BT, Published November 26, 2005

S-Reits score on yields and growth outlook

They stand out in this region on the two counts

THERE are eight stages in the development of the real estate investment trusts (Reits) market, and there are different challenges and characteristics in each one of them.

That's according to an analysis of Macquarie Research Equities in a 82-page report on Asian Reits issued last week. It's a pretty comprehensive report, and since in the last few weeks investors in Singapore have been grappling with understanding the impact of rising interest rates on the performance of Reits, I thought I would share with readers of this column some of the points highlighted by the analysts Matt Nacard and Frank Chen.

Eclipse

Macquarie named the eight-stage development of Reits the Eclipse Analysis.

The first stage is when Reits are first introduced to the market. The initial Reits in the market are usually lowly geared, illiquid property funds with single assets. Most of the units are retail-owned. Thailand and Korea are in this stage.

In the second stage, legislative changes will drive the sector's growth. Gearing limitations are lifted, tax breaks are given and foreign ownership restrictions relaxed. Malaysia, Taiwan and Hong Kong are here.

From there, Reits will experience an extended period of acquisition-driven growth.

The market prices the Reits for growth, thus giving them the cost of capital to acquire accretively. Asset universe is broad. Singapore and Japan are in the tail-end of the third stage.

The fourth stage is when growth plateaus. Acquisitions become more difficult and the management's focus turns to operational improvements. The trusts start to look offshore.

Higher-risk-oriented earnings streams, from development funds management and construction, and so on, will lead to higher earnings growth in the fifth stage.

Following that, the scarcity of accretive acquisitions will drive mergers and acquisitions. The stronger managers will bid for weaker managers with good assets. That's where New Zealand is at.

After the consolidation, interest returns to the market. And there will be an rise in overseas acquisitions and financial engineering. However, increasing calls on equity will place a drag on funds flow into the index. That's what we are seeing in Australia now.

And finally, stage eight is still pretty much an unknown.

The Asia Pacific Reit markets are approaching US$100 billion in market capitalisation with Hong Kong poised to become the growth driver in 2006. Hong Kong's Reit market cap is expected to be about US$4.5 billion by June 2006, while in Singapore, further growth is expected to boost its Reit market capitalisation to US$8 billion by that time.

The current total market cap for Singapore Reits is just over US$6 billion now.

The more mature a Reit market, the more significant the impact of rising long-term interest rates, says Macquarie Research.

Singapore and Japan's Reit markets showed no correlation with rates in their early years but in 2005, the correlation is a strong -0.75. The lessons from Australia's more mature listed property trusts (LPTs) market are clear - rising rates are generally a negative but this should not be over-played. It is important to look at how the LPTs perform relative to other sectors.

According to Macquarie, the two key periods of LPT underperformance were driven by the strong media performance in 1998-99 and the resources drive in 2003, rather than poor LPT performance. 'The defensive charateristics of Reits allow them to outperform in broader equity bear markets, even if rates are rising. This is particularly the case where rates rise over an extended period of time,' it says.

Macquarie is of the view that pricing is still reasonable in the dynamic Singapore Reit (S-Reit) market, although performance has stalled in recent weeks.

S-Reits continue to offer the highest yield spread to government 10-year bond yields in the region. Yields for S-Reits are slightly over two percentage points above the government 10-year bond yield.

Growth front

But spreads only tell part of the story. The growth outlook is just as important. And on this front, S-Reits are superior as well. According to Macquarie's forecast, its dividend-per-share growth next year is 4.4 per cent and its compounded annual growth rate between 2005 and 2009 is 4.1 per cent. This compares with Australian LPTs' growths of 3.6 per cent and 4 per cent respectively.

Another pertinent question: Is the acquisition party over?

Macquarie did a sub-sector analysis of S-Reits and found that the retail sub-sector is the most advanced. About 39 per cent of the investible retail properties have been acquired by Reits. The sub-sector accounts for more than 50 per cent of the total sector market capitalisation.

For offices, 18.4 per cent of the investible properties are owned by Reits, and for industrial 21.3 per cent. But despite the fact that office Reits only hold 18.4 per cent of all investment grade office properties, the typical capital rate of 5 per cent is the firmest in all sub-sectors. As such, yield-accretive acquisitions continue to be difficult to come by.

The current asset yield of about 7.2 per cent in the industrial sub-sector is still quite attractive to Reits. Furthermore, industrial rents only began to recover recently. Thus Macquarie believes there's more scope for rental increases moving forward.

'With Mapletree Reit and up to two more industrial Reits expected to list over the next six to 12 months, competition for industrial Reits is expected to drive down the average sub-sector yield. Nonetheless, the industrial sub-sector looks the most attractive to us at this point in time,' says Macquarie. Prime Reit is also in a good position.

In addition, the firm observes that the larger the size of an acquisition, the larger the earnings impact. Asset sourcing is thus important. Here, A-Reit through Ascendas, Mapletree via Temasek and Prime through Macquarie are best placed.

