Analysis of SUNTEC and KEPPEL REITS

With stronger balance sheets, REITS in Singapore are expected to become more aggressive as they seek to increase their earnings growth by capitalizing on lower asset valuations. The attempts to escalate growth increases risks of some REITS considered as weak economy fundamentals in Singapore and China. It also weighs on the demand as most sectors add supply. The REITS in the hotel industry is expected to decline in the future, but in slower pace as compared to the last two years.

Country Context

Keppel REIT is situated in Singapore, with investments allocated largely in Singapore. In addition, Keppel has investments in Australia, China and countries in the Eastern Asia region. The local market rental and capital value recovered in Singapore in 2014 was attributed to the emergence of positive climate and strengthening demand. Keppel REIT has an ongoing leasing effort that has resulted in achieving strong occupancy levels for its portfolio and properties (Analysis of Keppel REIT n.p.). The overall occupancy level in the year 2015 was at 99.3 percent as compared to average Singapore committed occupancy of 99.5 percent (Analysis of Keppel REIT n.p.). The figures suggest that the occupancy at Keppel properties corresponded to the market performance. The value of the properties at Keppel REIT increased from $7.2 billion in 2013 to $8.2 billion in 2014 (Analysis of Keppel REIT n.p.). Furthermore, approximately 16.8 percent of the committed rental gross income leases are to be renewed in 2016. The local market jurisdiction and enforcement in Singapore is favorable for Keppel’s operations. As compared to other countries in the East Asia, Singapore has one of the best enforcement laws and regimes in the region.

Property Type

Keppel has most of its properties in the high end office REIT. Although many of its tenants may vacate as they seek to cut their costs, it has a stable income generating office assets. Both Suntec  and Keppel REITS operate high end office properties. Keppel has over 78 percent of its office properties being occupied by banks, while Suntec REIT has only 47.5 percent of its high end office properties occupied by banks. Suntec has a 16 percent office portfolio rented by trading industry, and 14 percent by the information and telecommunication. Suntec REIT office portfolio is unlikely to suffer a massive loss of rental income due to vacation of a major tenant because they are diversified within the fourteen business sectors. Over 63 percent of the gross revenue from office is obtained from banking, insurance, financial services, and trading. In 2015, rent from food and beverage sector contributed 47.6 percent of the gross revenue of Suntec. The number is significantly higher as compared to only 17.3 percent of Keppel’s total gross revenue. If the two companies are to be rated based on diversification of rental tenants, the Suntec would be the leader owing to its performance in the market. However, when it comes to hotel ownership, both Keppel REIT and Suntec REIT have no business; it is a fact that is largely attributed to their tendency to want to concentrate on property portfolios (Analysis of Keppel REIT n.p.).

Leases

The lease expiry profile for Suntec REIT is comparatively healthy. Based on the 2014 December data, the leases that expired in 2015 were 0.7 percent, while the ones that were to expire in 2016 were 32.8 percent, 34.5 percent of all leases were to expire in 2018 and beyond. The data suggests that Suntec has a surety of the free future cash flows, which will score the company a lot in asset adjusted cash flow cushion score. Keppel REIT has a number of long-term leases; for example, the weighted average lease to expire is 7.5 years as compared to the industry’s average of 6.8 years. The high weighted average lease to expire is perceived by the credit rating bodies as favorable, because Keppel REIT is less likely to face risk of vacancy.

The tenors in the hotel REIT has always been shorter; however, the two REITS (Keppel and Suntec) have lower hotel REITS in their portfolios. The lower REITS implies that they both have longer periods of steady cash flow. The growth in contracted rent leases has resulted in averagely rising operating income, as existing leases increase due to improving performance of economy. The attractive and proactive leasing marketing efforts have made Keppel more attractive in the market, helping them to achieve a rare 100 percent tenant committed occupancy rate. Keppel has been a leader in innovation in the market, making it one of the best sought-after RIETS in the media and technology industry. The space booked or taken up by customers in 2015 almost doubled compared to 2013 as many companies sought to relocate to prime business areas. The significant rise suggests that more tenants believe in Keppel, hence increasing credit ratings. Keppel REIT is offering one of the best lease profiles in the market, providing stability to any eventuality of rental reversions. Keppel has a WALE of 2.9 years on co-location as compared to 2.5 years average market ratio, while the double or triple net lease has an average WALE of 10.8 years. The fixed escalation on co-location has a rental rate of 4 percent, which is almost the same as the market average of 3.6 percent. SUNTEC has nearly the same features on tenor as Keppel; however, it has WALE of 3.0 years on co-location and 12.1 years on triple net lease. The factor gives both REITS strong credit worthiness as they have steady future cash flow.

