think about property.

The global financial crisis, which was followed by austerity, high house prices in global cities and the decline of stable full-time employment, has reoriented people’s consumption behaviour towards more cost-efficient rental models. According to SBS, “a startling number of millennials have begun to question ownership as a necessity for security and a fulfilling life, and this is infectious”.

“The rapid change of the technological environment coupled with the emergence of millennials as prime users of space make it absolutely necessary for REIT managers to become proactive in implementing smart technologies in their buildings. It might seem a long-term versus short-term issue, but this perspective is wrong. Digital technologies will test real estate assets like never before,” Lecomte says.

“The so-called fourth industrial revolution is relentless, full of opportunities but also laden with challenges for those who ignore it. S-REITs with strong sponsors have a unique opportunity to turn innovation into a competitive advantage (and distribution per unit in the long term for their unitholders). It is about survival.”

Retail REITs at frontline of change

The most obvious sector under siege is the retail REIT sector. In a recent report, UOB Kay Hian points out that landlords are likely to alter rental structures, and will be prepared to let gross turnover (GTO) rents move up towards 20% of total rents over the longer term. At present, GTO rents are around 5% to 7% of total rents. “With the migration of retail online, a painful restructuring is taking place. Principals are connecting with consumers directly (that is, replacing the middlemen physical retailers),” UOB Kay Hian says.

As an example, SPH REIT announced that both its properties experienced negative rental reversions in 2Q and 1HFY2018 (the REIT has an August year-end). “The overall portfolio rental reversion remains at -7.1%,” it stated in its 1HFY2018 results announcement. Rental reversions for FY2017 stood at 1.2%. Clementi Mall’s tenant retention rate was 89% for its second renewal cycle in 2017. For FY2017, the rate was 86%.

For 1HFY2018, SPH REIT’s net property income (NPI) was flat, but fell 1.1% y-o-y in 2QFY2018. Distribution per unit (DPU) was also flat at 2.74 cents for 1HFY2018.

It has been a challenge for the REIT to grow organically despite high shopper traffic. “Paragon and The Clementi Mall continued to attract high visitor traffic of 18.3 million and 29.9 million respectively. Tenant sales at Paragon increased by 2.1%, benefiting from more tourist arrivals and continued support from locals. The Clementi Mall recorded a 5.8% decline in tenant sales due to the weak economic sentiment that dampened consumer spending,” SPH REIT said in its FY2017 annual report issued on Oct 10.

SPH REIT’s tenant retention rate actually compares favourably with CMT’s, which was only 79.3%. CMT’s rental reversions for the portfolio last year was -1.7%. Capital management is also important for REITs. CMT’s weighted average debt to maturity is the longest among the S-REITs at 4.9 years. SPH ­REIT’s is just 2.2 years.

Is acquisition-for-growth model passé?

The management of SPH REIT plans to grow DPU by acquisitions. It has a right of first refusal to The Seletar Mall, which opened in November 2014. On April 6, SPH REIT announced it would explore acquisition opportunities in Asia-Pacific that will add value to its portfolio and improve returns to unitholders.

REITs have to acquire for growth. This is their “traditional” mode of growth, but acquisitions should be done judiciously. For instance, analysts and investors are questioning whether Manulife US REIT is doing right by its unitholders by acquiring a further two buildings this year after buying two last year, one of which was financed with a rights issue. An aggressive acquisition strategy can leave the REIT vulnerable to refinancing and financing risks at a time when interest rates are rising. Manulife US REIT has announced a multi-currency medium-term note programme to finance its acquisitions of US$387 million ($506.5 million). As some REITs and developers innovate to grow, is Manulife US REIT taking a step backwards by growing assets?

REITs have few options. But rather than acquire blindly, they could take a look at their portfolios to optimise their properties. Green buildings are likely to use less energy, and smart buildings are likely to be more efficient, resulting in cost savings for the REIT and better productivity for tenants.

Real estate as a service

In contrast to REITs that are set on acquisition growth, CMT’s management has a vision of the future and is in the process of “future-proofing” its portfolio. “I believe that retail REITs have to lead in that respect. Their business model is under siege. More generally, we are moving into ‘real estate as a service’ industry. It is a paradigm shift that requires a change of focus in REIT managers’ perspective and mindset,” Lecomte says.

“As mall operators, CapitaLand’s relationship with our shoppers and retailers is the cornerstone of our ‘real estate as a service’ expertise,” its CEO Lim echoes. In the near term, the impact of digitalisation on DPU may be difficult to quantify.

Smart technologies foster operational efficiency and cost control (for example, heating ventilation and air conditioning or hvac systems implementation). Likewise, the smart grids can potentially turn buildings into prosumers of energy (consumer and producer at the same time). Hence, REITs will significantly reduce their energy costs by future-proofing their properties.

Smart technologies also enable REIT managers to create and capture more value from their properties by developing digital services that will attract tenants. This is the case for retail REITs with the bricks-and-clicks model. This will translate into DPU by promoting higher occupancy and asset profitability.

It is also too early to tell if CapitaLand’s DMSS and StarPay programmes will have an impact on the DPU of CMT and its sister REIT, CapitaLand Retail China Trust. But to its credit, CapitaLand is already providing a form of “real estate as a service” to other mall owners. In FY2017, it signed four retail mall management contracts in China and one in Singapore, with SingPost Centre. These additions bring the number of its managed malls for third parties to seven. Its management sees this as an efficient way of expanding its mall network and building a source of fee income.

