Strengthening REIT regulations
Singapore Industry Focus Singapore REITs Refer to important disclosures at the end of this report DBS Group Research . Equity Strengthening REIT regulations Proposed enhancements for Singapore REIT industry Better governance and transparency; proposals to instill confidence for investors Stock Picks: MAGIC, MCT, FCT, FCOT and Cache New proposed enhancements to Singapore’s REIT industry . The Monetary Authority of Singapore (“MAS”) released a consultation paper highlighting potential tweaks to the current regulatory regime governing REITs and REIT managers. Key proposals include: (i) improving the corporate governance and disclosures for REIT managers (ii) minimising instances of “conflicts of interests” between REIT managers and investors through refining REIT managers’ compensation methodologies; and (iii) operational tweaks like having REITs adhere to a higher leverage limit of 45% (vs 35% currently) and eliminating the 60% cap on REITs with a credit limit. In addition, MAS proposes to raise the development limit for REITs to 25% from the current 10% of total assets. These measures are likely to be implemented from 1st Jan 2016 onwards Better governance and confidence for investors in SREITs. Some details and our views on the key proposals: (i) REITs adopting a single-tier gearing limit of 45% (vs the current 35%/60% limits subject to a credit-rating) would allow more flexibility in acquisitions. This will also place S-REITs in line with regulations in Malaysia / HK which have gearing limits of 45% and 50%, respectively. (ii) Performance fees to be pegged to a methodology that improves alignment of interests and is linked to NAV or DPU to take into account unitholders’ long term interests. In addition, MAS is proposing to reduce acquisition fees to a “cost recovery basis” to mean that acquisition quality of acquisitions should improve. However, while we acknowledge that taking on development risks generally results in higher returns, we remain cautious on proposals to raise the development limit to 25% of deposited properties which implies potentially higher earnings volatility for an otherwise stable sector. Positive boost for REIT/property sector. We see the proposals as generally positive for the REIT sector. When passed, these should result in (i) a reduction in fees; and (ii) greater transparency and alignment between REITs and their unitholders. This should increase confidence and attractiveness of REITs to investors. A strong and functioning REIT sector is also a long term positive for sponsor/property developers who have another avenue to recycle assets efficiently. Our picks for the sector are Magic, FCT, MCT , Cache and FCOT. Potential negative impact on ARA Asset Management. These proposals when passed could potentially have a detrimental impact on ARA, which is estimated to derive c. 5560% of its revenues from fees from its managed REITs. When passed, we might see earnings cut when implemented in 2016. www.dbsvickers.com ed-JS / sa- JC 10 Oct 2014 STI : 3,259.25 Analyst Derek TAN +65 6682 3716 [email protected] Mervin SONG CFA +65 6682 8189 [email protected] Rachael TAN +65 6682 3713 [email protected] STOCKS Cache Logistics Trust Frasers Centrepoint Trust Frasers Commercial Trust Mapletree Commercial Trust Mapletree Greater China Commercial Trust Target Price Performance (%) 3 mth 12 mth S$ Price Mkt Cap S$ US$m 1.17 1.90 1.36 1.44 713 1,362 723 2,373 1.37 2.04 1.49 1.46 (4.5) 2.2 (1.8) 5.1 0.4 3.0 11.0 18.5 BUY BUY BUY BUY 0.93 1,966 1.04 3.9 4.5 BUY Rating Source: DBS Bank S-REIT historical yield 16.0% Yield Spread S-REIT Yield 14.0% - 1 SD +1 SD Mean 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Jan-06 Jan-07 Source: DBS Bank Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Industry Focus Singapore REITs Selected key proposals and our thoughts Corporate Governance – Tighter requirements Proposed : Current: A. MAS seeks views on its proposal to impose a statutory duty on a REIT manager and its individual directors to prioritise the