One of this year’s top performing REITs is First REIT, which was listed in 2006 with Indonesian healthcare assets — mainly hospitals. First REIT’s unit price is up some 40% this year. Most of the gains were recorded in November. On Dec 8, First REIT’s manager announced it plans to acquire 12 nursing homes from joint sponsor OUE Lippo Healthcare (OUELH) for JPY24.2 billion (around $290 million), a slight discount to the valuation of JPY25.2 billion.
To fund the purchase, First REIT is proposing a placement to OUELH at $0.305, a premium to its threemonth volume-weighted average price (VWAP) of $0.279. It is rare to have a placement at a premium to VWAP. In February this year, First REIT completed a dilutive rights issue, with rights units issued at 20 cents, and a theoretical ex-rights price or TERP of 31 cents. The purpose of the rights issue was to raise $158.2 million, to offset the shortfall in a debt refinancing structure caused by a sharp haircut in valuation.
Victor Tan, CEO of First REIT’s manager, says First REIT’s acquisition of OUELH’s 12 nursing homes is a first step in First REIT 2.0, which comprises four pillars. “The first one is for us to diversify out of the Indonesian market, so that in the next three to five years, we want at least 50% of our portfolio and by gross rental income to be coming outside of Indonesia.”
As at June 30, Indonesia comprised some 96% of assets by valuation. A Korean asset, Sarang Hospital, was divested in August for US$4.52 million ($6.12 million). It was acquired in 2011 for US$13 million. Indonesia’s share has fallen to 72% of assets after the acquisition.
Secondly, Tan is looking to reconfigure the portfolio to make it more capital-efficient. This consists of an attempt to divest the country club and a mall asset possibly to Lippo Mall Indonesia Retail Trust (LMIRT).
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“There’s synergy with this hotel and country club, Imperial Aryaduta Hotel & Country Club, diagonally opposite our flagship hospital. In the long run, this is one asset that we are exploring to divest,” Tan says. In November, First REIT announced it had renewed the asset’s master lease to Lippo Karawaci for a year. “If for some reason we cannot divest it, we are also looking at whether we could also develop the asset, and maybe sell it subsequently.”
The third pillar is to strengthen the REIT’s capital structure. Tan says the REIT needs to diversify its sources of funds — from just bank debt to debt securities and hybrid securities. “As we continue to grow, we definitely will need to diversify our sources of fund,” he adds. First REIT has a $60 million of perpetual securities which was reset to 4.98% in July this year from above 5.68% previously.
“We had just come out of the $260 million refinancing exercise in 1Q2021. It’s prudent for us to roll and reset the perp. There is about 70 basis point savings; it made a lot of commercial sense for us to roll over,” Tan explains.
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Riding on megatrend of ageing population
The fourth pillar is to ride on megatrends in healthcare and environmental, social, and governance (ESG). East Asia, in particular developed Asia such as Japan, Korea and Singapore, is ageing. Nursing homes in Japan have waiting lists. “The nursing home market is doing so well in Japan that there is actually a waiting list of about 300,000, people,” Tan says, citing independent market research.
The stability and defensiveness of nursing homes in Japan are evidenced by the performance of ParkwayLife REIT’s (PLife REIT) portfolio. PLife REIT diversified into Japan as far back as 2007, shortly after its IPO in 2007. Since IPO, PLife REIT has had distribution per unit (DPU) growth of 118%.
Interestingly, PLife REIT is one of only two REITs to have never had a placement or rights issue. In fact till 2020, the REIT did not even have a general mandate to issue units. However, this became one of the resolutions last year which was overwhelmingly passed.
PLife REIT’s Japanese portfolio has a long-term lease structure with weighted average lease term to expiry (WALE) of 11.89 years, with an up-only rental review provision for most of the nursing homes. The portfolio has a 100% committed occupancy. PLife REIT’s manager’s rationale for diversifying was to ride the trend of an acute ageing population in Japan. According to independent research, 1 in 3 Japanese are likely to be over 65 years old by 2050. In addition, as a developed economy, Japan has well-established laws and regulations.
On Dec 10, PLife REIT announced the acquisition of its third Japanese nursing home this year, bringing its total to 52 nursing homes. The property is operated by Fuyo Shoji Kabushiki Kaisha, a wholly-owned subsidiary of Habitation Group which is PLife REIT’s largest nursing home operator in Japan.
