The Link Reit, which has risen 58% over its initial public offering price stands out as an anomaly in a market where the other three listed Reits have been at best treading water since their respective debuts. Champion Reit which listed in late May is currently trading 30% below its IPO price, while Prosperity Reit, which came to market last December, is down 21%. GZI Reit, the only trust so far to be backed by Chinese assets, is flat versus its December listing price.
In June, two other planned Reits, backed by local property giants Sun Hung Kai Properties and Henderson Land Development were pulled before they started the official marketing in response to the difficult market environment.
Now Henderson is back with its Sunlight Reit, which has been restructured to be more appealing to investors. According to market sources, the trust is seeking to raise a bit less than $400 million, compared with about $450 million last time around. The valuation of its underlying office and retail properties have also come down somewhat, which together with a series of other measures will allow for a dividend yield approaching 9% versus a talked about yield in the 6.5-7% range in June.
Sunlight will go head-to-head with Regal Real Estate Investment Trust, which also started pre-marketing towards the end of last week after both vehicles received a preliminary listing approval from the regulators. Sponsored by Regal International Hotels Development, Regal Reit will be Hong KongÆs first and AsiaÆs second Reit backed by hotel properties and sources say it is seeking to raise a higher-than-earlier expected $600 million to $700 million.
The two vehicles are not only backed by different types of assets, but they also have a different structure, which means they offer a real choice for investors, depending on what they want out of their investments.
The most obvious difference between the two is the dividend yield, with Regal Reit expected to offer a first-year yield in the mid-five to low-six percent range. However, as shown by the many Reits listed in Singapore, this type of investment is as much about capital growth as it is about steady dividend payouts, i.e. ultimately it is the total returns that count.
No doubt this is an argument that will be stressed by Regal ReitÆs joint bookrunners, Deutsche Bank, Goldman Sachs and Merrill Lynch, and some observers say total returns for this particular vehicle should be in the mid-teens at least. A yield around 5.5% would put it on par with CDL Hospitality Trust in Singapore in terms of premiums over the 10-year bond yield. CDL trades at a premium of about 170 basis point to the risk-free rate and the Hong Kong 10-year note is currently quoted at about 3.8%.
CDL also trades at a 20% premium to its net asset value and the source noted that it is likely that Regal Reit will also be sold at a small premium or the yield may end up being a bit ôtoo richö, based on the initial HK$14 billion purchase price.
Another selling point put forward, fund managers say, is the fact that the dividend yield offered is a ôrealö yield and not boosted by any financial engineering measures.
However, to overcome the concern about the potential for revenues to vary substantially depending on occupancy at the hotels, the Reit has been structured so that the sponsor acts as the master lessee of the five hotels in the portfolio. The sponsor will pay a guaranteed minimum base rent until the end of 2010 that will act as downside protection for the investors with a variable rate on top which will depend on the performance of the hotels.
According to one source, the base rent will account for 80% of the projected rental income for the first full year in 2007 and will increase in dollar terms each year thereafter, while the ReitÆs portion of the variable rent will drop from 100% in 2006 and 2007 to 50% in 2010.
Regal International also has an independent credit line of HK$1 billion that can be used to cover the guaranteed rental payment in case the company should run into financial difficulties. This would give investors some comfort that Regal Reit wonÆt suffer should there be another negative event for the industry along the lines of Sars that may keep travelers away for a period of time.
In addition to that, the Reit will commit to pay a set absolute dividend until the end of 2007 to make sure the revenue growth feeds through to the bottom line and to provide investors with a visible floor with regard to their returns.
The sponsor said in a statement issued last week that Regal Reit will pay at least HK$14 billion ($1.8 billion) for the five hotels that will go into Reit. The properties have been valued at a combined HK$16.07 billion by an independent valuer. The statement also noted that the parent company will retain 50% in the Reit before the exercise of the greenshoe (and about 45% after). To arrive at the expected deal size of at least $600 million one will also need to include about $4.2 billion worth of debt. Earlier this year, market talk suggested the fund raising would be closer to $400 million to $500 million, with the difference said to be partly a result of the improvement in the underlying equity market.
