SINGAPORE (Sept 9): When news broke that national water body the Public Utilities Board was assuming control of Hyflux’s desalination plant, Adrian Chui, CEO of ESR--REIT’s manager, received calls from anxious unitholders. “Why are you allowing PUB to take away your assets without paying anything?”

In actual fact, PUB is taking over the plant at 92 Tuas South Avenue 3. What ESR-REIT owns is Hyflux’s nearby membrane production facility at 8 Tuas South Lane.

Chui recognises that investors are rightly concerned with the real estate investment trust’s exposure to Hyflux — especially since the beleaguered utilities company is among the REIT’s top 10 tenants. However, he stresses that its tenant base is very diversified and that any impact from Hyflux’s default, if any, will be minimal as it accounts for just 3.1% of ESR-REIT’s total rent collection.

Chui, who was speaking at a REIT forum organised by The Edge Singapore on Aug 26, adds that Hyflux, for all its debt woes over the past year, has yet to draw down on the security deposit of three months’ rent held by ESR-REIT. According to various reports, Hyflux may be close to a restructuring deal with a potential rescuer, Utico from United Arab Emirates.

In a subsequent announcement on Sept 5, ESR-REIT said another firm had taken up a 168,846 sq ft space at 8 Tuas South Lane. The REIT said P-Way Construction & Engineering had been contracted by the Land Transport Authority to provide track works services for the upcoming Jurong Region MRT line.

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From left: Goola Warden, managing editor of The Edge Singapore and panel moderator; Natarajan of RHB; Yeo of Cushman & Wakefield; and Chui of ESR-REIT

Merger with Sabana?

With a total portfolio of 56 industrial and logistics assets worth just over $3.03 billion, ESR-REIT is ranked as the fifth-largest industrial REIT in Singapore. Its sponsor is ESR, a Warburg Pincus-backed fund manager. The REIT, which was previously called Cambridge Industrial Trust, gained prominence when it merged with Viva Industrial Trust (VIT), sparking a REIT consolidation wave. In May this year, sponsor ESR bought a controlling stake in Sabana REIT, which led to speculation that ESR-REIT might undergo another merger.

However, Chui points out that he will evaluate Sabana’s assets no differently from how he evaluates other assets and consider if the transaction, if any, is accretive to ESR-REIT’s unitholders. “For the record, ESR cannot force us into a merger because ESR cannot vote on both sides of the coin — both are listed companies and this is something that was shown when we did the merger with [VIT]. So, if the transaction is not accretive or of value to my unitholders, I don’t think I should buy,” he says.

Resilient investments

Besides Chui, other speakers at the forum included Dennis Yeo, Cushman and Wakefield chief executive for Singapore and Southeast Asia, and Vijay Natarajan, an analyst with RHB Securities who specialises in REITs and property.

Apart from specific concerns about ESR-REIT’s business and prospects, the speakers were asked for their broader views on how REITs as an asset class would perform in the upcoming downturn compared with other assets such as bonds and commodities. Natarajan says while REITs are considered low risk, there may be risk when recession hits. REIT managers do, however, have more leeway to mitigate risks when this happens, he adds.

Yeo says while there is a danger of a downturn occurring, Singapore has been actively adapting to the situation, to the benefit of industrial REITs. For example, manufacturing remains a core economic activity, but instead of having to compete with lower-cost economies, Singapore has moved into “advanced” or “modern” manufacturing, which still requires factory space.

Multinational manufacturers are confident of operating here because of the strong intellectual property laws, and sound logistics support and connectivity. “If they are already in China or another country, or want to set up another facility that could be their sales centre as well as manufacturing plant, Singapore always comes up top,” he says.

According to Chui, REITs are more transparent relative to other asset classes. For one, they provide details such as length of leases and weighted average lease expiry, changes in rental and occupancy rates, and debt profile including weighted debt to -expiry — which give more visibility to the REITs’ top and bottom lines. In addition, the assets owned by these REITs are not intangible concepts and assets, but bricks and mortar.

