What We Can Learn From EC World REIT’s Troubles

Takeaways from EC World REIT’s recent financial troubles involving its inability to refinance its debt and missed collections from its key tenant.

EC World REIT (SGX: BWCU) is in hot water. The Singapore-listed real estate investment trust, which owns properties in China, is having trouble keeping sufficient funds in its interest reserves and the manager of the REIT also claims that the REIT is owed around S$27.5 million (RMB 145.8 million) from one of its tenants.

Its liquidity troubles led the REIT manager to call for a voluntary trading halt of its units. With financial issues mounting, the situation looks rather bleak for unit holders who are now left with no way to offload the units.

While unpleasant, a bad situation presents us with a learning opportunity. With that said, here are some lessons we can takeaway from EC World REIT’s troubles.

Beware of tenant concentration risk

Tenant concentration risk is a big risk for REITs.

EC World REIT is not the only REIT to suffer from missed payments by a major tenant. First REIT (SGX: AW9U), which owns healthcare properties in Indonesia, also suffered a shock a few years ago when its main tenant forced a restructuring of its master lease arrangement, leading to a drastic fall in income for the REIT.

Ability to refinance its debt

EC World REIT first ran into problems when it was unable to refinance its debt that was coming due.

REITs typically take “interest-only” loans. Unlike a home mortgage, in which the borrower pays a fixed amount every month to pay off the interest and a part of the principal, an interest-only loan is a loan where the borrower only pays interest on the loan and does not need to pay back the principal until the loan matures.

As a REIT is required to distribute 90% of its distributable income to its unitholders, a REIT usually does not have enough cash to pay back the principal when a loan matures. As such, the default option is to refinance the loan with a new loan. However, in a situation where the REIT is unable to refinance the loan, the REIT may end up with a liquidity issue.

REITs with stable assets, a diversified tenant base, other means to capital, and low debt-to-asset ratios will likely have less trouble refinancing their debt when it comes due as lenders will be willing to underwrite loans to these REITs. On the other hand, REITs that have unstable assets, tenant concentration risk, or an inability to raise other forms of capital may be at risk of being unable to refinance their debt.

Diversify your investments

A few years ago, I personally invested in both EC World REIT and First REIT (I sold both these companies in 2020). I was willing to invest in them as both offered high yields which I believed was fair compensation for the risks involved.

While there was a chance that the investments could turn sour, I was at least collecting 8-9% in annual distribution yields. Just a few good years and my distributions collected would have paid off my investment principal.

But I also made sure that these investments only made up a small percentage of my entire portfolio. If they turned out well, I would have made a decent return. But if they soured, the impact on my entire portfolio would still be minimal.

Bottom line

Investing is ultimately a game of probabilities. Some companies may provide better yields but have a higher element of risk while others provide lower yields but are less risky.

REIT investing is no different. Although investors tend to think of REITs as safer investments than companies, REITs also have their fair share of risk. REITs typical take on a lot of debt and this high leverage is one of the biggest risk factors for REITs.

In times of rising interest rates and tighter capital markets such as the current environment, the situation becomes even more uncertain for REITs. As such, we need to assess each individual REIT before investing and make sure that we diversify our investments to minimise the risk of ruin.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time.

Can a Company’s Stock Price Influence Its Business?

Are price and value always independent of each other? Maybe not. In special situations a rising stock price may actually be self fulfilling.

“Price is what you pay, value is what you get.” -Warren Buffett

The common wisdom is that a company’s stock price, in the short term, doesn’t always align with its intrinsic value. But eventually, stock prices gravitate towards intrinsic values. That’s the rule of thumb – that a stock’s price will move towards a company’s true value.

But could it also be the other way around? Instead of the stock price following value, can the stock price influence the value of a business?

In certain scenarios, this interesting dynamic has actually played out.

Self-fulfilling stock price

An example of how a stock’s price can influence a business’ value is when a company decides to make use of its rising stock price to raise money cheaply.

A rising stock price is an indicator of healthy investor appetite for a company’s shares, even though the appetite may not always be validated by the company’s fundamentals at that time.

As one of the main characters in the meme stock mania, Gamestop is a recent example. Gamestop’s stock price, due to retail investors banding together to try and trigger a short squeeze, soared to an extent that most experts will agree, far exceeded the company’s actual business value.

However, this steep mispricing in the stock price gave Gamestop’s management the opportunity to issue a secondary share offering at a much higher price than the company would have been able to if not for the meme stock craze.

As a result, the games retailer was able to raise more than a billion dollars with relatively minor dilution to current shareholders, thus improving its business fundamentals. This, in turn, has led to an improvement in the intrinsic value of the business.

Even Tesla has taken advantage of this

Self-fulfilling stock prices are not reserved solely for meme stocks. In fact, a host of other companies have taken advantage of their rising stock prices in 2020 to issue new shares to boost their balance sheets at relatively cheap rates.

Take Tesla for example. The electric vehicle front runner raised fresh capital three times in 2020 through secondary offerings as its stock price climbed. Each secondary offering happened when Tesla’s stock price hovered around a then-all-time high. These gave the company the dry powder to build new factories in Berlin and Texas and even invest in Bitcoin.

