Why I am not buying Mapletree Commercial Trust at $1.84

 

In last week’s article, I shared that (1) I disliked the MCT-MNACT merger, and (2) I would consider adding at $1.8 to $1.9.

By Tuesday this week, MCT had fallen to an intraday low of $1.81.

A lot of you reached out to ask if I am buying Mapletree Commercial Trust at this price.

I’ve had some time to dig deeper into MNACT’s portfolio this week. And the more I look, the more concerned I get.

So to update my views:

I now really, really dislike this merger.

I have revised my personal fair value for MCT down to $1.74 – $1.79.

Let me share why.

BTW – if you haven’t read last week’s article please do. I’m going to skip all the basics and go straight into the juicy stuff.

 

3 Big Problems with the Mapletree Commercial Trust Merger

There’s basically 3 big problems:

1. MNACT’s portfolio is… not good?
2. Valuations
3. Macro Headwinds

1. Mapletree North Asia Commercial Trust (MNACT) Portfolio is… not good?

The 2 biggest properties in Mapletree North Asia Commercial Trust are:

1. Festival Walk (Hong Kong Mall)
2. Gateway Plaza (Beijing Office)

They will form 26% and 7.9% of the newly merged Mapletree Commercial Trust respectively.

I’ve been reading a lot of commentary online, and a lot of investors detest these 2 properties.

The argument basically boils down to 3 factors:

1. Only 25 years left on the Lease
2. Capitalisation Rate too high
3. Rental Reversion is a disaster

Let’s discuss each of them.

Only 25 years left on the lease (Festival Walk)

A lot of investors have picked up on the fact that Festival Walk’s lease is only until 2047, which is only 25 years left.

Frankly speaking, this was the one I was least concerned about.

SCMP reports:

“According to the policy statement promulgated in July 1997, leases not containing a right of renewal may be extended for a term of 50 years without the payment of additional premiums. Moreover, an annual rent equivalent to 3 per cent of the rateable value of these properties shall be imposed. The case of Pok Fu Lam Gardens extending its lease in 2006 for 50 years without the payment of an additional premium has always been quoted by the government as a possible arrangement for the upcoming expiries.

Lands Department will generally accept applications for lease extensions from relevant owners three years before an expiry date. With the next batch of leases expiring in 2025, the department will only start accepting extension applications for these leases next year.”

So basically, it seems that *most likely* you just pay a small fee, and the lease will be extended for another 50 years.

Mainland China has a similar practice as well. Most of their commercial properties only have a 40-50 year lease, but apparently on expiry on expiry, you just pay a nominal fee to get it extended.

You can argue that the government can always change their mind overnight. It’s not impossible.

But practically speaking, that will unleash a shockwave through the Hong Kong commercial real estate market. Think about what would happen to the other players like Link REIT or Hang Lung. Or the Hong Kong tycoons.

I find the chances of this happening slim at best.

Capitalisation Rate too high

For those newer to real estate, capitalisation rate is basically (Rental Income / Property Value).

The lower the number, the more highly valued it is.

A lot of investors have picked up on the 4.15% capitalisation rate for Festival Walk.

This values Festival Walk as more expensive than Vivocity at 4.6%, which is a far superior mall.

I get it, and I agree with this as well.

But to be fair to MNACT, Hong Kong is an expensive market.

If you take a look at the capitalisation rates for Link REIT (the mega HK retail REIT), you find that their Hong Kong malls are valued at 3.1% to 4.5%.

So Festival Walk is still within this range, and it’s hard to say that it’s grossly overvalued.

If you want to buy a mall in Hong Kong now, this is the price you have to pay.

Rental Reversion

And now for the most frightening point.

Rental Reversions are basically the rent at which a new lease is signed at, compared to the previous lease.

Rental Reversion is a mind blowing negative 30% for Festival Walk, and negative 24% for Gateway Plaza.

I mean… holy shit?!

You’re telling me 34% of the newly merged MPACT has leases being renewed at 24-30% below the expiring lease?

That’s just an absolute disaster.

      

You can compare that to Link REIT, which has 3.4% rental reversion for Hong Kong retail.

So you can’t even argue that it’s a Hong Kong wide problems. This is unique to Festival Walk.

To be fair to Mapletree North Asia Commercial Trust though, Festival Walk has just been through a chain of disasters.

In 2019 it was trashed by the Hong Kong protesters, that took the property offline for quite a while.

And just this week, there was a COVID cluster at Festival Walk.

Is this mall cursed or what?

Now I love Vivocity and Mapletree Business City, but at this point they only make up 40% of MPACT.

A whopping 34% goes into Festival Walk and Gateway Plaza, which are looking a bit worrying.

Macro Situation in Hong Kong / China

The management insights provide a bit more colour.

To summarise, they expect:

• Rental Reversions for Festival Walk and Gateway Plaza to be poor for the rest of FY21/22
• One of the major tenants at Gateway Plaza has extended their lease to December 2023, and may not extend it further after that

They do explain that the poor rental reversions at Festival Walk is because of them trying to maintain a high occupancy.

