Singapore-listed REITs

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1 Singapore-listed REITs Real Estate Investment Trusts (REITs) invest in various types of property assets. First introduced in 2002, these are relatively novel financial instruments. REITs distribute at least 90% of their income to unit holders in return for tax concessions from the Singapore Government. The majority of REITs listed on the SGX invest in property assets pertaining to hotels & lodging, industrial & office, residential, retail and healthcare. To the investor, REITs provide an opportunity to own a share of a large and diversified portfolio without actually owning property. Current outlook on S-REITs In September 2012, the FTSE ST REIT Index appreciated 27.70% in price with dividend distribution of 6.35% in the year-to-date. The 34.70% total return of the FTSE ST REIT Index outperformed the STI s total return of 19.36% over the same period. Over a 12-month period ending 31 August, the REIT Index had been the least volatile, with half the volatility of the FTSE Real Estate Holding & Development Index, based on a similar asset class comparison. Figure 1: FTSE ST Real Estate Index 10-month rally However, investors may be cautious about buying REITs, given the rally over the past 10 months (Figure 1). The performance of these dividend stocks have soared roughly 30% since the start of Why REITs The higher liquidity 1 in the REITs market as compared to a typical property transaction is one advantage in investing in REITs. SGX provides retail investors with a compendium of different REITs specializing in different sectors, thereby providing inherent diversification of portfolio. Subject to strict regulations imposed by the Monetary Authority of Singapore, S-REITs offer better transparency and corporate governance that many other corporate sectors. As such, REITs tend not to experience high volatility as compared to other ST-indexes and investors 1 REITs are equity vehicles and hence their returns fluctuate with the overall equity market.

2 often adopt a buy-and-hold strategy to receive the timely dividend payouts derived from rental income. REITs are therefore increasingly attractive for retail investors who seek diversity and stability in the midst of cyclical fluctuations in the economy. Most S-REITs distribute at least 90% of their taxable annual income to shareholders and invest at least 75% of their assets in income-producing real estate. Furthermore, dividends, derived in part from rental income are strongly correlated with the high occupancy rates of assets, renewal of leases and better valuations of property in land-scarce Singapore. Categorizing and evaluating REITs The type and quality of a REIT s assets is an important factor affecting generated income. Categorizing REITs by the type of property assets allows for the manifest distinction between the alternating cycles of industrial, commercial and retail property assets. For example, demand for industrial and office properties tend to be more sensitive to the economic cycle than properties related to health care. This is because REITs are pro-cyclical investments where there is an economic downturn, a REIT may see a decline in occupancy rates 2 and rentals for its properties. Many of the S-REITs rely substantially on debt to finance property acquisitions. While leverage can enhance a REITs distributable income 3, it can also reduce its distributable income during periods of economic weakness and rising interest rates. Rising interest rates adversely affect REITs laden with high debt to equity ratios (gearing) 4. However, with expansionary monetary policy and strong repository of foreign reserves, Singapore is well fortified against such radical changes in the economy. REITs that are highly dependent upon short-term debt have higher refinancing risk than a REIT with mainly long-term debt. That is why REITs are often evaluated based on their gearing. REITs with high gearing may find difficulty in debt refinancing and may therefore be forced to take measures to depress its price. These measures include cutting dividends 5 to conserve cash or issuing new shares discounted to its recent share price. In October, the government introduced further belt-tightening measures in Singapore to curb the speculative residential property market by imposing caps on loan terms to prevent buyers from over-extending themselves, and lower loan-to-value ratios 6 for certain purchases. With probable knee-jerk reactions from the new measures, residential developers may find a slow-down in property demand due to higher down payment 2 Provides real estate or REITs investors on an indication of anticipated cash flows. A high occupancy rate correlates with stronger growth and higher cash flows. 3 Total amount of income distributed to unit holders typically amounts for at least 90% of taxable annual income. 4 REITs with high D/E ratios will find it costlier to refinance debts during periods of contractionary monetary policy. 5 REITs usually pay more dividends than they actually pay out for purposes of dividend smoothing. 6 Lending risk assessment ratio that financial institutions examine before approving a mortgage. Assessments with higher LTV ratios are generally equated with higher risk, which will cost the borrower more to borrow.

