I sold all my REITs except one

I started my REIT selling spree in early 2023 with the disposals of Suntec Real Estate Investment Trust (SGX:T82U), ESR-Logos REIT (SGX:J91U), and Sunway REIT (KLS:5176) as described in this blog.  My two main concerns are rising interest rates and the relatively short weighted average land lease expiry (WALL-E) that some REITs in Singapore and China are facing. I didn't stop at these three REITS and eventually sold all my REIT holdings for the same reasons. Except for Daiwa House Logistics REIT. Let's go through the details case by case. 

Sold out: CapitaLand China Trust (SGX:AU8U)

Well-run REIT with diversified properties in Mainland China. The WALL-E is below 25 years. I heard that land leases are usually extended in China, but that is anecdotal information. There is still a possibility that a property will lose its underlying land lease holding and must be demolished. Even if a land lease is extended, there is still uncertainty up to the moment of that decision. Suppose a property's land lease expiry is 8 years away and needs some renovations or enhancements. Management can not spend much money because it potentially has only 8 years to earn that investment back. This uncertainty is hard to quantify. The Capitaland China Trust currently has a dividend yield near 7%. It is too low for me to compensate the investor for these land lease expiry risks.

Sold out: China Merchants Commercial REIT (HKEX:1503)

This REIT is also active in Mainland China and has a dividend yield of 14%, which is appealing. Yet, I exited this HK-listed REIT with a -13.23% loss (including dividends received). Like Capitaland China Trust, the WALL-E of the land under the properties is below 25 years. Furthermore, its debt is higher than its equity. The interest coverage rate (ICR) of 3.2 worries me too much. Also, this REIT's debt repayments are not staggered over the years. It agreed on just one revolving loan facility, which is renewed every three years. This seems risky to me. I should have noticed this detail before buying this REIT. In 2022, I bought too many REITs in a short time period. At the time, I naively assumed that REITs are an ultra-safe asset class and don't need deep-dive research.

Sold out: Cromwell European REIT (SGX:CWBU) 

I like this REIT with its good logistics and office properties all over Europe. Almost all of its properties are on freehold land. The ICR is 4.9, which seems very safe until we realize that Cromwell has been borrowing at an average interest rate of only 2.4 %. One can no longer borrow at those rates in the new interest rate environment. This means that when Cromwell's debt agreements expire, it has to refinance at higher rates; 2.4 % becomes 5%, for example. The ICR will drop from 5 to only 2.5 in that example. Of course, Cromwell can raise the rents on their tenants to prevent that, but can they double the rents to keep up with doubling finance costs? I doubt that. 

ESR Group Ltd ultimately owns a large stake in Cromwell European REIT (HKEX:1821). I have expressed worries about the leverage of this group. In addition, I observed that Cromwell European REIT does not seem to fit their profile. By now, ESR Group has indeed announced its desire to sell Cromwell Property Group and Cromwell European REIT. But who will buy this in the current commercial real estate environment? The REIT seems somewhat orphaned now. I believe it is better to side-step these developments for the time being. However, I will keep an eye on Cromwell European REIT and possibly reinvest in the future.

Sold out: Axis REIT (5106.KL) 

This is a well-run Malaysian REIT with industrial and logistics properties. However, the price-to-book value has risen to 1.2 by now. I do not see a reason to pay more than the REIT's self-published net asset value. If anything, we should pay less, assuming the property value estimations ordered by management are likely to be too optimistic. With interest rates rising, capitalization rates are rising, and NAV calculation results will decrease. I am not sure why the market is paying more than the published NAV per share. I held Axis REIT for about a year and earned a decent 6.4% yield in price appreciation plus dividends. I am putting Axis back on my watch list for potential re-investment, for example, if the P/B drops back to 1.

Sold out: AIMS APAC REIT (SGX:O5RU)

Another well-run industrial REIT, but there are some leverage concerns. This REIT has issued a lot of perpetual bonds (perps). The holders of these bonds get paid before the unit holders get paid. In the case that AIMS APAC experiences liquidity issues, they can skip a perps coupon payment at a moment where they also skip the dividend payment to regular unit holders. They have two lines of defence, so to speak, and hence there are two ICR numbers to publish. AIMS APAC lists an ICR of 3.8, excluding distributions to perpetual bondholders and 2.3, including distributions to perpetual bondholders (As of 31 March 2023). I believe that a regular unit holder should use the second number. An ICR of 2.3 seems really low. AIMS APAC has been enjoying a debt funding cost of only 3.4%. Permanently higher interest rates will eventually affect this REIT. 

