Category: REIT
REITs – OCBC
Class gap implies different valuation catalysts
Class gap between S-REITs. Consensus forward yields, ranging from 7- 38%, are showing a wide divergence in valuations across the S-REIT sector. Our thesis is that the S-REIT sector is now broadly segregated into two camps – the “haves” (large, blue-chip sponsored REITs with strong balance sheets) and the “have-nots” (smaller, non-sponsored REITs with high gearing). Valuation catalysts also vary accordingly – we believe the market focus for the weaker “have-nots” is still on their ability to secure refinancing but the focus for the “haves” is on 1) how the macroeconomic picture affects earnings and 2) the need for equity issues to recapitalize balance sheets. Investors can expect some key data points on both the refinancing and the earnings fronts in the coming months.
Refi news impacts “have-nots” more. MacarthurCook Industrial REIT [NOT RATED] announced yesterday that it has received a 60 day extension for its loan facility worth S$220.8m maturing on 18 April. MI-REIT is geared at almost 40% and this facility constitutes the bulk of its borrowings. The extension buys MI-REIT some time to continue negotiations with its lenders, National Australia Bank and Commonwealth Bank of Australia. Its inability to secure a resolution by April is a disappointment, in our view. MI-REIT’s refinancing efforts will likely be benchmarked against the Dec 2008 refinancing completed by peer Cambridge Industrial Trust [NOT RATED] as both S-REITs are relatively smaller, non-sponsored and industrial focused. We expect negative refinancing news to further widen the valuation gap between the two S-REIT classes. For the broader sector, such refinancing news may be indicative of lender risk appetite. Tighter loan-tovalue demands may trigger a sector-wide overhaul of capital structures, potentially via equity issues.
Watch rents & vacancy data points for the “haves”. Most S-REITs should report 1Q CY09 earnings over the last two weeks in April. We believe that 1H09 earnings are worth watching as the impact of macroeconomic events slowly filters through to the S-REIT bottom-line. For the office sector, we will be watching the pace of the decline in achieved rents as well as any change in occupancy levels. Given the economic slowdown, occupancy levels will be the key metric to watch in the industrial space. We are also looking out for an update on the post-CNY retail landscape and validation of the consensus ‘suburban means defensive’ view. We maintain our NEUTRAL call on the sector and leave our estimates and ratings for individual S-REITs unchanged in anticipation of 1Q results.
Link – Table
REITs – BT
Scrip dividends for Reits: why not?
IS THE use of scrip – instead of cash – as a way of issuing dividends to unitholders a violation of the basic characteristics of a real estate investment trust (Reit)?
One school of thought says that it is a violation as the scrip dividend scheme, if widely practised, runs counter to the objective of a Reit as a ‘stable, high-payout, pass through vehicle’.
This argument has its merits. But given the current unprecedented global financial turmoil, which has made many rethink previously established financial practices, the issue deserves a look from a different perspective. This is important as, like it or not, more trusts are likely to resort to scrip dividends amid an environment of credit squeeze.
If proper guidelines are in place on how cash conserved from issuing scrip dividends should be used, there is no reason why some Reits can’t take the scrip dividend route, even if it is a part scrip, part cash scheme with an opt-out option.
Given the present economic climate, asset values have dropped, sometimes in large percentages and there is very tight financial liquidity as banks seek to manage risks and minimise losses. The nature of business or life is that nothing is ever certain. We try our best to manage the challenges as they confront us.
Often times, we adapt, improvise, modify and even take a 180 degree-turn just to survive.
A Reit which had a good business model just two years ago is probably facing a different set of figures now. Falling asset values cause the net gearing to rise. Drops in consumer spending due to unemployment and other reasons bring lower yields as rentals fall. A very high degree of conservatism among financial institutions to minimise potential non-performing loans (NPLs) brings higher borrowing costs.
Taken together, these three factors threaten to sink many a less sturdy Reit. Unitholders don’t want to see their Reits collapse due to refinancing failures, a view shared by those against the scrip dividend practice.
