William Tay, CEO of CapitaLand Ascendas REIT’s (CLAR) manager, cuts a relaxed figure as he walks through The Workshop @ Ang Mo Kio at Tech Place II, one of CLAR’s IPO properties back in 2002. The Workshop is a co-working industrial space comprising around 3,000 sq m (32,290 sq ft), offering modern flexible office desks, meeting and seminar rooms, as well as event spaces, for booking. It is also equipped with ample lockers, pigeon holes as well as utility areas. The Workshop is popular with young entrepreneurs, with nearly all the work-pods filled with techies on their computers. No surprise then that the facility has a committed occupancy of more than 90%.
“Tech Place was carved out to be injected into Technology Parks Pte Ltd,” Tay recalls, referring to Tech Place 1 and II on Ang Mo Kio Avenue 10 and 5, both IPO properties (CLAR was listed on Nov 19, 2002). Technology Parks, which also owned Science Park 1 and 2, was part of JTC. It was folded into another unit which eventually became Ascendas.
Tay is cognisant of the challenges REITs face, including his own, in view of the interest rate hike cycle which is negative for REITs in general, and market volatility. REITs often lean on their investors for growth through acquisitions. However, unitholders of CLAR (formerly Ascendas REIT) need not be too concerned that their REIT is likely to raise equity in the near term.
So far this year, CLAR’s acquisitions have been very modest. It acquired a cold storage facility at 1 Buroh Lane for $191.9 million announced on Sept 14; Philips APAC Centre in Singapore for $104.8 million announced on Aug 4; and seven logistics properties in Chicago for the equivalent of $133.2 million announced on May 10.
“Overseas, we are likely to see less activity, given that it is not easy to lend on a portfolio deal. A portfolio deal is likely to require a longer due diligence period and by the time it is completed, there could be another rate hike, so we prefer small bites, complete the due diligence and then announce. That is one reason why we prefer small bites versus a portfolio,” Tay explains during a recent wide-ranging interview, to commemorate CLAR’s 20th anniversary. “There is still a difference between asking price and bid price. There is no distressed sale. Sellers can hold on to assets. Transactions are quite thin,” he continues.
Could property funds start to divest if interest rates continue to rise? Would these hikes take a toll should these private property funds need to refinance? “We could see more deals in the market. Some assets were bought at very sharp [low] capitalisation rates when interest rates were low. But there was rent growth and they could still ride through this [turbulence] rather than [divest through] a sale,” Tay muses.
While the current interest rate hike cycle is causing discount rates to rise, and could lead to capitalisation rate expansion, valuations are also based on specific asset types, their ability to generate income, occupancy, quality of property, growth in cash-generating abilities, and so on. “If the asset is still doing well, it should be able to handle the higher discount rate,” Tay reckons.
Moreover, in the US, capitalisation rates also depend on the sub-markets. In addition, although discount rates tend to adjust upwards (sooner than cap rates), if the assets cash flow continues to grow, valuations can hold, or even rise.
Whatever the case, the challenges have not affected how Tay invests. “We focus on all mature markets, and on technology and logistics,” he says, adding that his investment philosophy is to ensure the entire portfolio remains resilient.
The main problem with Singapore industrial property is the short land lease tenure. While Tech Place II has 30 years of land lease left, many newer industrial land parcels are sold with shorter land lease tenures of 20 years. As land tenures decline, the asset values of the properties decline in tandem, based on guidelines.
In view of the short land lease tenure, CLAR has accelerated its overseas acquisitions. It made a brief foray into China, acquiring two business parks in Shanghai and one in Beijing in 2011. By the time CLAR divested its Chinese properties in 2016, the rise of the RMB coupled with cap rate compression resulted in the REIT doubling its returns. For instance, the Beijing business park was acquired at RMB300 million and divested in 2016 for RMB760 million. One of the business parks in Shanghai was acquired for RMB587 million and divested for RMB1.078 billion.
In 2015, CLAR acquired a logistics portfolio in Australia (in two tranches) for around $1 billion. Following that, CLAR acquired a couple of modest logistics portfolios in the UK. The big acquisition was in the US in 2019, followed by the acquisition of a data centre portfolio in Europe for around $904.6 million in 2021.
As at 1H2022, in terms of assets, CLAR has 40% of its assets overseas. This diversifies risks in terms of currencies, markets and asset classes, despite the focus on tech and logistics. Overseas assets carry with them their own risk as well.
CLAR had so-called “new economy” assets in its portfolio long before they were defined as new economy. Indeed logistics, data centres and life science properties (new economy) as well as business parks and industrial buildings were part of CLAR’s IPO portfolio. CLAR focuses on all mature markets in terms of geography, and technology and logistics in terms of sector.
“Each country we invest in has themes around tech and logistics. We have always been in the new economy from day one. We were in knowledge-based business parks, R&D. [By assets], we have 80% in new economy, and the other 20% is industrial and manufacturing,” Tay recounts.
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Globally, 64.3% of CLAR’s customer base is from the technology, logistics and life sciences industries. “The architecture has to be resilient, which is why we accelerated overseas acquisition, from 11% in Australia (in 2015) to 40% overseas so we can make sure of sustainable growth y-o-y,” Tay says.