3 required. Consequently, this may trigger a shift in interest to industrial properties. Despite a slowdown in economic growth and the slew of property-cooling measures, the industrial property sector may remain stable in the long run. Meanwhile, the tight industrial property market in Singapore is compelling REITs to acquire good quality properties from other countries besides land-scarce Singapore. This may present a resilient outlook for industrial REITs in terms of dividend yields (Figure 2) Figure 2: Average Dividend Yield (%) - Type of REIT Industrial Retail/ Office Residential/ Hospital In Singapore, the REITs sector will most certainly continue to benefit on the back of high liquidity and low interest rates. Writer s recommendation: Lippo Malls Indonesia Retail Trust

4 Lippo Malls Indonesia Retail Trust (LMIRT) is an Indonesian retail REIT listed on the SGX. LMIRT invests in a diversified portfolio of income producing retail properties in Indonesia. As of 31st December 2011, LMIRT s portfolio consists of 10 retail malls and 7 major retail units located within other retail malls. These retail malls and spaces are strategically located within large urban middle-class population areas in Jakarta, Bandung and Medan. Anchor tenants of these malls comprise of popular consumer brands and well-known retailers. Occupancy rate remains higher than industry average at 94.1% as of 31st December The portfolio consists of property with staggered lease expires in the next few years to ensure a steady earnings base. (Refer to table 3 for a comparison of LMIRT s performance with other similar REITs) Table 4: Calculating the liquidation value of LMIRT 2011 Balance Sheet The purpose of computing the liquidating value 7 of a company s share is to determine its floor (lowest) value. To determine the liquidation value of LMIRT 8, it is essential to itemize the relevant assets owned by the company. The forced sale value of each asset is represented by the estimated coefficient, which represents a conservative estimate. After which, the values of the residual assets (liquidating value) are aggregated and the liabilities discounted in order to arrive at a long-term conservative target price of $ The current price of the stock is therefore lower than its underlying fundamental value. (a) LMIRT had recently announced proposed acquisitions of 4 properties, 2 of which are located in Palembang, while the other 2 are to be located in East Jakarta. The total acquisition cost is expected to be $188.1 million. All 4 properties are to be purchased at a discount to the book value. In view of the upcoming acquisitions, it is likely that LMIRT s DPU will increase with a corresponding increase in the dividend yield in the long run. In the short run, additional interest expense (from acquisitions) may result in a drag on the DPU. 7 The liquidation value (LV) per share is computed as follows: LV = (LV of assets Total liabilities)/ No. of shares outstanding. 8 The distinction between Lippo Malls Retail Trust and Lippo Malls Group is made clear in the balance sheet 2011.

5 (b) In comparison to other retail REITs, LMIRT has a significantly lower debt to equity ratio of 9.30% (No loan repayable until June 2014) and a correspondingly high dividend yield of 7.10% as of 20th October The management is proposing to finance the acquisitions from proceeds raised from issuance of $250 million worth of 3-year notes at 4.88% and $50 million notes at 5.875%. It is likely that LMIRT will remain in a comfortable position due to its relatively flexible gearing. (c) One of the acquired malls, Kramat Jati Indah Plaza (KJI), has received a rental guarantee of approximately $1.4 million per quarter for FY2013 and FY2014. The current committed occupancy rate of approximately 70% is expected to increase. (d) From figure 3, LMIRT s lease terms are in a relatively safe zone, with a majority of leases expiring in and beyond As such, it is unlikely that LMIRT will experience difficulties negotiating extensions of lease in the near future, given that the lease expiries are not altogether concentrated within the next four years. Figure 3: LMIRT s portfolio lease profile

6 Figure 4: Lippo Malls Indonesian Retail Trust Daily Charts (Source: Chart Nexus) A general uptrend can be spotted over the past 12 months. A blue linear trend line is drawn to connect the respective highs. It is likely that there may be a retracement from the current high of $0.475, since the shadow of the doji has broken through the trend line. Based on price bar patterns, it seems that an evening star 9 has formed at the top of the chart. The doji gaps up from the bullish candle before gapping down to the bearish candle. From the volume indicator, it seems like there is a temporary exhaustion after the high buying volume. These are probable signs of downward retracement as well. However, an uptrend will be maintained over the mid-term before any possible mean reversion can occur to bring prices closer towards the long-term exponential moving average (green line). A fair value may probably range from $0.430 to $ Given LMIRT s rally over the past 10 months, it is probable that a retracement will occur and this may be a good opportunity to adopt a buy-and-hold strategy. Retail investors should not be over-concerned about the price of trust and should appreciate that LMIRT is currently at a discount to its underlying book value (conservative liquidation value of $0.550). A buy-and-hold strategy works well for LMIRT as well given the probably long-run increase in DPU due to the recent major acquisitions. Unit holders can expect to receive timely dividend payouts if they adopt a hold strategy. Joel Leong 9 A 3-bar pattern that is indicative of a bearish reversal.

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