DBS succeeds with S-REIT

The CapitaMall S-REIT is five times subscribed.

DBS has won a capital market coup by successfully launching Singapore's first S-REIT for CapitaLand. The CapitaMall deal was four times oversubscribed and garnered 39% of its demand from retail investors. It launched at the tight end of the range at S$0.96, a level which equates to a dividend yield of 7.2%, and saw S$235 million ($134 million) raised subject to the exercise of the greenshoe.

It will be recalled that last November, DBS and UBS Warburg had tried to launch the same S-REIT with a dividend yield of 5.75% but had been forced to pull the deal due to lacklustre demand. The deal was considerably larger then at S$740 million.

This time round the deal benefited from a more appropriate structure and better marketing. A report from S&P Equity research gave further comfort (from an independent source) that valuations being used were fair. It is reckoned the total return of the product will be about 12%, making it an excellent defensive instrument.

As S&P wrote in its research report: "CapitaMall will never be a 'growth stock' and must be accepted by the market for it own virtues - as a defensive, stable and effective diversification tool."

Stephen Finch, the head of DBS' debt capital markets team says: ""This deal has been a lot of hard work, but we found the right economic formula and this paves the way for more S-REITs going forward. This is a good product for Singapore."

A REIT is a pure property play, where investors buy a trust which holds various buildings. Investors are paid a yield each year based on rental incomes. Meanwhile no earnings are retained by the trust. The buildings in the trust are revalued every year, and it is thus the most transparent property vehicle an investor can own, with investors having access to every detail of leases and their expiry dates. Unlike a listed property company, it doesn't undertake any development activities.

There were a number of differences about this deal and the last aborted effort. Post-IPO, CapitaLand retains 37% of CapitaMall. In the previous deal it only owned 25% and investors had a sense that CapitaLand was simply dumping some overvalued properties into the trust and that there was no growth story to speak of. This perception was corrected in the new structure by paying CapitaLand a chunk of its fees (for managing the trust) in stock, a move which aligns its performance better with other shareholders of the REIT. This stock will be paid to CapitaLand at the IPO price, which makes this scheme a bit like a stock option.

It will thus be in CapitaLand s interest to enhance the value of the properties and their rental income stream (ie the cashflow of the REIT). Accordingly, the company will commit to enhancing the various malls in 2003 and 2004 by converting  dead space into new retail outlets that can be rented, and increase the total pool of rental income.

Investors were also impressed, says Finch, by how "extraordinarily well" the assets have performed in the last few months. The S-REIT is comprised of three shoppping malls: Tampines shopping mall, Junction 8 and the Funan IT Mall. All have seen improvement in their rentals.

The deal was able to offer a higher yield to investors this time versus last, by pricing at a 4% discount to the net asset value of the properties. Retails investors were clearly more impressed by the story this time around. Last year only S$50 million of demand was garnered from retail. On this occasion S$398 million was generated.

The importance of REITs for Singapore is fundamental, as it offers a way out of a very key impasse the economy faces. As an ING report stated last May: "We believe the establishment of S-REITs is vital to break the current restructuring impasse. The strategies of many listed entities, including the banks, are precariously pegged to the divestment of property assets, but there are simply not enough ready buyers to absorb the supply glut. Our conviction is premised on the need to stimulate capital liquidity flows to the investment market by creating new demand through pooling arrangements. Otherwise, corporate Singapore risks a prolonged shrinkage in its overall market capitalization if the deadlock is not resolved."

In the case of the banks, they own 26% of Singaporean property. They need to liquidate this by 2004, and use the proceeds to become regional financial players.

Meanwhile the property companies, like CapitaLand, want to emulate the likes of Westfield Holdings in Australia which thanks to REITs have been able separate property development from property ownership. Westfield has gained by taking a management fee for looking after the properties in the trust and raising capital from investors for future development projects, which boost return on equity. As such, Westfield Holdings trades at price earnings ratio of 35-40 times, and manages A$22 billion of assets on behalf of the trusts.

Ideally, S-REITs could be a mechanism for restoring liquidity to the Singapore property market, by allowing assets to be sold at a valuation that would be higher than that achieved by a direct sale, although at a slight discount to the overvalued NAVs at which the buildings are booked.

Shopping malls were always reckoned to be the most likely to succeed as S-REITs given the fact that rental yields on property malls are the highest of any rental sector in Singapore.

Office yields are much lower at 3-4% and from the outset have been viewed as a harder sell. The only way to make office-based REITs more palatable would be for the property company to take a severe haircut on the net asset value at which it injected the building.

Others are waiting in the wings. Other shopping malls may be packaged as S-REITs. Keppel Land has also expressed an interest in launching the first office-based S-REIT, injecting Capital Square, Prudential Tower and Ocean Towers.

Says Finch of DBS: "Each one of these deals has to be done on their own merits, with the right yield."

Goldman Sachs advised CapitaLand on the restructuring of this S-REIT after the failure of the first attempt and as Jay Nydick, a managing director at Goldman notes: "In restructuring this REIT transaction, CapitaLand has successfully executed its stated strategy while at the same time setting a benchmark for the broader real estate market to follow."

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