Scrip dividends have been with us for a long time. The argument is that if you bought into a business, getting a bit more of the business is often a good thing so long as sound management prevails. Though it’s perhaps unfortunate that in today’s context, more companies resort to it for different reasons.
Reitholders who had invested even a year ago are looking at large losses on the prices of their units. Many Reits are trading at substantial discounts to net tangible assets (NTAs) or initial public offering (IPO) prices.
Real estate is fundamentally a medium to long-term investment. From this viewpoint, the current guidelines for Reits to distribute at least 90 per cent of their distributable income to qualify for tax benefits should perhaps be re-examined. This percentage and the accompanying tax benefits could be reduced on condition that the amount not distributed as a result of a scrip dividend be set aside for paying debt. A regulatory requirement to ensure that the retained earnings are correctly deployed to mitigate the accompanying drop in cash distribution is important. Savvy long-term investors may then shift their focus on short-term DPUs (distribution per unit) to net gearing and cash balances. This allows for Reits to be built on sturdier ground to stabilise them from regular oscillations in asset values and economic cycles.
There are investors who look forward to putting their money in a Reit that has a good portfolio with very little gearing. It has to do with times past where we often looked upon debt as a burden and tried to pay cash for our purchases if possible.
A well-managed Reit that can reduce its gearing regularly over time may even end up with zero gearing or a net cash surplus position. Owning more shares in such a Reit is probably the best real estate investment one can make. It pays ‘good yields’ as there is little financing costs and insulates unitholders from bankers who keep the umbrella when it starts to pour. And a Reit built on ‘solid sturdy ground’ may trade close to or even above their NTAs in good times, a far cry from today’s deeply discounted prices.
REITs – BT
Scrip dividends violate Reits’ basic characteristics
THE authorities recently rejected the request of some real estate investment trust (Reit) managers to reduce the minimum payout ratio to unitholders while still being allowed to enjoy tax concessions.
Spelling out the government’s stand a few weeks ago, Senior Minister of State for Finance and Transport Lim Hwee Hua said: ‘The key characteristics of Reits as a stable, high-payout, pass-through vehicle are important considerations for investors and, hence, must be preserved.’
‘Ministry of Finance and Monetary Authority of Singapore have deliberated this issue and have decided that the minimum payout ratio would not be changed,’ she added.
Under current guidelines, Reits have to distribute to unitholders at least 90 per cent of their distributable income, in order to enjoy tax transparency, which means exemption from paying corporate tax at the Reit/vehicle, on the portion of income they distribute.
Reit managers have urged the government for a rule change as they deemed it conservative to retain cash in view of the very difficult credit market conditions. The worry is that they may not be able to get refinancing, and even if they could the costs may be exorbitant.
‘While we appreciate the refinancing difficulties faced by Reits, there are, at present, no strong grounds to justify a special tax treatment for Reits that is not made available to other entities,’ said Mrs Lim.
She noted that a few Singapore Reits have already managed to secure refinancing either through bank loans, loans from sponsors or recapitalisation, albeit at a higher cost. ‘It is unrealistic for S-Reits to expect to have continued access to cheap and easy credit during this recession,’ Mrs Lim commented.
While the authorities have made their stand clear on the minimum ‘payout’, the fact is there is another way within the confines of existing rules for Reits to conserve cash and yet still be entitled to the tax concessions: distribute scrip dividend instead of cash dividend.
By distributing scrip-only dividend, that is investors get additional units in the Reits instead of cash, these trusts are able to retain cash without altering their payout policies. Hence they are not in breach of their 90 per cent payout rule in order to be entitled to the tax concessions. Indeed, one Reit has already proposed doing that, and it is said that others are considering it as well.
