Asian REITs Discovery Weekly: Proxy For Asian Data Center Growth, Historical Peak And Trough P/B Valuations, Sub-Urban REIT's Recent Successful Fund Raising

Includes: AMZN, CWK, DLR, EQIX, FB, SP
by: The Value Pendulum

Singapore-listed data center REIT was the first of its kind to list in Asia and is still a proxy for the region's data center growth.

Screening for REITs trading at their historical P/B peaks or troughs throws up a list of investment candidates to do further research on.

The quality of Singapore's only pure-play sub-urban retail REIT was evident with its recent successful fund raising to finance property acquisition which was well-received.


The Asian REITs Discovery Weekly continues the hunt for Asian REIT ideas this week in the following three categories: 1) specific property sub-segment focus 2) screening REITs on quantitative metrics; and 3) events like financial results, fund raising activities and acquisitions or divestments.

Top-Down Property Sub-Segment: Data Center REIT

When investors discuss about REITs, retail malls and office buildings are usually the typical asset types and property sub-segments that come to mind. But there are also other niche REITs that own specialized assets such as data center REITs.

Keith D. Taylor, CFO of Equinix, Inc. (EQIX), the world's largest data center REIT, gave a good definition of the data center REIT business at the REIT's presentation at NAREIT's annual Investor Forum REITWeek 2019 in June 2019:

We sell power. We sell interconnection. And really, we are a crossroads between real estate technology and telecom...And we think of ourselves as really an enabler of technology, enabler of data distribution. And hence, we don't think of ourselves as a typical real estate company. We think of ourselves very much as a technology company...And you can think about autonomous vehicles, IoT, data analytics, the cloud business in and of itself, SaaS and other service providers like that. And we're at the crossroads of all those opportunities because at some point, there has to be a touch down from how one consumes and how one delivers. How do I consume Netflix (NFLX) and how does it get delivered? And the way that gets done is through the connective tissue of networks, and we happen to be at the crossroads of all of those opportunities.

There aren't many data center REITs listed in Asia. Keppel DC REIT [AJBU:SP] was the first pure-play data center REIT listed in Asia on the Singapore Stock Exchange in 2014.

Keppel DC REIT owns 15 data centers across eight countries in Asia and Europe, with Singapore and Australia accounting for 51.0% and 15.0%, respectively, of its portfolio assets under management or AUM. Other European assets (located in Ireland, U.K., Netherlands, Germany, and Italy) represent approximately 33.4% of AUM, with its Malaysian data center property accounting for a marginal 1.4% of AUM.

Let's start by understanding why data centers in general represent significant growth opportunities. Arthur William Stein, CEO of Digital Realty Trust, Inc. (DLR) spoke about the growth drivers for data centers in his presentation on the REIT at NAREIT's annual Investor Forum REITWeek 2019 in June 2019:

There are 2 categories of data center drivers. It's IT outsourcing and the digital economy. So we feel that IT outsourcing is still in very early innings with many companies still running their IT workloads in their server closets, in their office building or from a data center that they own. And those are typically overbuilt and highly inefficient. The move right now is to the cloud, and we believe it's a hybrid multi-cloud environment where a customer will put some of its applications hopefully on our campus, in our data center and connect with multiple clouds...But the fact of the matter is that trend, we are just at the very early stages of that. The other piece of this is the digital economy. So I'm sure virtually everyone in this room has bought something on Amazon (AMZN). That's a pretty good example right there. Many of you probably have Facebook (FB) accounts, and for the older people in the room, maybe your kids have Facebook accounts, and that's how you stay in touch with them. That's what I do. There are also LinkedIn accounts. Those are great for those of you who are looking for jobs. Uber for getting around or Lyft. So I mean all of these companies that do business solely over the Internet are important customers of ours. And we provide critical infrastructure to support their growth. So these are the demand trends. IT outsourcing, cloud computing, and any businesses that thrive over the Internet. But looking forward, beyond today, the drivers of growth are going to be autonomous cars. Your Tesla (TSLA), for example. Artificial intelligence, Internet of Things and virtual reality. So we feel good about the future, bottom line.

