Link REIT buys Jurong Point for $1.98 billion – Are real estate prices crashing?

4

 

Okay, so I wasn’t planning on doing this post.

But then I was reading the Link REIT acquisition of Jurong Point.

And posting quick thoughts on Twitter (do follow me on Twitter if you haven’t already).

And the more I looked at it, the more interesting this deal become.

So here goes… 3 key takeaways on Link REIT’s acquisition of Jurong Point.

        

3 Key Takeaways on Link REIT’s acquisition of Jurong Point

  1. Are Commercial Real Estate valuations going down?
  2. Financing is not cheap for Link REIT
  3. Are REITs in trouble?

Are Commercial Real Estate valuations going down?

I must admit this horse doesn’t have the best memory.

But I do vaguely recall Mercatus buying Jurong Point for quite a large number a while back (Mercatus being the seller, owned by NTUC).

And sure enough, Mercatus bought Jurong Point for $2.2 billion back in 2017.

And 5 years later, in 2022.

Mercatus is selling it for $1.988 billion to Link REIT.

Approximately a 10% drop in valuation.

In real estate speak – that works out to about a 4.8% cap rate (versus the 4.2% cap rate that Mercatus paid in 2017).

For those who are newer to real estate, cap rates tell you how expensive a property is, and the higher it is, the “cheaper” it is.

So simplistically – Jurong Point is cheaper today than it was in 2017.

I suppose there are only 2 ways to interpret this.

Either (1) Mercatus overpaid in 2017, or (2) commercial real estate prices are going down.

Is there a third option?

I suppose there is a third option that Link REIT got a good deal.

Because you know… they are savvy negotiators?

But considering that both CapitaLand (via CICT) and Frasers (via FCT) were both rumoured to be looking at the deal as well, it doesn’t seem like the case.

It seems like Mercatus did do proper price discovery with a few potential buyers, and this is close to the “best” price they could have gotten given current market conditions.

So… overpaid or are real estate prices going down?

As to whether it’s (1) or (2), I leave it to you to decide.

Although interestingly, just this week, Manulife also announced that they are revaluing their property portfolio downwards by 10.9% due to (1) higher interest rates (resulting in higher cap rates) and (2) weakening US submarket performance.

So… it does lend some support to the view that commercial real estate prices are weakening.

I’ve been talking for a while about how real estate prices valued in an era of 0% interest rates, no longer make sense when interest rates are going to 5%.

Is this a sign of things to come?

 

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Financing is not cheap for Link REIT

So… who in their right mind would buy $2.16 billion worth of real estate in this market you ask.

And how would they fund it?

Yeah… exact same questions I had.

Turns out Link REIT is funding it via cash and debt.

Their gearing is only 27.1%, so I suppose they do have a lot of debt headroom.

That said, debt still has a cost.

Link REIT raised S$568 million recently via convertible bonds.

At 4.5%.

But here’s the kicker – the conversion price (where the bonds can be converted into Link REIT Units) is $61.92.

For a REIT where the NAV is $80.86.

You can see the conversion price marked below, where Link REIT spent a good part of the past 5 years trading above.

I suppose what I’m trying to say, is that debt does not come cheap in this market.

4.5% convertible debt, with a conversion price that is (1) only 10% above current price, and (2) below NAV.

To buy real estate at a 4.8% cap rate.

Man… I can see why nobody is doing deals in this market.

The financing just doesn’t make sense.

For what it’s worth, Link REIT’s average cost of debt is 2.5% for now, but one expects that will surely increase going forward

So… why did Link REIT buy Jurong Point? And why did Mercatus sell?

If you recall, the original property portfolio was for (1) AMK Hub, (2) Jurong Point, (3) NEX and (4) Swing By @ Thomson Plaza.

Nex was taken out of the deal entirely.

While AMK Hub was taken out of the deal, but the sweetener is that Link REIT gets to manage AMK Hub “long-term”.

One assumes that this is a precursor to Link REIT eventually buying AMK Hub…

The fact that this had to happen, with both CICT and FCT pulling out of the deal (reportedly), is interesting.

I do have my own theories on why it played out this way, but that’s ultimately going to be speculation.

In any case, I suppose from Link REIT’s perspective, this acquisition can be seen as a longer term strategic move, to expand into Singapore.

And to diversify away from Hong Kong and Mainland China.

Interestingly, Link REIT is looking for partners for the acquisition.

So perhaps indeed, this acquisition is too big for them (or any one REIT) to swallow in this market conditions.

Are REITs in trouble?

Looking at the numbers, I can see why FCT and CICT backed out.

The financing does not make sense.

You can’t tap equity at these prices, not when your share price is so low (especially if its below NAV).

The equity fund raise would be too dilutive, and the market would murder you if you tried (look at SATS for reference).

And debt… well Link REIT tried doing debt.

And it’s quite clear the debt doesn’t come cheap these days.

4.5% convertible bond with a strike price that could very easily be exercised.

That’s not a good deal, and shows how tight the debt markets are right now.

So I really struggle to see how REITs will make any acquisitions moving forward.

Everyone is expecting interest rates to come down in 2023/2024.

If they don’t, and they stay up, I think commercial real estate might be in for a world of pain.

But let’s see…

 

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4 COMMENTS

  1. Everything being equal, is it not a fair valuation for the price of a leasehold property to be lower now than it was 5 years ago?

  2. nice post :). still working hard over the holiday weeks I see!

    What theories do you have behind why FCT and CICT pulled out of the race? Valuations of Jurong Point not low enough for them? Financing costs too high? Or is there something else?

    Also, in terms of revaluation timing for underlying properties, do you have any insight into when these will be done across the industry? So for example, we saw what happened with Manulife REIT. Should we be expecting the same for others sometime in 2023?

    • Thanks – wasn’t planning on writing this post but I was looking at Link’s numbers and I really couldn’t help myself after that…

      Yeah I didn’t want to dive into this question in the article because it would be just speculation, and I could be wrong.

      Since you asked though, my suspicion is due to (1) valuation not cheap, and (2) cant work out an appropriate financing package in this market.

      At 4.8% cap rate, it’s definitely cheaper than it was in 2021 (prob 4 – 4.5% cap rate last year), but not at the point where it is cheap enough that it’s a must buy (considering the risk free is going to 5%).

      And at 2b, that’s a big amount to swallow, which at the very minimum would require the sponsor to hold 50% of the purchase, and the rest would need to be funded via debt/equity, both of which is not going to come cheap in this market.

      So I can see why both stepped away, and I think it was the right thing to do. Market would have hammered their share price otherwise, and you can see how share price recovered once the market realised the acquisition was off the table for those 2 REITs.

      The revaluation is a good question. It feels like everyone knows that a storm is coming, but nobody wants to be the first to do it. They’re going to wait until they’re forced to do so, or until someone else does it. Or hope that Powell cuts rates before they are forced to make any hard decisions.

      I think the answer will go back to individual property portfolio and sponsor quality. No easy answers here.

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