Asian REITs Discovery Weekly: Retail REITs Battling E-Commerce, Betting On Interest Rates And Full Year Results For Asia's Largest REIT

by: The Value Pendulum

The impact of e-commerce on Asian retail REITs is viewed through the lens of Singapore's largest retail REIT.

You can choose Asian REITs with either high or low proportion of fixed-rate debt depending on your outlook on future interest rates.

Link REIT reports its full-year results this week, and reveals several insights relevant to REITs investment opportunities.


REITs have become increasingly popular over the years, as investors seek comfort in yield, defensiveness and asset downside protection. There are approximately over 160 Asian REITs, roughly half the number of those listed in the U.S., based on a screen for industry classification that I have done. This is the inaugural issue of Asian REITs Discovery Weekly which hopes to help readers seek investment opportunities in REITs listed in Asia.

The majority of Asian REITs are listed on stock exchanges in Japan, Hong Kong, Singapore and Malaysia, and I will be focusing on profiling Asian REITs listed in the above-mentioned markets, with the exception of Japan due to the lack of disclosures in English.

I primarily use three methods of "discovering" new Asian REIT ideas. Firstly, I zoom in onto a specific property sub-segment and assess if the property sub-segment is worth investing in before delving into the REITs owning properties in the particular property sub-segment. Secondly, screening for bottom-up metrics such as price-to-book, gearing and rent reversions among others can lead to under-covered REITs. Lastly, events like financial results and capital recycling activities like acquisitions/divestments could change the market perception of REITs in both positive and negative ways, creating investment opportunities as the share prices of these REITs fluctuate in the short term.

Top-Down Property Sub-Segment: Retail REITs And The Impact Of E-commerce

Singapore-listed CapitaLand Mall Trust (OTCPK:CPAMF) [CT:SP] is Singapore's largest retail-focused REIT by market capitalization (S$8 billion) and also the largest shopping mall owner (15 retail properties with a total net lettable area of 5.4 million square feet) in the country with its ownership of 14.6% of malls exceeding 100,000 square feet of net lettable area. Reviewing the REIT's financials, disclosures and progress in the past few years offer a perspective of how retail REITs have coped with the rising popularity and threat of e-commerce.

One of the key ways to deal with the threat of e-commerce is to focus on the things that cannot be disrupted by e-commerce, such as experiences. At its 2Q2016 results briefing, CapitaLand Mall Trust highlighted that it understood that young consumers are driven by experiences and food & beverage is one critical aspect of this. CapitaLand Mall Trust optimized the food & beverage tenant mix (I assume it is both in terms of quantity and quality) in one of its malls, J-Cube located in Jurong, Singapore, and witnessed improvements in visitor traffic and consumer spending following the change.

A review of CapitaLand Mall Trust's tenants’ YoY sales growth by trade categories in 1Q2019 suggested that not all tenants are equally affected by e-commerce and weakness in consumer sentiment. Tenants/retailers selling experience goods such as food & beverages, fashion, beauty & health continue to deliver steady sales growth, while the usual victims of e-commerce like retailers of music & video, IT & telecommunications are experiencing shrinking sales. More importantly, food & beverage tenants contributed 31% of CapitaLand Mall Trust's gross rental income as of end-December 2018, while tenants in fashion and beauty & health each account for an additional 12% of its gross rental income. The heavy weighting of tenants in these experience-driven segments plays a critical role in providing support for CapitaLand Mall Trust's rental income and dividend payout.

Source: CapitaLand Mall Trust 1Q2019 Results Presentation

Besides having a healthy mix of tenants offering experience goods particularly food & beverage, CapitaLand Mall Trust is also starting to experiment with new store formats to enhance the consumer experience. In November 2018, it launched Singapore’s first "phygital" (new buzzword that represents physical plus digital) store NomadX at Plaza Singapura, one of its malls in Dhoby Ghaut, Singapore, 11,000 square feet experiential, multi-label concept store.

New tenants or new concepts will be hosted at NomadX for a period of three or six months, with the retailers either show-rooming or using it as a test-bed for new concepts or products. Some other unique elements of NomadX include targeted product recommendations based on shopper profile (personal details provided during on-boarding process, automated store assistance via intuitive sensor technology (facial recognition technology and cameras used to monitor visits to various stores within NomadX) and cashless payment.

Photos of NomadX at Plaza Singapura

Source: CapitaLand Mall Trust May 2019 Investor Presentation

The results speak for themselves. Notwithstanding e-commerce gaining headway in recent years, CapitaLand Mall Trust has achieved an impressive 13.1% CAGR for distributable income for the 2003-2018 period. Although distributable income growth has slowed down in recent years as per the chart below, CapitaLand Mall Trust still managed an amazing feat of growing distributable income in every single year since 2004.

In terms of shareholder return, CapitaLand Mall Trust boasts year-to-date, three-year, five-year and 10-year total return (both capital gains and dividends) CAGRs of 9.5%, 10.9%, 8.0% and 9.3% respectively. These are very decent numbers and imply that if an investor had bought and held shares of CapitaLand Mall Trust for the past decade, he or she would have earned solid returns in excess of inflation and beyond.