Asia Pacific and Singapore specifically account for 67.4% and 51.0% of Keppel DC REIT's portfolio AUM, respectively, and these are key growth markets for data centers. Cushman & Wakefield's latest edition of Winning in Growth Cities Report 2018-2019 published in October 2018 states that Asia Pacific overtook EMEA to be the second largest data center investment market after Americas with a YoY growth of 3,348.7% for 1H2018, versus more modest annual growth rates of 241.4% and 138.6% for Americas and EMEA, respectively. Within Asia Pacific, the Singapore data center market stands out accounting for $549 million, or 40% of the total $1,377 million investment in total real estate investment in data centers across Asia Pacific for 1H2018.

On the flip side, the risks associated with betting on the growth in data centers are reflected in Keppel DC REIT's tenant sector concentration. Tenants in the internet enterprise, telecommunications, and information technology services sectors, respectively, accounted for 46.4%, 19.8%, and 24.3% of rental income in March 2019. This suggests that data center growth could slow if there is a downturn in the technology sector.

From a quantitative perspective, Keppel DC REIT's operating metrics are excellent, particularly its long weighted average lease expiry or WALE. Keppel DC REIT's WALE of 8.0 years (by net lettable area) is very impressive, particularly if one compares it against its peers. Based on my research, Singapore-listed office and retail REITs have WALEs between two and five years, while WALEs are between two and four years for Singapore industrial REITs. Do note this is not exactly an apples-for-apples comparison, as some REITs calculate WALE by weighting the leases by net lettable area, while other REITs weight the leases in terms of gross rental income. Nonetheless, Keppel DC REIT's rental income stream is much more stable and predictable than its peers, with only 2.4% and 4.9% of its leases expiring in 2019 and 2020, respectively.

Keppel DC REIT's credit strength is also decent. Its gearing of 33.2% is significantly below the statutory limit of 45%, implying a debt headroom of close to S$500 million. Assuming a more reasonable gearing of 40%, Keppel DC REIT still has a debt headroom of approximately S$270 million, equivalent to about 13.5% of its portfolio AUM of S$2.0 billion as of December 31, 2018. Approximately 81% of Keppel DC REIT's borrowings are on fixed rates or hedged via interest rate swaps.

The only thing of worry is that Keppel DC REIT has to refinance 18.2% of its total debt or S$130 million in FY2019, although undrawn credit facilities amounting to $140 million should easily cover that. Furthermore, Keppel DC REIT has the fourth lowest all-in cost of debt among Singapore-listed REITs at 1.70%, only higher than Parkway Life Real Estate Investment Trust [PREIT:SP] (0.91%), Cromwell European Real Estate Investment Trust [CERT:SP](1.39%) and IREIT Global [IREIT:SP] (1.50%). This is partly attributable to Keppel DC REIT's mix of foreign currency debt, with EUR-, GBP- and AUD-denominated debt accounting for 58.3%, 12.1%, and 11.4% of its total debt (SGD denominated debt is about 18%).

There are three potential risk factors when one considers investing in Keppel DC REIT.

Firstly, there have been concerns relating to oversupply in the Singapore data center market in the past, and significant new data center supply is coming on stream in the next few years. Singapore contributes slightly over half of Keppel DC REIT's portfolio AUM.

In a January 2016 report titled "Data Centers: The New Frontier," Cushman & Wakefield (CWK) commented on the supply of data centers (my emphasis):

Average DC occupancy islandwide currently stands at about 70%. With a large volume of new supply coming online next year, occupancy could fall further, but it should not be a cause for alarm. Prices could bottom out quickly next year due to the sustained demand from the growing tech/network content companies (such as Face - book, Netflix, Uber), major banks and insurance companies outsourcing the data centres to be compliant with MAS' requirement on threat and vulnerability risk assessment. We expect occupancy to be back in the 70% mark by 2018, and it will soon turn into a landlord's market with positive rental reversions once the supply is fully taken up over the next two years.

A follow-up report published by Cushman & Wakefield in October 2017 also noted that "There has been some price and vacancy pressure, particularly among smaller data center players." The latest February 2019 Cushman & Wakefield report indicates that overall vacancy rate for the Singapore data center market is 17%. Although no details were provided as to how the vacancy rate figure was arrived at, it does seem on the high side.

Keppel DC REIT commissioned BroadGroup Consulting, an independent research and consulting firm specializing in the data center sector, to do research on the Singapore data center market and published BroadGroup Consulting's research findings in its FY2018 annual report. As per BroadGroup Consulting's research and the chart below, it is estimated that between 43kW and 53kW of new data center supply is coming on stream every year between 2019 and 2022, which is higher than the 2015-2018 average annual supply additions of 35kW. BroadGroup Consulting takes the view that demand growth should offset the additional new supply, stating that "This trend of a tightening market is expected to continue into 2019, with data center supply from established providers expected to be absorbed faster" and estimates new demand in Singapore to grow at a 2018-2022 CAGR of 9.4%.