Elon Musk, Tesla’s self-proclaimed “Technoking” and CEO, and Zach Kirkhorn, Tesla’s “Master of Coin” and CFO, have done a great job in identifying instances when the appetite for Tesla shares in the public market allowed them to raise fresh capital cheaply, resulting in relatively minor dilution.

With its newfound financial firepower, Tesla is in a much stronger position to ramp up the production of its electric vehicles to meet the incessant consumer demand that it’s enjoying.

It happens in Singapore too

Although Singapore-listed stocks are known to trade at seemingly low prices, there are pockets of the market that may trade at a premium.

The best examples are real estate investment trusts (REITs) that trade at a premium to their tangible book values, such as those that are sponsored by big-name property giants such as CapitaLand and Mapletree. In such cases, it is actually beneficial for a REIT to raise capital by issuing new units.

For instance, in December 2020, Ascendas REIT raised close to S$1.2 billion from a preferential offering and private placement by issuing new units at a price that’s more than 38% above its last reported adjusted book value per unit.

With the new fundraise, Ascendas REIT immediately improved its book value per share.

Business fundamentals following stock prices down

In a similar light, business fundamentals can also decline because of a falling stock price.

At tech companies, stock-based compensation has become a big component of employees’ overall remuneration. When a tech company’s stock price is down, any stock-based compensation becomes less valuable. This could lead to an exodus of existing talent and make it more difficult for the company to attract new talent.

An example is Lending Club, a company that uses algorithms to originate personal loans. After a scandal involving its ex-CEO, Lending Club’s stock price collapsed and the value of employees’ stock-based compensation declined. According to a transcript I read, Lending Club has suffered high employee turnover due to its collapsing stock price.

Final thoughts

Value often precedes price. But in special situations, the opposite seems to be true too. This creates a self-fulfilling virtuous or vicious cycle that can make matters much worse or much better.

The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Tesla. Holdings are subject to change at any time.

Breaking Down The Relaxed Regulations on REITs in Singapore

The MAS has increased the gearing limit for REITs in Singapore and extended the deadline for REITs to pay out at least 90% of their distributable income.

In light of the challenges that real estate investment trusts (REITs) in Singapore are facing, the Monetary Authority of Singapore (MAS) has stepped in to relax the regulatory constraints for REITs. This is extremely timely and is welcome news for worried REIT investors.

In this article, I’ll summarise some of the key changes and what it means for REITs.

Extension of permissible time for REIT to distribute its taxable income.

REITs in Singapore are required to distribute at least 90% of their taxable income to unitholders to qualify for tax transparency treatment. Under the tax transparency treatment, a REIT is not taxed on its income that is distributed to unitholders.

Previously, REITs had to distribute this amount within 3 months of the end of its financial year. But MAS has now extended the deadline to 12 months for this financial year.

What does this mean for REITs?

This will give REITs a larger cash buffer for this difficult period, especially for REITs that intend to approve later collection of rents or provide rental rebates for their tenants. Such REITs will now have the cash buffer to pay off their expenses and interest payments first, while still supporting their tenants.

This is great news for REIT investors who may have been concerned that REITs who have cash flow issues will not be able to enjoy the tax benefits that REITs usually enjoy.

SPH REIT (SGX: SK6U) was the first REIT in Singapore to announce that it will retain a large chunk of its distributable income in its latest reporting quarter in anticipation that it will need the cash in the near future.

Higher leverage limit and deferral of interest coverage requirement

MAS has raised the leverage limit for REITs in Singapore from 45% to 50%. This gives REITs greater financial flexibility to manage their capital. Lenders will also be more willing to lend to REITs who were already close to the previous 45% regulatory ceiling.

MAS also announced that it will defer the implementation of a new minimum interest coverage ratio of 2.5 times to 2022.

What does this mean for REITs?

I believe that the pandemic could result in tenancy defaults. This, in turn, could result in lower net property income for some REITs in the near term, putting pressure on their interest coverage ratios.

The deferment of the minimum interest coverage ratio and the higher gearing limit will allow REITs to take on more debt to see them through this challenging period.

Investors who were concerned about REITs undertaking rights issues, in the process potentially diluting existing unitholders, can also breathe a sigh of relief. The increase in the gearing limit to 50% will enable REITs to raise capital through the debt markets rather than issuing new units at current depressed prices.

My take

The lightening of regulatory restrictions by MAS is good news for REITs. This is especially welcoming for REITs with gearing ratios that were already dangerously close to the 45% regulatory ceiling, such as ESR-REIT (SGX: J91U). It now can take on a bit more debt to see it through this tough period, without breaking MAS regulations.

At the same time, I would like to see REITs not abuse MAS’s new rules. They should still be prudent in the way they take on debt to expand their portfolio. Ideally, REITs that have expensive interest costs should be more careful about their debt load and not increase their debt beyond what they can handle.

I think this COVID-19 crisis is a great reminder for all REITs that they cannot take anything for granted and need to have safety measures in place to ride out similar challenges in the future.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

What To Look Out For When Singapore REITs Release Results

Some Singapore REITs will be providing quarterly updates soon. I’ll be keeping a close eye on any updates on rebates, distributions, and cashflow.

As an investor with a very long-term focus, I usually don’t pay much attention to quarter-to-quarter fluctuations in earnings. But these are not normal times. And as someone who invests in Real Estate Investment Trusts (REITs) in Singapore’s stock market, I will be paying close attention to the following elements in their upcoming earnings announcements.