Saizen Reit announced earlier this year that its board has proposed the adoption of a scrip-only dividend scheme. ‘Such scheme, if adopted, provides flexibility for Saizen Reit to pay out dividends in the form of units in future,’ it said. But it added that the payment of dividends in the form of units will be a temporary measure to conserve cash during this uncertain period. ‘Saizen Reit will resume its dividend payment in the form of cash once the loan refinancing issues are resolved,’ it assured unitholders.
Of course, distribution of scrip-only dividend is tantamount to a Reit not distributing its income at all. Hence, if adopted by many, it would mean that Reits’ key characteristics of being ‘a stable, high-payout, pass-through vehicle’ may no longer be met.
From the standpoint of unitholders, yes, they can sell the additional units received in the market to raise cash. But they will have to incur transaction costs. Furthermore, there is no telling what the market price will be in today’s environment. On the flip side, unitholders also don’t want to see the Reits collapse because of their inability to refinance their loans. That would not be in their interest at all.
In any case, the proposal of the scrip-dividend payout is still subject to approval by the Singapore Exchange (SGX). Given its inconsistency with the Ministry of Finance’s stand on preserving the key characteristics of Reits, it would be surprising if indeed SGX gives the go-ahead for the proposal to be implemented.
REIT – BT
Investment firm says once financial stability is achieved, Reits should do well as their underlying cash flows remain sound. By Genevieve Cua
REAL estate investment trusts are supposed to be stable assets and a core retiree holding, whose regular yield distributions help to cushion a portfolio. All these attributes went out the window in the wake of the severe and on-going credit crunch.
‘Real estate is very capital intensive. In Australia and Asia, most of the liabilities or loans have been relatively short term. Most of the issues relate to the need to refinance debt, and very little debt is available. It’s less of a real estate problem than a capital markets problem.’
Reits’ share prices have been battered amid the flood of deleveraging as investors dumped more liquid equity and bond holdings. Mr Redding, however, says Reits’ underlying cash flows remain sound. The caveat is that the more prolonged the credit squeeze, the greater the pressure on valuations and rentals. ‘Cash flows have been reasonably good. We think the world is focused on the wrong metric. To ascertain the value of a building an appraiser tries to find the cash flow or net operating income and arrives at a capitalisation rate. They look at other buildings . . . but we’ve had very few transactions. The way to really judge value in real estate is the cash flow. Right now, rents are under pressure, but lease terms can be long, so cash flows continue.’
Mr Redding has more than 20 years’ experience in real estate and has founded and co-founded three investment advisory firms specialising in real estate securities.
The AMP Global Property Securities Fund has US$1 billion in assets. In the year to end-December, the fund generated a return of minus 44.8 per cent in Aussie dollar terms, against minus 45.6 per cent by the UBS Global Real Estate Investor Index. Since inception in November 2004, the fund has delivered an annualised minus 3.8 per cent loss, compared to the index’s minus 5.9 per cent. The fund is not available to offshore investors.
Mr Redding notes that valuation metrics are at the lowest levels historically, with substantial yield spreads against Treasuries. In Singapore, listed Reits’ yield spreads against 10-year Singapore government bonds are well into double digits. In a March report, OCBC Securities’ Meenal Kumar estimates that S-Reits are currently valued at a 61 per cent discount to reported NAVs. ‘Lenders’ appetite for loan-to-value (LTV) have fallen because of an expectation of falling capital values and a decreased appetite and capacity for risk,’ she wrote.
Mr Redding is sanguine even as he notes that many Reits are in technical breach of their LTV covenants. ‘But if you look at the interest cover, or cash flow to service debt, that’s still very strong. In Australia, which is struggling, (Reits) have 2.7 times interest cover. We think lenders have so many problems, it’s hard to imagine that they would force companies that can adequately pay their interest costs into bankruptcy. Rational minds will prevail.’
He is often asked by investors if they should remain invested, and when is the right time to re-enter the market. The firm, which manages some US$2.9 billion in securities, saw net inflows last year. This year, some US investors have also allocated capital. ‘If we do have financial stability and one day we flip to inflation, Reits will do quite well.’