Source: BroadGroup Consulting, Keppel DC REIT

Secondly, other neighboring South-east Asian countries could potentially divert data center demand away from Singapore, Keppel DC REIT's largest market, in future. Cost-wise, it is at least half as cheap in terms of electricity prices and salaries of data center operations staff to operate data centers in Indonesia and Vietnam vis-a-vis Singapore. Lynus Pook, Associate Director of data centre advisory at Cushman & Wakefield, authored a Business Times opinion piece titled "Singapore's data centre market at a crossroads" in March 2019 and highlighted some of these advantages that other neighboring South-east Asian countries could have: "Vietnam's long coastline makes it a natural gateway and landing point for subsea cables to the other landlocked Asean cities" and "Indonesia has a population of 264 million...and a large proportion of their population is young, presenting tremendous potential for exponential demand for data based on these use cases." That being said, Keppel DC REIT has the option of acquiring data center assets in other countries or markets in future.

Thirdly, the valuation of Keppel DC REIT's assets, data centers, is tricky. Given that data centers are a specialized asset class, there are fewer acquisitions or disposals of data centers in any single year, making it challenging to cross-check valuation against actual market transactions. A common method of valuing REIT assets is the capitalization approach which discounts the asset's income stream using an appropriate capitalization rate to arrive at the market value; the capitalization rate is typically derived from or benchmarked against actual market transactions.

Keppel DC REIT trades at a P/B of 1.56 times, based on its share price of S$1.62 as of June 17, 2019, and Net Asset Value of S$1.05. This ranks Keppel DC REIT alongside Parkway Life Real Estate Investment Trust (P/B of 1.62 times), a healthcare REIT, as the two most expensive Singapore-listed REITs on a P/B basis. It is clear that both are of them are prized by the market for their defensiveness.

I drew up a list of Asian REITs trading at extreme ends of their historical P/B valuations in the next section.

Bottom-Up Metrics: REITs Trading At P/B Peak Or Trough Levels

Price-to-book ratio, yield spread (calculated as the difference between the REIT's DPU yield and the risk-free rate), and the Dividend Discount Model are the three most common methods of valuing Asian REITs.

Unlike U.S. REITs, it is possible to evaluate Asian REITs using the price-to-book ratio, because Asian REITs follow International Financial Reporting Standards and they carry the property assets on their books at fair value based on revaluations by independent property valuation companies at least once a year.

I screened for Asian REITs listed in Hong Kong, Singapore, Malaysia, and Thailand with price-to-book ratios at or close to their historical peaks or troughs. The five most expensive and the five most cheapest Asian REITs on a P/B basis are presented below. All share price data below are accurate as of June 17, 2019.

Five REITs Trading At Their Historical P/B Peak

  1. Frasers Logistics and Industrial Trust [FLT:SP] is trading at a historical P/B peak of 1.34 times.
  2. CapitaLand Commercial Trust [CCT:SP] is trading at a historical P/B peak of 1.13 times.
  3. Mapletree Logistics Trust (OTC:MAPGF) [MLT:SP] is trading at a historical P/B peak of 1.33 times.
  4. Mapletree North Asia Commercial Trust [MAGIC:SP] is trading at a historical P/B peak of 0.95 times.
  5. CPN Retail Growth Leasehold REIT [CPNREIT:TB] is trading at a historical P/B peak of 2.18 times.

Five REITs Trading At Their Historical P/B Trough

  1. AmFirst Real Estate Investment Trust [ARET:MK] is trading at a historical P/B trough of 0.41 times.
  2. Hektar Real Estate Investment Trust [HEKT:MK] is trading at a historical P/B trough of 0.76 times.
  3. Land and Houses Freehold and Leasehold Property Fund [LHPF:TB] is trading at a historical P/B trough of 0.80 times.
  4. MFC Industrial Real Estate Investment Trust [MIT:TB] is trading at a historical P/B trough of 0.45 times.
  5. WHA Business Complex Freehold and Leasehold REIT [WHABT:TB] is trading at a historical P/B trough of 0.94 times.