Cash flow

I suspect that REITs will continue to record the usual rental income on the income statement. However, actually collecting the cash from tenants is a different matter.

In the next earnings release, I will be keeping an eye on the cash flow statement. In particular, I’m watching the changes to the cash flow from operation.

The most important thing to look at in the balance sheet is the changes to the “Trade and other receivables” line. If that number increases disproportionately, it could be a sign that some tenants have not been able to hand over their rental payment to the REIT.

Updates on how they will help tenants

The Singapore government has stepped in to support businesses that are impacted by the COVID-19 pandemic. Restaurants, shops, hotels and tourist attractions will pay no property tax for 2020.

Property owners, such as REITs, are expected to pass these cost savings onto their tenants.

In the coming earnings update, I will be keeping my ears peeled on how the REITs will pass on these cost savings to tenants. This could be in the form of rental waivers or simply cash rebates.

SPH REIT was the first REIT to commit to helping its tenants. It said in its latest earnings announcement:

“To assist our tenants, SPH REIT will pass on fully the property tax rebates from IRAS announced by the Singapore Government on 26 March 2020, which will be disbursed in a targeted manner. On top of the Government’s property tax rebates, SPH REIT has provided further assistance to help tenants through this difficult period. In February and March 2020, tenant rebates amounting to approximately S$4.6 million have been granted to those affected tenants. This is part of the Tenants’ Assistance Scheme under which SPH REIT has rolled out to provide tenants with rent relief for February and March.
SPH REIT will extend Tenants’ Assistance Scheme for the months of April and May, for which the rebates will be granted according to the needs of the tenants. For the most affected tenants, they will be granted rental rebates of up to 50% of base rent. In addition, the full property tax rebates will be passed on to these tenants. Effectively, the most affected tenants will have their base rents waived for up to 2 months.
For tenants who are required by the Government to cease operations such as enrichment centres, SPH REIT will grant a full waiver of rental for the period of closure.”

I think this is the right way to go for REITs. Although landlords are not obliged to support their tenants through rent waivers, I think that providing some aid could be beneficial in the long term. Tenants that get support are more likely to remain a going concern and consequently can continue to rent the space in the future.

Distribution per unit

REITs are required to pay out at least 90% of their distributable income to receive special tax treatment. However, I think many of the REITs may opt to distribute much less than that in the first quarter of 2020.

SPH REIT was the first to slash its distribution per unit. It cut its distribution for the quarter ended 28 February 2020 by 78.7% despite a 12.2% increase in income available for distribution.

There are a few reasons I believe more REITs will follow in SPH REIT’s footsteps.

First, they may need the cash to tide them through the rest of the year if they foresee rental defaults or lower occupancy.

Second, as demonstrated by SPH REIT, some REITs are using their own cash to help tenants ride out this challenging period.

And third, the REIT is only required to pay out more than 90% of distributable income within the whole financial year. So REITs may opt to keep the cash first as a precaution. If the REIT doesn’t need the cash in the future, it can always distribute it in future quarters.

Updates on a rights issue

With REIT prices slashed this year, the last thing that investors want is a REIT being forced to raise money through a rights issue.

Unfortunately, this may be the case for REITs that are highly geared and that have trouble paying their interest expenses.

In addition, if a REIT’s rental yield falls, asset prices may decline and gearing levels will rise. REITs with a high debt-to-asset ratio may, in turn, have to pay higher interest rates when they refinance their loans. As such, it is possible that REITs with a high gearing ratio may choose to raise capital through a rights issue to deleverage their balance sheet.

Challenging times for REITs…

REITs are not spared in this challenging period for business.

Investors of REITs should pay close attention to the news the next few months to see which REITs are best positioned to ride out these unprecedented times.

Which S-REIT Could Face a Cashflow Problem?

REITs have fallen hard the last couple of weeks. Here’s a look at some REITs that could face cashflow issues if their tenants defaults.

It has been a nightmarish two weeks for Real Estate Investment Trust (REIT) investors in Singapore’s stock market.

Almost every S-REIT was massively sold down, with many losing more than 50% of their value. Investors who invested on margin were hit especially hard as their losses were amplified and they were forced into selling off positions at a loss.

Investors of REIT-ETFs also reportedly rushed to the exits, further exacerbating the situation.

It does not help that global economic activity has slowed down significantly because of COVID-19. Although most REITs will likely be able to weather this short-term storm, there are some that could face difficulties.

Last week, I published Which S-REIT Can Survive This Market Meltdown? In it, I said that some REITs may face a cashflow crisis if their tenants default on rent. This can lead to a vicious cycle of REITs struggling to pay their interest and end up having to sell assets or raise capital through rights offerings or private placements.

REITs that have a concentrated tenant base, high-interest expense, and less headroom to take on more debt (the regulatory ceiling is a 45% debt-to-asset ratio) are more at risk of a cashflow problem.

In this article, I will highlight some REITs that sport some of these unwanted characteristics.

High tenant concentration

REITs most at risk are those with tenants that cannot pay up their rent. Having a high tenant concentration means that the loss of revenue will be massive if the major tenant defaults.