CapitaLand Mall Trust's Historical Distributable Income Growth

Source: CapitaLand Mall Trust 1H2018 Results Presentation

I listened in to CapitaLand Mall Trust's historical half-yearly results webcasts, and I reproduce selected management comments on e-commerce below to end this section. Note that these quotes are based on my notes listening to the earnings call, and any error is mine.

Our retailers themselves are also embarking on that journey. So they are also trying very hard to ensure they don't miss out on the online market, right. And we are seeing that potentially it will also be an area that we will watch closely. It doesn't mean that when the retailers themselves are embarking on online journey, the traditional landlord role is over. There are many ways you can tap into it, whether we look at click, collect or mortar. I mean, there are many ways you can look at collaboration. So e-commerce space is a given. You'll continue to grow. What we hope to achieve is to ensure that we stay very relevant with our retailers and we'll always be the port of call whenever they need expansion. ~ CapitaLand Mall Trust FY2018 Results Webcast

These are marketing that we continue to do. It's important we engage our community. And our marketing program can be very targeted. It can be more about creating a market presence. So we'll continue to do that for 2018. And we'll ensure that each market that we trade in, we're able to engage the local community as close as possible. This is important. I think from a branding point of view, it's important because memory sticks. If you have a strong engagement with a retailer on the ground, a retailer and a shopper on the ground, the memory sticks. And in this way, I think it's something that you can't really replicate in the online space, right. ~ CapitaLand Mall Trust FY2017 Results Webcast

Bottom-Up Metrics: Proportion Of Fixed Rate Debt

The metrics used to assess REITs can be divided into three main categories: valuation, operational and credit. Valuation metrics include price-to book and dividend yield, operational metrics include occupancy rate and rental reversions, while credit metrics include gearing and financing details.

With the Fed suggesting that an interest rate cut is likely, REITs with a low proportion of fixed-rate debt (i.e. more floating interest rate debt) should benefit from lower interest costs and consequently higher dividend payout. Nevertheless, given the uncertainty of macroeconomic developments, conservative investors might prefer REITs with a high proportion of fixed-rate debt instead which offers certainty on interest cost. I provide a list of Asian REITs with the highest and lowest (on a relative basis) proportion of debt on fixed-rate terms for investors' consideration. I also provide additional details of the REIT's all-in interest cost (weighted-average cost of the various tranches of debt) and percentage of debt maturing in the current financial year (which could potentially change the proportion of fixed-rate and floating rate debt).

Aggressive Investors' Watchlist: Asian REITs With The Lowest Proportion Of Fixed-Rate Debt

  1. Yuexiu Real Estate Investment Trust [405:HK] has 20% of its debt on fixed-rate terms with an all-in interest cost of 4.0%. No details of its debt maturity schedule were provided.
  2. Champion Real Estate Investment Trust [2778:HK] has 54% of its debt on fixed-rate terms with an all-in interest cost of 3.1% and 24% of its total debt maturing in the current financial year.
  3. Lippo Malls Indonesia Retail Trust [LMRTA:SP] has 58% of its debt on fixed-rate terms with an all-in interest cost of 5.6% and 18% of its total debt maturing in the current financial year.
  4. CDL Hospitality Trusts (OTC:CDHSF) (OTC:CDHSY) [CDREIT:SP] has 60% of its debt on fixed-rate terms with an all-in interest cost of 2.4% and 20% of its total debt maturing in the current financial year.
  5. First Real Estate Investment Trust (OTC:FESNF) [FIRT:SP] has 60% of its debt on fixed-rate terms with an all-in interest cost of 4.0% and 20% of its total debt maturing in the current financial year.

Conservative Investors' Watchlist: Asian REITs With The Highest Proportion Of Fixed-Rate Debt

  1. EC World REIT [ECWREIT:SP] has 100% of its debt on fixed-rate terms with an all-in interest cost of 4.9% and none of its total debt maturing in the current financial year.
  2. Keppel-KBS US REIT [KORE:SP] has 100% of its debt on fixed-rate terms with an all-in interest cost of 3.8% and a marginal 1% of its total debt maturing in the current financial year.
  3. Manulife US Real Estate Investment Trust [MUST:SP] has 98% of its debt on fixed-rate terms with an all-in interest cost of 3.3% and 16% of its total debt maturing in the current financial year.

Note that both lists above are not recommendations to buy or sell on its own, but serve as watchlists for idea generation, as REITs need to be assessed on a range of attributes including valuation, operational performance and credit risks among others.

Events: Insights From Full-Year Results Briefing Of Asia's Largest REIT

Hong Kong-listed Link REIT [823:HK] is Asia's largest REIT in terms of asset size and market capitalization with a portfolio comprising retail facilities, car parks and offices in Hong Kong and China. Based on my research, Link REIT is the best-performing Asian REIT in terms of total return (capital gains and dividends) for shareholders over the past decade, having delivered a 10-year annualized total return CAGR of 21.65%

Link REIT reported full-year FY2019 (year ended March) results on June 3, 2019, and drew a couple of insights which I would share with readers here.

