SINGAPORE (Jan 23): Adrian Chui, CEO of ESR-REIT’s manager may have started a trend. In 2018, ESR-REIT merged with Viva Industrial Trust in a share and cash offer. VIT unitholders were paid 96 cents per unit of which 90% was with ESR-REIT units, and 10% in cash. In 2019, two mergers were completed, between OUE Commercial REIT and OUE Hospitality Trust, and Ascott Residence Trust and Ascendas Hospitality Trust.

“We saw the onset of this trend three years ago. I guess REITs with sponsors are in a better position to grow bigger. Independent REITs have to find a way to survive,” Chui says during a recent results briefing.

In the initial decade of S-REIT existence, they competed with each other to buy properties. After the global financial crisis, REITs had to compete against each other and with private funds as well. REITs’ gearing (loan-to-value) is capped at 45% but private funds could borrow up to 60% of property value. “In a low interest rate environment [post GFC], the chase for yield started with sovereign wealth funds, family offices and pension funds all looking for higher returns,” Chui points out. The field is a lot more crowded, and these private funds have a lot more flexibility.

Investors are pretty clear on what they want. “Everyone can see the benefit of getting into an index, and greater liquidity. For instance fund raising is easier. Investors want to invest in liquid stocks and index stocks,” Chui notes. “Three years ago, VIT and ESR-REIT were trading at an average daily volume of less than one million each. Now our average daily volume is six million. Previously, we had two analysts covering us, and VIT had one. Now as a merged entity we have eight.”

Bigger is better for these REITs

During a briefing on Jan 22, the managers of both CapitaLand Commercial Trust and CapitaLand Mall Trust articulated that the merged entity, CapitaLand Integrated Commercial Trust, would have the capacity to take on larger scale projects given its higher debt and development headroom. If approvals are received for the merger, CICT would have an asset size of $22.9 billion and market cap of $16.8 billion.

De-risking the portfolio through diversification was another key reason for the CMT-CCT merger. The merged entity will have a balanced portfolio with diversified exposures across five integrated developments, eight office assets and 11 retail assets. This provides a hedge against market cycles in any particular sub-sector, the managers of CMT and CCT said.

Asset concentration risk falls the more properties there are in a portfolio. The merged CMT-CCT entity would be able to better manage any financial impact from redevelopments or AEIs due to its larger income and asset base. For instance, if 21 Collyer Quay had to shut down to undertake AEIs in 2019, the impact of the downtime would have resulted in a 6% impact to CCT’s 2019 NPI but this impact would only translate to 2% of CICT’s NPI due to its larger base. In April this year, 21 Collyer Quay will be shut down for AEIs. CCT has signed a binding agreement with WeWorks to occupy the whole building, starting from 2Q2021 for seven years.

Mapletree North Asia Commercial Trust is an example of single asset concentration risk. Last year, MNACT’s manager warned that distributions per unit would be impacted by closure of Festival Walk in Hong Kong, which had for the six months to Sept 30, 2019, contributed around 62% to NPI. In the nine months to Dec 31, 2019 Festival Walk’s contribution fell to 56% of NPI.

Alignment of interest crucial

The smaller REITs increasingly want to become constituents of major indices. The most desired index appears to be the FTSE EPRA NAREIT Developed Index. In 2019, Frasers Logistics Trust, Frasers Centrepoint Trust and Keppel DC REIT were admitted into the index following acquisitions funded by equity issuances which increased their free float market cap, but where their sponsors kept their substantial stakes of more than 20%. Manulife US REIT also qualified as a constituent of the index by acquisitions which were partly funded by issuing more units. However its sponsor has a small stake of below 10% because of tax issues.

“We grow our free float market cap by buying more property and issuing more equity, or by reducing the sponsor’s stake. But there is an alignment of interest and investors would like their sponsors to hold 15% to 20% of the REIT,” Chui observes. If not, are the manager and sponsor here for the fees? That question is being increasingly asked of the US REITs that have listed in Singapore where the sponsors’ stakes are low.  

For mergers, managers and sponsors have a duty to unitholders to ensure that the both the acquirer and the target can find the right price where unitholders have to be encouraged to be part of a bigger REIT. That is a different scenario from privatisation. “If you want to take the REIT private, you must get unitholders the best price,” Chui says.

ESR-REIT reported a 61.3% y-o-y rise in revenue to $253 million, and a 67.7% rise in NPI to $67.7 million. DPU rose 4% y-o-y to 4.011 cents because the number of units used for DPU calculation rose 71.1%.

ESR-REIT’s acquisition strategy

At its IPO, in Australia, ESR Cayman directly owned 481.7 million sq m in gross floor area (GFA) of completed properties, 35.9 million sq m in GFA of properties under construction, and four parcels of land.

In Nov last year, ESR Cayman set up ESR Australia Logistics Trust, which was seeded by A$175 million of properties owned by ESR Cayman. The fund has a target AUM of A$350 million over 12 months.

As Chui tells it, ESR-REIT has access to ESR Cayman’s pipeline and some of these are freehold properties. Singapore industrial land leases are getting shorter, and some of ESR-REIT’s properties dropped in value because of lower land leases. “Accessing our sponsor’s pipeline gives us freehold assets which are managed by our sponsor,” Chui points out.   

One way to acquire is to buy a portfolio for freehold assets which would result in transformation of the REIT. ESR-REIT could also invest in property funds managed by ESR Cayman. The latter also directly owns 575 million sq m in GFA of properties under construction in Japan, and 1,105 million sq m in GFA of completed properties in China. “I could take a stake in a private core plus fund managed by ESR Cayman,” Chui says, so long as its DPU accretive, he adds.