CFA Society Singapore
SINGAPORE (Jan 8): When a few real estate investment trusts raised equity through rights issues in 2017, some unitholders were unhappy. Among them were unitholders of Manulife US REIT. This year, though, with a distribution per unit (DPU) uplift from a couple of acquisitions, Manulife US REIT is unlikely to ask unitholders for more cash. It is probably one of two commercial REITs that may not be tapping unitholders for equity. The other is CapitaLand Commercial Trust (CCT).
Office sector upswing
Growth is returning to the office sector, according to DBS Research. On Dec 15, the brokerage made a bold forecast: “In 2018, after years of downturn, the office sector is projected to deliver 12% y-o-y growth in rents, as take-up rates for new buildings have been robust while new supply entering the market over 2018 to 2020 (600,000 sq ft per year) remains supportive of higher rents.”
Maybank Kim Eng Research expects capital values to stay strong because of “keen interest in office assets”. It forecasts office yields will remain at 3.1% for 2018, unchanged from 2017. The main beneficiaries of firmer capital values and a recovery in rents are likely to be the REITs that acquired Grade-A Singapore office buildings last year and have lease expiries this year and in 2019.
CCT is clearly a beneficiary. It raised the largest amount in a rights issue last year — $700 million — to partially fund the acquisition of Asia Square Tower 2. Initially, the acquisition dilutes pro-forma DPU by 4.6%.
The building was acquired at a capitalisation rate of just 3.6%. This could compress, as CCT sold two buildings last year — a 50% stake in One George Street, at a cap rate of 3.2%, and Wilkie Edge, at 3.4%. In addition, the committed occupancy rate of Asia Square Tower 2 as at June 30, 2017 was just 88.7%, giving CCT the opportunity to lease out the unoccupied net lettable area as rents firm. Some 9% of CCT’s NLA is up for renewal this year and 25%, in 2019.
The REIT is likely to have its hands full in the next few years. Last year, it announced the redevelopment of Golden Shoe Car Park into a Grade-A building that will be among the tallest in Raffles Place. The development is scheduled to receive its temporary occupation permit in 1H2021.
While it is not impossible for CCT to acquire another building this year that requires unitholders’ support to finance it, it is unlikely.
Proxy to US GDP growth
Manulife US REIT raised US$208 million ($278 million) through a rights issue last October, which was used to buy 10 Exchange Place, Jersey City, New Jersey. The property will add 2.2% to DPU despite the rights issue. The Class-A building on the Hudson Waterfront with NLA of 730,598 sq ft was the REIT’s second acquisition within a few months. Last July, Manulife US REIT bought Plaza at 500 Plaza Drive, a Class-A suburban building with 461,525 sq ft of NLA, in Meadowlands, Secaucus, also in New Jersey. DBS Research is forecasting a DPU of 5.98 cents for FY2018, up 11.9% y-o-y from an estimated DPU of 5.34 cents for 2017, and it remains bullish on Manulife US REIT.
The rental cycle of Northern New Jersey, where Plaza is situated, is at the bottom of the property clock, according to JLL. Moreover, the US economy is recovering, with GDP growth for 3Q2017 accelerating to 3.3% from 3.1% in 2Q2017.
In addition, Jill Smith, CEO of Manulife US REIT’s manager, acknowledged during a recent property tour by the media to New Jersey that unitholders will want to see these buildings perform.
Why REITs tap investors
In total, six REITs raised more than $1.8 billion from rights issues (see table) in 2017. That was more than 3.5 times the monies raised in 2016. Sabana Shari’ah Compliant Industrial REIT’s rights issue in January 2017 kicked off a process that is still reverberating through the REIT sector. A few of its minority unitholders requisitioned an extraordinary general meeting to remove the manager after a deeply discounted rights issue was announced to acquire non-yield-accretive, overvalued properties.
When investing in REITs, it is worth noting that they need to pay out 90% of their distributable income, leaving them with no reserves. As a result, they need to lean on their unitholders for acquisitions and asset enhancement initiatives. Unitholders want a regular, steady income. At times, though, because of the market cycle, they may be called upon to help the REIT grow DPU or lower its gearing. What they do not like is financial engineering — enriching the manager through more fees — and growing for the sake of growth.
Keppel REIT, which was listed by Keppel Land in 2006 at $1.41 through a dividend-in-specie, quickly grew from assets under management (AUM) of $630 million to $2.6 billion in 2007 by acquiring a one-third stake in One Raffles Quay, funded by debt and a rights issue. In 2010, it acquired a one-third stake in Marina Bay Financial Centre Phase 1, partly funded by an asset swap. In 2011, Keppel REIT bought Ocean Financial Centre, which was partly financed by a rights issue. In 2014, the REIT purchased a one-third stake in MBFC Phase 2. Since its IPO, Keppel REIT has had three rights issues: in 2008, 2009 and 2011. Its total AUM as at Sept 30 stood at $7.6 billion.
