Depending on how shareholders vote on Aug 10 in an EGM and scheme meeting, CapitaLand Investment (CLI) is likely to make an appearance on the Singapore Exchange on Sept 17. When it does, investors may ponder, how heavy or light should CLI’s balance sheet be?

During a briefing on Aug 17, Andrew Lim, group CFO of CapitaLand and CFO-designate of CLI, says, “if you look at CLI, it’s a hybrid. It’s not a pure real estate investment manager (REIM). [At listing] it comes with a heavy component of balance sheet equity underpinned by assets and stakes in funds and REITs. We believe in maintaining, and to deploy that headroom. If we have equity that we can raise that brings in another component and allows us to deliver transformative growth.”

Lim is of the view that CLI should deliver an ROE that is above its cost of capital, which is a high bar. In a survey of 165 companies with price to book values of less than 0.6 times, only six companies recorded ROEs higher than their cost of capital. However, 13 companies from the same sample delivered higher ROE than their weighted average cost of capital.

“We hope — and I am encouraged — that we are in the middle of a recovery process, to deliver resilient fee income, and the second driver of ROE, to recycle our portfolio for good capital gains,” Lim continues. “How that translates into ROE depends on how the equity base looks like in two to three years.”

REIMs are usually asset-light. The most notable REIM listed on the SGX was the now privatised ARA Asset Management, which maintained its business model of being a manager of REITs and funds. It sidestepped owning large stakes in its REITs and funds, preferring instead to maintain its fee income from managing REITs and funds. That business model continues. ARA garners AUM through the management companies and platforms it acquires.

“REIMs tend to be valued differently from developers. REIMs tend to trade higher on a P/NAV and P/E basis. Our chronic P/NAV discount has hampered the growth of CapitaLand,” Lim notes.

Eschewing pure REIM model to support its REITs

As sponsor to its REITs, CapitaLand has supported them during redevelopments, acquisitions, and with equity fund raisings. CLI is expected to do the same as it will be sponsor to the CapitaLand’s six REITs, CapitaLand Integrated Commercial Trust (CICT), Ascendas REIT, CapitaLand China Trust, Ascott Residence Trust (ART), Ascendas India Trust and CapitaLand Mall Malaysia Trust.

“[With] CLI being sponsor of the REITs, we will definitely want to make sure the REITs do well. We will continue to provide the same level of support and our wish is to continue to hold long-term stakes in the REITs of 20–25%. Whether we will review this target depends on how the various REITs are growing. If they are growing significantly bigger we can review this,” says Lee Chee Koon, group CEO of CapitaLand and CEO-designate of CLI.

He also clarifies that if the privately held CapitaLand Development (CLD) can inject an asset into the REIT it would do so. “This depends on specific details of joint-venture agreements between CLD and the REITs,” Lee says.

For instance, CapitaLand is in a joint venture with CICT to develop CapitaSpring which has topped out. CICT has a call option to acquire the portion of CapitaSpring it does not own. ART and CapitaLand are jointly developing a 678-bed purpose-built student accommodation (PBSA) to serve over 35,000 undergraduate and graduate students from the nearby University of South Carolina (USC). Construction of the student accommodation asset is scheduled to start in 3Q2021 and complete in 2Q2023.

“There is no need for double handling if CLD can inject the asset directly into the REIT,” Lee confirms. CLD will be the privately held development business when the restructure takes place, while CLI will be listed.

“We have set out recent transactions which are a good representation of transactions where we partnered with our REITs, which demonstrates the role of a responsible sponsor to help the REIT digest a major redevelopment,” Lim says.

Should the REIT identify an interesting asset, CLI can step in with its balance sheet to support the organic growth of its REITs. Looking ahead, Lim indicates that much of the support could be tied to redeveloping and renewing the REITs’ portfolio.

“This renewal theme is starting to play out and could become a major capital requirement in Singapore and China for our older assets where our REITs are starting to redevelop and rejuvenate. This is where both sponsor and REIT can come in to renew our current portfolio to repurpose and future proof these assets in a post-Covid environment,” Lim elaborates.

