The US Federal Reserve’s decision to ease off its rising interest rate cycle has given Asian equity markets a big fill-up so far this year and fuelled a surge of real estate investment trust (Reit) offerings from new markets including India and South Korea.
Sizeable Reit initial public offerings (IPOs) for Embassy Office Parks in India, Homeplus in South Korea and KBS Realty Advisors in Singapore are all at varying but advanced stages of execution.
What the deals have in common is very good timing, catching a key inflexion point in financial markets as investors evaluate whether the Fed’s next move might well be down rather than up. The outperformance of Reits during periods of falling interest rates should - in theory - auger well for all three.
Some market participants, however, wonder whether investors have run ahead of themselves by piling back into high yielding stocks too fast, too soon. In a recent interview with FinanceAsia, Ricky Tang, Schroders' deputy head of multi-asset products for North Asia, argued just that. He said that value stocks were looking expensive.
Current valuations could, therefore, also prompt a wave of secondary market deals particularly from Asia’s Reit centre, Singapore. In a sales note to clients this week, DBS suggested that: “the large-cap Reits are at a level where there’s a high chance of equity raisings to fund acquisitions. Investors could possibly get a chance to buy at lower levels.”
Yang Du, head of asset management at China Securities International agrees and believes that wider Asian equity market momentum may run out of steam soon too.
“We’re not optimistic yet,” he said. “We want to see the performance of China’s structural reforms.”
Du argues that Chinese markets overshot on the downside in the latter half of 2018 because domestic retail investors were so pessimistic about trade talks. Conversely, he believes they have overshot on the upside during 2019 because retail investors are more optimistic about the outcome.
“There’s a big gap between the performance of China’s domestic markets and Hong Kong,” he said. “That’s because Hong Kong is dominated by institutional investors who have a far more cautious outlook.”
Richard Taylor, head of Asian equity capital markets and corporate finance at CLSA, has a more optimistic outlook while acknowledging that many investors wonder whether Asia’s average 10% secondary market uplift is “for real”.
“We feel that Asian equity markets are structurally more positive thanks to progress in the trade talks and liquidity easing in China,” he said. “They’re also underpinned by relatively attractive valuations, strong inflows into emerging market funds and stable currencies.”
Taylor also highlights the fact that CLSA’s chief strategist, Christopher Wood, was one of the first to predict that the Fed’s next interest rate move would be down late last year.
The first Asian Reit IPO to take advantage of this advantageous US rates backdrop is South Korea’s Homeplus, which has already launched a W1.6 trillion to W1.7 trillion ($1.4 billion to $1.5 billion) offering.
The 345.7 million unit offering is scheduled to price on March 14 and has been pitched at an attractive discount to smaller peers even though it is the only one that will classify for the FTSE EPRA/Nareit Global Reit Index.
The MBK Partners-backed deal is being marketed on a forward dividend yield of 6.6% to 7% and an overall 2019 return of 14.5% to 15.1%. Bankers say the additional 8% growth kicker derives from a combination of organic growth (2.5% annual rental growth from the underlying portfolio), capex and potential asset injections thanks a call option, embedded at the Reit level.
In contrast, comparables such as Shinhan Alpha Reit and E KOCREF CR-Reit are yielding in the 5% to 6% range. Both have traded in from their respective IPO dividend yields of 7% in May 2018 and 7.2% in June 2018.
Bankers say that Homeplus’s discount is a function of its IPO status, larger size and its significance for an asset class, which is only just starting to find its feet. Even though South Korea has had Reit legislation in place for nearly two decades, the first string of deals only started to emerge last year after the government put renewed emphasis on the sector.
In December, the Financial Services Commission (FSC) and the Ministry of Land Infrastructure and Transportation (MoLIT) jointly announced a series of new initiatives. These included: waiving the eligibility review application, previously required for all issuers; allowing the Korea Urban Fund to invest in publicly listed Reits; and introducing a Reit credit rating system.
The government’s actions are not that surprising given that South Korea has one of the world’s highest and fastest growing demographic deficits. It makes stable income generating instruments such as Reits an ideal investment vehicle for its greying population.
Much like the US, South Korean interest rates are on a declining trend. Homeplus is offering a 480bp spread over 10-year government paper at the mid-point of its price range. This is some 130bp higher than the 350bp spread, more typical of developed Reit markets.
Bankers also say that South Korean Reits do not have the negative tax implications which have sometimes been flagged as a limiting factor.