Below are some S-REITs that have relatively high tenant concentration. Do note that this is not an exhaustive list, they are just some REITs that I have studied:

First REIT (SGX: AW9U): The healthcare REIT derived around 82% of its rental income from PT Lippo Karawaci Tbk and its subsidiaries in 2018.
EC World REIT (SGX: BWCU): The E-commerce and specialised logistics REIT owns China assets and is dependent on two major tenants: Hangzhou Fu Gang Supply Chain Co Ltd and Forchn Holdings Group Ltd. Combined, the two tenants contributed 67.4% of the REIT’s total rental income in 2018.
Elite Commercial REIT (SGX: MXNU): The UK-focused REIT rents practically its entire portfolio to the UK government.

High tenant concentration is risky but it also depends on the type of tenant that the REIT is renting to.

In First REIT’s case, its assets are healthcare properties such as hospitals and nursing homes. Business in healthcare properties should continue as usual during the COVID-19 pandemic, so the tenants will most likely have the means to pay its rent.

Elite Commercial REIT’s tenant is the UK government, which will almost certainly have the means to cover its obligations.

So, while it is important to think about tenant concentration, it is equally important to judge the likelihood of the main tenant defaulting.

High gearing

REITs that have high gearing will have little debt headroom to take on more borrowings if the need arises.

Below are some REITs that have gearing ratios that are close to the 45% regulatory ceiling.

ESR-REIT (SGX: J91U): With a gearing ratio of 41.5% at end-2019, the industrial REIT is one of the highest geared REITs in Singapore.
Cache Logistics Trust (SGX: K2LU): The logistics REIT has a gearing of 40.1% as of 31 December 2019.
Ascendas REIT (SGX: A17U): As of December 2019, the largest REIT in Singapore by market cap had a gearing ratio of 35.1%.

Again this is not an exhaustive list and not all REITs with a high gearing ratio will face default. However, REITs that have high gearing have less financial flexibility and may need to tap into the equity markets to raise money in the unlikely situation of a cashflow crisis. Tapping on the equity markets could mean dilution for a REIT’s existing unitholders.

Low interest coverage

For a simple but not exact definition, the interest coverage ratio compares a REIT’s interest expense against its net property income. A high interest coverage ratio means that the REIT is able to service its interest expense easily with its income.

In a time of crisis, it is important that a REIT’s rental income can at least cover its interest expense to tide things over. Defaulting on debt obligations can hurt a REIT’s credit rating and ability to negotiate lower interest rates in the future.

Here are some S-REITs with a low interest coverage ratio (again, it’s not an exhaustive list):

ESR-REIT: With its high gearing, ESR-REIT’s interest expense is naturally high compared to its rental income. As of 31 December 2019, it had an interest coverage ratio of 3.7 times.
EC World REIT: China-focused REITs traditionally have a higher cost of debt so its no surprise that EC World REIT has a low interest coverage ratio of just 2.5 times:
Ascendas India Trust (SGX: CY6U): Technically a business trust, Ascendas India Trust owns IT-related and logistics properties in India. It has an interest coverage ratio of 3.6 times.

The REITs above have low interest cover so a drop in rental income may result in their inability to pay their interest expense.

Wait and see…

The above-mentioned REITs have some of the unwanted characteristics that make them susceptible to cash flow issues. However, it is not clear whether they will end up facing tenant defaults.

Ultimately, whether the REIT can weather the storm comes down to if their tenants can meet their rental obligations. So far, none of the REITs have made any announcements of tenant defaults, so it is best not to panic yet. As a REIT investor, I have not sold any of my positions and I believe that most of the REITs in my portfolio will be able to weather this storm.

For the time being, I am taking a wait-and-see approach but will be keeping a close eye for any announcements or earnings updates.

*EDITORS NOTE: The article erroneously stated that Ascendas REIT had a gearing ratio of 39.9%. We have since edited to reflect the correct figure of 35.1%.

Which S-REIT Can Survive This Market Meltdown?

REITs in Singapore have dropped like a rock this week as investors flee the stock market. What should you do now and are your REITs safe?

Real Estate Investment Trusts (REITs) are considered by many to be a safe-haven asset class due to their relatively stable rental income and debt-to-asset ceiling of 45%. However, it seems that REITs are still susceptible to steep drawdowns just as much as other stocks.

The REIT market in Singapore has been hammered as badly as the Straits Times Index, if not worse, over the past few days.

The table below shows the price changes of some of the REITs in Singapore since 9 March 2020. Even REITs backed by traditionally strong sponsors such as Mapletree Investments Pte Ltd and CapitaLand Ltd have not been spared.

*Source: My compilation of data from Yahoo Finance*

Why?

In my mind, the likely reason why REITs have been hammered so badly recently is that investors are worried that REITs’ tenants will not be able to pay their committed leases.

Loss of revenue could potentially bankrupt businesses causing them to default on their rent.

REITs, in turn, will then face lower rental income in the coming months. This leads to a vicious cycle, where the REITs are then not able to service their interest expenses and may need to liquidate assets or raise capital in this extremely harsh environment.

Worried investors have been scared off from REITs during these difficult times and have flocked to “real” safe-haven assets such as treasuries and US dollars.

What now?

I think this is a perfect time for investors to take a step back to reassess their portfolio. It is important to know which REITs in your portfolio can weather a storm and which are at risk of a liquidity crisis.

