Perpetuals lure as cheap equity for hungry-to-acquire Reits

Singapore

THERE are businesses that list in Singapore, and raise no further capital once their listing status is secured.

That, however, is not the story for real estate investment trusts (Reits) listed here.

In particular, the S-Reits are active in raising equity in the secondary market to buy properties. Though acquisitions can be funded by debt, which is cheaper than equity, at some point Reits need to increase their equity base.

Guidelines governing Reits state that leverage limit, which is total borrowings and deferred payments divided by deposited property, should not exceed 50 per cent.

From Jan 1, 2022, leverage limit can exceed 45 per cent and go up to a maximum of 50 per cent if the Reit has a minimum interest coverage ratio of 2.5 times.

When a Reit's gearing approaches the leverage limit, it typically raises new equity to fund identified acquisitions, secure headroom for potential acquisitions or get some breathing space.

On May 20, Mapletree Industrial Trust (MIT) launched an equity raising comprising a secondary placement and a preferential offering mainly to help fund a US$1.32 billion acquisition of 29 data centres in the United States.

MIT raised S$513 million from a secondary placement. Pricing was at a discount of 2.3 per cent to the volume-weighted average price (VWAP) of trades done on the day prior to launch of the equity raising.

Secondary placements are a quick way to raise equity. Books of orders for MIT's issue closed within a day. Settlement and subsequent listing of new units were completed just over a week thereafter.

Secondary placements are not open to all unit holders. Existing unit holders may see their proportionate equity interest diluted by the issue of new units at a discount to market price.

Rights issues and pro-rata preferential offerings of units get around the issue of dilution to existing unit holders as they can keep their proportionate interest by participating in these exercises. Such exercises, though, take longer to complete.

MIT also did a preferential offering to raise S$310 million on the basis of five new units for every 100 units held. Pricing was at a discount of 4.3 per cent to the VWAP. New units from the preferential offering will be listed about a month after the announcement of the equity offering.

In a separate equity fund raising exercise done earlier in May, MIT successfully undertook its inaugural issue of S$300 million worth of perpetual securities that were rated "BBB-" by Fitch Ratings.

While the issue of perpetual securities is not open to subscription by all existing unit holders, it is possibly a Reit's most attractive equity raising option.

For a Reit's sponsor, advantages of issuing perpetual securities include not having to inject more monies under a rights issue and not being diluted as with a secondary placement.

MIT's perpetual securities issue took about a week to complete.

What is compelling is the pricing of the issue, with distribution rate at 3.15 per cent per annum.

This is higher than MIT's weighted average all-in funding cost for the quarter ended March 31, 2020, of 2.8 per cent. But the accounting treatment of perpetual securities is that of equity and the perpetual securities appear to be cheap equity.

MIT trades at historical distribution per unit (DPU) yield of around 4.5 per cent. Investors in units of MIT would look to get around 4.5 per cent yield, which is over 130 basis points more than what the Reit pays its perpetual securities holders.

The perpetual securities are callable after five years and the distribution rate payable will be reset after five years to the then prevailing Singapore dollar swap offer rate or its replacement plus the initial spread of 2.082 per cent.

There are numerous examples of perpetual securities in the local market that are called by their issuers on the first call date.

But, a precedent may have been set by Ascott Residence Trust (ART). The hospitality trust issued perpetual securities on June 30, 2015, at 4.68 per cent, with its first call date on June 30, 2020. It did not redeem the perpetual securities and instead reset the rate to 3.07 per cent per annum for the next five years.

In determining the reset rate, the initial spread to the swap offer rate is fixed. In five years' time, whether MIT can reset the rate it pays perpetual securities holders to below 3.15 per cent depends on movements in the swap offer rate or its replacement.

Even if MIT has to pay a higher reset rate, it can make sense not to redeem the perpetual securities.

A higher reset rate would be due to interest rates rising, which, in turn, would likely result in MIT trading at a higher DPU yield than today. As such, the perpetual securities can still be relatively cheap equity.

In contrast, perpetual securities issued by developer groups such as those by Frasers Property in 2019 and GuocoLand in 2018 have a step-up component that kicks in at the time of rate reset. The reset rate would be based on prevailing swap offer rates plus the initial spread plus the step-up of 100 basis points.

The perpetual securities issued last week by Keppel Infrastructure Trust also have a step-up margin of 100 basis points applicable at the time of rate reset.

The punitive element of the step-up feature incentivises issuers to redeem their issues when the time comes for rates to reset.

MIT started with S$2.1 billion of assets, comprising flatted factories, business parks and other industrial buildings in Singapore when it listed in October 2010.

With its latest acquisition of data centres in the US, MIT's assets under management will reach S$8.6 billion, with 54 per cent of that in data centres. Its manager may not be done with buying data centres as its strategy is to have up to two-thirds portfolio contribution from data centres.

If portfolio growth drivers remain intact or accelerate, there is little reason for MIT not to treat the inaugural perpetual securities as being perpetual. For any acquisitive entity, access to relatively cheap equity in the form of perpetual securities provides a competitive edge.

With abundant liquidity for good names to tap, two other Reits did maiden issues of perpetual securities earlier this month.

Lendlease Global Commercial Reit did a S$200 million issue, while Mapletree North Asia Commercial Trust issued S$250 million in perpetual securities at per annum rates of 4.20 per cent and 3.50 per cent respectively.

Meanwhile, Suntec Reit, which issued S$200 million of perpetual securities last October, announced another issue of S$150 million of perpetual securities at a rate of 4.25 per cent per annum, which are expected to be issued on Monday.

Going forward, expect Reits to continue to actively use perpetual securities.

Being sharp on cost of capital facilitates bulking up via accretive acquisitions. That, in turn, drives better unit price, creating a virtuous circle.