The impact of covid 19 has not spared Keppel REIT, an office REIT. Its stock price is currently lower than it was prior to the outbreak.
In fact, if we look at its share price over the last five years, it hasn’t changed significantly. So, what’s the issue with this REIT? Let’s investigate why Keppel REIT’s share price has remained stagnant for so long.
P.S. If you own shares in Singapore Press Holdings, this article may be of interest to you as well, as Keppel Corporation has proposed a merger with SPH. (More details can be found in Alvin’s video)
You will receive a mix of cash, SPH REIT and Keppel REIT if the approval is given in exchange for your SPH shares.
Overview
Keppel REIT is a Singapore-based real estate investment trust with a portfolio of Grade A commercial properties in Singapore, Australia, and South Korea. It currently owns ten office buildings, with its Singapore assets accounting for the majority of the portfolio.
Surprisingly, Keppel REIT does not possess a 100% stake in most of the buildings it manages.
For example, let’s look at the assets it has in Singapore. Only Keppel Bay Tower is 100% owned, while owning between 33.3% to 79.9% of the other three assets.
With 385 tenants, Keppel REIT’s Tenant Base is well-diversified and many of them are well-established businesses. These tenants come from various sectors, including banking, insurance, financial services, government institutions, technology, media, and telecommunications.
Its top ten tenants currently account for 40.2% of its Net Lettable Area (NLA) and 35.6% of the total rent, which is a sizeable portion.
Keppel REIT’s Singapore properties are accountable for most of its Net Property Income (64.9%), with Ocean Financial Centre and Marina Bay Financial Centre contributing 20.9% and 30.6% respectively, to the first half of 2021 income.
Keppel REIT’s Financial Performance
Income
Keppel REIT’s revenue has been stagnant for the past six years, with no signs of improvement. The total distributable income for FY2020 was $194.6 million, which included a $10 million capital gains distribution. The slight improvement in distributable income was due mainly to contributions from T Tower and Victoria Police Centre, as well as lowered borrowing costs.
Although the poor performance in 2020 can be excused due to the pandemic, there is no excuse for Keppel’s poor performance in the other years.
On the positive side, distributable income for the first half of FY2021 was up by 11.5% year over year to $105.7 million, indicating that the worst is finally coming to an end.
For the past six years, its distribution income has also been higher than its net property revenue. Typically, this would be a reason for concern. However, we do not need to be concerned in Keppel REIT’s case due to the manner it has categorised its investment. Its associates had generated roughly $88 million in revenue for FY2020 while its joint ventures generated around $29 million.
Distribution Per Unit
With the decrease in its distribution income, Keppel REIT’s DPU has also been dropping year on year. Distribution per Unit for FY2020 was 5.73 cents (including DPU of 2.93 cents for the second half of 2020).
Net Asset Value
Despite many acquisitions, total assets have remained flat for the past few years, owing to the REIT’s multiple divestments. Net asset value has been declining as well, which is not a good indicator because it suggests that each share is worth less.
Keppel REIT sold its first Australian property, 275 George Street, in June 2021, after purchasing it in 2010. While it is generally ok for a REIT to divest and use the proceeds to acquire better properties, I am concerned about Keppel REIT’s divestment.
According to its report, the divestment revenues will be used to repay debt and transaction costs in the interim, to improve capital efficiency and to manage borrowing costs before being redeployed to strategic and better yielding growth prospects. This raises a series of questions.
Is this capital so critical to Keppel REIT’s day-to-day operations? Are they cash-strapped? Was this a cash flow issue that prompted the divestment?
The rationale of Keppel’s acquisitions and divestments can be called into question. It has done a lot of these, and yet neither its income nor its NAV has improved.
While we can’t determine how much the company’s shareholders had profited from such transactions, we can safely assume that the manager is benefiting from all the buying and selling. (A REIT manager is often compensated a percentage of an acquisition or divestiture.)
Occupancy Rate
Currently, Keppel REIT has a highly committed portfolio occupancy even amid the pandemic when many are working from home.
The REIT also has a relatively long Weighted Average Lease Expiry (WALE) of 6.2 years.
However, if we take a closer look at the breakdown, its Singapore portfolio, which accounts for the majority of the company’s assets, only has a WALE of 2.9 years. This might be an area of concern.
Keppel REIT’s Financial Strength
Even in difficult times, REITs with a strong balance sheet can thrive.
Keppel REIT has an aggregate leverage of 38.9% as of 30 June 2021, which is less than the regulatory maximum of 50%. I believe it is reasonable at the current level but, any more increases may not be good for the organisation, particularly in an inflationary economy.
Keppel REIT appears to be in good shape to service its loans, with a respectable interest coverage ratio of 4x.
It’s also worth noting that 68% of Keppel REIT’s debt is tied to a fixed rate, which is excellent news, especially if greater inflationary pressure is expected in the coming years. Indeed, Singapore’s recent tightening of monetary policy is just another clear indicator that this inflationary effect has already begun.
Looking at its debt maturity profile, Keppel REIT’s weighted average term to maturity of borrowings as of 30 June 2021 was 3.1 years and seemed spread out across the next six years.
Cash is king. In terms of cash flow, the REIT generated a total of $104 million from operating activities for FY2020 up from $93 million for FY2019. As a result, its cash and cash equivalent for FY2020 increased by $30 million to $144 million
And with that, Keppel REIT financial strength seems alright.
Notable Controversy (Ocean Financial Center)
Keppel REIT purchased Ocean Financial Centre from its sponsor in 2011. There was a great commotion at the time because the agreement only lasted for 99 years until 2110, despite the fact that the building has a 999-year lease.
