Much has been said about the prospects of going overseas, less about its challenges. The challenges of going overseas were recently highlighted in the proposed privatisation of Frasers Hospitality Trust by a unit of its sponsor, Frasers Property (FPL).
FHT’s manager cites three reasons for privatising. The first is muted growth in distributions per stapled security (DPS) and net asset value (NAV). The second is the uncertain recovery after Covid-19 amid recessionary fears and inflationary pressures. Lastly, FHT’s small size limits its liquidity and impacts its cost of capital.
Despite FHT’s “proactive pursuit of yield-accretive acquisitions and value creation through refurbishments and AEI,” the strengthening of the Singapore dollar against FHT’s operational currencies has offset gains made over the years, according to its scheme document. FHT held an EGM to change its trust deed and a scheme meeting to approve privatisation on Sept 12, albeit unsuccessfully. Only 74.88% of votes were garnered for the scheme which required a minimum of 75%.
Rising interest rates are also expected to lead to a higher cost of capital for REITs in general. While focusing on the impact of rising interest rates on distributions per unit (DPU) and DPS, the immediate volatility of unit prices is affected by movements in risk-free rates. These are usually the yield on 10-year US treasuries or 10-year Singapore Government Securities (SGS). R
EITs trade at a ‘yield spread’ above risk-free rates. When rates rise, unit prices fall to maintain the yield spread.
In the meantime, FHT’s manager is cognisant that “further strengthening of Singapore dollar could potentially limit any potential NAV and DPS growth from a Covid-19 recovery”.
Currency impact on NAV
FHT is not the first REIT to face challenges with a translation impact on its DPS and NAV. When healthcare-focused First REIT was listed in 2006 with a portfolio of Indonesian hospitals, its sponsor and major unitholder Lippo Karawaci (LPKR) was also the major tenant as it was the master lessee. Its subsidiary Siloam Hospitals, which was subsequently listed in 2013, operated the hospitals. The rental revenue was paid in Singapore dollars.
In June 2020, LPKR announced that it is changing the master lease arrangements, with rental revenue paid in Indonesian rupiah. The rupiah had weakened significantly since First REIT’s IPO, and LPKR could no longer provide such rental income. Covid-19 has also affected the revenues of Indonesian hospitals. The new master lease structure would require the immediate rental revenue to decline.
Since the Indonesian hospitals are valued based on the master leases, their valuation fell, and lenders OCBC Bank and CIMB needed their loans to First REIT to be “topped up”. First REIT had a rights issue to raise $158 million to repay debt. Despite the apparent dilution, the alternative would have been a default.
The case study involving First REIT is perhaps an extreme example of the challenges and pitfalls of investing in a REIT with overseas assets. Its NAV fell from 99.64 cents as of Dec 31, 2019, to 28.78 cents as of Dec 31 last year after the rights issue and impact of the new master lease priced in rupiah (see chart).
Managing forex risk
Two REITs with properties in multiple markets have weathered currency volatility without significant impact on NAV, Ascott Residence Trust (ART), now in 15 countries, and Mapletree Logistics Trust, which owns assets in nine countries.
“With properties located globally across 15 countries, cash flow generated by our assets and their capital values are subjected to foreign exchange movements. Due to the geographically diversified nature of ART’s portfolio and with currencies working in pairs, the weakening of some currencies is offset by the strengthening of others. To the extent possible, we adopt a natural hedging strategy by borrowing in the same currency as the underlying asset. To further mitigate exposures to foreign currency fluctuations, we use hedging instruments such as cross currency interest rate swaps and foreign currency forward contracts where appropriate, considering the cost of hedging,” says a spokeswoman for ART’s manager earlier this year.
In more recent briefings during July and August, Serena Teo, CEO of ART’s manager, says: “ART’s portfolio is divided across 12 currencies, and this provides offsets from strengthening and weakening pairs (like the US dollar versus the Japanese yen). Regarding hedging of currencies coming back, we hedge about 20% of distributions in the US dollar, Australian dollar and the Euro. Because of this, we’ve been able to keep forex volatility of plus-minus (+/–) 3%. Year-to-date to June 30, 2020, we’ve kept [forex volatility] at a tighter range, and the impact is –1.3%.” Teo says.