BT, Published November 23, 2005

What's behind Reit price slide?

A FEW months ago, we asked in this column whether the real estate investment trust (Reit) sector was in for a rough time because of rising interest rates (BT, Hock Lock Siew, Aug 26 - 'Is Reits bubble bursting?'). At the time, we noted severe signs of strain in the sector, with prices weakening alarmingly in the weeks following the government's announcement on July 19 of measures seen as boosting the physical property market. The logical conclusion then was that funds were probably switching out of Reits into property stocks to play the expected recovery.

Since then, things have gone from bad to worse for Reits. Not only has the sector sagged during the intervening three months, but the selling has intensified recently - in one week, Mapletree Logistics has lost almost 10 per cent and Ascendas Reit 8 per cent, while Macquarie Meag Prime Reit yesterday slumped to an all-time low of 90.5 cents. CapitaMall Trust, arguably the sector's leader, is down 16 per cent since August.

What gives? How is it that a sector which was touted as offering the best avenue for growth in the local market has lost that much shine in such a short space of time?

No doubt, rising interest rates have played some part. US short rates have been jacked up at every Fed meeting this year, and by most analysts' reckoning, there are at least two or three more rises to come. This has placed pressure on local rates, which have been creeping recently. Reits are, after all, primarily yield plays and all such plays will appear less attractive when alternative, relatively less risky alternatives are available.

In addition, our August suggestion that funds would shift out of an outperforming Reit sector into underperforming property stocks has turned out to be accurate - the SGX Properties Index has risen just under 7 per cent from Aug 26.

At least three other factors have also probably contributed. First, the JTC news that it is to sell off its industrial property businesses has created fears of a Reit-overhang if the properties are packaged into a Reit. According to one estimate, such a Reit could be worth around $4 billion - a sizeable sum that would surely drain liquidity out of other Reits.

Second, the upcoming listing of Link Reit in Hong Kong this Friday. Although the final price has not been announced officially, a best-guess is that it will be fixed at HK$10.30 per unit, which is the upper end of the indicative price range. At this price, the offer is set to raise HK$19.8 billion (S$4.33 billion) for the government. If the overallotment option is exercised, the figure could rise to HK$22 billion.

Either way, if demand for Link Reit is as high as news reports make it out to be, funds could be forced to sell their other holdings to raise the necessary cash.

Finally, even speculative money could be deserting the sector. It's worth noting that over the past fortnight as Reits have dived, technology stocks like Chartered Semiconductor and Creative Technology have been in heavy play - partly because of Nasdaq's gains, partly because the stocks concerned had been bashed to fresh year-lows and partly because of a belief that year-end sales of computers and electronics should improve with the onset of the Christmas holiday season.

Even if earnings are not really that significantly boosted, the momentum shift in Reits versus tech stocks gives short-term tactical funds an excuse to sell a sector that has outperformed and to switch into a sector that has underperformed.

There could, of course, be situation-specific factors at work. Mapletree's purchase this week of a logistics centre in China, for example, has not exactly set the market's pulses racing. In a 'hold' recommendation yesterday, OCBC Investment Research said that after deducting what are expected to be hefty interest charges, the acquisition will only be modestly yield-accretive for Mapletree.

Kim Eng Securities yesterday noted that Ascendas Reit still trades at a 57 per cent premium to net asset value and that upside is likely to be limited because of a 'modest acquisition growth outlook'.

Still, the recent collapses should have made the instruments more appealing to buy-and-hold investors who still place dividends above capital gains. As such, there should be support forthcoming from this part of the market.

For prospective Reit issuers though, many of whom are rushing to jump on the bandwagon, the message is clear: the instrument has lost its shine and the key to success will lie in pricing. Offering yields of 4-5 per cent may not be good enough anymore - not when the interbank rate is hovering around 3 per cent.

Extracts fm Merrill Lynch Report dated 12-July-05,

Highlights:

• A perfect storm. of trends and developments has created an unusually wide gap between REIT property valuations and normal property market valuations. We think REITS are the most active participants in commercial and retail property markets
  
  
• We expect a large trend of transferring property assets into REIT structure and that corporate Singapore will get better value than expected.
  
  
• Value creation - The combination of corporate Singapore.s focus on divesting non-core assets and capital management with a timely boost to asset values implies good value creation for the leading yield/capital management plays in Singapore. We think SPH, F&N, SGX, Parkway, and even banks will benefit from this trend.

CNA, 25 October 2005 1938 hrs

CapitaLand aims to double revenue in five years, plans China REIT

SINGAPORE : CapitaLand aims to double its revenue in the next five years, with growth driven by its China operations. The comment came from chief executive Liew Mun Leong when speaking to reporters during his visit to Beijing on Tuesday. He says the property firm also plans to launch a real estate investment trust, or REIT, in China, although it expects this to take about six months to a year.