“There’s no corporate income tax at the Reit level if more than 90% of the income is distributed to investors,” said one banker.
He also added that when it comes to withholding taxes: “there’s not much difference with other Reit centres like Singapore since Korea has tax treaties with most of the jurisdictions where foreign investors are based.”
Where South Korea does differ with Singapore is the amount of leverage which Reits can carry. The country has a high 67% threshold, although bankers point out that Homeplus has gearing around the 40% level, about ten percentage points lower than its peers.
EMBASSY OFFICE PARKS
Behind Homeplus is likely to be Embassy Office Parks, which is scheduled to launch a roughly Rs60 billion ($850 million) IPO over the next week or so.
This will also be a benchmark transaction since it represents India’s first Reit and another stab at persuading equity investors to park their money in income-generating instruments.
The group has two very strong sponsors (Embassy and Blackstone) behind its Rs300 billion asset portfolio, which comprises 33 million square feet of commercial properties in four major cities led by Bangalore.
But the offering may face some challenges given the poor performance of the country’s outstanding infrastructure trusts (InvIT).
While Reits offers more capital appreciation, investors remain aware that the InvIT sector has not lived up to expectations since IRB InvIT executed its $756 million deal in May 2017.
The stock has lost one-third of its value since listing at Rs102 per share. Likewise, India Grid Trust has lost 15% since its IPO the same month.
Both are now respectively yielding 18.59% and 14.35% on a current year basis.
On the plus side, Reits have a lower investment threshold of Rs50,000 ($715) compared to $14,000 for InvITs. This should make them much more attractive to retail investors and reflects pressure on the Securities & Exchange Board of India (Sebi) to target income products at an investor base that is likely to be receptive to them.
The other factor that Embassy Office Parks has in its favour, over the short-term at least, is declining interest rates. The Reserve Bank of India unexpectedly dropped its benchmark rate to 6.25% in early February. Many economists concluded that it had come under political pressure to boost economic growth ahead of May’s general election
Government bonds currently yield 7.36% at the 10-year part of the curve, while fixed deposits are paying out 6.8% for one- to five-years. This means that Embassy Office Parks Reit will need to offer a double-digit yield to tempt local investors who have a tendency to adopt a wait and see mode to new asset classes.
Crisil analysts believe the all-in return will touch 14% thanks to strong growth in the underlying commercial property sector, where occupancy rates and rental reversions are high.
Director, Sushmita Majumdar, also told FinanceAsia that the Reit's assets are situated in "very good geographies across four major commercial markets".
She noted that the Grade A commercial sector as a whole has averaged "a 10% rental increase over the past three years".
However, SmartKarma insight provider, Sumeet Singh, points out that the Reit could end up competing with one of its sponsors over future assets since it has no Right Of First Offer (ROFO) with Blackstone.
Joint global co-ordinators for Embassy Office Parks are Morgan Stanley, Kotak Investment Banking, JP Morgan, Bank of America Merrill Lynch and Karvy, with lead managers comprising Axis Capital, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, IIFL, JM Financial and Nomura.
KBS REALTY ADVISORS
Reit activity is also picking up in Asia’s main fundraising centre: Singapore.
Dealogic figures show that Cromwell European Reit raised $113 million in January from a follow-on offering, while Mapletree Industrial Trust raised $148 million in mid-February.
Meanwhile, one of America’s largest commercial real estate managers is returning to the Lion City for a second bite of the cherry. KBS Realty Advisors is in the final stages of preparing a roughly $600 million IPO.
The news has had a negative impact on its existing Singapore-listed counter, Keppel-KBS US Reit, which has underperformed the sector. On March 11, it was trading at S$0.68 ($0.49), down nearly 25% from its IPO price of S$0.88 in November 2017.
It is currently trading on a forward yield of roughly 9% compared to 5.6% for Singapore-listed commercial property backed Reits.
In a recent research report, DBS attributes this underperformance to “disappointment over having a rights issue so soon after its listing, potential for another US office Reit’s listing and concerns over a negative ruling on its tax structure.”
But the bank has an "outperform" rating on S-Reits in general. They are currently trading around their historical mean spread of 3.5% over government bonds. DBS believes they may tighten to 3% by year-end.
In a research report, published in mid-February, it also said that it expects 10-year government bond yields to rise by 25bp to 2.35% by the end of 2019, a reduction from its previous forecast of 2.7%.