interests of unitholders over those of the REIT manager and its shareholders, in the event of a conflict of interest. A. Statutory duty not imposed on REIT manager REIT manager and any director who breaches this duty will be subject to criminal and civil liability. B. To enhance the independence of the board of directors through either (i) half the Board to comprise of independent directors, if unitholders of the REIT are not given a right to appoint the directors and if such a right is given, the requirement that the Board to consist of at least one-third of independent directors will continue to apply to that REIT manager or (ii) at least a majority of the Board to comprise of independent directors. B. One third of the board to be independent. Currently, it is noted that 24 out of the 33 REIT managers have Boards that are at least half-independent, while 15 out of 33 REIT managers have Boards that are majority-independent. C. The REIT manager is required to disclose in the annual report, the REIT manager’s remuneration policies and procedures in setting remuneration of directors and executive officers. The remuneration of each individual director and CEO and at least top five executive officers in bands of S$250,000 to be disclosed. C. No requirement to disclose remuneration bands of the REIT’s top executives D. To stipulate a minimum of three directors for the audit committee. In the case of a sponsor’s nominated member, to have a minimum of three other directors who are independent. D. No requirement on minimum number of directors E. A review on whether the current approach of relying on unitholders to initiate a review on REIT managers appointment is effective. E. Unitholders to call for a vote (general meeting) on removal of REIT manager and will likely exercise this right only in the scenario where the REIT manager fails in its duties DBS View: We believe that REIT managers already exercise strong corporate governance and transparency and have board of directors that are at least halfor-majority independent. The above proposals will further improve the transparency and independence of the REIT boards and will boost investors’ confidence on the REIT managers. This will eventually benefit minorities. The disclosure of remuneration bands for REIT managers will close the gap between requirements under CG code for listed companies. This will enable unitholders to understand the link between remuneration paid to directors and key executive officers and their performance. Source: DBS Bank, MAS Page 2 Industry Focus Singapore REITs Alignment of incentives - Pegging fees to long term unitholder interests Fee Structure Proposed Amendments Current Base fee: Aligned with long term interest of interest of the REIT and its unitholders Typically based on fixed percentage of the value of the REIT's deposited properties Performance fees: Crystallisation of performance fee should be no more frequent than once a year Most REITs usually pay a performance fee on an annual basis Linked to an appropriate metric which takes into account the long term interest of the REIT and its unitholders such as NAV or DPU/unit Pegged to certain metrics such as REIT's gross revenue, net property income or distributions per unit Should not be linked to the REIT's gross revenue Acquisition fee: Fee determined on a cost recovery basis Usually 1% of purchase consideration Divestment fee: Fee determined on a cost recovery basis Usually between 0.5-1% of the sale consideration DBS View Impact on REITs Impact on Sponsor Generally positive as it lowers the fees for the REITs. However, REITs may miss out on value accretive acquisitions, as their sponsor has less incentive to find acquisitions for the REIT. Negative. Lower fee income Disclosure requirements Proposed Amendments Current For disposal of properties by REIT to an interested party Audit Committee of REIT manager to certify that if is not aware of any other offer with, and has no reason to believe that the divestment can be made on terms that are more favourable than those offered