Mergers With Common Managers Are Typically Easier To Transact

Analysts expect increased consolidation to fuel Singapore-REITs’ next phase of growth.

Mergers and acquisitions are ways to lower the cost of
capital and improve performance, but not all mergers are the same.

One issue relates to the cost of the manager, says Charlene-Jayne Chang, Head of Capital Markets & Investor Relations, ESR-REIT. The industrialasset-focused REIT merged with Viva Industrial Trust last year in a deal worth about S$936.75 million (US$674.93 million).

“Acquirers tend not to want to pay for the manager,” says Chang. However, in the case of a merger between two REITs that have a common manager or sponsor, the negotiations are typically more straightforward.

Ascott Residence Trust (Ascott REIT) is merging with Ascendas Hospitality Trust (A-HTrust), and CapitaLand Limited owns the sponsors of the two REITs. OUE Commercial REIT (OUE C-REIT) merged with OUE Hospitality Trust earlier this year, and they are both sponsored by OUE Limited.

The ESR-REIT and Viva Industrial Trust transaction, touted as the first-ever merger of two S-REITs, is one of the few REIT mergers in the past year where the managers of the individual REIT are not related.  

ESTR-REIT’s Charlene Chang

ESR-REIT,which is backed by private equity firm Warburg Pincus, treated the manager’s value as a transaction cost, with benefits accruing over the longer term via scale and synergies, Chang explains. This has helped to facilitate the ESR-REIT and Viva REIT transaction, says Chang. She added that in some cases, the managers were internalised before the deals were done. An example of this is Blackstone’s buyout of Croesus Retail Trust in 2017.

Merging To Build Scale

The Singapore REIT sector has seen at least S$5 billion worth of merger and acquisition transactions in the last three years. The merger with the most extensive portfolio of properties will be the combined Ascott Residence Trust (Ascott REIT) and Ascendas Hospitality Trust (A-HTrust) group, which will have total assets valued at S$7.6 billion based on March 31, 2019 financial data. This is followed by OUE Commercial REIT’s tie-up with OUE
Hospitality Trust, which marks the first-ever merger of two S-REITs belonging to different asset classes.

BoAML Martin Siah

“The current S-REIT consolidation activity is primarily underpinned by the capital markets’ focus on their increasing scale and trading liquidity, and their ability to compete effectively for acquisition growth, particularly against private markets players,” says Martin Siah, Head of Asia Pacific Real Estate, Gaming and Leisure at Bank of America Merrill Lynch. The bank was the sole financial adviser to Viva Industrial Trust and OUE Hospitality Trust on their respective merger with ESR-REIT and OUE Commercial REIT.

“The disparity between large and small REITs simply widens over time,” says ESR-REIT’s Chang. “There are also implications beyond acquisitions and in asset enhancement initiatives. For example, industrial today is less manufacturing centric and certain industrial buildings like data centres require more investment to keep current. A higher cost of capital will be a vicious cycle that hampers a REIT from keeping their portfolio current,” she explains.

Expanding Overseas And Competing With Private Equity

According to KPMG, more than 70% of Singapore CBD Grade A-office stock is already owned by S-REITs and local developers. As such, REITs’ acquisition of assets outside Singapore has intensified in recent years because managers are searching for yield-accretive assets to improve distributions to investors. Generally, the bigger the REIT, the better it can finance acquisitions and seek quality assets.

RHB Research Institute said in a note that the trend is likely to continue, with smaller REITs feeling the pressure.

Smaller REITs tend to trade at a discount due to the lack of liquidity and often fall under the radar of larger institutional funds. Consolidation is a natural option for REIT managers who are looking at their REITs’ next phase of growth. We should expect more to come as the sector matures,” says Beh Siew Khim, Chief Executive Officer of Ascott Residence Trust Management Limited.

Beh explains that mergers allow for the creation of bigger trusts with larger market capitalisations, which will result in higher trading liquidity and greater institutional investor following. “Secondly, size also brings about other benefits such as greater access to growth opportunities, including development and conversion projects. Lastly, larger trusts are usually better able to tap the capital markets for funding. All these will result in a lower cost of capital, more growth opportunities for the trust and hence enhanced returns to unitholders,” she says.

Leverage Ratio

S-REITs may fund a merger or acquisition through debt or equity as long as they keep the debt to equity ratio at below 45%. However, the Monetary Authority is considering raising the limit to enable REITs to better compete against private capital and foreign REITs when making real estate acquisitions.

According to KPMG, the industry’s market value has grown at a 22% compounded annual growth rate over the last ten years. REITs’ investment mandates have expanded far beyond Singapore’s shores.

To date, 80% of S-REITs and property trusts own offshore assets across the Asia Pacific, South Asia, North America and Europe.

Larger REITs will have better acquisition competitiveness, particularly against private market players, says Siah. “The confluence of relative trading prices, which facilitates scrip-for-scrip mergers, the low-interest-rate environment and S-REIT sponsors’ willingness to merge their platforms has helped to drive consolidation activity,” he adds.