The share price of a REIT may not be truly reflective of its ability to weather the storm. Some REITs that have been sold off hard may actually have the means to run the course, while others that have yet to be sold down may end up having to raise more capital. So I am more interested in the fundamentals of the REIT, rather than the price action.

What I am looking out for

In these unprecedented times, here are some things I look for in my REITs:

1. Stable and reliable tenants

If tenants can pay and renew their rents, REITs will have no trouble in these difficult times. For instance, REITs that have government entities as tenants are safer than REITs that have small and highly leveraged companies as tenants. Elite Commercial REIT (SGX: MXNU) is an example of a REIT with a stable tenant. The UK government is its main tenant and contributes more than 99% of its rental income.

2. A diversified tenant base

In addition to the first point, REITs that have a highly diversified tenant base are more likely to survive. For instance, malls and office building owners whose buildings are multi-tenanted are likely to be less susceptible to a sudden plunge in rental income should any tenant default. Mapletree Commercial Trust (SGX: N2IU) and CapitaLand Mall Trust (SGX: C38U) have multiple tenants and are less susceptible to a collapse in net property income.

3. Low interest expense and high interest-coverage ratio

REITs such as Parkway Life REIT (SGX: C2PU) are more likely able to service its debt as its interest expense is much lower than its earnings. At the end of 2019, Parkway Life REIT had a high interest-coverage ratio of 14.1. So Parkway Life REIT should be able to service its debt even if there is a fall in earnings.

4. Low gearing

A low debt-to-asset ratio is important in these tumultuous times. REITs that have low gearing can borrow more to tide them through this rough patch. REITs such as Sasseur REIT (SGX: CRPU) and SPH REIT (SGX: SK6U) boast gearing ratios of below 30%.

Don’t Panic…

The last thing you want to do now is panic. In a time like this, is important to stay sharp and not do anything rash that can hurt your portfolio.

Breathe. Take a step back and reassess your positions. Don’t focus too much on the price of a REIT. Instead, focus on its business fundamentals and whether it can survive this difficult period. If so, then the REIT will likely rebound when this COVID-19 fear finally settles.

My Thoughts on Elite Commercial REIT

Elite Commercial REIT will start trading on 6 Feburary 2020. Here are some factors to know If you are considering buying into the UK-focused REIT.

Elite Commercial REIT is set to be the first REIT listing in Singapore in 2020. I know this article is a little late as the public offer closed yesterday. However, if you are still considering buying units in the open market, here are some factors to consider.

Things I like about the REIT

Let’s start with a quick rundown of some of the positive characteristics of the UK-based REIT. There are many points to go through here so I will be as brief as possible for each point.

Multi-property portfolio

Based on the prospectus, Elite Commercial REIT has an initial portfolio of 97 commercial properties in the UK. While the properties are all located in the United Kingdom, the large number of properties means that the REIT is not overly-reliant on any single property. The properties are also well-spread across the entire UK, with properties situated in Northern Ireland, Wales, Scotland and England.

Another thing to like is that all except for one property is free-hold. Even the sole property that is not free-hold has a very long land lease of 235 years.

Reliable tenant

Perhaps the most appealing aspect of the REIT is that all of its properties are leased to the UK government, specifically the Department for Work and Pensions.

As it is virtually impossible that the UK government will default on its rent, there is very little tenancy risk.

Long leases

The weighted average lease expiry for the properties stands at a fairly long 8.6 years. Given the long leases, investors can rest easy knowing that the distribution will be fairly consistent for the next few years.

However, investors should note that some properties have a break option in 3.6 years. Assuming these options are exercised, the portfolio’s weighted average lease expiry will drop to 4.89 years.

The properties are important to the UK government

80 of the 97 properties in the portfolio are used for front-end services such as JobCentre Plus. Furthermore, 86.3% of these JobCentre Pluses do not have an alternative JobCentre Plus within a 3-mile radius. This is important as investors need to know that there is a high likelihood that the Departement for Work and Pensions will renew its leases when the current contracts expire in 2028.

Triple net leases

The UK government has signed triple net leases for the properties. What this means is that it will cover all operational costs, property taxes and building insurance. The triple net leases provide the REIT with more visibility on cost for the period of the remaining lease.

Low gearing

Another thing to like about the REIT is its low gearing of 33.6%. That is well below the 45% regulatory ceiling, giving it room to make acquisitions in the future.

Decent Yield

The REIT’s IPO price of £0.68 represents a price-to-book ratio of 1.03 based on Collyer’s valuation report. In addition, the indicated distribution yield of 7.1% is higher than the average distribution yield of Singapore-listed REITs.

What I dislike

There are certainly a lot of things I like about Elite Commercial REIT. On the surface, it looks like a very stable REIT with a reliable tenant and the potential for acquisition growth. However, looking under the hood, I found unsavoury characteristics that might put off some investors.

Leases all expire at the same time

The previous owners of the property negotiated to lease the properties back to the UK government with all leases expiring on the same day- 31 March 2028. I much prefer a staggered lease expiry profile as it gives the REIT time to find new tenant should existing tenants fail to renew their leases.

Another concern is whether the UK government will indeed renew all contracts with the REIT when their leases expire. While the REIT is quick to point out that the UK government is likely to renew its leases, things could easily change in the future. If the UK government decides not to renew a few of its leases, the REIT will need to find a quick solution to prevent a rental gap.