ôItÆs a play on the tourism traffic from China to Hong Kong, which people generally expect will continue to increase,ö says one observer, who notes that Regal ReitÆs hotels have a good geographic spread within Hong Kong to capture that increase. ôFor one, it will own the hotel at the Hong Kong airport.ö
The other four hotels are located in Causeway Bay, Tsim Sha Tsui, Kowloon City and in Shatin. In total, the hotels comprise 3,348 rooms, making Regal Reit one of the largest hotel operators in Hong Kong with a 7.3% market share.
The new Reit is also expected to benefit from the gains in Singapore-listed CDL Hospitality Trust, which is the only other hotel Reit in Asia. Since its listing in July this year, CDL has risen 52% above its IPO price and currently trades at a yield just above 4%.
The Reit needs approval from the parent companyÆs existing shareholders to formally launch its offering and it expects to receive this at a shareholders meeting scheduled for December 7. The public offering to Hong Kong retail investors cannot take place until that approval is in place, but the institutional bookbuilding is planned to start slightly earlier around December 4, give or take a day or two. The listing is expected to take place before Christmas.
Sunlight Reit, which is being brought to market by Deutsche Bank, HSBC and Macquarie, is not large enough in relation to HendersonÆs total asset size to require shareholders approval, which means it may gain an edge over Regal Reit in terms of timing. At the moment, however, their timetables look very similar with Sunlight too hoping to start the roadshow on December 4. The plan is to price the deal around the 13th and have it start trading on the 20th.
SunlightÆs portfolio of 12 office and eight retail properties hasnÆt changed since it planned to come to market in June, although the appraised valued has dropped slightly to about HK$9.1 billion ($1.2 billion) from around $10 billion, according to sources.
Henderson hasnÆt revealed what the Reit will pay of the injection of the properties û which will come from both Henderson Land itself (15%) and from the Chairman Lee Shau KeeÆs private investments (85%) - but to achieve a 9% dividend yield the price would have be at discount of around 15% versus the total asset value, one source estimates. The Reit will also take on about 30% to 35% of debt.
Even so, to achieve a dividend yield of at least 8% on these properties, a degree of ôfinancial engineeringö will be needed. While it was pretty clear that investors didnÆt like the use of such measures in the case of Prosperity and Champion, sources say the way Sunlight Reit is structured should be more appealing to the market.
And according to one source, the ôfinancial engineeringö measures arenÆt put in place just to apiece investors, but are there to bridge the gap between the capital value of properties, which tend to rise much faster, and rental income, which is bound by three-year contracts.
For one, it is using a swap to reduce its interest payments at a flat rate for the next five years, rather than one that progressively increases the payments, resulting in less refinancing risk. It also means that any rental increases will be able to feed through to the bottom line. At the same time, the swap will be a non-income producing asset on the balance sheet, which may need to be compensated for by offering the units at a greater discount to NAV, one source notes.
The sponsors will also guarantee the rental for the properties in the Reit portfolio until fiscal 2009, which ends in June that year. For the first fiscal year to June 2007 the guarantee will be equal to what the rent would be if all the units were rented out at current market rates. Given that a large part of the portfolio is still on old leases that pay a rent that is below market, this will definitely help boost the distributable income. In subsequent years, the guarantee will increase by about 5-5.5% per year to reflect the average increase in the Hong Kong rental growth.
To further increase the amount of money available to distribute to investors, Henderson and Lee Shau Kee, which together will hold 30% of the Reit, will waive their right to receive dividends in the first three fiscal years and will give up a portion of their dividends for another two years. The Reit will commit to a minimum dividend per unit for the next 2.5 years.
Among the key selling arguments for this trust will be its diversified portfolio, the high quality of the sponsors and the fact that they are still sitting on HK$40 billion worth of rental income assets that could be injected into the Reit. In fact, they have already made a commitment to offer at least two office or retail properties worth at least 30% of the appraised value of the Reit to Sunlight within six months after the first anniversary of the listing.
While some observers say this should appeal to investors looking for capital growth, others note that it could be hard to make yield accretive acquisitions for a portfolio that is already yielding more than 8%, however.
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