The latest Japanese nursing home was acquired at a net property income (NPI) yield of 5.9%. In June, PLife REIT acquired two nursing homes at NPI yields of 5.7%. In January, PLife REIT announced the divestment of P-Life Matsuda, an industrial property, at an NPI yield of 4.3% and 12% above its purchase price. PLife REIT’s gearing level, following the acquisition of its 52nd Japanese property, will increase from 34.9% to 36%. As at Sept 30, its interest coverage ratio was around 21 times.
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Occupancy cost in line with market average
The occupancy cost — or Rent/Ebitda ratio — of Japanese nursing homes range from 40% to 50%. In an earlier interview, Yong Yean Chau, CEO of PLife REIT’s manager, indicated that his REIT’s occupancy cost is within this range. However, the occupancy cost of PLife REIT’s three Singapore hospitals is a lot lower. While the details are not officially released, IHH Healthcare’s annual report provides some guidance, and analysts have indicated that PLife REIT’s occupancy costs are below 20%.
The NPI yield of First REIT’s new portfolio — which is subject to an EGM — is around 5%, Tan says, and lower than the NPI yield of the Indonesian portfolio of 7% to 8%. Even then, the Japanese properties will add 0.8% to First REIT’s 1HFY2021 of 1.3 cents. However, because First REIT’s NAV is 35 cents, the transaction is dilutive to NAV as the placement units are being issued at a discount to NAV.
When First REIT was listed in 2006, its prospectus had indicated that Rent/Ebitda of the Indonesian portfolio was at 99% but it would fall in the following years because of ebitda growth. But, because rent was paid to the REIT in Singapore dollars, and the rupiah weakened against the Singapore dollar, this did not materialise. Instead, by 2020, Lippo Karawaci, the master lessee, announced it could no longer pay rent in Singapore dollars.
This year, rents of First REIT’s Indonesian portfolio are being paid in rupiah for the first time in 15 years. With this, First REIT’s Rent/ Ebitda is in the 40% to 45% range, Tan says. Fortunately, the rupiah has been stable against the Singapore dollar.
“Ever since we restructured the master lease agreements, the rupiah has been very stable. In fact, it slightly appreciated against the Singapore dollar. We have been debating whether we should do some form of hedging. At every board meeting, the board will say, let’s monitor the currency, don’t rush into it, because there is always a cost associated with hedging and the cost could be quite high,” Tan explains.
In addition, Tan points out that there is a negative correlation between the Japanese yen and Indonesian rupiah. “So there is a bit of a natural hedge there now. Ultimately, we will have to hedge in some form or another,” he adds.
PLife REIT extended its yen net income hedge till 3Q2026 so as to enhance the stability of distribution to the unitholders, the manager announced in an update in 3QFY2021. PLife REIT says foreign currency risk is managed by adopting a natural hedge strategy for the Japanese investments to maintain a stable NAV, and putting in place yen forward exchange contracts to shield against yen currency volatility.
In 3Q2021, the group entered into additional yen forward contracts to extend the hedge maturity till 3Q2026. In addition, 70% of the REIT’s interest rate exposure is hedged and the all-in cost of debt is 0.53%. In its Dec 10 announcement, PLife REIT said it will use yen debt for its acquisitions as a natural hedge against the depreciation of the yen.
Does First REIT plan to do likewise? “We are assuming the yen debt that was part of the portfolio. Going forward, we will look at how we can borrow more in Japanese yen to make the transaction more accretive,” Tan says.
Long WALE, stable portfolio
First REIT’s new portfolio — subject to an EGM — has an occupancy rate of 90%. One of the master lessees is Hikari Heights, which is a listed entity. The portfolio leased to Hikari Heights contributes 70% in rent to the Japanese portfolio. The remaining 30% is master leased to two operators — Safety Life and Orchard Care.
Although the master lease period is for 30 years, the master lessees can break the lease with 12 months’ notice. Tan is quick to add that First REIT has a back-up operator, similar to PLife REIT. But he says it is unlikely that the master lessees terminate the lease.
“Our parent company has an inhouse asset management team. So, we will be inheriting it and it’s an advantage because we will be able to tap on the expertise of the local team there,” Tan says.
OUELH will be getting the First REIT placement at around its TERP of 31 cents. Based on the annualised pro forma DPU of 1.31 cents, DPU yield is 8.4%. P/NAV is 0.87 times based on a NAV of 35.12 cents, and 0.9 times based on pro forma NAV of 33.68 cents.
These valuations are cheaper than PLife REIT’s — which is trading at 2.5 times its NAV, and at a tight DPU yield. Still, PLife REIT’s unit price alone is up 28% this year, but behind First REIT’s 40% gain.
Photo credit: First REIT