Sold out: Frasers Centrepoint Trust (SGX:J69U)

This REIT has nine retail malls and an office building in Singapore. Its ICR = 4.4 as of 31 March 2023. When an ICR dives below 1, it becomes problematic as the operating income (EBIT) does not even cover the interest payments, let alone dividend payments. This is unlikely to happen with Frasers Centrepoint, but an increase in finance costs will still have to be financed. This can only be done by a decrease in dividend payments unless it can raise rents drastically. Looking at a weighted average debt maturity of not even 2 years, we know that Frasers has to renegotiate a large part of its fixed-rate debt agreements. 

Instead of repeating my interest rate worries again, let me introduce two Youtubers with similar concerns. SingvestingDiary is worried about higher interest rates for the long term and finds the dividend yield of Frasers Centrepoint insufficient to compensate for this. Gabriel Yap is even more bearish on Frasers Centrepoint and believes the management is too aggressive with its acquisitions for the REIT. Note that the production quality of these Youtube clips is poor, but both have some worthwhile analysis to share. Finally, this article may be interesting if you prefer a similar analysis, although not specifically about Frasers, in written format. 

Sold out: Sabana Industrial REIT (SGX:M1GU)

Sabana has 18 industrial properties, all located in Singapore. All my fears come together in this one REIT. The WALL-E is only 30 years (1 January 2023). That means we lose 3.33% in value to the decay in the remaining land lease value. Hence, of the current 7% dividend yield, only 3.66% is of real value to us. Looking at the debt, we see an ICR of 3.8 on 31 March 2023. Not disastrous, but not very good either. 

To complete my nightmare, ESR Group is involved in Sabana too. ESR attempted to merge Sabana with ESR REIT (Now ESR-LOGOS) with a lowball payout offer. Since it holds only about 20% of Sabana, other shareholders were able to block this transaction. The feuds between the shareholders didn't end there. News of disagreements between Sabana plus ESR management versus other shareholders keeps popping up in the local business media. I want to have no part in this.

Sold out: Frasers Logistics & Commercial Trust (SGX:BUOU)

The disposal of Frasers Logistics & Commercial Trust at a small loss concludes my REIT sell-fest. The ICR of this REIT is 8.4 (31 March 2023), and the WALL-E is 88 years (30 September 2023). My two pet peeve concerns are non-issues here. The REIT is conservatively managed with regard to debt. The properties are mostly located in Australia, where freehold land holdings are the norm. 

So why did I sell? The share price seems high compared to different valuation estimates. Also, I have no insights at all into the Australian commercial real estate market. A few articles suggest that this market is in bubble territory, and weakness is to be expected here. When I came across a cheap consumer staple stock, I sold Frasers Logistics & Commercial Trust to free up funds to buy it. 

I will write about my consumer staples stock buy-fest in the next posting. First, let me wrap up this blog by featuring the last remaining REIT in my portfolio.

Hold: Daiwa House Logistics REIT (SGX:DHLU)

This REIT has 16 large logistics properties in Japan. These warehouses are, on average, only 5 years old. The WALL-E is 67 Years (1 January 2023), and the ICR is 11.4 (31 March 2023). No concerns here. With a Price to FFO of 14.07 and a dividend yield of 9.4%, the REIT seems very cheap considering the quality of the assets. 

The consistent drop of the Japanese Yen against the Singapore Dollar since late 2021 could offer an explanation for the low share price of Daiwa House Logistics REIT. Its share price decline correlates with the Yen decline. The REIT is listed in Singapore, and most of its unit holders are also based in Singapore. The weak Yen means that the REITs' dividend will be lower when converted into Singapore Dollars. It looks like the REIT's share price dropped because unit investors seek a higher dividend yield to compensate for this currency loss. 

Besides the currency rate issue, I don't see any fundamental reason for Daiwa House Logistics REIT to be priced so low. Its logistics business does not seem distressed or irrelevant in any way. We know that Japan is facing an ageing and declining population, but this would first affect labour-intensive sectors such as shops and restaurants rather than e-commerce. If anything, remote areas in Japan will depend more on e-commerce to receive necessities. 

Daiwa House Logistics REIT does not face typical Japanese corporate governance issues. Management consists of Japanese and Singaporean individuals, as does the board. IR materials are in English. Strategy and operational issues are clearly described. I went to the REIT's first AGM. Board members and management seemed frank and open towards investor questions and feedback. The payout ratio of dividends out of income is mandated at 90% by the Singaporean REIT regime. Hence, there can be no hoarding of cash on the balance sheet. Unlike in Japan, there is no withholding tax on dividends in Singapore. Enough reasons to hold on to Daiwa House Logistics REIT.

