Overseas Retail Reits – Risk Or Reward?

Foreword from ShareInvestor

This article “Overseas Retail Reits – Risk Or Reward?” by Cai HaoXiang was first published in The Business Times on 07 Apr 2014 and is reproduced in this blog in its entirety.

It could take a projected yield of 7% for these Reits to be attractive

Retail real estate investment trusts (Reits) are popular because they are regarded as defensive investments – after all, people will still shop, especially at suburban malls, no matter how badly the economy is doing. Moreover, their current yield of about 6 per cent per year is far higher than bank deposit rates.

On top of safety or defensiveness, overseas retail Reits present an additional interesting proposition –on the one hand, they are still “safe” in the sense that they include well-located malls that will mint money no matter the economic circumstances, but they also give investors exposure to growing spending power in two countries with the largest number of potential middle class consumers in the world, China and Indonesia.

However, there are potential downsides. Because earnings are in a foreign currency, and because the malls are located in a less certain political environment, the risks of investing in them might clash with investors’ original intent to invest in “safe” assets.

For one thing, the malls they own are remote and can’t be easily visited. Also, higher potential returns in the medium to long term come with currency depreciation risks in Indonesia, the risk of China slowing down, cooling retail rents in Hong Kong, and rising interest rates in general.

As a result, analysts have justifiably remained cautious on overseas retail Reits – for instance, OCBC Investment Research had a “neutral” rating on the sector last December, though it pointed out that occupancies and rent renewals are healthy.

Four Reits listed here fall in the overseas retail category – Fortune Reit, Mapletree Greater China Commercial Trust (MGCCT), CapitaRetail China Trust (CRCT) and Lippo Malls Indonesia Retail Trust.

While all four appear to have strong sponsors, each has different debt profiles and property characteristics compared to local retail Reits.

For example, leases for some of Lippo Reit’s malls are granted under the Hak Guna Bangunan (HGB) title, with lease terms of 30 plus 20 years. Leases for some malls thus expire as early as 2020. After expiry, a new title or renewal has to be granted by the authorities.

Similarly, leases for many Hong Kong properties expire in 2047. This affects Fortune Reit and MGCCT. For CRCT, leases also expire in the 2040s.

Distributions might fall drastically if leases cannot be renewed, and current distributions become, in effect, a return of investors’ monies back to them, called a “return of capital”.

Reits might also need to pay hefty sums to governments to secure lease renewals. In contrast, leases for shopping malls in Singapore tend to be on 99-year terms that expire in the 2070s to 2090s. This gives more certainty to their cashflows.

Looking ahead, the overseas retail Reit scene here might be boosted by a fifth Reit. South Korea’s Lotte Shopping could list its mall assets here in a massive initial public offering to raise more than $1 billion. The initial public offering was supposed to happen in the first quarter of this year, but it ran into a snag after Lotte had reportedly planned to offer a yield of 6 to 7 per cent, but investors demanded more.

This is a good gauge of market sentiment. With yields on long-term risk-free bonds expected to go up to 4-plus per cent, and with Reit investors demanding, say, two to three percentage points above risk-free rates, investors should only buy Reits that give a projected yield of 7 per cent or so.

All else being equal, Reits with overseas properties might require an aitional percentage point of yield on top of that, given higher market, political and currency risks. On the other hand, their potential growth could justify a lower yield so one could argue that the two might cancel each other out.

MGCCT currently offers the highest yield. Better than forecast results on top of a price slide since its IPO, have bumped up its projected yield to 7 per cent. The Reit, however, is reliant on just one major property for its earnings; the other three have a more diversified asset base.

Lippo looks less attractive in the short-term (Disclosure: writer has a small stake). The Indonesian rupiah has been weak, though it has strengthened somewhat this year. Domestic demand is likely to be curbed by high interest rates as the Indonesian central bank tries to control inflation.

Both Fortune and CRCT have earnings catalysts in newly acquired malls. But a cloud is hanging over both Hong Kong and China due to fears of a China economic collapse. If that happens, spending power will be curbed and asset valuations will fall. Growth will be limited and rental rates might drop, lowering distributions.

Still, the next time you go on holiday to Jakarta, Beijing, or Hong Kong, try to do your shopping in some of the malls these Reits own. No harm getting some market research done along with your retail therapy.