Pure-play Chinese S-REITs expect to overcome challenges

For FY2017, BHG Retail REIT — which was listed in December 2015 — announced a 3.1% y-o-y rise in revenue to $64.52 million and a 6.6% rise in net property income (NPI) to $42.94 million. Distributable income rose 7.5% to $20 million and distribution per unit (DPU) was up 2.8% to 5.47 cents.

BHG Retail REIT’s DPU is still within an income support period in the form of a DPU waiver from its sponsor, which owns 30% of the REIT. In FY2016, the sponsor waived its full 30% share of DPU so that minority unitholders were entitled to 100% of the distributable income. In FY2017, the waiver was reduced to 27.5%. This year, the sponsor will waive 25% so that unitholders will be entitled to 95% of distributable income. By next year, the distributable income waiver will drop to 15%, and in 2020, to 5%.

For FY2017, CRCT announced a 6.9% rise in revenue to $229.2 million, and a 6.8% rise in NPI to $142.2 million. Distributable income rose $6.1% to $91.13 million, and DPU inched marginally higher to 10.10 cents. Last December, CRCT issued 64.4 million units in a private placement to raise $101.7 million to finance the acquisition of Rock Square in Guangzhou.

Challenging portfolio performance

Despite a credible full-year performance, CRCT reported a 5.2% y-o-y decline in NPI to $33 million for 4QFY2017. It sold CapitaMall Anzhen during the fourth quarter for $230 million, or 12.9% above valuation, to Beijing Hualian Anzhen Business Development Co. It is using part of the proceeds from the sale, and the December private placement proceeds, to pay for a 51% stake in Rock Square. Last November, CapitaLand and CRCT announced the joint acquisition of 100% of Rock Square for $684.8 million. CRCT’s portion including expenses and fees is $353.7 million.

CRCT’s malls had a mixed performance. Two of them, CapitaMall Minzhongleyuan in Wuhan and CapitaMall Wuhu, are under “stabilisation” and are not making positive contributions. In addition, CRCT had to set aside provisions to compensate tenants of CapitaMall Grand Canyon, whose NPI fell 20.4% y-o-y to RMB17.2 million ($3.6 million) in 4QFY2017. “The mall went through some months when some parts of it were closed because of more stringent checks by the Beijing authorities,” says Tan Tze Wooi, CEO of CRCT’s manager. For the full year though, Grand Canyon’s NPI was marginally higher. The mall accounted for 12.4% of total NPI. The portfolio’s full-year NPI was boosted by an RMB89.7 million contribution from CapitaMall Xinnan, which was acquired in 2016.

The completion of Rock Square in 1QFY2018 should further boost NPI and DPU this year. CRCT paid for its share of Rock Square with proceeds from the sale of CapitaMall Anzhen, equity raising and debt, and announced in November that the acquisition is immediately DPUaccretive. The pro forma DPU for FY2016 would be 10.16 cents, versus actual DPU of 10.06 cents. It is also DPU-accretive versus FY2017’s DPU of 10.10 cents. Rock Square is connected to a Metro interchange and is within a catchment population of 800,000 within a 3km zone.

With leases accounting for over half of Rock Square’s total rent up for renewal between 2018 and 2020, CRCT’s manager believes it can achieve rental uplift through asset enhancement initiatives (AEIs) including tenant mix adjustments, unit reconfiguration and improvements to the layout.

“The acquisition is in line with our sponsor’s move into tier-1 and tier-2 city malls. CRCT’s strategy is aligned with this. We’ve decided to focus on five core city clusters and to hold on to dominant malls in those cities. We want to anchor down here rather than be more spread out,” Tan explains. “Generally, these are the city clusters seeing greater growth.”

Two malls CapitaMall Wuhu which is in Anhui province, and CapitaMall Saihan, in Hohhot, Inner Mongolia are not part of the five city clusters. CRCT has articulated a portfolio reconstitution strategy where newer assets with longer land tenures and higher growth potential are likely to replace older malls with falling land tenures and which have reached their potential.

Help with distributions

Investors balk at investing in pureplay Chinese REITs because they are concerned that distributable income may be delayed. To date though, all the pure-play Chinese REITs have paid their DPU on time.