by the interested party. Interested party transactions to be carried out on normal commercial terms and at arms length DBS View Impact on REITs Impact on Sponsor Positive - Improved transparency and confidence in divestment process Positive - Increased confidence in alignment of interest between REIT, interested parties, sponsor and unitholders Source: DBS Bank, MAS Page 3 Industry Focus Singapore REITs Alignment of incentives - Pegging fees to long term unitholder interests Remuneration Proposed Amendments Current Directors and executive officers Prohibit directors of the REIT manager to be (1) paid in the form of shares or interests in the Sponsor or its related entities (2) linked in any way to the performance of any entities other than the REIT Due to the limited disclosure on how directors are paid, we are unable to ascertain whether the remuneration structure of REIT managers is inconsistent with the proposed changes. Prohibit remuneration of executive directors of a REIT manager from being linked to revenue of the REIT. Fees payable to the non-executive directors of a REIT manager to be a fixed sum DBS View Impact on REITs Impact on Sponsor Positive - Increases alignment between REIT, Sponsor and unitholders Negative. However, we are unaware of any sponsors who have consistently acted against the best interest unitholders by only acquiring properties solely to boost their assets under management. Source: DBS Bank, MAS Operational flexibility – Higher gearing limits for all un-rated REITs/doing away with a need for credit rating. Proposed Amendment Current Single tier gearing limit of 45%, regardless of whether credit limit is obtained 35% gearing limit for REITs without a credit rating 60% gearing limit if a credit rating is obtained REITs may engage in development activities up to 25% of deposited properties, contingent upon (a) receipt of approval by unitholders for the higher development limit, and (b) the additional 15% allowance is used only to refurbish existing properties that have been held for at least three years, and will be held for at least three years thereafter Property development activities should not exceed 10% of the REIT's deposited property DBS View: We are positive about the new gearing limits, as these will streamline and limit the amount of leverage that a REIT may take; this reinforces the notion that all REITs must employ the same level of stringency when it comes to capital management, regardless of whether the REIT has obtained a credit rating or not.. That said, the sector has maintained an average gearing of c.33-34% over the years, with the exception of certain REITs (K-REIT, which is nearer to the 43% level). We also note that Croesus’ gearing is c. 50% but it is a business trust with REIT-like features. There might be changes when the new policies are in place. We are slightly cautious about higher development limits, as this could increase the amount of risk associated with a REIT, which, by virtue of its structure, is meant to provide stable dividends to unitholders. While higher development limits may be positive for smaller REITs, which occasionally may have to complete a development project in phases in order to comply with existing limits, we think that the additional 15% development allowance for existing properties is a little high - most asset redevelopment works rarely require such a steep capex requirement, and large ticket redevelopments could in turn adversely impact distributions as operations are disrupted. Source: DBS Bank, MAS Page 4 Industry Focus Singapore REITs REIT Structuring – Further tightening and clarity from income support arrangements Proposed amendments Current REITs must disclose total operating expenditure (a) in absolute terms; (b) as a percentage of NAV; and ( c) as a percentage of distributions declared for the FY in their annual reports Although REITs are compelled to disclose total operating expenses, the level and manner of disclosure is not regulated and may vary among different REITs All REITs must both report