Inflated market value

Another thing that I got alerted to by a fellow blogger’s article was that Collyer’s valuation of the portfolio was based on current rental leases. The existing leases are slightly above market rates and could suggest that the market value is somewhat inflated.

Likewise, as market rent is below the current rent, we could see rental rates reduce come 2028 when new contracts are signed.

IPO NAV Price Represents a 13.1% jump from purchase price just a year ago

Another thing to note is that the private trust of Elite Partners Holdings is selling the portfolio to the REIT just a year after buying the property. The sale price represents a 13.1% gain for the initial investors of the property portfolio.

Floating rate debt

The REIT has taken a floating rate loan. While floating-rate loans tend to have lower rates when it is first negotiated, it can also rise in the future. Even though rates have been dropping the last year, things could change in the future. Higher interest rate payments will result in lower distribution yield for investors.

Brexit concerns

The United Kingdom has just finalised its exit from the European Union. There are so many uncertainties regarding its exit. How will this impact its economy, property prices and even the value of the pound?

All of which could potentially impact distribution and rental rates in the UK.

The Good Investor’s Take

Elite Commercial REIT has both positive and negative characteristics. The indicative 7.1% yield and backing by the UK government are the main draws. However, the fact that all leases expire on the same day, the uncertainty surrounding Brexit and the potentially inflated market rate of the properties are things that investors should be concerned about.

Given these concerns, I will likely be staying on the sidelines for now.

*Editors note: In an earlier version of the article I stated that one of my concerns was that the private trust of Elite Partner Holdings was not participating in the IPO. However, upon clarification with the managers of Elite Commercial REIT, I realised that the four individual investors and Sunway Re Capital, who were the investors in the private trust that initially owned the portfolio were individually participating in the IPO. They each rolled over their principal investment amount from the private trust to the REIT. Elite Partner Holdings also has an interest in the REIT via Ho Lee Group and Tan Dah Ching. I have since edited the article to reflect the new information gleaned from management.

Is CapitaLand Mall Trust and Capitaland Commercial Trust’s Proposed Merger Good For Unitholders?

CapitaLand Mall Trust and CapitaLand Commercial Trust are set to merge to form the biggest REIT in Singapore. Does it benefit the unitholders of both REITs?

CapitaLand Mall Trust (CMT) and CapitaLand Commercial Trust (CCT) are set to combine to form the largest REIT in Singapore. The proposed merger is the latest in a string of mergers over the last few years.

Mergers may benefit REITs through greater diversification, higher liquidity, cost savings due to economies of scale and access to cheaper equity.

With that said, here are some things that investors should note about the proposed deal between the two CapitaLand REITs.

Details of the merger

CMT is offering to buy each CCT unit for 0.72 new units of itself and S$0.259 in cash. The enlarged REIT will be renamed Capitaland Integrated Commercial Trust (CICT).

Source: Presentation slides for CMT and CCT merger

The combined REIT will own both CMT and CCT’s existing portfolios, making it the largest REIT in Singapore and the third-largest in Asia Pacific. Its portfolio will include 24 properties valued at S$22.9 billion.

Source: Joint announcement by CCT and CMT regarding the merger

What does it mean for current CMT unitholders?

The best way to analyse such a deal is to look at it from the angle of both parties separately.

For CMT unitholders, the merger will result in them owning a smaller stake in an enlarged REIT. Here are the key points that investors should note:

Based on pro forma calculations, the merger is distribution per unit-accretive. The chart below shows the DPU (distribution per unit) increase had the merger taken place last year.

Based on similar assumptions, the deal is NAV-accretive. The net asset value (NAV) per unit of the enlarged REIT is expected to be S$2.11, higher compared to S$2.07 before the merger.
As debt will be used, it will cause CMT’s aggregate leverage to increase from 32.9% to 38.3%.

The question here is whether current CMT owners will be better off owning units in the merged entity. I think so. The deal will be both DPU and NAV-accretive. While the merged entity will have a higher gearing, I think the trade-off is still advantageous.

On top of that, the enlarged REIT will also benefit from economies of scale. As I briefly mentioned earlier, bigger REITs benefit from diversification, cost savings and the ability to take on bigger projects.

The downside for CMT

Although I think the deal is beneficial to unitholders of CMT, I doubt it is the most efficient use of capital.

CMT is paying 0.72 new units of itself, plus S$0.259 in cash, for each CCT unit. That works out to around S$2.131 for each CCT unit. Even though that seems fair when you consider CCT’s current unit price of S$2.13, the purchase price is much higher than CCT’s actual book value per unit of S$1.82.

Needless to say, CMT unitholders would benefit more if CMT is able to buy properties at or below their book value. Ultimately, because of the current market premium attached to CCT units, CMT will end up having to pay a 17% premium to CCT’s book value.

Although the impact of paying above book value is countered by the fact that CMT will be issuing new units of itself at close to 25% above book value, I can’t hep but wonder if CMT could gain more by issuing new units to buy other properties at or below book values.

What does it mean for CCT unitholders?

At the other end of the deal, CCT unitholders are getting a stake in the merged entity and some cash for each unit they own.