ART employs hedges where it thinks it is optimal between volatility and costs. “This is in addition to our natural hedge where around 50% of our balance sheet has a natural hedge,” she adds. Regarding ART’s assets, it has a natural hedge where the loans are in the operating currency of the asset’s geography.
For more stories about where money flows, click here for Capital Section
ART’s 2021 annual report states that approximately 48% of ART’s assets denominated in foreign currency were hedged on a portfolio basis. These are done via derivative financial instruments. In FY2021, ART had around $30.8 million of derivative financial assets and $1.8 million of derivative financial liabilities. Net derivatives of $29 million represented 0.7% of ART’s net assets.
“MLT’s diversified geographic presence across nine regional markets subjects the trust’s operations to various market risks, including interest and foreign exchange risks. To minimise the impact of interest rate and foreign exchange rate volatilities on distribution income,” MLT’s FY2022 annual report states that exposure to these risks is managed via derivative financial instruments.
Of the different currencies MLT operates in, 39% are in hedged currencies comprising the Japanese yen, Hong Kong dollar, South Korean won, Chinese renminbi and Australian dollar; 37% are in Singapore dollars, and the remaining 24% are unhedged.
Size and liquidity
The reason why some REITs can trade at lower yields is possible because of liquidity, good assets and sponsor support. By logic, the larger a REIT is, the more diverse its investors and the more liquid it is. No surprise then that REITs — primarily those with a common sponsor — have merged to gain size, liquidity, and hopefully the lower cost of capital.
This year, ESR-REIT merged with ARA-LOGOS Logistics Trust to form ESR-LOGOS REIT (E-LOG). Mapletree Commercial Trust acquired Mapletree North Asia Commercial Trust to form Mapletree Pan Asia Commercial Trust (MPACT). The rationale for the two mergers was different. However, the mergers resulted in larger, more diversified REIT by tenants, property type and geography in MPACT’s case.
In 2020, CapitaLand Mall Trust and CapitaLand Commercial Trust merged to form CapitaLand Integrated Commercial Trust. In 2019, OUE Commercial REIT acquired OUE Hospitality Trust. Also, in 2019, ART acquired Ascendas Hospitality Trust following the acquisition of Ascendas-Singbridge by CapitaLand.
“As we get bigger, the pivot is towards institutional investors. Institutional investors can participate in overnight placement. You have to be in the indices to have more institutional investors because they track them. Regarding investor profile, we have institutional investors who are long only or real estate specialists. The ideal investor base is to have around 40% to 50% institutional, 20% to 30% for family offices, high net worth individuals at 10% and retail investors at another 10%,” says Adrian Chui, CEO of E-LOG’s manager.
Before the ARA LOGOS Logistics Trust merger, ESR-REIT had around 30% of its unitholders deemed as institutional. Following the merger, this rose to 35%. “The register is changing quite a bit. Larger names have come in who previously wouldn’t have looked at us. It helps that we are large,” Chui says.
Lack of liquidity or sponsor support?
It has not gone unnoticed that overseas-sponsored REITs with US, European and Chinese assets are trading at higher yields than REITs with Singapore assets (see table on page 8). Indeed, a couple of REITs with freehold US assets are trading at yields of 9% and 10%. Even though US risk-free rates are rising, the yield on the 10-year US treasuries is around 3.2%. These REITs appear to be trading at a yield spread of more than 600 bps.
When asked whether Singapore has room for more REIT structures, Vice-president of REITAS Jonathan Quek says that Singapore’s external manager model is now well accepted because S-REITs have performed well.
He adds: “US REITs are internally managed because investors in the US put a hefty discount on externally managed REITs because of poor corporate governance. There were a lot of questions by a lot of international investors around externally managed REITs. Over time, the resilience of that structure has been proven largely by the delivery of returns. People have accepted that these vehicles are excellent. It’s down to asset quality, sponsor support.”
Is that why S-REITs with US assets are trading at high yields? Is there a question mark over asset quality and sponsor support? As an example, Quek cites Digital Core REIT — which has strong sponsor support — as trading at lower yields. “It’s down to the same factors, like the quality of your sponsor, asset quality and size of the pipeline. Digital Core REIT trades at 4% to 5% yield and has all US properties.”