CapitaLand has been aggressively expanding abroad, especially into China, to diversify its holdings. Its overseas operations now contribute about two thirds of its earnings. But the property firm aims to raise that to three quarter over the next few years. It says the China market is its mainstay, driving its future growth overseas. China now accounts for about 11 percent of the group's business in terms of asset size. CapitaLand expects this market to contribute 30 to 35 percent of its earnings before interest and tax in the next few years. Said Mr Liew, "I believe that China will divert growth into high quality investments. In other words, I don't believe the government wants to reduce the growth. They will put the growth in better quality assets and investments."

CapitaLand has just set up a new US$400 million private equity fund with Citigroup to invest in China's real estate. And it plans to launch a real estate investment trust in China to take advantage of the country's economic boom. But since there is no trust structure in China at the moment, CapitaLand says it will have to wait for the Chinese government to review this possibility. Said Mr Liew, "Real estate investment trust is a special investment trust where it depends heavily on tax transparency. So the government has to look at tax transparency, look at what assets we can put in, borrowings, debt management. So there are a number of things that the government has to review before it can be REITs friendly."

But CapitaLand is confident that it can float the REIT in about 6 to 12 months time. The group says it is now studying which assets can be deployed into the trust when it gets the green light from the Chinese government. - CNA /ct

Extracts fm Lim and Tan Report dated 24-Oct-05,

The MAS has issued new guidelines for Singapore Reits, with the main ones being:

• Gearing limit has been raised to 60% from 35%.
  
• Deferred payments are allowed, but they must be included in the gearing.
  
• Credit rating must also be obtained from agencies.
  
• Reit managers can be ousted if at least 50% of unit holders, present and voting, agree to do so.
  
• Reits must obtain 2 independent valuations of properties in deals with interested parties.
  
• The 12-month moratorium from IPO date during which reits cannot strike deals with interested parties will be removed.

COMMENTS

1. The new guidelines are positive for the reit sector.
   
2. Allowing deferred payments is however a surprise after the recent controversy generated by Temasek Holdings, suggesting the deal between City Developments and Suntec Reit can be revived. Indeed, as Mr Kwek Leng Beng had then pointed out, Sintec Reit had the advice of 1 investment bank, and obtained valuation by 2 independent valuers.
   
3. Our picks remain CMT, indisputably the most professionally and competently run reit, and CCT the “purest” proxy to office property market. Based on the latest distribution of 1.81 cents per unit for the Sept quarter, CCT yields 4.8%, comparable to CMT’s.
   
4. This is especially so as we expect investors to be more discerning in choosing between Reits, now that credit ratings will soon be readily available.

THE new Monetary Authority of Singapore (MAS) guidelines for real estate investment trusts (Reits) appear to strike the right balance between safeguarding the interests of unit holders and giving managers flexibility. With these guidelines, Singapore cements its position as a leader in Reits in Asia.

There are safeguards should a trust acquire partial ownership in properties. The gearing limit is capped at 60 per cent - compared with 45 per cent in Hong Kong. Deferred payments are allowed but need to be counted as debt when calculating the gearing level. Time will tell whether this will revive the Suntec Reit deal to acquire 11 properties from City Developments for $788 million; Suntec Reit is trying to abandon the purchase for lack of regulatory approval.

Perhaps most welcome of all to unit holders is that a trust's managers can be dismissed if 50 per cent of unit holders vote for them to go. This is the case for companies and should have been the case for Reits right from day one. Until MAS's revision, managers of billion-dollar Reits had an entrenched position, as it required a 75 per cent vote to remove them.

The manager's role in a Reit is pivotal; the onus to deliver ever growing distribution per unit falls squarely on the managerial shoulders. With more Reits competing for investor attention and for property acquisitions, the ability of the manager to deliver will become both more apparent and more important. It is not inconceivable that unit holders can find another party who can do the job better or more cheaply than the manager who is linked to a 30 per cent owner of the trust.

A Reit manager stands to make very good money. Take the recent acquisition of Parco Bugis Junction by CapitaMall Trust (CMT). CMT's manager, CapitaMall Trust Management, earned an acquisition fee of one per cent on this transaction worth $580.8 million, which works out to $5.8 million. Such fees earned are over and above the manager's recurrent income. In CMT's case, the total paid out in asset management fees for 2004 was $11.3 million, or 6.4 per cent of gross revenue.

Different Reits have different payment structures, being a mix of base fees and performance fees. Effectively, Reit managers are being paid around 0.5-0.6 per cent of the total value of properties within a trust. In short, earning $10 million on a $2 billion portfolio on a recurrent basis for a people business is no small change.

In Australia, which has a mature Reit industry, trusts have been acquired because the acquiring party wants to be manager of the underlying properties.

Going forward, it is possible that Reits in Singapore will consolidate, as with size come economies of scale. This points to an area where Reit regulations can be enhanced. Listed companies have the takeover code to ensure that there is a framework to guide how takeovers should be conducted. But the code does not apply to Reits. The takeover code might well need tweaking to be applicable to Reits - but let's start making those changes now. Investors are best served by knowing what the rules are should the day come when someone wants to take over a Reit.