Disclosure: Long Daiwa House Logistics at the time of this writing

WALL-E; Industrial S-REIT's dirty little secret

An S-REIT is a REIT listed on the Singaporean stock exchange. This article concerns industrial and logistic REITs listed in Singapore and also owning properties there. Most of such properties are built on land leased from the Singaporean government. These land leases are relatively short, 30 to 60 years, and part of that time has already passed. The remaining time is expressed as the Weighted Average Land Lease Expiry, which I will shorten as WALL-E, like in the namesake movie. 

When the land lease of a particular property has expired, the REIT owning that property has to demolish it and return the land to the government. The REIT may also manage to extend the land lease, but it must pay a large lease payment. It is really a lose-lose dilemma for the REIT. This WALL-E issue does not get much exposure in the media. This may be because the weighted expiry is still 30 years or more in the future, which is an eternity for most of us.

Still, it is the elephant in the room for me. Imagine the worst-case scenario where a REIT can not extend any of its land leases after 30 years. The impact on the REIT valuation is like a discounted cash flow calculation without a terminal value. If you are unfamiliar with these calculations, let me assure you that it dramatically decreases the value. Another way to think about it: you should at least get a 3.33% dividend yield per year just to be compensated for the fact that a year of the properties' earnings potential has been lost. Only the yield above 3.33% is what you truly earn. 

The best Singaporean finance blogger Kyith Ng wrote about this issue in 2011  and concluded:

"It will be prudent to value a REIT as if this is a non-perpetual asset with a finite lifespan and calculate the internal rate of return as accordingly."

As Kyith Ng mentions in this article, the JTC Corporation is responsible for either extending a land lease or terminating it on behalf of the Singaporean government. Looking at historical cases, it seems that JTC will usually renew a land lease, but it might not do so when there are redevelopment plans for the area where an industrial property is located. Thus, JTC's decisions seem to be driven by urban planning motives rather than attempts to maximize profits. It may not be as bad as it looks for the REITs. 

Even so, I am annoyed by the WALL-E issue. I do not feel I really own an asset if it must be returned within 30 years. Funny enough, I don't have this concern when a lease expires in 60 years or more. The expiring land lease issue could get increasing media attention as we get closer to the expiry dates of more and more properties. In a few years, the threat might be felt as more pressing and could influence the share prices of REITs. At least one S-REIT manager seems to share this concern...

5. Rebalancing of portfolio to freehold assets, whilst not compromising on growth:

a. With our Singapore properties, accounting for 60.5% of our portfolio by valuation, held through Jurong Town Corporation (JTC) on a leasehold basis, it is prudent that we progressively rebalance AA REIT’s portfolio to longer tenure or freehold properties to minimise the future impact of a shortening land tenure.

(AIMS APAC REIT, Annual Report 2022, page 8)

The WALL-E issue affects S-REITs with industrial properties in Singapore, like ESR-LOGOS REIT, AIMS APAC REIT, and Sabana REIT. It is much lesser an issue for S-REITS with offices, hotels, and malls, which are sectors where land leases tend to be much longer. It is also not an issue for industrial S-REITs like Daiwa House Logistics (Japan) and Frasers L&C (Australia, Europe), which, although listed in Singapore, are active in countries where land lease expiry is very long or properties are typically on freehold land. That said,  there are other countries, such as Vietnam and China, where land leases are also relatively short. S-REITs like CapitaLand China Trust and EC World REIT may be impacted in these cases. 

In my portfolio, the WALL-E issue concerns ESR-LOGOS REIT, AIMS APAC REIT, Sabana REIT, CapitaLand China Trust and China Merchants REIT in Hong Kong. I sold all of these.

Family-owned REITs in my portfolio

Earlier, I discussed the pros and cons of investing in a family business. In the same post, I went through my own stock portfolio to identify all family businesses and the families behind them. Among them were a few of my REIT holdings too. Let's discuss those first.

A REIT is a property business which must be run according to a set of strict guidelines. Formal restrictions are meant to prevent the majority shareholder or REIT manager from taking advantage of the other, minority shareholders. Of course, abuse is still possible and we should be alert to it. A family that controls a REIT is able to dump their undesirable properties into it, for example when they also own a property developer which is in need of cash. This means the REIT does not buy the best properties available in the market. Additionally, the family could also be overcharging for such properties. It's a subtle form of abuse, but let's still try to determine if this could potentially happen in my current REIT holdings.

ESR-LOGOS REIT

ESR-LOGOS has a 6% shareholder in the person of Mr Tong Jinquan. He is the owner of Summit Group, a real-estate developer in Shanghai. I don't think there is any overlap in the activities of Summit and ESR. As a side note, ESR Group is a larger shareholder and Mr Tong recently sold a large part of his shareholding to them. ESR-LOGOS was likely just an investment to Mr Tong and he seems to be withdrawing his involvement.