As at June 30, 15% of CLAR’s assets are in the US, 14% in Australia, 10% in the UK and Europe, and 61% in Singapore.
So far, so good, for US portfolio
Back in 2019, investors and analysts questioned whether CLAR’s acquisition of 28 business parks in the US from its sponsor for the equivalent of $1.285 billion was a wise move. CLAR had proposed to acquire the 28 US business parks and two properties in Singapore for a total of $1.66 billion. To partly fund the acquisition, CLAR raised $1.31 billion in a rights issue.
In November 2019, Tay had to meet analysts and investors to explain the rationale. Some were difficult to convince. Three years on, they are likely to be more accepting of that acquisition. CLAR’s US portfolio’s occupancy and rental reversions are — arguably — better than those of the pure US REITs listed on the Singapore Exchange (SGX). Rental reversions have been consistently in double digits for the US portfolio.
The committed occupancy rate for the US portfolio stood at 95.3% as at end-June 2022, compared to 94.5% as at end-December 2021 and 92.8% as at end-June 2021. Some individual properties may be lower, but only the occupancies of three, perhaps four, properties have fallen since June 2021.
In fact, CLAR announced it will undertake a convert-to-suit exercise and transform one of its business park’s properties in San Diego into a life science property for Nasdaq-listed Crinetics Pharmaceuticals at a cost of US$40 million ($56.9 million). The new lease will be a triple-net lease commitment of 11.5 years, with an option to extend two additional five-year terms. The yield-on-cost of the conversion is likely to be 9%.
Keppel Pacific Oak US REIT (KORE), the best performer this year among the US SREITs, and with the best operating metrics, announced committed occupancy of 92% as at June 30, 2022, with rental reversions of 1.6%. Its DPU fell marginally y-o-y to 3.02 cents. Based on its last done price, KORE is trading at an annualised DPU yield of 10.2%, the most compressed among the US S-REITs.
“There’s no such thing as no risk. The key difference obviously lies in our ability to execute. Occupancy overseas has been strong; we are very committed to grow in a disciplined manner. We stay selective and prudent. Each acquisition is accretive. And we make sure there’s a team on the ground able to negotiate leases and manage the properties. Over time, we have shown that asset performance has not gone down; they continue to perform,” Tay says, almost as a response (or riposte perhaps?) to CLAR’s erstwhile detractors back in 2019.
“Logistics is probably considered as the easiest asset class [to manage] with low hanging fruit because of triple net, long leases. We can then set up a team on the ground, with boots on the ground,” Tay says.
For the overseas acquisitions, his policy is to retain the existing property managers engaged by the vendor of the properties. “We just continue with the existing property managers before we decide whether we’re going to change or not,” he says.
The US campus properties were acquired from CLAR’s sponsor which already had a team on the ground. “The US portfolio is mainly multi-tenanted, essentially campus office properties. The US is probably the largest tech market, and the team on the ground has been managing them for more than a year,” Tay points out.
The asset managers work with local brokers and property managers on the leasing front. For instance, there are long lease negotiations, and referrals for new demand. “Even if it’s an existing demand from existing tenants, they may have corporate real estate agents who work for them to renegotiate the leases and renew them,” Tay explains.
According to him, the US team managing assets and leases is split into two for eastern US and western US, which is where CLAR’s portfolio is located — mainly Raleigh, Portland, San Diego and San Francisco. In 2021 and 2022, CLAR acquired logistics properties in Chicago and Kansas City. In the US, funds and REITs use consultants to lease and manage the properties. By contrast, in Singapore, CLAR has its own property managers. “Overseas, the platform is probably not big enough for us to insource,” Tay suggests.
In addition, in overseas developed markets, an outsourced model is more likely as there are many funds buying and selling, and they usually do not have their own management platforms.
Shed, warehouse, logistics
“A shed is a shed is a shed.” So says Tay. What turns a shed into a warehouse and a logistics asset is the infrastructure, the automation that takes place within the shed, and the ability to move goods efficiently in and out of the shed. Some sheds can be turned into cold storages for food, meat and pharmaceuticals. Interestingly, e-commerce has turned warehouses into so-called new economy assets. The supply chain around e-commerce depends on transportation, the quality of roads, ports, airports and railroads.
“All this hasn’t changed, you can call it ‘new economy’, but a supply chain requires all these ingredients. We are not in the big boxes while e-commerce, the Amazons, all these big guys are in big boxes. In the past few years, it’s been so hot that we couldn’t afford them. But we were happy to focus on what we deem as a resilient asset, which is the last-mile location. These assets are near population centres,” Tay explains.
Minimising costs, maximising profit
As a REIT, costs comprise service agreements with tenants, and utilities. Most industrial REITs have had to recalibrate their utilities cost and service agreements, where some of the costs are passed through to tenants. Labour costs and the like are usually addressed in property management and manager’s management fees. The manager’s cost is paid by base, performance, acquisition and divestment fees. Property management fee is another cost to the REIT, and is also paid to outsourced partners for property management.