and provide a detailed explanation of any material deviation of actual DPU from forecast DPU in their annual reports While REITs are required to highlight any deviation of actual DPU from forecast DPU, no explanation for the deviation is mandated REITs must disclose the WALE of new leases entered into in the past year (and their % of contribution to total revenue), as well as debt maturity profile in their annual reports No requirements for disclosure of average WALE or debt expiry profile Where there is income support, REITs must disclose (a) the amount of income support received by the REIT for the year, and (b) the difference between underlying rents and the implied rents under income support, in their annual reports There are no mandatory disclosure guidelines for master leases embedded with income support (i.e. where underlying rents are lower than master lease rent) DBS view: We are upbeat on the enhanced disclosure guidelines concerning income support, as these would encourage REITs to only consider acquisitions where the underlying rent levels could eventually be DPU accretive on a sustained basis, and discourage REITs from purchasing assets whose underlying NPI yield is not and may not be accretive to unitholders. Disclosure of WALE and debt expiry profile could also help investors make more informed investment decisions based on their risk appetite concerning these additional categories Source: DBS Bank, MAS Page 5 Industry Focus Singapore REITs REIT Regulations across the Asia Pacific region Gearing limits Tax transparency REIT manager Development limit Australia - "Safe harbour" debt limit of 60% of adjusted Australian asset base for income years - REIT is taxed on a "flowthrough" basis, i.e. at the hands of unitholders rather than the trust. - REIT must be managed by a corporate trustee, responsible entity or fund manager - Hong Kong - 45% of the gross asset value - No tax transparency - Property manager must be considered acceptable to the Securities and Futures Commission - Japan - All loans must be borrowed from qualified institutional investors - 20% withholding tax - Asset management must be outsourced - If a REIT undertakes development activity, it will be subject to Australian corporate tax No development activity is permitted save for refurishments, retrofitting or renovations NA Malaysia - 50% of total asset value All borrowings must be through licensed institutions, or through issuance of debentures - Tax deduction allowed for initial expenses pertaining to the establishment of a REIT - Asset must be managed by a qualified property manager - NA Philippines - 35% of Deposited Properties for non-credit rated REITs 70% gearing limit for REITs with an investment grade credit rating - REIT is not subject to minimum corporate income tax - N.A - 35% of Deposited Properties for non-credit rated REITs 60% gearing limit for REITs which have disclosed its credit rating - REIT is taxed on a "flowthrough" basis - REIT manager must have a physical office in Singapore and minimum shareholders' funds of S$1m - REIT is not permitted to undertake property development unless it plans to hold the completed property for three years Development cap of 10% of Deposited Properties - Singapore - South Korea - Borrowings may not exceed two times net equity without an extraordinary resolution of shareholders' meeting, and capped at 10 times - No tax transparency - N.A - NA Taiwan - 35% of total asset value without a credit-rating; 50% of asset value if the REIT discloses its credit rating - REIT funds are taxed on a "flow through" basis - - NA 35% of Deposited Properties for non-credit rated REITs 60% gearing limit for REITs which have disclosed their credit rating - Income is taxed at the unitholder level, but there is no regulation concerning taxation of cash dividends yet. - REIT funds must be managed by a trust enterprise, which has been established for more than three years and is rated above a certain level by a recognised credit rating institution REIT manager must be approved and licensed