He sees some positive signs in California where home sales have picked up. US households’ savings rate have also shot up to 5 per cent from minus 2.5 per cent last year. ‘The sooner people repair their balance sheets and work off a solid base, the better off we’ll be.’ Large firms such as Westfields are beginning to scout for acquisitions – a sign that the market is on the mend.
The portfolio is defensively positioned with securities that the firm puts into the top quintile in terms of quality. Mr Redding, however, says that he is beginning to scrutinise lower quintile firms for opportunities. ‘I have to be an optimist. I think US$3.4 trillion in US fiscal stimulus will ultimately stabilise the system. So then the companies that would do best are those that trade like they are almost going into bankruptcy. They could see a very rapid rise in share prices. But we have to be cautious because we don’t know how long capital markets will stay frozen.’
Meanwhile, Moody’s in a January report maintained its negative outlook on the Singapore Reits sector due to a number of risks relating to refinancing, asset devaluation and a weaker operating environment. Moody’s has since downgraded three S-Reits, including Ascendas, and put a number of others on credit watch.
The firm says 11 rated S-Reits have some $3.7 billion in debt maturing this year and nearly half are CMBS (commercial mortgage backed securities). As the latter market is now moribund, the Reits will have to rely on bank lending. It points out that S-Reits also have a high level of encumbered assets, which limit their financial flexibility. For rated S-Reits, only 17 per cent of assets are unencumbered against 70 per cent among rated Australian Reits. ‘As S-Reits try to get new loans over the next 12 to 18 months, the relative share of secured debt is likely to increase through new charges over assets.’
The prospect of asset devaluation is yet another concern. S-Reits have enjoyed sharp rises in property values in the last couple of years. ‘This rise in property values masks an underlying high level of leverage, even though debt-to-asset metrics have remained well below 45 per cent. The ratio of debt to Ebitda, however, presents a different picture. Several rated S-Reits are close to or have already breached their trigger levels for downgrades.’
Moody’s reckons that a 15 per cent decline in S-Reits’ asset values would have the most impact on those trusts with high leverage and covenants tied to such measures.
REITs – BT
Watch Reits loan-to- value ratio: report
WATCH the loan-to-value ratio of real estate investment trusts (Reits) rather than the leverage, OCBC Investment Research said in a report yesterday.
This comes as S-Reits’ financial statements give mismatched estimates of their debt and balance sheet strength, said analyst Meenal Kumar, keeping her ‘neutral’ rating.
‘Loan-to-value is more important than reported leverage,’ she noted.
The loan-to-value ratio is used to determine the fair value of an asset against the loan that is financing its purchase and can indicate losses from non-payment that may be recovered by selling the asset.
Most fourth-quarter results from the S-Reits were in line with Ms Kumar’s expectations, but she said that this is not a sign of a stable market.
‘This quarter’s performance was not evidence of stability or invulnerability but more a function of timing lags,’ she said.
She added that indicators such as reversionary rents – the change in income after a rent review or renewal of a lease – at Suntec City have fallen 11 per cent on a quarterly basis.
‘The same inertia played out in net asset values,’ she said.
‘Overall, we feel cap rates used by the independent valuers still do not fully reflect the downward trend in capital values.’
As a result of this lag, Ms Kumar said reported balance sheet figures are ‘under-estimating leverage and over-estimating balance sheet strength’, adding that the market is now valuing S-Reits at an average 61 per cent discount to their reported net asset value.
She noted that unit prices ‘more than reflect the realities of falling capital values and refinancing risks’. ‘The focus is now on how deeply S-Reit earnings will be affected by deteriorating economic conditions – and consequently what is the ‘real’ distribution yield,’ she said.
With more equity fund-raising such as rights issues expected among S-Reits, Ms Kumar said the issues will need underwriters to secure funding amid stiff competition.
‘The strength of the sponsor and the size of its stake will make a difference,’ she said.