Who will be next to merge in the S-Reit universe?

A critical need for scale - the driver behind the merger between OUE Commercial Reit and OUE Hospitality Trust - is likely to spur more mergers within the real estate investment trust (Reit) sector here.

Four of the biggest Reits/business trusts are constituents of the benchmark Straits Times Index (STI) and 10 have also made it to the FTSE EPRA/NAREIT Developed Asia Index.

If index inclusion is the end game, possible candidates from among the Reits to merge would be those that currently have a market value that is below S$1 billion. Still, the structure of the Reits and their respective sponsors, and the ownership of those sponsors, matter when considering the feasibility of a merger. Not any Reit can be merged with another.

With this in mind, here are some possibilities. Top of the list is a merger between Ascott Reit and Ascendas Hospitality Trust (AHT), given that their respective sponsors, CapitaLand and Ascendas-Singbridge, are merging. CapitaLand's management has said that merger is one way it could deal with the overlap in the Reits' respective mandates. Other ways of eliminating the duplicates are changing the mandate of one or both of the Reits and an outright sale.

Another possibility for a Reits merger could revolve around ESR Cayman's continued acquisition of other smallish industrial Reits in a bid to satiate its aggressively expanding appetite. Its possible targets include Sabana Reit, AIMS Apac Reit and Cache Logistics Trust.

ESR-Reit has already merged with Viva Industrial Trust - a move which has significantly improved its trading liquidity. But with a floating market cap of under S$1 billion, it remains too lightweight for inclusion in the FTSE EPRA/NAREIT Developed Asia Index. ESR has been making quiet moves in the market. Late last year, its shareholding in AIMS Apac Reit crossed 5 per cent, while it has also acquired a controlling stake in Sabana Reit's manager. It currently owns about 13 per cent of Sabana Reit. (see amendment note)

ESR's parent Warburg Pincus remains the biggest investor in ARA Asset Management, which runs Cache Logistics Trust. Cache has been bandied about as another potential acquisition target by ESR. It won't be the most natural coming-together party, though. An analyst who did not want to be named noted that ESR and ARA are separate entities with different strategies.

"ESR wants to list and be its own entity (in Hong Kong), while ARA also wants to list once it hits S$100 billion in assets under management. ARA has been ramping up very quickly; taking out cash would actually be detrimental to its goal. So, it's a bit less likely, unless you can work out a creative way to go about it, such as a joint management like an ESR-ARA joint venture to manage Cache," the analyst said.

CapitaLand Retail China Trust could consider a merger with CapitaLand Mall Trust (CMT), since both have retail exposure. CMT is an STI constituent and also in the FTSE EPRA/NAREIT Developed Asia Index.

Likewise, a merger between Frasers Commercial Trust and Frasers Centrepoint Trust is a possibility, giving birth to a diversified office-cum-retail Reit.

Intra-sponsor Reit mergers are simpler to execute since both managers are owned or controlled by the same entity. Conversely, mergers between independent Reits, that is, those not backed by sponsors, would be a harder sell. Quite often, the sponsor plays a critical role in pushing for a deal; it lends confidence to unitholders when the motion to merge is put to a vote.

There have been other recent activities in the Reit manager space, including ARA's acquisition of a 20 per cent stake in Cromwell European Reit's manager last year, and OUE acquiring a controlling stake in First Reit's manager.

Morgan Stanley research analyst Wilson Ng said in a report this month that he believes the consolidation trend is driven by the pursuit of scale, which not only yields cost benefits for managers, but also helps Reits qualify for inclusion into major benchmark indices. Index stocks tend to attract a valuation premium.

"We expect more of consolidation activity to persist, which we see as a long-term positive for both Reit managers and Reits."

Higher borrowing limits and stock market price - which makes it more attractive to raise money from equity offerings - also make it easier for larger Reits to buy assets, thus enabling them to grow through acquisitions. Larger Reits also have higher success rates of completing acquisitions because they don't have to get unitholders' approval for smaller buys.

In one banker's words, the Singapore Reit universe is starting to resemble a "fund supermart", riddled with too many smallish Reits to keep track of. In which case, it makes consolidation the next natural step in the sector's evolution.

Amendment note: We earlier reported the wrong value of ESR-Reit's floating market cap. We are sorry for the error.