AIMS APAC REIT

On the list of major shareholders in AIMS APAC REIT two private shareholders attract our attention: Chan Wai Kheong 5.83% and George Wang 9.28%. Mr Chan is a hedge fund manager, who was also involved in a recent boardroom drama within Sabana Industrial REIT. Besides Sabana, I could not find any other real estate interests of him. Mr Wang, on the other hand,  is not only a shareholder of AIMS APAC REIT but also Chairman of The Board of Directors of its manager. Furthermore, he is the founder of AIMS Financial Group which still has an interest of 7.61% in AIMS APAC REIT which they founded, as the name already suggests. All in all, a powerful position, but I could not find any cases where AIMS APAC bought properties in which Mr Wang had an interest. Also, in this REIT we find the ESR Group again with a shareholding of 12.82% to somewhat counterpoint his influence.

Frasers Centrepoint Trust, Frasers Logistics & Commercial 

The Sirivadhanabhakdi family has large stakes in Frasers Centrepoint Trust and Frasers Logistics & Commercial Trust through their stake in Frasers Property. All three entities are multi-billion dollar operations with their own business dynamics. Although they still share the same website, I did not see any suspicious transactions between them. Let us also note that Charoen Sirivadhanabhakdi did not set up this network of companies himself. He inherited this structure when he took over Fraser Property after winning the battle for its parent company the Fraser & Neave conglomerate in 2013. A battle that he mainly fought for the soft drinks division of Fraser & Neave rather than its real-estate holdings.

Sunway REIT

40.89% of the shares in Sunway Real Estate Investment Trust are owned by Sunway Berhad, which is controlled by the Cheah family. Sunway Berhad is a large Malaysian conglomerate with a lot of property development activities. As such, Sunway REIT taking over properties developed by Sunway Berhad is the whole idea behind the REIT. It owns malls, hotels, offices, a medical centre, industrial properties and a university campus, all developed by Sunway Berhad. I am not aware of any signals that these acquisitions were executed at any disadvantage to the minority shareholders of Sunway REIT.

Hutchison Port Holdings Trust

Hutchison Port Holdings Trust is not a REIT, but a business trust, which is comparable in nature. CK Hutchison Holdings Limited holds 30.07%, with the Li Ka-Shing family controlling CK Hutchison. Part of the port activities of CK Hutchison was disposed to the trust at its conception in 2011, more specifically the container terminals in the Pearl River Delta, China. I don't think any assets were added to the trust ever since, so there is not much to watch here. The share has been performing quite bad for other reasons. It looks like the valuation (P/E, P/B) simply deteriorated rather than the business performance. Maybe the stock is too boring to hold for a long time and consequently it can now be bought at a very low valuation, which I did.

The other REITs I hold have no family involvement. If I overlooked anything, feel free to alert me in the comments below. 

ESR Group Ltd

I am not invested in ESR Group, but I noticed their presence in AIMS APAC, ESR-LOGOS (obviously), Sabana Industrial REIT (20%) and Cromwell European REIT (28% through Cromwell Property Group).

Perhaps this should not surprise me because I prefer to invest in industrial and logistics properties and ESR considers itself a REIM (Real Estate Investment Manager) in this particular sector and focused on Asia too. This means they develop, buy, sell and manage logistics properties, similar to the recently transformed Capitaland Investment Ltd. I don't like to invest in REIM's, since it is basically trading and the profits come and go depending on economic cycles. It's also a key people-based business and those key people may leave. There is not really any moat. Besides all that, the balance sheet of ESR looks quite over-levered with debt.

ESR Group grew fast in recent years. In 2021, they took over ARA/LOGOS. Their holdings in Cromwell and ARA-LOGOS (now ESR-LOGOS) are the result of this acquisition. The last one is clearly within the focus of ESR Group, but I am not so sure about the office-oriented Cromwell Property Group, which is an Australian developer. Their Cromwell European REIT is 50/50 invested in offices and logistics properties in Europe. But note that ESR Group's focus is Asia rather than Europe. I wonder if Cromwell Property Group and Cromwell European REIT might be disposed of by ESR at some time. 

Maybe the conclusion from this review is that I should monitor ESR Group more closely rather than the family holdings in the REITs I own. 

Disclosure: at the time of posting this article, I hold shares in Sunway REIT, ESR-LOGOS REIT, AIMS APAC REIT, CK Hutchison, Hutchison Port Holdings Trust, Cromwell European REIT, Sabana Industrial REIT, Fraser & Neave, Frasers Centrepoint Trust and Frasers Logistics & Commercial.