Sponsor

The sponsors of REITs play crucial roles in ensuring the REITs have the support that they need in different markets. There are several advantages of having a well-known sponsor when sourcing the credits. For instance, a financial institution is likely to be more than willing to assist or to lend because of the good relationship that they have with the sponsor. Both Suntec and Keppel have private sponsors, which ensure that they receive the necessary financial support. The sponsor of Keppel REIT is Keppel Land. It is one of the Asia’s large property companies that have been known for its award winning residential developments and commercial property investments. The company has strong corporate governance policy and good geographical representation in Singapore, Vietnam, Indonesia, and India (Keppel REIT 13).

Being an established sponsor, Keppel Land enabled financial support for Keppel REIT. As one of the respected sponsors in the market, Keppel has an advantage over other REITs. Suntec has Suntec City Development as its sponsor. Suntec City Development was incorporated in 1988; it is the single largest privately owned commercial development in Singapore. It is also funded by Asia’s best entrepreneurs in the 21^st century. As sources of credit and equity, the two reputable sponsors have contributed through the years to the ability of Suntec REIT and Keppel REIT gain strong credit ratings (S-REIT Investor n.p.).

Capital Structure of REIT

Capital structure can be used to analyze the credit worthiness of a REIT. For the highlighted cases, the capital structure of Keppel REIT and Suntec REIT are assessed using gearing ratio and diversification of funding sources. Gearing ratio of a REIT is the financial method that compares capital to borrowed funds. It is most often used as a measure of REIT financial leverage. In addition, it shows a degree, to which REIT activities are funded by sponsor and unit holders’ funds. In the current case scenario, the gearing ratio of Keppel stood at 38.5 percent as of 30 July 2015. The 38.5 percent score is considered one of the highest ranking office and commercial RIETs in the market. The gearing ratio could be compared to the average in the industry, which was 36.6 percent. Comparatively, Suntec RIET had a gearing ratio of 38.3 percent in the same period, which is among the best performing RIETs in Singapore. The gearing ratio of the two RIETs above shows that they are well managed, hence their credit ratings are likely to improve. Consequently, the better managed RIETs have resulted in high investor confidence and credit rating.

Diversifying funding sources in REIT is finding different ways of financing. Keppel has consistently diversified its sources of finance; it ventured into the traditional income from rent and funds from sponsors and maiden issuance of a 7 year $50 million MTN at a fixed rate of 3.15 percent per annum repayable in 2022. The achievement is additional to gross borrowing of $3,544 million that is due in 2016. The ability of Keppel to get funding easily depended on its credit ratings, which are derived from the healthy borrowing trends. On the other hand, Suntec REIT received approval of OCBC securities to get a loan with a low margin of 3.5 percent from 6.5 percent, which is affirmation that the credit rating of the company is strong. The analysis shows that both Keppel and SUTEC have strong credit ratings, which are based on their ability to collect funds from different sources of finance (Keppel REIT 8)

Coverage Ratio for REITs

Coverage ratio can be used as one of the key factors in credit analysis on REITS. The major components of REITs as credit analysis are stabilized cash flow assumptions, fixed versus floating interest assumption, and impact of interest rate swap and swap fees. In brief, coverage ratio is the ability of the REIT to service its financial obligations. Keppel REIT has an interest coverage ratio of 4.6 times as of March 2015. With the higher maintenance of tenant retention rate of 96 percent, and 9 out of 10 completed offices achieving 100 percent occupancy, there is the conclusion that revenue will continue incoming from rent.

Suntec REIT has opted for both fixed and variable interest rates depending on the nature of the borrowing. The fixed borrowing is 72 percent and variable borrowing is 28 percent (Suntec, 16). Keppel, on the other hand, has an interest composition of 65 percent fixed interest rate, and 35 percent variable interest rate. The rates show that both RIETS are trusted by the financial and credit institutions and the management of the two companies can negotiate interest rate in their favor without difficulty. In an example, in 2013, the interest composition of Keppel REIT was at 47 percent variable and 53 percent fixed interest. The figures are depictive of the fact that the corporation is trusted in the market, and can negotiate any interest composition that suits them (Keppel REIT 28). In Q3 of 2015, Keppel REIT maintained an average cost of capital at 2.5 percent despite a high federal rate of 5.7 percent through interest rate swap. The analysis shows that the credit rating of both REITS is stable to secure them an interest rate swap.