The escalation of U.S.-China trade tensions, the most hotly debated topic of interest for investors, is not entirely negative for Link REIT.

Firstly, Link REIT is seeing more acquisition opportunities, because Chinese property developers are divesting assets as an alternative to debt refinancing as banks in China become more cautious in lending in the current environment. Link REIT acquired two properties in China in FY2019, Roosevelt Plaza in Beijing and CentralWalk in Shenzhen, with a total of 1.6 million square feet for RMB 9 billion in total. China assets currently account for 13.2% of the REIT's assets versus its target/guidance of 20% China exposure, implying significant room for further acquisitions.

Secondly, Link REIT continues to deliver strong results supported by an 8.7% increase in statutory minimum hourly wage from HK$34.50 to HK$37.50 in Hong Kong in May 2019. The Hong Kong retail portfolio is 97.1% occupied with a rental reversion rate of 22.5%, while average unit rent increased by 9% to HK$68 per square foot and tenant sales grew by 5.4% YoY (versus 4.5% YoY growth for overall Hong Kong retail market over the same period). This is largely attributable to Link REIT's defensive tenant mix, with 63% of its rental income for its Hong Kong retail portfolio derived from tenants in food-related trades such as food and beverage, supermarket and foodstuff and markets/cooked food stalls.

Lastly, Link REIT highlights the possibility of China introducing stimulus measures to boost domestic consumption, which would benefit retailers and retail REITs like Link REIT.

Another point of note is that Link REIT's occupancy cost, measured by rent-to-tenant sales, rose from 11% in FY2016 to 13.5% in FY2019. Occupancy cost is an indicator of both the bargaining power of a landlord with its tenants and also the "pain threshold" of retailers/tenants. Rising occupancy cost over the past three years implies that Link REIT has strong bargaining power with its tenants. More importantly, Link REIT mentioned at the results briefing that a 15% rent-to-tenant sales ratio is the level when it would "alert us to be looking at the reversion rate going forward." This suggests that there is still room for healthy rental reversions for Link REIT's portfolio.

Link REIT's capital return strategy also differentiates it from its peers which rely primarily on dividend payouts. Link REIT has repurchased an estimated 9.7% of its outstanding units for HK$13.3 billion in the past five years. It has guided for the repurchase of 60 million units (representing approximately 2.8% of units outstanding) for FY2020 to offset the DPU (dividend per unit) dilution impact from HK$9 billion of asset disposals in FY2019.

Link REIT also has limited downside credit risks. Its gearing is 10.7% with interest cost for approximately 70% for its Hong Kong dollar-denominated debt portfolio hedged on fixed-rate interest rate terms, and the average debt maturity for its Hong Kong dollar-denominated fixed-rate debt is a healthy 4.8 years.

Looking forward, Link REIT has targeted a decent high-single-digit growth CAGR in assets under management for the next six years. The only bugbear for Link REIT as a potential investment is its valuation. In other words, much of the positives I mentioned earlier have been priced in. Based on its share price of HK$95.85 as of June 3, 2019, Link REIT is trading at 1.1 times P/B and 2.8% FY19 dividend yield. As per the valuation charts below, Link REIT is trading at a historical low dividend yield of 2.8% and it is now trading above book value which represents a five-year P/B peak. Note that price-to-book ratio is a commonly-used valuation metric for most Asian-listed REITs and business trusts, as the value of the property assets on their books are revalued by independent property valuation companies at least once a year in line with International Financial Reporting Standards (as opposed to GAAP).

Link REIT's Historical P/B Ratio

Source: Gurufocus

Link REIT's Historical Dividend Yield

Source: Gurufocus

Closing Thoughts

CapitaLand Mall Trust is a classic case study of how different reality could be from headline-grabbing negative news. While it is true that e-commerce is gaining in popularity and online is grabbing a larger slice of the retail price from off-line, retail REITs should not be avoided solely on this basis. CapitaLand Mall Trust's historical total shareholder return (10-year CAGR of 9.3%) would easily trump many of the dot-com stocks which went bust at the start of the century.

Also, there are no straightforward answers or rules of thumb when it comes to investing in both stocks and REITs. While it is tempting to bet on REITs with a high proportion of floating-rate debt to benefit from potential interest rate cuts, conservative investors might prefer to head the other way and own REITs with higher proportion of fixed interest-rate debt to have greater confidence in DPU stability (floating-rate debt could cause a spike in interest costs and reduce DPU).

Link REIT's latest financial results is a testament to the quality of its assets and the track record management team. Although it seems pricey at this point in time, it could be attractive again when the market climate turns to risk-on mode some time down the road and investors starting to switch out of REITs into riskier options, possibly making Link REIT's price more attractive.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.