Which okay, I can give them the benefit of the doubt.

Management does expect things to pick up in 2022 – 2023.

But I’m just going to take that with a huge pinch of salt looking at the broader macro.

The real estate crisis in China is still playing out like a slow motion train wreck. The tech crackdown is still playing out.

All while China/Hong Kong attempts to maintain zero COVID policy, in the face of the more contagious Omicron.

Whichever way you look at it, I find it hard to get excited about China / Hong Kong real estate short term.

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2. Valuations of Mapletree Commercial Trust

But at this point the sharp-eyed reader will say – Hey FH, there’s no such thing as bad real estate, only a bad price.

And I agree.

As much as Festival Walk and Gateway Plaza are an unmitigated disaster, perhaps the question is – What price would I be a buyer?

MNACT has traded the past 2 years at about the 0.9+ range, which is about 20% discount to NAV.

And the more I think about it, the more I think that’s the price I would be a buyer of MNACT.

Best case, you could probably convince me to pay up to 15% discount to NAV.

Whereas for MCT I am happy to buy it at a 15% premium to book (1.93 pre-merger).

This is Mapletree Business City and Vivocity after all, the crown jewels of the Mapletree portfolio.

So if you blend them together, you get a range of 0.975 – 1.0x NAV.

Ie. my fair value for the new Mapletree Commercial Trust is $1.74 – 1.79

Whereas MCT at the current price of $1.84 is roughly equivalent to buying the old MCT at 20% premium and MNACT at 15% discount.

I mean that’s ok, but it’s not exactly a screaming value buy if you get what I mean.

I like the CapitaLand REITs more at these valuations

Some comparisons:

• CapitaLand China Trust – trades at 0.73x book value, 6.7% yield
• CapitaLand Integrated Commercial Trust – trades at 0.98x book value, 5.4% yield

Versus MCT at 5.2% yield, 1.02x book value (post-merger).

Which means I can buy CapitaLand Integrated Commercial Trust and CapitaLand China Trust in an 80:20 mix, and get a 5.66% yield.

Higher than MCT at its 5.2% yield, with the following asset allocation:

I get that it’s not an apples-to-apples comparison, but I’m liking the CapitaLand REITs a lot more at these valuations.

 

3. Macro Headwinds

In my latest Macro Post, I shared my concerns about rising rates and inflation in 2022.

QE will end by March, 3 rate hikes this year, and now the Feds are talking about balance sheet run off.

It’s important to understand when the macro paradigm has shifted, and I think it very clearly will shift this year (if not already).

The Feds are no longer your best friend, but your worst enemy.

It doesn’t necessarily mean I’m going to sell all my REITs tomorrow, but it also means I will be a lot more selective about the deployment of capital.

I think there will come a time in Q2 / Q3 this year when I will back up the truck and load up on REITs. When everyone is freaking out about inflation and rate hikes.

But I don’t think this is the time just yet.

I haven’t seen capitulation in the bond market yet.

For those who are keen, you can keep track of when and what I buy, together with my full portfolio and REIT / Stock watchlist, on Patreon.

Bonus Point – Technical Damage

By Tuesday alone, Mapletree Commercial Trust had broken through its 50 and 200-day moving averages

You can argue there is some weak support at the 1.8+ level, so that might be an important level to watch.

Whatever the case, the charts are a disaster, and it looks like this may take some time to play out.

There’s a lot of disgruntled MNACT / MCT unitholders who may exit in the coming months, which could place a lot of selling pressure on Mapletree Commercial Trust.

Big Caveat: I am an existing Mapletree Commercial Trust / Mapletree North Asia Commercial Trust unitholder

That being said, I do want to qualify that I already have a big position in MCT, and a smaller position in MNACT.

In fact my average buy in price for MCT is about $1.5.

So my comment that I am not averaging in at $1.84, needs to be viewed in light of all this.

I am already vested in both REITs, it’s just that I am not averaging in at this price.

If you have no position in MCT at all, then maybe the analysis will be different for you.

Closing Thoughts: Is Mapletree still an S Tier Sponsor?

There used to be a time when Mapletree was an S Tier sponsor in my books.

This placed it even higher than CapitaLand and Frasers.

But the recent moves from Mapletree have really led me to question that.

A few months back they dumped a billion worth of China logistics real estate into Mapletree Logistics Trust. Right in the midst of the China real estate slowdown.

And now they’re divesting MNACT into MCT.

And I can’t really figure out why this sudden change of heart too.

Not naming names, but for some of the other REITs where the Sponsor needs cash, or where the Sponsor is publicly listed with its own shareholders to answer to, I can see why they would abuse the REIT.

But Mapletree is a 100% Temasek owned entity. Not public listed.

Who is the one calling the shots, and making these big picture moves? Will there be more to come?

Whatever the case, I’m going to be a lot more cautious on Mapletree REITs going forward.

Love to hear what you think! Are you buying MCT at $1.84?

As always, this article is written on 7 Jan 2022 and will not be updated going forward. Latest thoughts (and my stock watch and personal portfolio) are available on Patron.

 

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