Among the key differences from last time are a higher yield and a significant reduction in size û although sources say the latter is a function of the higher yield as the sponsor was reluctant to sell any more of the vehicle to the public at the new valuation.
Regal Reit is now looking to raise between HK$2.33 billion and HK$2.94 billion ($299 million to $377 million) and will be offering a yield of up to 7.5% - well above the 5.5% to just above 6% range that was talked about last time. It also offers a sizeable margin over the one-year Hong Kong notes at about 4%. People involved in the offering stress that this is a ôcleanö yield, meaning the Reit doesnÆt use financial engineering to pay a higher dividend than the underlying properties can support, and therefore it should be very attractive to investors.
Still, the company could have hoped for a better day to launch its offering as equity markets across Asia fell sharply Wednesday after rising US home-loan delinquencies and slower-than-forecast retail sales suggested the worldÆs biggest economy is slowing.
In Hong Kong, the Hang Seng Index lost 2.6%, or 496 points, to a close of 18,836 points, just as confidence may have been returning after the 777-point drop on March 5.
With another week to go before the offer closes on March 22, a lot can still happen in the markets, however, and sources familiar with the offering say the response during pre-marketing has been good.
ôThere is a lot of positive news on the regionÆs economic dynamics that is feeding into the hotel sector in particular and over the past six to nine months Asia has also seen a tangible increase in the number of dedicated property funds with money to invest,ö notes one observer. And if they are looking to invest in Hong Kong Reits, there arenÆt a lot of options available, he adds.
Regal Reit, which is brought to market by Deutsche Bank, Goldman Sachs and Merrill Lynch, will be Hong KongÆs sixth listed Reit and the first to be backed by hotel properties. Aside from Link Reit, which has risen 80% since its IPO in November 2005, none of the others has done particularly well, which can partly be explained by the fact that investors donÆt like the high degree of financial engineering done to push up the yield in the first few years.
To be fair, Champion Reit has seen a strong bounce over the past couple of months thanks to an income boost from rental reversion. At the beginning of this year it also gained approval to buy three more floors at Citibank Plaza, which is the sole asset in its portfolio. As of yesterday, the stock was up 21.4% from a low of HK$3.69 in early January, but at HK$4.48 itÆs still below its IPO price of HK$5.10 from May last year.
Prosperity Reit, GZI Reit and Sunlight Reit also trade below their respective IPO prices.
Regal Reit is offering 869.3 million new units, or 28% of the entire Reit, to investors with the usual 10% earmarked for the Hong Kong public offering, sources say. The remaining 72% of the trust will be retained by the sponsor, Regal International. When the trust first planned to come to market in December last year, Regal International was to hold only 50%, which meant the IPO would have totalled as much as $600 million to $700 million.
The current offer includes a 15% greenshoe, which may increase the public float to 32.2% and the total amount of proceeds to about $433 million. Last time around the greenshoe was only 10% of the base offering.
The indicative price range is HK$2.68 to HK$3.38, which based on a guaranteed dividend payout of HK$420.3 million for the remainder of this year, will give an annualised dividend yield of 5.8% to 7.5%.
The higher yield is primarily due to the fact that the acquisition price for the five properties will be lower than it would have been in December. According to a circular issued by the sponsor, the minimum acquisition price will be HK$12.5 billion, which represents a 21.4% discount to the total asset value of the properties, which has been estimated at HK$15.9 billion by CB Richard Ellis. The maximum purchase price will be HK$14.6 billion or a 7.8% discount to the asset value.
Back in December, the minimum acquisition price was to have been HK$14 billion, which would have equalled a 12.9% discount to the appraised value of HK$16.07 billion at the time. That offer was never officially launched even though it did receive the approval from Regal International's shareholders.
The trust will have HK$4.35 billion worth of debt at the time of listing, which gives it a debt to total asset ratio of 27.4%.
The yield will compare favourably to the around 3.5% offered by CDL Hospitality Trust in Singapore, which is the only other hotel Reit in Asia. However, investors who buy Singapore Reits tend to be less focused on yield than Hong Kong investors and more open to the addition of capital growth as a way to boost total creators, which means they are willing to accept lower yields. CDL has rallied 130% since its debut in July last year, supported by the shortage of hotel rooms in Singapore.
In Hong Kong, Prosperity Reit 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 the 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.
The reason why the Reits that are backed by industrial and office properties have a lower yield on an unstructured basis has to do with the low capitalisation rates in Hong Kong as property valuations have been running ahead of rents. Oftentimes, the cap rate, or the net operating income divided by the property value, is only 2%-3%, which leaves a big gap up to the dividend yield of 5%-6% that investors require to buy a Reit.
Being backed by hotel properties, Regal Reit doesnÆt face the same problem. And over the next couple of years, its rental income is expected to increase by about 10% per year driven partly by an addition of 468 new rooms through refurbishments at four if its hotels, the sources say. It is also expected to be able to increase the occupancy rate, particularly at the Regal Airport hotel which at just over 70% occupancy trails the other hotels in the portfolio which are seeing more than 90% occupancy.
Together, this should lead to a rise in the dividend yield to about 8% in 2008 and 8.5% in 2009, based on the bottom of the price range.
ôOver the next couple of years the focus will be on organic growth, but after that it may look at acquiring more assets. And China will be the obvious place to expand,ö notes one source.
To overcome any potential concerns about the cyclicality of the hotel industry, which can see revenues vary substantially depending on occupancy rates, Regal Reit has been structured so that the sponsor acts as the master lessee of the five hotels in the portfolio. As such it will pay a guaranteed minimum base rent until the end of 2010 that will provide downside protection for investors, with a variable rate on top that will depend on the performance of the hotels.
In the first year, the Reit will receive 100% of any additional income above the base rate, in 2008 it will get 70%, in 2009 60% and in 2010 50%.
Aside from the hotel at the airport, Regal Reit will also include hotels in Causeway Bay, Tsim Sha Tsui, Kowloon City and Shatin. The five hotels comprise a total of 3,348 rooms, making Regal Reit one of the largest hotel operators in Hong Kong.
The retail portion of the deal will open to subscription next Monday and the pricing is expected March 23. The trading debut is set for March 30.
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