Moody’s revises S-Reit outlook to stable from negative

Rental decline in office, retail and industrial sectors slowing down

MOODY’S Investors Service has revised its outlook for Singapore’s real estate investment trusts (S-Reits) to stable from negative, reflecting its view that the sector’s fundamental credit conditions will neither erode nor improve materially over the next 12 to 18 months. ‘The stable outlook is supported by three primary factors: the strong rebound in Singapore’s economy; the stabilisation of rents across the retail, office and industrial property sub-sectors; and the steady performance and lower refinancing risk of the rated S-Reits,’ said Peter Choy, a Moody’s vice-president and senior credit officer.

Moody’s is bullish as it feels the rental decline in the office, retail and industrial sectors is slowing down.

‘Although developers are launching a strong supply of office, retail and industrial properties in Singapore during the rest of 2010 and into 2011, the downward adjustment in rents of the last 12 months has already – and substantially – reflected the coming increase in inventory,’ said Mr Choy. ‘We therefore expect a slowing in the decline in rents for these sectors.’

Most S-Reits also saw some improvement in their first-quarter revenue year on year, Moody’s noted. Its report also pointed out that since the second half of 2009, S-Reits have taken action to improve their capital structure.

In addition, the decline in acquisitions has alleviated the need for short-term bridging loans.

As a result, the amount of debt maturing in 2010 is quite low. Those S-Reits with a higher amount of debt falling due in 2011 have already proved their ability to refinance their debt during challenging conditions, as they did in 2009, Moody’s said.

But in a separate report, Fitch Ratings pointed out that recent Australian acquisitions made by a few S-Reits come with some risks.

Fitch said that while there are benefits to offshore acquisitions – in terms of geographic and cashflow diversification – such expansion needs to be managed well from a property management viewpoint and with prudent balance sheet management.

Recent Australian acquisitions by S-Reits have spanned sectors across hotels retail, and office properties. Notable deals in Q4 2009 and Q1 2010 include CDL Hospitality Trust’s purchase of several Australian hotels, K-Reit Asia’s acquisition of a 50 per cent interest in an office building in Brisbane and Starhill Global Reit’s acquisition of the David Jones building in Perth.

‘S-Reits are expected to benefit from a more diversified cashflow arising from their Australian acquisitions, reducing their reliance on cashflows from a single market in Singapore,’ said Peeyush Pallav, a director with Fitch’s Reit team. ‘Furthermore, outside of Singapore, Australia benefits from a well-established legal framework and liquid property markets in comparison to many other Asian countries.’

But the impact of Australian acquisitions on the S-Reits’ credit profiles is expected to be varied – depending on the assets acquired and the funding, hedging and property management strategies adopted, Fitch added.

And while such expansion brings benefits such as cashflow and tenant diversification, it also increases the risks in terms of newer markets potentially less understood by external investors and exchange rate volatility that can impact capital values and income streams, Fitch warned.

Sticking a foot in investors’ eyes

FOOTNOTES, which have gained widespread disrepute in investment product brochures, seem to have found a new refuge in the press releases and financial statements of some real estate investment trusts (Reits).

Most Reits which carried out rights issues last year have been most generous in providing shelter to these tiny characters. These trusts have had quite a bit of explaining to do about their shrinking distributions per unit (DPUs), and the footnotes help clear the air just fine.

Or do they? Most investors wouldn’t think so.

What tends to happen is this. The Reit reports the DPUs for its latest financial quarter and for the year-ago quarter in its press release. The numbers invariably show a year-on-year growth in DPU, and there will be a paragraph or two of text reinforcing this achievement.

But look closer, and there is usually a footnote linked to the year-ago DPU. Turns out that this is not the actual DPU that the Reit raked in last year, but what the DPU would have been if the rights issue had happened then. This means that the number is smaller than it should be because of a restated larger unit base.

In other words, an unvarnished press release would have reflected a year-on-year fall in DPU. When a Reit issues new units to raise cash during the year, the unit base grows, and this dilutes the amount of distributable income each unitholder receives. But this effect has been downplayed by the footnotes.

If every company was as liberal with assumptions, reported bottom lines would never drop. Let’s take this approach further for illustration purposes. Technically, a firm could assume that the recession never happened, post higher projected profits, but add a footnote to say that the actual profit was lower because the downturn did come.

If it sounds illogical for a company to report its finances in such a way, why should it be acceptable for some Reits to publicise DPUs laden with restatements and what-ifs?

Granted, there is nothing wrong with dressing up the presentation of numbers in press releases. But this happens even in the financial statements of some Reits, where figures are supposed to be as bare as possible. The actual year-ago DPUs are usually hidden deep in an obscure section of the report, if investors care to look for them.

Yes, there is full disclosure, but this way of reporting numbers has made it hard for the implications of rights issues to surface. First, investors have to be diligent enough to read the footnotes appended to the DPUs last year. Next, they have to understand the fine print – not an easy task given that it is peppered with terms such as ‘pursuant’ and ‘proforma’.

Then, investors have to comb through the financial statements to find out what the DPU really was a year ago, before they can calculate just how much lower this year’s DPU is.

Reits which made cash calls last year should do unitholders the small favour of explaining just what happened – that the unit base expanded and DPUs had to fall. And they should let footnotes return to where they belong – in the realms of academia rather than in reams of financial statements.

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.

Diversifying funding sources

• Maintain Neutral. SREITs recently raised more than S$900m from capital markets at lower interest rates and longer tenures than a year ago. The opening up of capital markets should be very positive for the REIT sector, particularly as debts maturing in 2011-12 remain chunky. Nonetheless, we continue to perceive risks in the medium term if investors' appetite for bonds and notes does not grow more significantly, or if demand for higher yields intensifies in 2H10. We have not adjusted our interest-rate assumptions for REITs that have announced their refinancing as the quantum of issuance remains rather small and/or is significantly hedged. We maintain our financial estimates, target prices and Neutral position on the sector. Large-cap REITs (AREIT, CMT, CCT) are still relatively expensive and lack near-term catalysts. CDL-HT remains our sector top pick for its low gearing and on the back of our positive outlook for the hospitality industry

• Lower interest rates and longer tenures. Cost of debt has declined 100-150bp from a year ago for 3-year debt. Additionally, almost 90% of the issuances had tenures of 5-7 years, much longer than the standard three years which were available to the sector in the same period.

• Relief for chunky debt maturing this year and funding for acquisitions. The opening up of capital markets should be very positive for the REIT sector in providing a alternative funding source for refinancing and acquisitions. If capital markets remain open, debt maturity profiles for the whole sector could be termed out gradually. REITs seeking to acquire more assets would also have an alternative funding source.

• Medium term refinancing risk still exists. Nonetheless, we continue to perceive risks in the medium term if investors' appetite for bonds and notes does not grow more significantly, or if demand for higher yields intensifies in 2H10.