Price is what you buy, and value is what you get. REITs trading at or close to their historical P/B trough are not necessarily undervalued, if their balance sheets are weak, the portfolios are poorly managed with low occupancy rates and negative rental reversions and DPUs are on a declining trend. On the flip side, certain REITs could be justified trading at or close to their historical P/B peak, if gearing and borrowing costs are low, portfolios show positive trends of rising occupancy rates and positive rental reversions, and they have a consistent track record of DPU growth over time.

Furthermore, it is necessary to examine the assumptions that the independent valuer uses in valuing the property assets of a specific REIT, if such disclosures are available. One key assumption is the capitalization rate. If a REIT's property assets are valued using an unreasonably low (relative to recent or historical market transactions) range of capitalization rates, its net asset value could be inflated, and a low P/B ratio could be misleading.

Notwithstanding, the P/B ratio is a quick and dirty way to assess a REIT's cheapness and serves as a good initial screen for potential investment candidates.

Events: Sub-urban REIT Sees Healthy Response To Fund Raising

Last month, Frasers Centrepoint Trust (OTCPK:FRZCF) [FCT:SP] announced the issuance of new equity of approximately 184.0 million new units in the REIT through a private placement and non-renounceable preferential offering to partly fund its acquisition of a 33% interest in Waterway Point, a sub-urban retail mall located at 83 Punggol Central. On June 17, 2019, Frasers Centrepoint Trust confirmed that it managed to raise S$437.4 million in total - S$369.6 million (155.2 million new units issued) from the private placement and S$67.7 million from the preferential offering.

Frasers Centrepoint Trust's private placement was approximately 2.3 times subscribed by both new and existing institutional, accredited investors at the top end of the issue price range of between S$2.30 and S$2.382 per new unit issued. The private placement issue price of S$2.382 represents a very slight discount of 1.5% to the volume-weighted average price (of all trades done on May 15, 2019) of S$2.4189 per unit. Frasers Centrepoint Trust's pro-rata and non-renounceable preferential offering was also subscribed by close to two times, with valid acceptances, and excess applications were received for 196.8% of the total number of new units available under the preferential offering.

Fraser Centrepoint Trust's ability to raise equity funding from both institutional and retail investors, new and old unit holders, is evident based on how well-received the Private Placement And Preferential Offering were.

Fraser Centrepoint Trust has a key differentiating factor that sets it apart from CapitaLand Mall Trust (OTCPK:OTCPK:CPAMF) [CT:SP], Singapore's largest retail-focused REIT, which I discussed in earlier issue of the Asian REITs Discovery Weekly. All of Fraser Centrepoint Trust's six retail malls are all sub-urban malls, including the to-be-acquired Waterpoint Point. These sub-urban malls are all located in established residential townships and adjacent or close to train stations and bus interchanges. In other words, unlike CapitaLand Mall Trust which has a mix of both sub-urban retail malls and urban/city malls located in the central region of Singapore, Fraser Centrepoint Trust's malls are not dependent on discretionary spending by tourists visiting the country; instead Fraser Centrepoint Trust's malls benefit from a steady stream of local residents and workers living or working within the vicinity.

Fraser Centrepoint Trust highlighted the differences between sub-urban malls and central region malls in a 2014 investor presentation below:

Source: Fraser Centrepoint Trust September 2014 Investor Presentation

On the other hand, Fraser Centrepoint Trust shares a similar characteristic with Hong Kong-listed Link REIT [823:HK], Asia's largest REIT in terms of asset size and market capitalization and the best-performing Asian REIT in terms of total shareholder returns for the past decade. When I wrote about Link REIT two weeks ago, I highlighted Link REIT's defensive tenant mix, as it derives approximately 63% of its Hong Kong retail portfolio rental income from tenants in food-related trades such as food and beverage, supermarket and foodstuff and markets/cooked food stalls. Similarly, Fraser Centrepoint Trust generated over 71% of its 2QFY2019 (YE September) gross rental income from tenants in the non-discretionary trade mix categories such as food, healthcare, supermarket, personal care and services, based on portfolio statistics provided by the REIT.

