Sabana REIT: More clarity or more uncertainties going forward?
- Watershed moment for S-REITs as unitholders vote to internalise the REIT
- Transition process into an internalised manager may cast near term operational and financial uncertainties on SSREIT, which could be an overhang on DPUs
- Unprecedented development for S-REITs but we believe this case is unique to SSREIT with sponsors now needing to demonstrate clear “value-add” to their managed REITs.
- Downgrade to FULLY VALUED with lower TP of S$0.30.
At SSREIT’s EGM on 7 August 2023, unitholders voted to pass both the resolutions tabled via a simple majority (more than 50%). The resolutions set forth were: i) The removal of Sabana Real Estate Investment Management Pte Ltd (SREIM) as the manager of the REIT and ii) the internalisation of the REIT management function by incorporating a subsidiary wholly owned by the trustee.
As a simple majority was obtained for both resolutions, SREIM will be removed as the manager of the SSREIT, and the trustee will now work on the internalisation of the REIT management function.
What are the implications?
SREIM will continue to serve as the interim manager of the REIT until the trustee has given a written notice to SREIM to remove it as the manager. We understand that this may be a lengthy process that may take up to 12 months or more.
We also understand that as part of the internalisation process, the trustee may have to potentially hold two or more further EGMs to amend the trust deed, obtain further directions from unitholders on the implementation of the resolutions and the ongoing operations of SSREIT, and approve the appointment of the internalised management structure.
Our thoughts
In our view, we believe that the passing of both resolutions last morning has created additional uncertainties for SSREIT that could potentially drag out into the medium term.
Operating uncertainties in the near term; cost savings and benefits of an internalised REIT to be felt only in the medium term
The removal of SREIM could likely lead to changes and uncertainties in the operations of the REIT. The internalisation process will take time, as the trustee is required to make the necessary amendments to the trust deed and seek the relevant regulatory approvals. Moreover, the process of identifying and hiring candidates for the post of internal manager will take time and additional costs. For example, there could be costs incurred to set up and implement new systems and processes, additional costs to migrate and maintain databases, etc.
Given that the replacement and internalisation exercise could be a lengthy process, the additional costs involved for the initial set-up and for regulatory and administrative purposes will need to be spent. Although these are likely one-off in nature, the expected cost savings from the internalisation of the manager may not be evident in the near to medium term. Cost savings would probably only be more evident once the internal manager has settled into their role and their operations have stabilised, which could come sometime in 2024.
Furthermore, during the interim period where SREIM remains as the manager while the internal manager in formed, SSREIT will have to pay management fees to both SREIM as well as the incoming internal management team. Assuming the new internal manager will be made up of an entirely new management team, it will take time for the handing-over process to a new team and for the new manager to get familiarised with the portfolio and its operations.
Unknowns to the financial metrics could be an overhang
As stated by SREIM, the change in control of the REIT will likely lead to a review event from the lenders. Although it is uncertain at this point what is the likely impact, we believe this uncertainty will likely be a near term overhang. We note that SSREIT has reported an improvement in its capital management metrics (especially overall cost of debt) over the past five years.
As shown in the chart below, SSREIT has seen an improvement in its all-in financing cost since the middle of FY19, which coincided with the ESR Group’s takeover of SREIM. While part of this could be due to taking advantage of falling base lending rates during that period, we believe that SSREIT could also enjoy thinning margins as being part of an enlarged group with the ESR Group as the REIT’s sponsor. Subsequently, when base rates started to spike from the beginning of FY22, we noted that the rate of increase in SSREIT’s borrowing costs started to inch up at a much slower pace as compared to the base rates. Since the begging of FY22, the reference base rates (three-month SORA) spiked by more than 330bps, while SSREIT’s financing costs only inched up c.80bps despite the gradual unencumbering of assets as loans were refinanced.
Although it is uncertain if there will be any impact to borrowing costs in the immediate term, we believe that, given the REIT’s internalised status, lenders may relook credit spreads when loans come due for refinancing. Based on our estimates, every 100bps increase in borrowing costs will lead to a c.9.2% downside in DPU, which we have not priced in. This may result in a DPU yield falling from c.7.3% to 6.6% respectively, based on FY23F estimates.
The voice of the minority has been heard, sponsors have to “value -add” to be given a vote.
The voting out of SSREIT’s manager is a watershed moment for the S-REITs after years of unitholders questioning the value add that sponsor ESR Cayman has brought to the REIT as manager, in our view. As sponsor to another REIT, ESR Logos REIT, we have also heard questions about the potential conflict of interests due to the management of two REITs with overlapping investment mandates.