“If you take a train to UE BizHub East (which is a key property in ESR-REIT’s portfolio), you can see the assets there, you can see how they’re performing. I’m not sure about commodities but when you invest in a coal mine, you hope coal is there and not pebbles,” he says. “If you buy a bond of a company, you may not necessarily be able to see the underlying performance. For REITs, it is very clear — you buy a retail REIT, you go to a retail mall, you can see the footfall, you see if the traffic is increasing or decreasing, you can see shops closing.”

Chui adds that relative to other assets such as shares, REITs have proven to be relatively resilient as well. The sector has weathered recessions and market cycles. “Generally, you don’t see distributions collapsing 30% or 40%; you don’t see REITs going belly up. Some fund managers tell me that REITs are actually counter-cyclical. Generally, you get a clear picture when you invest in REITs.”

Retail REITs

However, in the REIT universe, retail -REITs are seen as more vulnerable than the other REITs, as e-commerce is growing in popularity at the expense of physical retail. -Natarajan points out that this is not a new challenge. REIT managers have been actively looking at which of their tenants are at risk, finding new ones that stand a better chance of drawing in footfall and converting the traffic into sales. “The retail sector is here to stay, but not all retail malls are here to stay,” he states.

Chui agrees that the retail scene is constantly evolving, and that retail REITs are adapting with it. Previously, F&B outlets were tucked away on the top floor or basement of malls. Today, big-name restaurants are given prime ground-floor positions. For example, at CapitaLand’s Bedok Mall, which he frequents, popular hotpot chain Hai Di Lao and McDonalds are located near the main ground floor entrance. “Landlords, like us, adapt with the times,” he says.

Yeo notes that the retail industry’s changing dynamics have benefited industrial rather than retail landlords. “For example, Lazada will not take a retail mall as their place of operation, but they will take a warehouse for their e-commerce activities. So, I won’t call it a boom, but this is where I see demand coming from. The market is changing,” says Yeo, referring to Southeast Asia’s leading online shopping platform, which is backed by Alibaba Group Holding.

Higher gearing?

As the Singapore REIT sector develops, regulators are ready to adapt the rules governing it. As part of a proposal mooted in July by the Monetary Authority of Singapore, REITs will be allowed to increase their gearing limit above the 45% level now. This means they can borrow more to boost their asset base.

The panellists agree that this is a positive move. “Cost of debt is much, much cheaper than cost of equity at this point in time in the market, and if there’s a higher gearing, they can borrow a bit more; they can use the cheaper cost of debt to buy assets with much higher yields,” says Natarajan.

However, he warns that REIT managers must strike a balance in their gearing, which he calls a double-edged sword. “Past crises have definitely shown that -higher gearing at the wrong point in time can punish you quite badly,” he adds. Nevertheless, he is confident that REITs typically will not max out their gearing limits. The current cap is 45%, but the average gearing of the sector as a whole was 34% as at May 31, 2019.

From Chui’s perspective, the higher gearing limit gives managers more flexibility. He is confident that market discipline is effective and if any REIT leverages up too much, investors will react accordingly.

He also warns of potential risks in this prolonged, low interest rate environment. “The challenge is for REIT managers like us to control our urge to go on a debt--fuelled acquisition just for the sake of gaining market share.”

When rates come down, what is likely to happen is that everybody will be chasing good-quality assets, which would go to the bigger players. The second-tier -REITs, meanwhile, would then be compelled to buy second-tier assets. “After everything is bought up, financial engineering will come in and this is the danger I see,” warns Chui.

While he recommends safeguards in the form of mandated interest cover limits, the optimal approach is to leave it to market discipline. “Singapore REITs have been here for 20 years already; all of you are very sophisticated investors. The market is discerning enough to know and differentiate which are the REITs that just want to buy for the sake of buying and earning fees, and which are the ones that are here for the longer term, to create sustainable value,” says Chui.