In most cases, acquisitions are funded by a mixture of debt and equity. Placements are popular because they are quick, can be done overnight and at minimal discounts to the trading price of the REIT, and are often “yield-accretive”. Preferential equity fundraisings are the next most popular option. Unitholders subscribe on a pro-rata basis, similar to rights, but they are non-renounceable. The discount between the trading price and EFR price is usually not more than 10%.
Rights issues are unpopular because unitholders see them as dilutive. They are also not that popular with REIT managers and sponsors. While EFR takes about a month to complete, rights issues may take more than two months, and this is a concern to the issuers when markets are volatile. During the offer period, the rights price must be attractive enough to entice unitholders to subscribe. For instance, during the rights issue for Sabana REIT, announced in December 2016, the manager said it was priced at a 48.9% discount to its volume-weighted average price, to take into account market conditions.
Institutional investors usually invest in REITs with a market cap of US$1 billion and above. Therefore, larger REITs are likely to be under less pressure to expand than smaller ones. Also, larger REITs have an institutional following, which lowers their cost of capital.
Small and mid-sized foreign REITs such as BHG Retail REIT, EC World REIT and Keppel-KBS US REIT have all articulated a desire to grow. On Nov 2, 2017, in a results announcement, Frasers Industrial and Logistics Trust said it had a right of first refusal to 14 assets in Australia and 25 assets in Europe from its sponsor. “Looking ahead, the REIT manager will continue to grow FLT’s prime industrial portfolio, with a focus on generating sustainable, long-term value for our unitholders,” the REIT says.
On Dec 14, Frasers Commercial Trust announced that it had acquired a 50% stake in a business park in the UK for £87.3 million ($157.7 million). Its parent, Frasers Centrepoint (FCL), owns the remaining 50%. The announcement added that the REIT has a right of first refusal over more than $4 billion of properties FCL owns in Europe, including the UK. FCOT had an asset value of $2.07 billion and gearing of 34.7% before taking into account its latest acquisition.
Frasers Centrepoint Trust, which has never had a rights issue, has access to three retail malls in Singapore held by its sponsor. Parent FCL has a one-third stake in the 371,000 sq ft Waterway Point, valued at $1.148 billion as at Sept 30, 2017, the date of its opening. FCL also owns Northpoint City South Wing, which opened last month. It was valued at $1.162 billion as at Sept 30 2017. FCT financed the acquisitions of Bedok Point and Changi City Point through debt and equity placements.
According to a recent DBS Research report, this year could be a year for REITs to make acquisitions, as the cost of capital has fallen, following 2017’s price rally. REITs are trading at 1.1 times their book value. OUE Commercial REIT could acquire OUE Downtown this year, according to the report. Parkway Life REIT, a serial acquirer of properties, could acquire hospitals in the region, including Novena Mount Elizabeth, DBS indicates.
Acquisitions and fundraisings could result in larger market caps and a compression in DPU yields as institutional investors become unitholders, says DBS. However, for investors who may not want to fund a rights issue, there are also choices among the REITs, and the two office REITs that made big acquisitions in 2017 have the additional advantage of DPU growth prospects for 2018 and a sector upcycle.
Why raise equity?
Equity fundraising through a rights issue is done for a few reasons. The most common one is to fund growth. Real estate investment trusts (REITs) with growth plans and a strong pipeline from sponsors are more likely to ask unitholders for cash through preferential EFRs or rights issues.
Other than funding acquisitions, debt and declining capital values may also prompt REITs to ask their unitholders for cash. If debt levels are too high — the regulatory ceiling for REITs is 45% — and capital values fall, REITs may need to raise equity.
Cache Logistics Trust raised $102.7 million last October. Of this, $99.9 million was used to partially repay Cache’s borrowings to reduce aggregate leverage and create additional debt headroom for future growth. Around $2.8 million was used for expenses in connection with the rights issue, and the remainder, for working capital.
In January 2017, Sabana Shari’ah Compliant Industrial REIT raised $80.2 million. Of this, $60 million was used to repay a five-year $75 million term Commodity Murabaha facility, $16.5 million was placed in short-term bank deposits, $2.5 million was used to pay the underwriting commission and expenses and $1.2 million was used to pay the other expenses related to the rights issue.
In cases where gearing is high and the manager has articulated a strategy of making acquisitions, a rights issue or preferential EFR exercise is even more probable. IREIT Global falls into this category. Viva Industrial Trust’s gearing is at 39% and, if its assets are revalued downwards or it has to top up some land leases, it may need to raise equity (more details will be given in Issue 813 of The Edge Singapore).
Often, a REIT with gearing levels close to the 40%-to-45% range may make a significant acquisition in order to call for a rights issue, as this may be more palatable to unitholders than just asking them to lower debt levels.
This article appeared in Issue 812 (Jan 8) of The Edge Singapore.