S-Reit sector bounces back from global crisis

With the completion of recapitalisation exercises and major refinancing S-Reits are poised for acquisitive growth

IN LATE 2008, the effects of the global financial crisis had come to a head.

What started as a spike in real estate prices in the United States gradually spread to other jurisdictions and when the bubble eventually burst, the fallout brought global credit markets to their collective knees. Real estate companies, having witnessed their stock prices plummet, were forced to watch as credit liquidity dried up.

The negative investor sentiment did not spare Singapore real estate investment trusts (S-Reits). The market capitalisation of S-Reits declined by more than 50 per cent in the second half of 2008, and continued their slide into the first quarter of 2009. The impact was widespread, with little distinction being made for the individual qualities of particular Reits.

Credit/refinancing risk (in view of the requirement to distribute in excess of 90 per cent of taxable income in order to enjoy tax transparency) was cited as one of the primary reasons for the unit price declines and S-Reits sought to address this concern. However, this was no easy task for Reit managers, as banks, constrained by their own credit considerations and with no clear idea of the extent and duration of market uncertainties, were less than eager to put their balance sheets in jeopardy.

With the completion of recapitalisation exercises and major refinancing, the S-Reit sector has re-rated and prices have rebounded strongly. By the end of 2009, S-Reit prices were up approximately 60 per cent from the start of the year.

Over the last eight years, S-Reits have grown not only in scale, but also in complexity and depth. S-Reits now own assets in retail, commercial, industrial, healthcare, hospitality and residential sectors, located in numerous jurisdictions around the region.

Structures have changed too, with the constraints posed by the traditional Reit regulatory regime being overcome by the use of alternative structures. For example, selected property trusts have utilised the business trust structure to overcome development constraints, whilst incorporating a majority of traditional Reit structure elements to leverage on the relatively wider Reit investor base. Investors too have matured, with many now largely able to differentiate the quality of individual property trusts.

2010 began on a positive note, with the $182 million placement exercise undertaken by Frasers Centrepoint Trust executed at a tight discount of 3.7 per cent to adjusted volume weighted average price. This was followed by the IPO of Cache Logistics Trust (CLT), the first property trust IPO in almost two years. Cache’s IPO attracted a subscription rate of approximately 7.8 times, demonstrating the market’s strong appetite for new Reit products.

It would be safe to assume that issuers will aim to repeat the success of CLT’s; seeking to raise capital and kick-start growth plans which may have been largely set aside in the preceding years. Listed Reits, free from refinancing concerns (only approximately 17 per cent of S-Reit debt matures in 2010) retain the option to revisit the capital markets this year, and to undertake equity fund raising to fund acquisitive growth.

Reit managers, with the events of 2009 still fresh in their minds, are unlikely to be keen to gear up too excessively to fund acquisitions, despite liquidity having largely returned to the credit markets. In this regard, listed Reits that are trading at premiums to net asset value, are well positioned to deliver accretive acquisitive growth to unitholders.

As the S-Reit market continues to mature, investors should not lose sight of the fundamentals that led to the sector’s success in the first place. Investors seeking to invest in a particular Reit should begin by analysing its property portfolio.

Areas for consideration include property type, geographical location, occupancy rates, demographics, lease terms, tenant quality and diversity. These, in turn, would impact the portfolio’s aggregate rental income and ultimately, the sustainability and stability of the Reit’s distributable income.

Investors should also consider the Reit manager, a critical component of a high quality Reit. The principal responsibilities of the Reit manager include the development and implementation of the Reit’s investment strategy as well as the management of its portfolio and capital structure to ensure the long term success of the Reit. A strong Reit manager is made up of a team of experienced individuals, with expertise specific to the asset portfolio and the Reit structure.

Besides the Reit manager, investors should also look to the quality and commitment of the Reit sponsor. A Reit sponsor would typically hold a meaningful stake in the Reit, hold a stake (part or whole) in the Reit manager, provide an acquisition pipeline by means of a right of first refusal and make available a business network to facilitate the Reit’s growth plans. On occasion, the sponsor shares its name with the Reit to provide familiarity to investors based on its own track record of performance.

As global equity and credit markets continue to recover, potential Reit sponsors from around the region will continue to look to Singapore as a premier listing destination.

This is given the critical mass of listed Reits trading on the Singapore Exchange, its vibrancy and strong track record of market performance, conducive regulatory and tax framework as well as investor familiarity and confidence in standards of governance. The manner in which regulators and market participants have worked together, to enable the Reit sector to weather and emerge stronger after an unprecedented financial crisis, has not gone unnoticed.

At the end of the day, in a world of increasing complexity, the simplicity of the Reit model, its strong underlying fundamentals, and relatively risk averse nature, make it an attractive option for investors to consider.