Compared to Keppel REIT’s AUM at the time, this was a significant deal, driving many to question the alignment of interest between investors and the REIT manager. (As previously said, REIT managers are paid a fee for acquisitions, and with such a large deal, they undoubtedly earned a substantial sum.)
After seven years, Keppel REIT sold a 20% stake in Ocean Financial Centre to Allianz Real Estate. According to management, the divestiture allowed unitholders to realise a portion of the property’s capital gains, totalling $77.1 million, or an annual yield of 8.3%.
Was it truly beneficial to the unitholder? It’s entirely up to you to decide. But one thing for sure is that it benefited the REIT manager’s pocket since they received $2.7 million in disposal fees.
Sponsor
I have to mention this every time I analyse a REIT: excellent REITs usually have good backing. REITs can generally get lower interest rates on loans if they have a strong sponsor. Apart from that, it assures that the REIT has access to a pipeline of assets from which to acquire.
So, is Keppel Land Limited, the sponsor of the Keppel REIT and a subsidiary of Keppel Corporation, a good sponsor?
First off, Keppel REIT all-in interest rate currently stands at 1.97%, which may signal that the sponsor has some influence in the field.
What about the pipeline of assets? I’ve checked Keppel Land website and found that they don’t have many commercial assets that could be transferred to Keppel REIT. In Singapore, it only has 2 projects, Keppel Towers and i12 Katong, that is still under Keppel Land.
We have a lot more choices in China, as shown in the graphic below. However, because the REIT has not yet ventured into China, we may rule these properties out of the pipeline of assets Keppel REIT can acquire for the time being.
Apart from that, Keppel Land owns one or two properties in Vietnam, Indonesia, Myanmar, Malaysia, and the Philippines, which I do not believe the Reit will purchase at this time.
So is Keppel Land a reliable sponsor? I’d say it’s acceptable but not exceptional.
Keppel REIT’s Future Outlook
Office Demand likely to return, according to surveys
The pandamic has had a significant impact on how organisations see office spaces.
Working from home has become the norm for the past year due to existing policies. Many companies have gone virtual or shrunk their offices because they no longer need to accommodate all of their employees simultaneously.
However, even with the present pandemic, I believe there will still be a demand for office space in Singapore. Singapore remains an appealing destination to do business in, and many corporations continue to flock to the city-state to establish their regional headquarters. Technology giants such as BtyeDance and Alibaba have flocked to Singapore to fill the void left by downsizing companies.
According to a CBRE survey, while more companies are showing an interest in remote working, they still expect their employees to eventually return to the office, with over 66% of respondents planning to enable remote working for no more than 1 to 2 days per week.
Finally, a physical office location is still vital, especially for companies that wish to have a physical presence and cultivate a social identity for their employees.
According to the CBRE analysis, there will be a ‘Flight to Quality.‘ Not all office buildings are created equal, and as companies began to shrink, the study revealed a stronger preference for grade A office space. In 2020, the Grade A office market remained resilient, with a consistent vacancy rate of 3.9%, while the vacancy rate in the Grade B market has increased over the previous year.
Keppel REIT owns Grade A office buildings, which is fantastic. Having said that, management must continue to stay up with the current trend. While the forecast for the office market does not appear to be particularly bleak, things may change and management should be prepared.
Potential merger between Keppel and SPH REIT
The acquisition of SPH by Keppel would be the next component. If this deal goes through (which it most likely will), Keppel will own roughly 20% of both REITs, and we may look at the possibility of a future merger between Keppel REIT and SPH REIT.
SPH Reit’s portfolio comprises shopping malls like Paragon and The Clementi Mall in Singapore, whereas Keppel REIT’s portfolio includes office spaces. Who knows, they might construct a real estate investment trust, similar to Capitaland Integrated Commercial Trust.
More details:
Keppel REIT Valuations
So, how does Keppel REIT’s valuation look?
Before that, let’s take a look at how several commercial real estate investment trusts have done over the last five years. Warning: Not really good.
Excluding dividends, Capitaland Integrated Commercial Trust (orange) gained 1.42%, Keppel REIT (blue) lost 2.68%, and Suntec REIT (cyan) lost 14.70%.
Dividend yield
In terms of dividend yield, Keppel REIT annualised dividend yield is around 4.85% now. At this price, it is fairly valued given that its peers Capitaland Integrated Commerical Trust is giving 3.61% while Suntec REIT is giving 4.97%.
It is also near its historical average at current yield, which further cements that it is currently fairly priced.
Price to Book
Keppel REIT currently has a PB ratio of 0.83 which is between Capitaland Integrated Commercial Trust of 1.04 and Suntech REIT of 0.72.
I believe the quality of the properties differs for the different REITs, hence it is hard to say whether Keppel REIT is under or overvalued based on its peers PB.
However, we can look at its historical PB average, which Keppel REIT is currently trading at. At this level, we can further support that Keppel is fairly valued at the moment.
My Opinion
So, how do you feel about Keppel REIT? Here’s mine.
While the REIT appears to be reasonably priced from a valuation standpoint, the lack of growth and a history of misalignment between shareholders and management are the main reasons I would avoid it. Even at its present dividend yield, I feel there are other REITs that offer a similar income while being of superior quality. That being said, I’m going to pass on this one.
And what about the SPH shareholders, what should you do now?
Here’re some guiding questions for you:
- Where do you think SPH REIT and Keppel REIT will be in 5 years?
- Do you believe they will be able to overcome all of the pandemic and upcoming inflationary pressures in the short term?
- Do you have faith in the manager to look out for your best interests?
You’ll know what to do after answering these questions.
P.S. Chris Ng built a portfolio that allowed him to continue drawing a dividend income that feeds his family throughout covid. If you want to learn how to pick the best REITs, he’ll be sharing his method here.