How It Works

Liquidity Coverage for REITs

The other key credit analysis factor is liquidity coverage. Liquidity coverage includes highly valued assets held by REITs to meet short term financial obligations. Suntec REIT had a security deposit of $19,157 to borrow as liquidity coverage in 2013. However, the number reduced to $12,479 as a result of amortization of the loans, suggesting that the credit ratings of Suntec REIT was not satisfactory for the financial lending institutions to issue the short-term loans (Suntec 61). Keppel REIT secured a bank loan worth $638,980,000 down from $888,642,000 secured by an investment portfolio, with an interest that ranged from 0.79% to 0.93% upon maturity; and unsecured loan of $ 540,138,000 from $882, 642,000 on fixed interest rate of 1.85%. The amortization of loans shows that the credit ratings of the two REITs decreased, forcing banks to reduce lending short secured and unsecured loans (Keppel REIT, 26). The uncommitted liquidity lines available in the banks were used by REITS, foreign exchange market and risks of settlement, for example written and forwards options were employed by Keppel and Suntec under uncommitted facilities. For a financial institution to offer the uncommitted facilities, it has to possess a high level of trust.

Debt Maturity Profile

The tenor of Suntec REIT is five years and below, the company prefers short-term bonds. The bond that matured in 2013 was taken in 2008, with a tenor of 5 years. The current bond was acquired in 2013 and will mature in 2018, another tenor of five years. The initial conversion premium for the bond is 20 percent over reference share price. The redemption price of the bond is 100 percent of the principle amount. The bond value in 2018 is $280 million, and the carrying amount as of 2015 was $263 million dollars (Suntec REIT 1). On the contrary, the financial statements of Keppel REITs do not show that it procured any bond; the liabilities reported in the Keppel financial statements are long-term secured and unsecured loans (Keppel REIT 14). It can be deduced that the credit ratings of Suntec REIT is a stronger than Keppel REIT. The reason is that the holder of the beneficial interest in the bond (who is not known to the public) has trust that Suntec REIT is a going concern.

Unencumbered Assets

Unencumbered property or asset is a free and clear of any claims from the creditors or liens. The properties or assets are easier to dispose of, than one with encumbrance. As of 31^st December 2014, the unencumbered assets were 28 percent of total assets held by Keppel REITs. The number means that Keppel could use 28 percent of the unencumbered assets to source the finances in case of needs (Moody n.p.). According to Suntec 2014 financial statements, the unencumbered assets held as at the time were 24 percent of the total properties, which means that 76 percent of the properties were encumbered or charged to different financial obligations. As Keppel continues to unencumber its assets, it creates a direct relationship between the percentage of unencumberement with financial and strategic flexibility. Concisely, it results in Keppel being more credit worthy as compared to Suntec REITs (Moody n.p.). However, Suntec REITs is better when compared to other industry place in the market, which has average unencumbered assets of 119.4 percent.

Banking Relationships

Suntec REITs have relationships with many banks across Asia, Australia, America, and Europe. It has cooperated with Deutsche Bank from Germany, DBS Bank from Singapore, and Citigroup Bank, which is an international financial institution (Suntec 83). It is a strong financial indicator that proves good reputation. Keppel REIT also works with banks to ensure that all its transactions are smooth. The banking nstitutions that Keppel work with includes Citibank in Singapore, United Overseas bank, and Bank of Singapore. The aforementioned financial institutions are organizations of good repute. Thus, the relationship shows that Suntec REIT and Keppel REIT work smoothly for several years without issues, which shows that their credit ratings are sound.

Conclusion

REITs are increasingly becoming attractive in Singapore; the REITs industry yielded an average of 5.4 percent. However, both Keppel and Suntec REITs yielded above the average market rate. Keppel yielded 7.8 percent in 2015, while Suntec reported 5.83 percent. Both Keppel and Suntec REITs have a gearing ratio of 38.8 percent and 38.5 respectively. The companies have been in competition with Fraser Commercial in the SGX market. The case analysis suggests that both REITs are similar in terms of credit worthiness; consequently, it is advisable for an investor to buy both Suntec and Keppel for long-term projections, because they increase as the Singapore economy strengthens.