Undervalued Reits: selling assets trumps mergers
IN spite of the Covid-19 pandemic, real estate investment trusts (Reits) owning retail and office assets posted decent results for 2021.
Suntec Reit, which owns retail and office properties in Singapore, Australia and the United Kingdom posted growth in distribution per unit (DPU) for the year ended Dec 31, 2021 of 17.1 per cent.
CapitaLand China Trust (CLCT), which has a portfolio of 11 shopping malls, 5 business parks and 4 logistics properties in China, saw DPU for the year ended Dec 31, 2021 rise 37.5 per cent.
Suntec Reit and CLCT are both fairly established trusts, with the former being listed in 2004 and the latter in 2006 as CapitaRetail China Trust.
Both Suntec Reit and CLCT trade at large discounts to their net asset values (NAV) as at Dec 31, 2021 - of 26 per cent and 24 per cent, respectively, based on unit prices at the close of the market on Feb 9, 2022.
Should these 2 Reits follow in the paths of other undervalued Reits that have looked to re-rate through merging with Reits with better valuations? Perhaps CLCT can merge with other Reits that share its sponsor, namely CapitaLand Investment, such as CapitaLand Integrated Commercial Trust (CICT) or Ascendas Reit.
Suntec Reit, meanwhile, is managed by a unit of Ara Asset Management, which has recently been acquired by Hong Kong-listed ESR Cayman. Its potential merger partners might include other ESR or Ara-managed Reits, or even other commercial Reits such as CICT or Mapletree Commercial Trust (MCT).
But mergers are tricky to execute. When 2 entities that trade at differing price-to-book multiples propose to come together, the entity that trades at a better multiple may be punished by investors.
The reaction of investors to the proposed merger of MCT and Mapletree North Asia Commercial Trust (MNACT) may cause Reits thinking of merging to reconsider such plans.
MNACT was trading at a discount to NAV. Under the proposed merger, unitholders of MNACT would receive either new units of MCT or a mix of new MCT units and cash. The total scheme consideration price is S$1.1949 per MNACT unit held.
The price of S$1.1949 reflects MNACT's NAV per unit as at Sep 30, 2021, adjusted to exclude MNACT's DPU for the 6 months to Sep 30, 2021, and to incorporate a valuation of the trust's investment properties and joint venture as of Oct 31, 2021.
While the valuation of MNACT appears fair to the Reit's unitholders, MCT's unitholders did not feel the same way.
MCT's units fell 4 per cent on their first day of trading after the announcement. As of Feb 9, the counter has declined 9 per cent from its last price of S$2 before the proposed merger.
MNACT's unitholders now stand to receive less than the scheme consideration price of S$1.1949 per MNACT unit held.
Reits that want to avoid such a situation should instead consider divesting their portfolios of assets at book value or a premium to book value. Divestment proceeds can be returned to unitholders and the said trusts wound up. There appears to be ample liquidity from various pools of buyers of physical real estate to support the execution of such a strategy.
Last year, Suntec Reit sold strata office units at Suntec Tower One and Suntec Tower Two in Singapore's Central Business District (CBD) for a sale consideration of S$197 million or S$2,510 per square foot of strata area. The sale consideration was 8.9 per cent higher than the independent valuation.
In January, Frasers Logistics and Commercial Trust announced it had agreed to sell mixed-use commercial asset Cross Street Exchange in Singapore's CBD for S$810.8 million. This represents a premium of 28.3 per cent to book value as at end-September 2021.
Of course, resolving the issue of Reits that persistently trade below NAV by selling assets and winding up the trusts can hurt sponsors of the trusts. As the sponsors typically own the external managers of the Reits, they stand to lose very valuable management fees. Besides losing high-quality recurrent income, they would see the size of their funds under management shrink.
Suntec Reit will this year be able to ride the reopening of Singapore's economy. The trust's manager sees its office assets benefiting from more businesses setting up and strengthening their presence here because of Singapore's attractiveness as a technological and financial hub.
As for CLCT, perhaps it can continue to evolve its investment story by adding more logistics assets. The trust's manager wants to grow its exposure to new economy assets such as logistics and business park properties from around 21.9 per cent of assets under management as at end-2021 to 30 per cent over the next 5 years.
Investors can expect the managers of Suntec Reit and CLCT to continue to proactively drive growth in DPU and NAV while vigilantly monitoring borrowings in an environment in which interest rates are likely to rise. But will such efforts help these Reits to eliminate their discounts to NAV?
Should the answer be no and the optimal strategic option be that of selling assets and winding up, let us hope these trusts have the courage to pursue such a course.
The Reit sector wins if strategic actions are taken by trusts that prioritise the interest of unitholders.
- The writer holds units of Suntec Reit, MCT and MNACT.