On July 6, CLAR’s unitholders held an EGM to renew the property management fee agreements for 10 years, starting from Oct 1 this year. On a pro forma basis, under the new property management fee agreements, property and lease management fees are likely to fall, while marketing and leasing, project management and third-party facilities fees will remain unchanged. Carpark fees are likely to rise to $4.2 million (previously none) on a pro forma basis, based on FY2021 statistics. The net result, on a pro forma basis, is higher property management fee of $3.8 million. Service charges for operating the REITs — which include security, cleaning and energy costs in relation to lobbies and lifts — are recovered from tenants.
“The next level [of our strategy] is obviously to maximise profit for unitholders responsibly,” Tay says. This includes taking into account ESG goals.
Capital management, hedging
For REITs, the largest cost is interest expense. Hence, capital management is a key focus of all REIT managers. First off, REIT managers need to ensure that they have a reasonable and manageable weighted average debt expiry. For CLAR, its debt maturity is well-spread with expiries as far away as 2032. The average weighted debt expiry as at June 30, 2022, is 3.9 years.
“Each year, we have to, on average, refinance $700 million,” Tay notes. Total debt is around $6.43 billion, of which green financing is around $1.56 billion. Sources of debt are diversified, with 52% in term loans, 36% in medium-term notes, and the rest in committed revolving credit facilities and revolving credit facilities.
Rising interest rates are likely to raise interest expense for most REITs. CLAR has 80% of its debt on fixed rates for an average of 3.7 years. CLAR’s manager has provided a sensitivity table for the impact of interest rates in its 1HFY2022 results presentation. “We are 80% fixed. For the 20% exposure to floating rates, we’ve given a range of the impact. We have benefitted by taking on more fixed rate debt in the past,” Tay indicates.
For instance, for every 100 basis-point rise in rates, distributable income is likely to decline by $12.5 million and DPU by 0.3 cents. In 1H2022, distributable income was $330.7 million and DPU was 7.873 cents.
“Over time we will see a higher debt cost,” Tay acknowledges. CLAR’s all-in debt cost as at June 30 was 2.1%. “We brought it down from 2.4% [as at June 30, 2021] to 2.1%. It will eventually start to rise as we refinance but we have a low base to start off with.”
In June 2021, CLAR had a seven-year EUR300 million ($419 million) bond issuance with a coupon of 0.75% (to part-pay for the European data centre portfolio) due in 2028. In February this year, CLAR issued a HK$661 million ($120 million) green bond with a coupon of 3.08% due in 2032
“We are A3-rated, which means doors are more open and we could issue our first inaugural Euro bond. It was a good price for parties at that point in time. We were new to the market and not a lot of Eurobond investors know us,” Tay recalls.
Ratings agencies such as Moody’s Investors Service look at a few benchmarks for ratings, including debt/total deposited assets, net debt/Ebitda, Ebitda/interest expense and secured debt/total deposited assets.
With 40% of assets overseas, CLAR’s manager needs a robust hedging strategy that keeps DPU stable through cycles. Part of this stability is from maintaining some 75% of overseas income returning to Singapore hedged. “We look at natural hedging, making sure that currency in terms of liability is actually protected to ensure that there is stable NAV and income. [For income,] we actually hedge that for 12 months on a rolling forward basis,” Tay says. Although 75% of its overseas income is hedged, various hedges range from 60% to 100%, depending on the currency exposure. In fact, if all the currencies move against CLAR by 10% to 15%, the impact on distributions is less than 2%, but NAV would be affected.
Asset and geographical mix
How big should or could CLAR be? Would unitholders be happy with a stable REIT with less growth? Well, since 2016, CLAR’s AUM has grown from $9.8 billion to $17.4 billion based on June 30, 2022 financials (see table, “CapitaLand Ascendas REIT’s fast track on growth”). However, DPU has only grown from 15.357 cents to 15.75 cents (annualising 1HFY2022 DPU) because of a rights issue in 2019 that raised the number of units by 498 million to 3.6 billion. As at June 30 this year, there were 4.2 billion units.
“What is meaningful in terms of the diversification for us is, for example, to have $2 billion in each asset class in each country by way of asset value to be meaningful and sizeable enough. Then we will have built further resilience in each of the countries we operate,” Tay suggests.
CLAR was listed as Ascendas REIT and started trading on Nov 19, 2002. Its IPO price was 88 cents. Based on its annualised DPU of 15.75 cents for this year, CLAR’s DPU yield would be 17.9%. Its actual DPU yield is around 6%. CLAR’s longevity means that it has navigated SARS, the global financial crisis, the European debt crisis, the pandemic and currently, the steepest rate hikes the world has known since the 1970s.
Still, CLAR with its A3 rating, coupled with Singapore’s safe haven status, has enabled its unit price to hold up better than peers. CLAR is down 12% this year, compared with Mapletree Logistics Trust’s 22% decline, Mapletree Industrial Trust’s 18% decline, and EC-World REIT’s whopping 37% decline.
“Even up to today, we still have reverse inquiries from certain banks [for bond issuance] despite all these uncertainties,” Tay says. That’s probably why he can walk nonchalantly through The Workshop.