Please note that quotes are based on memory, given that no recordings were allowed of the EGM. I also reached out to the Investor Relations (IR) team at IREIT, and tried to correct errors. Any that remain are my fault.
Walk 30 minutes late into the IREIT Extraordinary General Meeting (EGM) and you would hear an angry shareholder demand,
Can you explain why the share price has dropped so low?
From the time it was at 88 cents till what it is today at 43 cents, can you explain why we should continue to hold onto IREIT?
Louis, the CEO of IREIT gently explained that he had no say over the share price, but all they could do was continue to find acquisitions that would be Assets Under Management (AUM) and yield accretive. And in the management’s view, the retail parks they were looking at was such an asset. That’s why they did the rights issue.
Value for money, or value trap?
Whilst acquisitions sound sexy on paper, the deeper question that must be asked is,
with the drop in share price, does this present value for money, or is it a value trap?
Let’s dive right in.
After the EGM, I further spoke to Kevin Tan and Anne Chua, the Head of Investor Relations and the Chief Financial Officer respectively, to understand their thinking behind the REIT’s operations.
How do you grow a REIT?
If you look at the wider market of REITs in Singapore, REITs seem easy to grow. At least the theory seems easy. Flip through the annual reports of any REIT, and they would share 3 common principles.
- Inorganic growth via acquisitions
- Organic growth via Asset Enhancement Initiatives (AEI), which therefore allows for higher rentals from the asset
- Capital management
- Keeping cost of debt low
- Keeping gearing within healthy limits to allow for flexibility in acquisitions
One of the most successful REITs, judging by the returns since IPO, is Mapletree Industrial Trust.
We studied what they outlined as their key strategy at the start of their IPO, and how they executed against that after 5 years.
For starters, Mapletree Industrial Trust IPO-ed with an AUM of $2.2 billion, which is far larger than what IREIT has today.
With such an AUM, it allows them to be listed in key indices, which gives greater opportunity for institutional investors to pick them up. With a smaller market cap, institutional investors might not pick it up as their entry and exit would heavily skew the market. Retail investors might move 10 to 20,000 dollars of stock, but institutional investors move 6 to 7 digits of stock.
It’s on a different scale, which thus hinders smaller REITs from being picked up.
Kevin pointed out the example of how NAREIT changed its criteria a few years back. As a result, more REITs were listed in the index. Quickly, the share prices of those REITs rose 10 to 20%.
But what I found more interesting was that the acquisitions they had were those from their sponsor, Mapletree.
They concentrated on Build to Suit projects, those that are deliberately developed for a business’ specific needs.
For example, in their 2011 Annual Report, they shared how Tata Communications Exchange had won the prestigious Gold LEED Award.
The successful development represents the ability of the Manager to rely on the Sponsor’s expertise in developing ‘Built-to-Suit’ projects where the design and construction of industrial facilities is tailored to specialised business needs.
The Sponsor’s experience in developing and managing more than S$15.4 billion (as at 31 March 2011)…
What this means is that Mapletree develops, builds, and then injects the asset into the REIT. Compare this to the acquisitions that IREIT goes for, where they source from the market, rather than bringing properties from paper, to life.
If you compare this to IREIT’s acquisition strategy, their sponsors Tikehau Capital and CDL do not (or so far have not) bought land from the market, developed and injected the asset back into the REIT.
What Tikehau Capital and CDL do is to source for opportunities which IREIT can then buy.
If you look at our sponsors, it is unique in the market. There are very seldom two sponsors of great quality.
What CDL provides is a known brand within Singapore, whilst Tikehau provides the expertise in asset management in continental Europe.
Is there an advantage of taking the whole suite of functions within the REIT? If we look at the better performing REITs, they seem to have taken the whole suite in-house.
But once again, they are operating at a larger scale compared to IREIT.
Comparing them to IREIT might thus be unfair.
But here we do see why IREIT has constantly looked for more acquisitions to grow their portfolio.
It’s not simply a question of ego, but one they need to do to exceed investor expectations.
How might the smaller REITs grow then?
Were there other smaller REITs who had made the jump from being a small cap stock, to one that was mid or large cap?
How did they do it successfully?
The story of AIMS REIT
In 2009, MacarthurCook Industrial Trust (MI-REIT) faced severe financial distress.
As of 31 March 2009, market capitalisation was around S$60 million, total assets were approx. S$544 million, with huge debt refinancing obligations of S$220.8 million, and no lender was willing to go close to rescue it.