Fraser Centrepoint Trust's new acquisition, Waterway Point, has a lot in common with its current portfolio of retail malls. Waterway Point is located close to the Punggol trains stations, a temporary bus interchange and served by major expressways, including the Tampines Expressway and the Seletar Expressway. Tenants in the non-discretionary trade mix categories such as food, healthcare, supermarket, personal care and services, contributed 71.9% of Waterway Point's rental income. There was a population of 175,000 residents living in the vicinity of Waterway Point, and the Punggol area is under-penetrated with a retail mall floor space per capita of 2.77 sq ft versus Singapore's overall average of 5.9 sq ft.

Fraser Centrepoint Trust's sub-urban mall focus and its defensive tenant mix explain why the REIT has achieved strong operating performance historically. Fraser Centrepoint Trust's current portfolio occupancy is high at 96% as of the most recent 2QFY2019 quarter. It has delivered positive DPU growth and positive rental reversions for every financial year since its listing in July 2006.

Source: Fraser Centrepoint Trust April 2019 Investor Presentation

Source: Fraser Centrepoint Trust 2QFY2019 Results Presentation

There are two key risk factors to take note for Fraser Centrepoint Trust.

Firstly, Fraser Centrepoint Trust's upcoming lease renewals are a potential concern. Its WALE (weighted by gross rental income) is short at 1.73 years, which is slightly lower than CapitaLand Mall Trust's 1.90 years. Approximately 11.4% and 37.8% of its leases are expiring in FY2019 and FY2020, respectively.

For 2QFY2019, its largest mall, Causeway Point, located in Woodlands, Singapore, registered its lowest occupancy (which is still a very healthy 97.4%) in 6 years due to the liquidation of former tenant, Newstead Technologies, an electronics retailer. While this is a one-off event and Fraser Centrepoint Trust should not have any issues finding replacement tenants, it is something to watch with close to half of the REIT's leases expiring in FY2019 and FY2020.

Certain malls are not doing as well. For example, a unitholder asked about Bedok Point's declining Net Property Income at the REIT's Annual General Meeting in January 2019 and the CEO replied that the REIT manager "was exploring various options for Bedok Point and would not preclude a divestment if a good offer was received." But do note that Bedok Point only contributed a marginal 1.5% of Fraser Centrepoint Trust's net property income for the most recent 2QFY2019 quarter.

Secondly, Fraser Centrepoint Trust's proportion of borrowings on fixed rates or hedged via interest rate swaps is relatively low at 62% versus 90% for CapitaLand Mall Trust. On a related note, its weighted average debt maturity is relatively short at 2.4 years with 12% (which takes into account the refinancing of S$120 million of current borrowings on 10 April 2019) and 28% of its total debt maturing in FY2019 and FY2020, respectively.

Unitholders shared the same concern and a question relating to Fraser Centrepoint Trust's relatively lower level of hedged borrowings and shorter weighted average debt to maturity relative to its peers was asked at the 2019 Annual General Meeting in January 2019. The REIT recorded CEO's response in the minutes of its Annual General Meeting as follows:

The Manager would, in determining the proportion of Fraser Centrepoint Trust's borrowings to be hedged, weigh the trade-off between the certainty over the interest rates and the cost of hedging which, during low but increasing interest rate environment, would be expensive... Fraser Centrepoint Trust's position was relatively safe but informed that the Manager would continue to monitor the interest rate movements closely and consider additional hedging arrangements if the rates were favorable.

There are no straightforward right or wrong answers when it comes to the question of what is the optimal amount or proportion of hedging. If interest rates decline as what market is expecting, a lower proportion of fixed interest rate borrowings could help to lower all-in borrowing costs. I highlighted Asian REITs with the lowest and highest proportion of fixed-rate debt in the inaugural issue of the Asian REITs Weekly.

Closing Thoughts

Conventional thinking tends to associate REITs with brick & mortar and victims of technology disruption. Data center REITs are a notable exception, as they are a beneficiary of technology trends such as artificial intelligence, autonomous vehicles, virtual reality, and Internet of Things among others. Keppel DC REIT is a proxy for data center growth in the Asia Pacific, as Asia Pacific accounts for 67.4% of its portfolio AUM.

A list of REITs, trading at extreme ends of their historical P/B valuation range is provided, warrants further research. The P/B ratio is a useful screening metric for Asian REITs, as they revalue their assets every year based on fair values determined by independent property valuers.

Singapore's only pure-play sub-urban mall REIT raises funds to buy a new property, and it is not a surprise that its fund raising was well received. The unique defensive characteristics of a sub-urban mall REIT like Fraser Centrepoint Trust are highlighted above.

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.