First REIT has to be one of the most disastrous performing REITs over the past 3 years (the only worse one is Eagle Hospitality). From a record high S$1.40 per unit in 2018, it has now dropped to just a mere former shadow of itself of S$0.40 per unit as at 3rd December 2020. When the detailed rental restructuring plan was released on 29 November 2020, it crashed the previous week ending market valuation of S$0.475 per unit. What was released in the announcement on that fateful day was apparently worse than the basic expectation of most investors.
1. Sponsor and main lessees Lippo Karawaci & Siloam in trouble
Lippo Karawaci is having cashflow challenges due to COVID-19. It is having problems selling its properties in development amidst the current pandemic and also having problems divesting off assets such as retail shopping mall to raise cash. On 2nd December 2020, unitholders of Lippo Malls Indonesia Retail Trust (“LMIRT”) grilled the Trust’s manager over the pricing and timing of purchase of strata title units of Lippo Mall Puri in West Jakarta from Lippo Karawaci for S$336.5Mil. There are doubts by LMIRT unit holders on whether or not the valuation done at the end of 2018 is reasonable enough given the current adverse impact of COVID-19 in Indonesia. Hence there is a probability that Lippo Karawaci is unable to download the asset into LMIRT to raise fund.
First REIT Trust Manager’s rational for the new Master Lease Agreement (“MLA”) is to avoid the adverse consequences of a default by Lippo Karawaci if it maintains the existing MLAs. Personally, I thought that this move is as good as admitting that First REIT is undergoing a potential default by its tenants as it had already given 4 months of rental waiver to its tenants.
2. Nightmarish terms of new MLAs for First REIT owners
(i) What are the main changes to the MLAs?
The aggregate commencement base rent for the bulk of the portfolio, LPKR hospitals, will be reduced from S$80.9 Mil to approximately S$50.9Mil (or around IDR550.7 billion) per annum. This is a whopping cut of <58.9%> in base rent. The restructured MLAs will also feature a new performance-based rent mechanism where the actual rent paid will be the higher of either the base rent
The main changes is that instead of receiving the rental in Singapore dollars, the new MLAs changed this to Indonesian Rupiah. The commencement base rent will enjoy a fixed escalation rate of 4.5% per annum, compared to the previous base rent escalation capped at 2.0% per annum under existing LPKR MLAs.
(ii) Is the higher annual escalation rate of 4.5% relative to the current 2.0% per annum a much better deal?
The answer to this seems to be no better. Investors are generally worst off albeit the seemingly higher escalation rate of 4.5%. This is because the risk of foreign currency risk is now being passed on to First REIT investors as the rental denomination currency has been changed to IDR instead of SGD. The IDR lost around 32% of its value over the past 10 years. If there is hyper-inflation or changes in monetary policy such as printing lots of money by the Central Bank, then the IDR may face a substantial drop that is double digit and definitely more than 4.5%.
(iii) What is the point of signing a new lease agreement if the tenant does not intend to honour it?
The important question here is what if there is another pandemic or major recession in another few years’ time? Will Lippo Karawaci come back to ask for another restructuring of MLAs? If one can dishonor an agreement one time, then one can surely do it again to the unit-holders a second or third time. They should have only changed the terms for the upcoming first batch of hospitals that have leases expiring and do for the rest later on upon expiry. Personally, I think this has seriously damaged their reputation and branding. They should have gone for a rights issue to raise cash at the holding company level back in Indonesia to meet future obligations instead of blatantly breaching signed lease agreements.
3. Dividend trap with high yield or really good buy now?
Dividend yield look good with 4.44 cents after the restructuring. At the last traded unit price of S$0.40 per unit, this is an attractive dividend yield of 11.1%.. If we exclude the one off non-recurring restructuring costs of S$3.4Mil, then one will get an even higher dividend yield of 12.2%.
As at 30 June 2020, net asset value dropped from S$0.969 per unit to S$0.494 per unit after the restructuring exercise. Compare to the market price of S$0.40 per unit last traded on 4 December 2020, there is thus a current discount of around 19% to NAV.
However leverage ratio jumped to 48.6% which is almost near the new ceiling of 50% by MAS.
4. Parting Thoughts
I am not sure how First REIT will be able to get any yield accretive new properties acquisition at the current super high yield expected by investors and also the fact that it is near to bursting the debt limit of 50% hence unable to take advantage of the current low interest rate environment.
Hence despite the seemingly very attractive potential dividend yield of up to 12.2% per annum, I will give First REIT a miss due to the change in rental base (forex fluctuation risk) from SGD to IDR and an over-leveraged financial position. Perhaps most importantly, I looked at the sorry state of another Lippo Karawaci sponsored Reit, LMIRT, and can't help but worried that any investment in First REIT will go the same way in the near future. Last but not least, my personal thoughts are that breaking lease agreements means that the senior management of Lippo Karawaci group will simply repeat the same act once there is another economic crisis.
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