Its share price dropped from a high of $1.47 since listing, to as low as $0.20.
AIMS swooped in.
AIMS acquired Macarthurcook Limited, subsequently refinanced the REIT, and renamed it as AA REIT.
You can see from the graph above how its total assets have grown since then.
But what did it do?
In Chairman George Wang’s sharing in the 2020 Annual Report, the 11th year of AIMS’ work with the REIT, he shared three points.
Again, we see the tendency for turnaround stories to involve some development expertise to build new properties from scratch.
As of now, it doesn’t look like IREIT is going into that area.
But more importantly, it focused on constantly upgrading its assets to yield significantly more.
And we have seen what this has done for the share price.
What are the lessons we can apply towards understanding if IREIT is an equally strong REIT?
The right acquisitions, at the right cost
One of the trends has been divesting away from office properties in developed economies, towards logistics and industrial spaces.
At Cromwell European REIT (CEREIT), a peer in the European REIT space, they have a Pivot to Logistics Strategy.
They have adjusted their portfolio away from Office, into more light industrial, logistics properties. Whether this will translate into shareholder returns remains to be seen.
Whether or not they overpaid for these properties, also remains a key concern.
In their answers to Unitholders, they were pointedly asked why their assets had drastic drops in valuations, and whether the management had overpaid for those properties.
Just look at this shareholder laying it in in his questions.
Cromwell explained that “they were disappointed in the UK valuations in the last 6 months.”
We have reviewed our processes to ensure we did not miss any key variables in our underwriting and have largely concluded that the political led unrest in financial markets during the “Liz Truss” period was difficult to foresee.
Response to Unitholders’ and SIAS’ Questions 2023
Only time will tell whether they did overpay.
When I asked Kevin why IREIT hadn’t explored logistics and industrial properties, he explained that these properties were at a premium.
It reflects a reluctance to overpay for assets, and to be patient.
But you might argue that retail parks don’t seem as sexy as owning logistics warehouses occupied by the likes of Amazon.
The case for (boring) retail parks
Retail parks look like an underlooked asset class, especially when people’s eyes are on the properties tied to fancy stocks featured in the papers, like Amazon, or Apple.
Secondly, as Anne, the CFO, explained, retail parks give a high visibility of future income.
Looking at the graph above, you would have seen that they have pushed back the expiry of the leases, with less than 44% of the leases now expiring before 2028.
What’s more, the rental is Consumer Price Index linked. This means that there is a built in escalation in the rental, depending on the yearly inflation rates.
With the strong growth of discount retailers driven by the broader macroeconomic uncertainties, consumers are out looking for a bargain. The argument is that this would lead to the retaining of these discount retailers in their current locations, and lead to the lower tendency of them to break their leases.
In comparison, the departure of big tenants from IREIT’s portfolio, such as when the single tenant GMG, a subsidiary of Deutsche Telekom, left in November 2022, saw their rental income dropping by €5.4m.
That’s why the acquisitions of the retail parks housing Decathlon, and now, B&M, make sense.
If you look at what IREIT has done, with the past two acquisitions, 2 of the top 5 tenants in Decathlon and B&M weren’t even there 2 years ago.
They are rapidly diversifying away from their big tenants, after recognising the trend away from office space, towards other hybrid forms of working.
Operationally ingenious capital management
One of the things Kevin shared was how well managed the debt was managed at IREIT. If you look at the current borrowings, in a high interest rate environment, to have no debt repayments to make between now and 2025 gives it greater headroom to grow.
Compare this to the other European REITs, such as Cromwell.
CEREIT’s all-in interest rate at the end of 2022 (is) at 2.38% and trending upwards in 2023
Cromwell European REIT Annual Report 2022, page 7
REITs are, quite simply, investment vehicles that raise funds to buy real estate, and allow unit holders the chance to become landlords.
Having a significantly lower cost of debt, allows them to make more returns to the shareholder.
It also gives them the flexibility to take on more debt, if they do want to make more acquisitions.
Should you take on IREIT?
Whilst that decision will lie in your hands, recognising that this is a bad time for REITs in an era of rising interest rates will help you to be patient.
Amongst the smaller REITs, IREIT is certainly one of the better run ones.
IREIT will attempt a difficult and arduous journey to become a larger REIT, one that many have tried, and where few have succeeded.
With a management that doesn’t overpay for acquisitions, expertise in managing debt well, and joint sponsors that are in it for the long term, it might be worth a look.
Disclosure: Please note that I currently hold shares in IREIT.