Regal Reit attracts modest but high-quality demand

Hong Kong's first hotel Reit prices at the bottom for a 7.5% yield ahead of a trading debut that could have implications for the entire HK Reit market.
Hong KongÆs first real estate investment trust backed by hotel properties quite predictably attracted modest demand as investors who bought four of the other five Reits listed in the city are still hurting from losses.

The offer was priced at the bottom of the HK$2.68 to HK$3.38 price range for a total deal size of HK$2.33 billion ($299 million). At this price, Regal offers an annualised yield of 7.5% for this year.

However, sources say the deal did attract solid demand from some of the largest property-focused Asian funds who took the time to do their homework and to understand how this offering differs from the previous Reit IPOs in Hong Kong. In the end, the institutional tranche was just over three times covered although there was clearly a limit on how much they were willing to pay.

Retail investors were less keen and the 10% of the offer set aside for them was only 1.8 times subscribed û the lowest retail subscription rate for any Hong Kong IPO this year. According to the sources, hedge funds and other types of ôspeculative moneyö was also largely absent from this deal, which meant the offer didnÆt get the early momentum that tends to drive up the subscription rates on Hong Kong IPOs.

Having witnessed other Hong Kong Reits (aside from Link Reit) slide below their IPO prices shortly after listing, many of the absent investors likely anticipated limited possibility for quick gains from this deal too. Regal International, which is the sponsor of the new hotel Reit, is also injecting all its five hotels into the trust, which means there isnÆt an obvious pipeline of potential acquisitions which could support future asset growth.

Consequently, Regal Reit was bought more for its high yield and stable income than as a hot, exciting growth story. The yield is expected to rise to about 8% in 2008 and 8.5% in 2009, supported by a 10% per year rental growth and higher occupancy rates as the number of tourism arrivals continue to grow.

ôThe high yield and the clean structure of this yield was a good starting point, but there is also potential for organic growth,ö one observer says. ôAnd longer-term there will likely be an acquisition strategy û primarily focused on China.ö

With no clawback to increase the retail tranche and a modest oversubscription ratio on the institutional side meant joint bookrunners Deutsche Bank, Goldman Sachs and Merrill Lynch were able to give meaningful allocations to long-term investors who are likely to hold on to the shares for a steady annual income. This should be helpful in terms of providing support to the unit price after Regal Reit starts trading on March 30.

And this is important not just for the investors who bought into the deal but for the entire market. If this Reit too trades down from its IPO price, it will likely be extremely difficult for any other Reits backed by Hong Kong properties to seek a listing.

As the trust had postponed its original listing plan in December, funds had had quite a lot of time to look into the business and according to the sources more than 80% of the institutional portion of the deal was allocated to pure institutions û as opposed to private wealth individuals. Close to 100 institutional investors bought into the deal with some 52% of the demand coming from Asia, 28% from Europe and 20% from the US.

Regal Reit offered 869.3 million new units, or 28% of the trust, with the remaining 72% to be retained by Regal International. The 15% greenshoe will come out of the sponsorÆs portion, however, and consequently its stake will fall to 67.8% if the shoe is fully exercised. The total amount of proceeds could then increase to $343.5 million.

The ôcleanö yield structure refers to the fact that Regal Reit doesnÆt use financial engineering to pay a higher dividend than the underlying properties can support û a method disliked by investors, but used by other Hong Kong Reits to bridge the gap between a low capitalisation rate and the yield that investors typically require to buy a Reit.

A low cap rate, or the net operating income divided by the property value, has become symptomatic of industrial and office properties in Hong Kong in the past few years as property valuations have been running ahead of rents. Being backed by hotel properties, Regal Reit is driven by different dynamics and doesnÆt face the same problem.

Prosperity Reit currently trades at a 2007 yield of 6%-6.5% while Sunlight Reit, which came to market as recently as December, is trading at about 10%. However, without financial engineering, ProsperityÆs would yield only 4% while Sunlight would see its dividend yield fall to 2.5%, which highlights the risk of a significant drop in returns once these temporary arrangements come to an end, one source notes.

Regal ReitÆs 7.5% yield also offers a sizeable margin over the one-year Hong Kong notes at about 4% and is well above the 3.5% offered by CDL Hospitality Trust in Singapore, which is the only other hotel Reit in Asia. CDL was bought more for its growth opportunities, however, and has rallied 130% since its debut in July last year on the back of a shortage of hotel rooms in Singapore.

Among the Hong Kong-listed Reit, Champion Reit is still trading 13% below its May IPO price even after a strong bounce in January. Prosperity Reit, which listed in December 2005, is down 18.5% and Sunlight Reit, which was the most recent one to come to market three months ago, has fallen 15%.

GZI Reit, which is backed by commercial properties in China, has just squeezed above its IPO price from December 2005 by 0.5 HK cent, but the only really successful Hong Kong Reit is still the Link Reit which has gained 80% since listing.
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