by the Securities and Exchange Commission - NA - Thailand - Source: DBS Bank, APREA Page 6 Industry Focus Singapore REITs Peer Comparisons REIT Code FYE Price Rec Target Price (S$) Total Return Mkt Cap Yield Yield Yield DPU Growth CAGR P/Bk (%) S$'m FY14/15F FY15/16F FY16/17F FY13-15 FY14-16 (x) Office CCT FCOT K-REIT OUECT Dec Sep Dec Dec 1.61 1.36 1.20 0.80 Hold Buy Hold NR 1.67 1.49 1.29 0.85 10% 16% 14% 14% 4,717 920 3,602 691 9,930 5.3% 6.1% 6.4% 6.8% 5.9% 5.4% 6.7% 5.7% 6.9% 5.7% 5.9% 6.8% 5.8% 7.0% 6.0% 3% 7% -6% 11% 2% 9% -11% 0% 0.96 0.87 0.92 0.78 Retail CRCT CMT CRT FCT SPH REIT Dec Dec Jun Sep Aug 1.58 1.93 0.93 1.90 1.07 Buy Hold Buy Buy Hold 1.70 2.14 1.10 2.04 1.01 14% 17% 28% 13% 0% 1,307 6,663 472 1,735 2,678 12,855 6.8% 5.7% 8.9% 5.9% 5.5% 5.9% 7.5% 5.9% 9.0% 6.1% 5.1% 6.0% 8.3% 6.0% 9.0% 6.2% 5.1% 6.2% 15% 5% -4% 2% 45% 10% 4% 1% 3% -8% 1.08 1.11 1.23 1.19 1.20 Commercial MCT MAGIC SGREIT Suntec Mar Mar Dec Dec 1.44 0.93 0.79 1.80 Buy Buy Buy Hold 1.46 1.04 0.90 1.85 7% 19% 21% 8% 3,021 2,503 1,701 4,483 12,310 5.5% 6.7% 6.5% 5.0% 5.4% 5.9% 7.2% 6.7% 5.5% 5.8% 6.1% 7.5% 7.0% 6.0% 6.5% 7% 3% 3% 3% 6% 8% 3% 10% 1.25 0.88 0.85 0.90 Industrial a-itrust A-REIT Cache CREIT MINT MLT SBREIT Mar Mar Dec Dec Mar Mar Dec 0.75 2.23 1.17 0.72 1.45 1.17 0.80 Hold Buy Buy Hold Buy Buy Buy 0.85 2.51 1.37 0.77 1.53 1.24 0.89 21% 19% 25% 15% 13% 13% 20% 686 5,361 908 903 2,480 2,881 645 13,863 6.4% 6.6% 7.4% 7.2% 7.0% 6.5% 7.7% 6.8% 6.9% 6.8% 8.0% 7.7% 7.1% 6.6% 8.3% 7.0% 7.0% 6.8% 8.5% 7.8% 7.1% 6.8% 8.5% 7.1% 6% 3% 4% 5% 2% 3% 71% 7% 3% 9% 6% 1% 2% 8% 1.13 1.11 1.19 1.05 1.22 1.05 1.00 Hospitality ASCHT ART CDREIT FEHT FHT OUEHT Mar Dec Dec Dec Sep Dec 0.73 1.23 1.69 0.81 0.90 0.91 Hold Buy Hold Hold Buy Buy 0.77 1.33 1.84 0.88 0.94 0.95 14% 14% 16% 16% 12% 13% 811 1,883 1,649 1,435 1,067 1,194 8,039 8.2% 6.7% 6.8% 6.7% 6.6% 7.5% 7.0% 8.4% 7.0% 7.2% 7.0% 6.9% 7.8% 7.3% 8.8% 7.2% 7.4% 7.2% 7.0% 8.1% 7.5% 6% 2% 5% 0% 6% 55% 2% 5% 6% 4% 5% 4% 1.23 0.86 1.03 0.83 1.07 1.01 Healthcare P-Life RHT Dec Mar 2.32 0.95 Buy Hold 2.62 0.82 18% -5% 1,404 753 2,157 5.1% 8.6% 6.3% 5.2% 7.6% 6.1% 5.3% 7.8% 6.2% 6% 42% 3% -12% 1.42 1.07 IREIT Dec 0.90 Buy 0.95 13% 375 375 59,529 7.3% 7.6% 7.5% 4% 1.20 6.2% 6.4% 6.7% Sector Average Source: DBS Bank Page 7 Industry Focus Singapore REITs DBS Bank recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame) Share price appreciation + dividends GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Bank Ltd. 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DBS Bank Ltd., DBS Vickers Securities (Singapore) Pte Ltd (“DBSVS”), their subsidiaries and/or other affiliates do not have a proprietary position in the securities recommended in this report as of 31 Aug 2014, except for CapitaCommercial Trust, Keppel REIT, Capitamall Trust, CapitaRetail China Trust, SPH REIT, Starhill Global REIT, Suntec REIT, Mapletree Commercial Trust, Mapletree Greater China Commercial Trust, Ascendas REIT, Ascendas India Trust, Mapletree Industrial Trust, Mapletree Logistics Trust, Cambridge Industrial Trust, Cache Logistics Trust, Soilbuild Business Space Reit, Ascendas Hospitality Trust, Ascott Residence Trust, CDL Hospitality Trusts, Far East Hospitality Trust, Frasers Hospitality Trust, OUE Hospitality Trust, Parkway Life Real Estate Investment Trust, Religare Health Trust, Croesus Retail Trust. 2. Page 8 DBS Bank Ltd., DBSVS, DBSVUSA, their subsidiaries and/or other affiliates beneficially own a total of 1% of any class of common equity securities of the Keppel REIT, Starhill Global REIT, Mapletree Greater China Commercial Trust, Soilbuild Business Space Reit, Ascendas Hospitality Trust, Ascott Residence Trust, Far East Hospitality Trust, Frasers Hospitality Trust, Croesus Retail Trust as of 31 Aug 2014. DBS Bank Ltd., DBSVS, DBSVUSA, their subsidiaries and/or other affiliates beneficially own a total of 5% of any class of common equity securities of Ascendas Hospitality Trust as of 31 Aug 2014. Industry Focus Singapore REITs 3. 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