As at end-December, its serviced arm Ascott managed close to 72,000 units, of which about 43,000 are operational and 29,000 are under development. Ascott also opened around 3,800 units, including its first properties in Cambodia and Turkey. The operational units contributed $166 million of hospitality management and service fees. Fee income contributed 7.8% to CapitaLand’s total revenue of $4.6 billion for FY2017.

On April 11, CapitaLand CEO Lim addressed the Boao Forum for Asia (BFA) 2018 held in Hainan. BFA, popularly known as Asia’s Davos, is an annual event where heads of governments and business leaders from around the world converge in Hainan, China, to exchange views on issues affecting the future of Asia and the rest of the world.

“New Retail is not just a concept or trend; it is the new reality. New Retail — or as how I see it, ‘omni-channel retail’ — is a reality challenging all industry players to integrate online, offline, logistics and data across a single value chain. Every company in the retail sector, whether born online or offline, is moving to seamlessly integrate the two. Companies from both sides of the line, be it Alibaba, ­Amazon or Walmart, are clear that neither an offline-only nor online-only business model will work; it is in the combination of offline and online (O&O) [that] long-term success can be found,” Lim said.

Real estate has been a spectator to technology disruption for years, but that is changing fast as smart technologies applied to the built environment become widespread, Lecomte indicates. “Disruption comes from two concomitant changes. First, the property sector itself has moved to the epicentre of a techno­logy revolution with the emergence of proptech. Secondly, digital innovations are revolutionising the way urban environments and buildings function and interact, enabling new lifestyles favoured by millennials and giving rise to a new type of building known as Smart Buildings,” he adds.

“I also believe Singapore REITs need to become even more international and look at African countries where the future growth will be. S-REITs have strong brands they should capitalise on,” Lecomte says.

Interestingly, Ascott expanded into Africa by securing contracts to manage two properties — the 220-unit Ascott, 1 Oxford Street, and 40-unit Kwarleyz Residence, Accra, in the capital of Ghana. CapitaLand uses Ascott to “sample” new geographies. Last year, Ascott bought an 80% stake in US-based Synergy Global Housing, a company that provides corporate housing solutions. It also invested US$50 million to acquire Hotel Central Fifth Avenue New York, which will be renovated and rebranded as Citadines Fifth Avenue New York. Ascott also spent US$58.2 million on The Domain Hotel in Silicon Valley, California, which will be refurbished and rebranded as Citadines Cupertino Sunnyvale this year.

As part of its “real estate as a service” approach, CapitaLand manages a total of 15 private vehicles and five listed REITS with assets under management of $51.2 billion, making it the largest local property fund management company and one of the largest in Asia. For FY2017, the company reported profit after tax and minority interests of $1.6 billion, the highest in the past five years. Operating profit, which excludes revaluation gains, accounted for 60% or $908.3 million of Patmi. Return on equity stood at 8.5% as at end-December, up from 6.6% as at end-2016.

Growing DPU for the long term

Do unitholders care about how they get their DPU? Minority unitholders are generally more focused on just receiving their DPU. Its quality, sustainability, and a REIT manager that does not destroy value are additional considerations unitholders may study. Increasingly, unitholders are turning away from financially engineered yields, whether through the application of cheaper short-term debt or unsustainable master leases. However, the future of real estate and the future uses for real estate are not likely to be key considerations for retail investors at present.

“Growing DPU should not be a concern for sponsored REITs, especially in the context of rising interest rates globally. It is a short-term concern that I believe is misguided,” ­Lecomte says.

As REITs undergo digitalisation and challenges mount, sponsored REITs with reputable sponsors are likely to provide investors with greater transparency, lower debt costs, a pipeline and support in the event of capital-­raising, and a vision of how the portfolio will develop in the Proptech 3.0 age.

S-REITs without a strong sponsor are the ones at a disadvantage. “They will struggle to raise equity if their returns are too weak. They have to find tech partners (like Cisco or Siemens) to help them smart up their properties,” Lecomte says. “Helmut Schmidt, the former German Chancellor, once said: ‘Today’s profits are tomorrow’s investments, which in turn are long-term jobs’. I believe so.”

REIT performance

Based on the performance of the commercial real estate investment trusts, it appears that investors are discerning and the future does matter. CapitaLand Commercial Trust (CCT) – arguably the most efficient in terms of fee structure and, with its buildings carrying at least a Green Mark Gold Plus certification, the most efficient operating structure – continues to outperform other commercial REITs, the FTSE NAREIT REIT Index and the FTSE REIT Index. ­(The two buildings that do not have Green Mark Gold certification are HSBC Building and Bugis Village.)

Manulife US REIT is well regarded, but has not performed as well as CCT based on price performance. If foreign-exchange fluctuations are taken into consideration, Manulife US REIT would have underperformed to a greater extent. Both REITs outperformed the FTSE NAREIT REIT Index.

CapitaLand Mall Trust was a notable underperformer in FY2017. However, since the listing of SPH REIT, its performance has kept pace with SPH REIT. Both outperformed the FTSE REIT index during the period under review.

Investors who are interested in just distributions per unit and not too concerned about how they are obtained are likely to be comfortable investing in REITs such as Manulife US REIT and SPH REIT. However, long-term investors, cognisant of the rise of “real estate as a service”, may want to scrutinise whether their REITs have kept up with changes in the way real estate is being used. In Asia, CapitaLand’s REITs are at the forefront of that change.