Among a major redevelopment involving CapitaLand, ART, City Developments and CDL Hospitality Trusts is the redevelopment of Liang Court into an integrated development with hotel, serviced residence, shopping mall and two residential towers with a fresh 99-year lease.

Growing shareholders equity

While balance sheets are a representation of a company’s financials at a point in time such as June 30, or Dec 31, they are not static representations. Balance sheets are usually strengthened through revenue reserves and retained earnings. For instance, while a company’s number of shares and its share capital may not change, its shareholders’ funds are boosted by retained earnings.

If shareholders vote for the restructure on Aug 10, CLI will list with share capital of $10.7 billion, $15.3 billion in shareholders equity and $19.1 billion of total equity, and a debt to equity ratio of 0.55 times based on its pro forma financial statements as of March 31.

CLI’s future earnings can continue to accrete to its revenue reserves, strengthening its shareholders’ equity. Any profit that CLI makes to the extent it is not paid out as dividend would be available to fund new investments, including participation in REITs’ equity fund raising (EFR).

“Ideally, I would want CLI to replenish as it divests so that the balance sheet is not strained,” an analyst remarked recently.

CFO Lim has articulated that a steady state debt to equity level is likely to be around 0.6 times, hence it has debt headroom.

Growth trajectory for CLI

CLI plans to come to market with real estate assets under management of $115 billion, and funds under management (FUM) in its REITs and private equity funds of $78 billion. It will have $10 billion in assets that are scheduled to be recycled into its FUM.

“The divestment target is $3 billion a year, and the target is to get this into FUM in the next two to three years,” Lim says.

In a results briefing of Ascott Residence Trust (ART), the CEO of its manager, Beh Siew Kim, said, “CLI has about $1.4 billion of multi-family assets. It fits our mandate. At the right price, I’m interested, because of stability of income.” Multi-family assets are the equivalent of rental housing in Japan.

Some 9% of ART’s portfolio by value comprises rental housing and PBSA. Beh says a target of around 15% to 20% of assets comprising PBSA, multi-family and rental housing is a reasonable target to have for ART’s portfolio.

CapitaLand delivered a 10% ROE in 2019. “If you believe ROE is an important barometer of our ability to engineer returns for shareholders, the starting point for us is at 10%. Delivering sustainable double-digit ROE must be part of the equation we bring to our shareholders,” Lim continues.

CEO Lee believes that CLI could grow by acquiring new assets or platforms to create new REITs, funds and products. Or CLI could acquire certain platforms in certain markets that the CapitaLand group may be interested in. CLI could also form joint-ventures and in the seeding of new funds. “There could be other major M&As we could be looking at. One important point is having the ecosystem with CLD which gives us a lot of flexibility to look at M&A. Having a partner we can work with allows us the flexibility to see which parts of capital we can call on to maximise fire power and maximise returns to various stakeholders,” Lee says.

Whatever the case, every transaction must complement CLI and the CapitaLand group’s existing operations. When asked if CLI would look at infrastructure assets, Lee said that CLI will not just grow AUM for AUM’s sake. He does not plan to move into new asset classes where the group has no inherent abilities, and which do not offer synergies with CLI’s other businesses, its REITs and funds.

The rationale for splitting CapitaLand — where 65% of its NAV goes into CLI, and 35% is in CLD — is so that CLI can trade nearer its NAV. Developers traditionally trade at a discount. The development cycle for commercial property such as malls, integrated developments and office towers take three years, and stabilising them could take a further three years. CFO Lim refers to capital tied up in developing property as patient capital.

“If it sits on the balance sheet for anything more than three years it is patient capital, it is not capital that can be converted into FUM and generate fee related earnings (FRE),” Lim says.

For a CLI listing, shareholders have to vote in favour of the various inter-dependent resolutions at CapitaLand’s EGM and scheme meeting on Aug 10. Based on the valuation of $4.102 each CapitaLand shareholder receives one CLI share, 0.155 CapitaLand Integrated Commercial Trust unit, and 95.1 cents in cash. As a result, CLI’s NAV on a pro forma basis as at Dec 31, 2020 is $2.823.

For CLI to be a success, its share price should trade at or above its NAV.

For successful S-REIT model, CapitaLand Investment may need to stay a hybrid

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