“We had a shareholder loan going into China and the way we extract cash out of China is [from] the interest on this shareholder loan. Dividends are paid on a semi-annual basis after we settle all taxes,” Tan says. “There is a time gap and it’s quite common that we fund it through a little bit of gearing.”

BHG Retail REIT pays DPU semiannually, and the largest portion of DPU is a capital distribution. The capital distribution is tax exempt and is funded from borrowing at the REIT level.

In order to get the money out of China, the financial statement needs to be properly audited. Hence, BHG Retail REIT uses a secured bank facility to pay unitholders first, to avoid delay. The REIT gets the cash flow from China once the accounts are properly audited.

EC World REIT’s DPU for 3QFY2017 declined 3.7% compared with the forecast in its IPO prospectus of 1.44 cents. This was due to withholding tax from cash repatriation.

Some risks ahead

BHG Retail REIT is a relatively small REIT with a market cap of $380 million. It has right of first refusal over 14 properties with a combined gross floor area of more than one million sq m. Three out of the 14 ROFR properties were granted by a private fund, managed by a fund manager 50% owned by Beijing Hualian Group Investment Holding Co, which controls Beijing Hualian Department Store Co, the REIT’s sponsor. One of the ROFR properties, Anzhen Mall held by Beijing Hualian Group Investment Holding Co, was recently divested by CRCT.

In a results announcement in January, BHG Retail REIT said that acquisitions will have to be yieldaccretive with a potential for AEI, and the location would need to be near a transport node with a targeted catchment. To acquire even a modestly sized asset such as Anzhen Mall, BHG Retail REIT would need to tap its unitholders for equity.

EC World REIT’s operations were somewhat more challenging than the retail REITs’. Its 4QFY2017 revenue was down 16.4% y-o-y to $20.7 million, and NPI was 17.6% lower at $17.9 million. In a statement, EC World REIT said this was due to “due to accounting adjustments for effective rent which have no impact on the DPU”. The lower NPI also included a $1.1 million provision for impairment on receivables (probably rent) at Fu Zhuo Industrial Co.

CBRE sees retail rebound

Retail sales expanded by 10. 2% y-o-y in China in 2017, and the country is set to become the world’s largest consumer market, CBRE says. The consultant is expecting double-digit growth this year as well. The Central Economic Work Conference says China already has the largest middle-income population globally. “Bricks-and-mortar retail began to rebound in 2017,” CBRE adds.

China’s Ministry of Commerce data indicates that retail business grew by 4.6% y-o-y in 2017, four percentage points higher than in 2016. Total retail profits rose 7.1%.

The mall oversupply situation has abated and the decrease in supply is expected to continue to at least 2020, CBRE says. New retail supply in 17 major tier-1 and 2 cities in 2018 is expected to fall by 15.9% y-o-y, the consultant adds. According to CBRE’s research, new supply in Beijing and Guangzhou is very limited and risk of oversupply is low.

CRCT’s acquisition of a property in Guangzhou is timely. It is one of nine cities that make up the Greater Bay Area in China, an initiative by the Chinese government to drive the country’s next growth phase. The other cities are Shenzhen, Zhuhai, Foshan, Dongguan, Huizhou, Jiangmen, Zhongshan and Zhaoqing. They, along with Hong Kong and Macau, are part of an ambitious plan to turn GBA into an economic rival to the Greater Tokyo Area, San Francisco Bay Area and Greater New York.

CRCT’s 51% stake in Rock Square will make the mall its fifth largest by size and income contribution after, in order of size, CapitaMall Xizhimen, CapitaMall Wangjing, CapitaMall Grand Canyon and CapitaMall Xinnan.

Tan says his aim is to provide stable distributions, with some proceeds from the divestment of Anzhen to be used for top-ups. If Grand Canyon’s woes are behind it, and Xinnan and Rock Square provide new, growing contributions, CRCT’s DPU could inch higher to 10.89 cents, according to J P Morgan. This would translate into a forward yield of 6.84%.

Investors looking for yield and growth may want to stay with CRCT. Investors who are prepared to fund their REIT’s inorganic growth may consider BHG Retail REIT because it can potentially grow quite fast with unitholder support.