Here are the key things to note if you are a CCT unitholder:

Based on pro forma calculations, the merger is DPU-accretive for CCT, if we assume that the cash consideration is reinvested at a return of 3% per annum.

From a book value perspective, the deal will be dilutive for CCT unitholders. Before the merger, each CCT unit had a book value of S$1.82. After the deal, CCT unitholders will own 0.72 new units in the enlarged REIT and S$0.259 in cash. The enlarged REIT (based on pro forma calculations) will have a NAV per unit of S$2.11. Ultimately, each CCT unit will end with a book value of S$1.78, a slight decrease from S$1.82 before the deal.

Other considerations for CCT unitholders

For CCT unitholders, the question is whether they will be better off owning (1) units of the existing CCT, or (2) cash plus 0.72 units of the enlarged REIT.

I think there is no right answer here. Ownership of the enlarged REIT has its benefits but CCT unitholders also end up obtaining the new units at quite a large premium to book value.

Although the deal will result in DPU-accretion for current CCT unitholders, the enlarged REIT also has a higher gearing than CCT and consequently, has less financial power to make future acquisitions.

Investors need to decide whether the yield-accretion is worth paying up for (due to the new units being issued at 25% premium to book value), or whether they rather maintain the status quo of owning a decent REIT with a lower gearing and better book value per unit.

The Good Investors’ Conclusion

There are certainly reasons for both sets of unitholders to support the proposed merger between these two CapitaLand REITs. The deal will benefit CMT unitholders in terms of both DPU and NAV-accretion, while CCT unitholders will also gain in terms of DPU growth.

In addition, the enlarged REIT could theoretically benefit from economies of scale, portfolio diversification, and greater liquidity.

That said, I have my doubts on whether it is the best use of capital by CMT due to the purchase price’s 17% premium to CCT’s book value. CCT unitholders also have a lot to digest, and they will need to assess if they are comfortable that the deal will be dilutive to them from a book value perspective.

Does Your REIT Manager Have Your Interests at Heart?

REITs are a popular investment vehicle that provide regular cash flow. But REIT managers may pursue goals that end up harming investor returns.

Real Estate Investment Trusts (REITs) are increasingly popular in Singapore. Besides providing exposure to real estate at a low starting capital outlay, REITs also offer portfolio diversification, enjoy tax incentives, and offer relatively high yields.

But REITs are by no accounts perfect.

One flaw is that some REITs’ managers may not be specifically incentivised to increase their REITs’ distribution per unit- the metric that is most important to unitholders.

Because of this misalignment in interest, REIT managers may be tempted to pursue goals that end up harming unitholders. I did a quick review of some REITs in Singapore to compare how their managers are incentivised.

Misaligned interests?

For instance, Frasers Logistics and Industrial Trust’s manager is paid a performance fee that is 5% percent of the REIT’s annual distributable income. Mapletree Industrial Trust and Keppel REIT’s managers are paid a performance fee of 3.6% and 3% of the net property income, respectively.

At first glance, investors may think this is a fair practice, since it encourages the managers to grow their respective REITs’ distributable income and net property income. But the reality is that an increase in either of these may not actually result in an increase in distribution per unit (DPU).

In some cases, the net property income and distributable income may rise because of the issuance of new units to buy new properties, without actually increasing DPU.

Keppel REIT is a prime example of a REIT whose unitholders have suffered declining DPU in the past while its manager enjoyed high fees.

Performance fees aligned with unitholders

That said, there are REITs that have good performance fee structures.

For instance, Sasseur REIT and EC World REIT’s managers are paid a performance fee based on 25% of the difference in the DPU in a financial year with the DPU in the preceding year. In this way, they are only paid a performance fee if the DPU increases.

ESR-REIT has an even more favourable performance fee structure. They are paid 25% of the difference between this year’s DPU and the highest DPU ever achieved.

Base fees

We should also discuss base fee incentives. Besides performance fees, REIT managers are also typically paid a base fee.

The base fee may be pegged to asset value, distributable income, or net property income. The base fee helps the manager cover the cost of its operation. A base fee pegged to the size of the assets makes sense since a larger portfolio requires more manpower and overheads to maintain.

In my opinion, the base fee should be there to help cover the cost of managing the REIT, while the performance fee should be the main incentives for the REIT managers.

Based on a quick study of base fees, ESR-REIT and Mapletree Industrial Trust are two REITs that pay their managers a relatively high base fee of 0.5% of the deposited asset value. Sasseur and EC World REIT’s managers are paid a base fee structure based on 10% of distributable income.

Typically, investors should look for REITs that pay their manager a low base fee, which in turn incentivises the manager to strive to achieve its performance fees.

Conflicts of interests

As you can see, managers and minority unitholders of REITs may end up with conflicts of interests simply because of the way REIT managers are remunerated. If a manager is incentivised based solely on net property income, it may be tempted to pursue growth at all costs, even though the all-important DPU may decline.

On top of that, REIT managers’ are also often owned by the REIT’s sponsor. This might result in an additional conflict of interests between sponsors and REIT minority holders.

But having said all that, conflicts of interests may not always end up being bad for investors. Even if remuneration structures and interests are not aligned, an honest and fair sponsor might still feel obliged to treat minority unitholders fairly.

