Property groups should sell low-yielding investment properties, go slow in raising debt 

ACCESS to debt appears fine for Singapore-listed property groups. Frasers Property announced in July that it had secured a sustainability-linked loan amounting to around S$904 million, comprising an Australian dollar tranche and a US dollar tranche.

In early June, GuocoLand issued S$180 million of three-year notes at a fixed interest rate of 4.05 per cent per annum.

In July, Ho Bee Land issued S$160 million of five-year green notes at a fixed interest rate of 4.35 per cent per annum. An entity linked to the group’s executive chairman Chua Thian Poh bought a substantial chunk of the said notes.

Property groups constantly tap banks and debt investors to fund refinancing, working capital and other corporate requirements. The availability of debt funding at reasonably competitive interest rates bodes well for property groups. Ho Bee’s five-year notes were priced at about 110 basis points above the then-prevailing five-year Singapore government bond yield.

Kudos too to various property groups for going green, not only in their projects, but also in their financing.

However, as many property types here offer low yields and interest rates may not fall sharply, perhaps property groups should look to divest assets to reduce debt instead of raising debt.

Ho Bee recently announced the sale of a 49 per cent stake in its special-purpose vehicle which holds Elementum, a biomedical life-science development at 1 North Buona Vista Link. This deal will yield an estimated gain of S$34.8 million before deducting related transaction costs. Assuming the stake sale was effected at end-2023, Ho Bee’s net gearing would go down from 0.8 times to 0.69 times.

Low yields

As it stands, some investment properties here offer skinny yields, which may not cover borrowing costs.

Take premium-grade office buildings. The capitalisation rates used by independent valuers in the end-June valuations of the Singapore portfolio of Keppel Reit , which comprises mainly top-grade office buildings, ranged between 3.15 per cent and 3.55 per cent. 

In the income capitalisation method, a property’s value is derived by dividing the assumed net property income by its cap rate. The property’s value is inversely related to the cap rate used.

Arguably, borrowing to hold low-yielding assets is irrational, especially if debt costs going forward may not fall sharply.

Take a property valued at S$500 million offering a net property income yield of 3.3 per cent, which is financed by S$250 million of debt costing 3.8 per cent per annum. Here, the owner’s return on equity (ROE) is 2.8 per cent per annum. 

A listed entity achieving a low single-digit ROE post-leverage from owning investment property should probably consider pursuing many other business opportunities instead, as a low single-digit ROE will hardly cut it for equity investors.

Sure, an owner might opt to hang on to a property because of potential asset enhancement opportunities. However, near-term opportunities for value-enhancing asset upgrading works are probably limited for buildings with high specifications. 

Unexciting capital gains

Does possible capital appreciation justify borrowing to fund the ownership of low-yielding properties? Perhaps not, if the scope for capital gains is limited. 

A key driver of capital appreciation is cap rate compression. However, where cap rates are thin, the room for rates to shrink is limited. Compared with many major cities, cap rates for Singapore properties are relatively low.

Indeed, cap rates for some leasehold properties here might expand as the land lease remaining diminishes. For an asset valued at S$500 million based on a 3.3 per cent cap rate, a 25 basis-point cap rate increase will cause a 7 per cent fall in the property value.

Certainly, growing a building’s net property income can help drive higher valuation over time. However, across many sectors, space users here are watching costs hawkishly, and could resist rental hikes. Many space users may be acutely mindful of rental costs here, given Singapore’s high operating costs relative to that in many other jurisdictions.

In addition, landlords might see falling net property income margins due to the effects of inflation on their operating costs.

Numerous listed property groups trade at sharp discounts to their book values, partly due to low free floats and poor trading liquidity. Still, a key contributor to languishing share prices of many property groups is their unexciting ROEs. And owning investment properties here may hinder efforts to drive improvement in ROE.

Housing development

Interestingly, the risk-reward for property groups in the Singapore market could increasingly favour housing development over property investment.

Today, housing demand is being restrained by the hefty Additional Buyer’s Stamp Duty (ABSD) applicable to locals buying multiple homes and non-permanent resident foreigners buying any home. Nonetheless, there is demand for private homes from locals aspiring to the condo lifestyle and rising household formation. Still, with highly selective homebuyers, only developers offering the right product will be amply rewarded.

Housing developers compete in a fragmented market. They face high construction, financing and selling costs. They also pay property taxes, stamp duties and other fees. On top of that, they have tight deadlines to sell their housing inventory, failing which they are subject to clawback of ABSD that was remitted upfront. 

However, a major cost item for any housing project, namely land cost, has generally been declining, based on the results of recent state land tenders.

In May, a consortium led by UOL Group and CapitaLand Development won a 99-year leasehold private housing site in Holland Drive for a price per square foot per plot ratio (psf ppr) of about S$1,285; this is around 32 per cent below the S$1,888 psf ppr fetched in 2018 for the adjacent commercial and residential site. 

If the sale prices of new private homes are flat or rise marginally, and lower land costs mitigate higher non-land development costs, margins from housing development projects could expand.

Perhaps, property groups should sell low-yielding investment properties, go slow with raising debt and step up housing development activity here.