With unitholders voting to take the route of an internalised manager REIT, while untested in Singapore, could be beneficial over time. Questions will likely arise if this could turn out to be a trend in S-REIT space, although we believe it is unlikely for now. That said, sponsors now have to be more active in showing “value-add” through providing pipelines to grow the REIT and how REITs can benefit from a financial standpoint from being part of an enlarged sponsor group (through access to a bigger panel of lenders and at more attractive credit spreads). While potential cost savings from an internal management model may only be more evident for larger REITs that can reap economies of scale, this has to be weighed against the intangible benefits that unitholders enjoy from being part of an enlarged sponsor group.
That said, the benefits of an externally managed REIT model are less tangible and may provide other intrinsic value for the mid-cap S-REITs where unitholders could be having the same questions around potential that one could have if they take the internal route. SSREIT’s EGM yesterday could have set a precedence for S-REITs, but we believe that this is an event that is unique to SSREIT, where questions surrounding the sponsor’s influence and value add has been a key driver for unit holders voting for a removal.
Downgrade to FULLY VALUED with a lower TP of S$0.30.
Given the uncertainties surrounding, we are downgrading our recommendation to FULLY VALUED with a revised TP of S$0.30 where ongoing operational and financial uncertainties in a challenging operational outlook could be key overhang on the stock. Further EGMs and administrative procedures will have to be convened in the coming months, and these will lead to additional costs for the REIT that we believe will result in further pressure to returns. Furthermore, the process of internalising and searching for replacement management candidates could be a long-drawn-out process that also comes with additional costs and resources, potentially eroding any expected cost savings, at least in the near to medium term.
Another uncertainty that may not be evident until a later time would be the impact to financing costs and profits of SSREIT. Lenders could relook the REIT’s overall financial standing when loans come due and we may possibly see wider credit margins or potentially even requiring the REIT to encumber assets during refinancing resulting in lesser financial flexibility. Based on our sensitivity analysis above, a 100bps increase in financing cost will lead to a c.9.2% downside to DPUs, and a 0.7ppt decline in forward yields.
Given the uncertainties, we have hiked our cost of equity assumptions and thus result in a cut in TP to S$0.30 from TP S$0.48, and thus downgrading SSREIT to FULLY VALUED with a lower TP of S$0.30. While yields are attractive at >7.0% for the stock, near term overhang are potential cost spikes and uncertainties around its refinancing are key areas to keep a close watch on.
Given the uncertainties, we have hiked our cost of equity assumptions and thus result in a cut in TP to S$0.30 from TP S$0.48, and thus downgrading SSREIT to FULLY VALUED with a lower TP of S$0.30. While yields are attractive at >7.0% for the stock, near term overhang are potential cost spikes and uncertainties around its refinancing are key areas to keep a close watch on.
| FY Dec | 4Q2018 | 3Q2019 | 4Q2019 | % chg yoy | % chg qoq |
|---|---|---|---|---|---|
| Gross revenue | 20.0 | 20.2 | 19.4 | (2.9) | (3.6) |
| Property expenses | (7.02) | (6.25) | (6.44) | (8.3) | 3.0 |
| Net Property Income | 13.0 | 13.9 | 13.0 | 0.0 | (6.5) |
| Other Operating expenses | (1.56) | (1.41) | (1.41) | (9.2) | 0.6 |
| Other Non Opg (Exp)/Inc | (0.26) | (0.15) | (0.09) | 66.0 | (39.9) |
| Net Interest (Exp)/Inc | (3.79) | (3.69) | (4.00) | (5.5) | (8.3) |
| Exceptional Gain/(Loss) | 0.00 | 0.00 | 0.00 | - | - |
| Net Income | 7.40 | 8.67 | 7.51 | 1.5 | (13.4) |
| Tax | 0.00 | 0.00 | 0.00 | - | - |
| Minority Interest | 0.00 | 0.00 | 0.00 | - | - |
| Net Income after Tax | 7.40 | 8.67 | 7.51 | 1.5 | (13.4) |
| Total Return | 58.4 | 8.32 | 9.91 | (83.0) | 19.2 |
| Non-tax deductible Items | (50.9) | 0.38 | (2.31) | (95.5) | (712.7) |
| Net Inc available for Dist. | 7.44 | 8.69 | 8.08 | 8.7 | (7.1) |
| Growth & Ratio | |||||
| Net Prop Inc Margin (%) | 64.9 | 69.0 | 66.9 | ||
| Dist. Payout Ratio (%) | 100.0 | 100.0 | 100.0 |
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