OUE's REIT ambitions

Invest Stock - http://oceanforestcorp.com
Any expression of trading idea found on this website is for sharing only and does not constitute an invitation to trade or investment advice. Please read disclaimer page here.

OUE's REIT ambitions

Barely a fortnight after media company Singapore Press Holdings (SPH) announced it was exploring the creation of a real estate investment trust (REIT) to be listed on the Singapore Exchange, conglomerate Overseas Union Enterprise has confirmed news reports that it is also looking to spin off a REIT. 

OUE has reportedly chosen three banks for a planned $1 billion hospitality REIT to be listed in 2H2013. OUE's management had previously raised its intention to spin off its hotel assets in order to unlock value. Some of the assets that could make it in to the REIT are Mandarin Orchard and Crowne Plaza Changi Airport, both of which are directly owned. Two hotels in China – Meritus Mandarin Haikou and Meritus Shantou – are also directly held. 

In a report, Deutsche Bank notes that these four assets made up 48% of OUE's FY2012 revenue and 56% of its earnings before interest, taxes, depreciation and amortisation. The report also suggests potential pipeline assets for the REIT. OUE has said it is exploring options to convert the offices of DBS Tower 1 and one residential tower in Twin Peaks into serviced residences. An extension is also planned for Crowne Plaza Changi Airport.


Unlocking value  

What makes the REIT exciting for shareholders of OUE is that both Mandarin Orchard and Crowne Plaza Changi Airport are held at a historical cost of $364 million on OUE's books, says Deutsche Bank. Injecting these assets into a REIT would enable OUE to unlock a surplus of some $1.1 billion by the bank's estimates. 

Deutsche Bank values Mandarin Orchard at $1.2 billion and Crowne Plaza Changi Airport at $277 million. The two Singapore-focused hotel REITs CDL Hospitality Trusts and Far East Hospitality Trust are currently trading at about 1.2 times their book values. If OUE's REIT is listed at a similar valuation, and assuming OUE brings its leverage down to 40% and retains a 50% stake in the REIT, Deutsche Bank calculates the move would boost OUE's revalued net asset value by 20 cents a share or 5%. 

Shares of OUE, which had been ticking up through the month, climbed 4.3% to close at $3.13 yesterday on the confirmation of the potential spin-off. The activity mirrored market reaction to SPH's REIT plan, which sent SPH stock up 8.4% over the course of one week. 

In fact, the popularity of REITs over the past year looks set to create a fertile market for property firms to unlock asset values through trust listings. Chua Thian Poh, chairman of luxury property developer Ho Bee Investment, was quoted in a news report as saying that the company does not rule out launching a REIT in the next two years for its commercial properties.

Window of opportunity  

But can developers move fast enough to take advantage of what may be a narrowing window? Analysts are now sounding caution on these investments. OCBC Investment Research highlights the challenging industry environment that hospitality REITs are facing. The brokerage notes that in 4Q2012 CDL Hospitality Trusts, Far East Hospitality Trust and Ascott Residence Trust reported uninspiring numbers. This middling performance, they say, is likely to continue this year. "We have learnt that players in the local serviced residence industry believe that demand for 2013 will remain flat, with rates staying flat or declining," OCBC says. Between now and 2015, it sees hotel room supply outpacing demand. And, partially because of the rising Singapore dollar, the average length of stay per visitor is declining. The hospitality industry is also grappling with a tight labour force and high operating costs, which will put a squeeze on margins. 

Concerns are not limited to the hospitality sector alone. Maybank Kim Eng research analyst Ong Kian Lin says in a report today that investors would be wise to temper their exuberance for the local REITs. The so-called S-REITs have returned 5% year-to-date and 43% since end-2011, he says. But now, yield spreads against ten-year bonds are tightening and there has been downward pressure on rentals due to the slowing economic growth. He also sees a risk that asset prices may decline if monetary tightening is not done gradually enough. Japan, for instance, saw asset prices plunge after it raised interest rates sharply in 1989. 

Higher interest rates will also create refinancing difficulties. Johann Kenny, director of corporates at Fitch Ratings, notes that S-REITs have been increasing short-term debt with record-low interest rates. But they face refinancing risks when borrowing costs rise, and may be pushed to sell assets or shares to boost their funding, Kenny said in a Bloomberg interview. 

Moody's Investors Service analyst Jacintha Poh notes that S-REITs have been able to improve their financing flexibility and diversify their funding sources by increasingly opting for unsecured rather than secured funding. Moody's also thinks that low interest rates will persist for the next 12 to 18 months. But that does little to assure investors that REITs will continue to be the best place to put their capital this year. 

On the other hand, the property owners are looking increasingly attractive as they offload their assets and unlock value for shareholders.