The Good Investors’ Conclusion

As retail investors, we have little power over the decision-making processes in a REIT. We depend almost entirely on the REIT manager. It is, therefore, essential that we invest in REITs who have managers that we trust will do what is right for us. So how do we do that?

The first step is to study the REIT’s manager’s remuneration package. Ideally, the REIT manager should be remunerated based on DPU growth. If the manager has poorly-aligned interests, you then need to assess if it has a track record of making honest decisions. Look at the REIT’s DPU history. Has it allocated capital efficiently and in a way that maximises DPU?

Too often investors overlook how important it is to have a manager that has the interests of minority unitholders at heart. Hopefully, this article brings to light the importance of having a good and honest sponsor and manager.

What Should Frasers Commercial Trust Unitholders Do Now?

Frasers Logistics and Industrial Trust is proposing to acquire Frasers Commercial Trust. Here’s a breakdown on possible scenarios and what actions to take.

Frasers Logistics and Industrial Trust has proposed to acquire Frasers Commercial Trust in a shares plus cash deal. In essence, Frasers Commercial Trust unitholders will receive 1.233 Frasers Logistics and Industrial Trust units and S$0.151 in cash for every unit of Frasers Commercial Trust they own.

In light of the proposed deal, I had previously shared my thoughts on what it means for Frasers Logistics and Industrial Trust’s unitholders. Below are my thoughts on what the merger means for Frasers Commercial Trust’s unitholders.

Scenario 1: The proposed deal goes through

Existing unitholders of Frasers Commercial Trust can accept the offer tabled to them. In exchange, they will receive cash and units of the new REIT. This outcome could be fairly rewarding.

For one, there are reasons to believe that the new REIT can provide solid returns for unitholders. If the deal does go through, Frasers Commercial Trust unitholders will be able to participate in the new REIT’s potential upside.

The new REIT is expected to provide a 6% distribution yield (if you consider the market price at the time of writing of S$1.23 per unit). The enlarged REIT will benefit from a diversified portfolio with the potential to grow its rental income organically.

The deal will also enable Frasers Commercial Trust’s unitholders to cash out a portion of their holdings, due to the cash portion of the acquisition.

Scenario 2: The proposed deal gets rejected

If the deal gets rejected by either party, it will not go through. In that case, Frasers Commercial Trust unitholders get to keep their stake in the existing REIT.

I think the main reason why Frasers Commercial Trust unitholders may reject the deal is that they may not view the purchase price to be high enough. They will also be receiving new units of the enlarged REIT at fairly high prices. Based on current market prices, the new units will be issued at a 29% premium to book value.

Scenario 3: Unitholders can sell their units now

Unitholders of Frasers Commercial Trust can also sell their units before the results of the deal. By selling your units, you can get the cash out immediately and reinvest elsewhere.

This option is for unitholders of Frasers Commercial Trust who do not want to hold on to the units of the newly formed REIT.

This is a reasonable action to take if you have found an investment that is better suited for your portfolio.

Scenario 4: Looking for arbitrage opportunities

The fourth option is to make use of the deal as an arbitrage opportunity.

Although I encourage long-term, buy-and-hold investing, mispricings in the market, especially after a deal has been proposed, can result in the opportunity to make an immediate profit.

To understand how to do this, we must first look at the mechanics of the deal. Frasers Commercial Trust unitholders will be getting 1.233 Frasers Logistics and Industrial Trust units plus 15.1 Singapore cents.

At the time of writing, Frasers Logistics and Industrial Trust shares trade at $1.23 per unit. As a result, the market value of what Frasers Commercial Trust unitholders will receive ($1.667 per unit) is slightly lower than the current market price of $1.67.

As such, investors can instead choose to sell their holdings in Frasers Commercial Trust and purchase Frasers Logistics and Industrial Trust. Of course, they should factor in whether it still makes sense after including any transaction costs (it might not, depending on the broker you use).

The Good Investors’ Conclusion

The proposed acquisition of Frasers Commercial Trust has given its unitholders a lot to think about. Should you simply wait for the deal to pass and enjoy the upside of the enlarged REIT? Or should investors take active steps to achieve a better return by seizing the current arbitrage opportunity? The risk of trying to maximise returns through arbitrage is that the deal falls through.

Additionally, unitholders who do not want a stake in the enlarged REIT can also choose to encash their units now.

Personally, I think trying to make an arbitrage profit is too much effort for too small of an upside (this may change if either REIT’s unit price moves dramatically, which is unlikely as arbitragers will force the price to equilibrate). So for now, I think it is best for Frasers Commercial Trust unitholders to simply wait for the outcome of the deal.

There are potential pros and cons to either outcome. If the deal goes through, exiting Frasers Commercial Trust unitholders can enjoy distribution per unit-accretion, if they reinvest the cash portion of the deal into Frasers Logistics and Industrial Trust. The new trust will also enjoy potential economies of scale, access to cheaper debt, and potentially trade at higher valuations. The downside is that the new units are being issued at a fairly high valuation of 1.29 times book value and the purchase price is fairly low.

Conversely, if the deal falls through, unitholders will continue to hold onto their Frasers Commercial Trust units, which also has a good portfolio of properties, low gearing, and could potentially pay out higher distribution per unit in the future. However, unitholders will miss out on the yield-accretion and the potential to participate in the growth opportunity of a larger, more liquid REIT with access to cheaper debt and equity.