Simon Garing, CEO of Cromwell European REIT’s (CE REIT) manager, is keen to point out that the REIT has been well-rated in Singapore Corporate Governance scores, such as Governance Index for Trusts or GIFT, and GRESB.
“Because we are a REIT with a foreign sponsor, you need the trust of the investors. So we need to show our numbers and performance because this is how you get investors to trust you,” Garing says. “Since we listed, we have been in the top 10 in GIFT — we’re now number 4,” Garing points out. “In terms of disclosure and how we convey our information, we rank very high, and this is feedback from investors.”
Since its IPO in 2017, CE REIT has traded mainly at a discount to its net asset value (NAV). As at Jan 10, its unit price is at EUR2.53 ($3.60), a few cents above its latest reported NAV of EUR2.49. In May 2020, the manager and sponsor decided that both the base fee and the property management fee would be fully paid in cash from 1Q2020 onwards, as compared to 100% and 40% in CE REIT units previously.
“Traditionally, Singapore REITs pay out part of their fees to the sponsor [in units], out of capital and not out of earnings,” Garing argues. It is not in the interest of unitholders to pay out of capital, he says. Garing adds that if the payout is 100% of distributable income — which some REITs pay out — the actual distribution would be higher, of say 110%, should units be used to pay for management fees, and this would be from capital.
“During the last two years with Covid, the REITs have been trading below NAV and have been issuing units below NAV. A lot of our investors applauded what we did although DPU [distribution per unit] fell. The DPU we pay out is not out of capital. If you do that in the long term, you end up with no capital left,” Garing says.
Yet, Garing has no qualms introducing a distribution reinvestment programme (DRP) for minority unitholders who choose to take their distributions in units. In fact units issued for payment of fees and payment of distributions add to capital, and to the number of units giving the REIT a larger equity base.
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REITs pay distributable income after expenses, which include both property management fees, base fees and performance fees (performance fees are only paid once a year). At any rate, because REITs have a very simple capital structure in that they do not record retained earnings, REITs’ NAV usually fall after the payouts. So it makes little difference whether the fees are paid in cash or units. The difference is in the alignment of interests between REIT and sponsor. If the sponsor is paid in units, there is greater alignment of interests.
“The sponsor participated in the rights issue. It’s not allowed to take part in private placements, so it’s stake has been diluted from 35% to 28%,” Garing explains. CE REIT — which listed in 2017 — had a rights issue in 2018, to raise EUR224.1 million. Since IPO, the REIT has had at least two placements.
Sponsor was subject of tussle
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In 2015, sponsor Cromwell Property Group acquired a management company, Valad Europe, for EUR145 million, a fund manager with assets under management of EUR5.3 billion with 24 mandates across 13 countries. CE REIT was listed on the Singapore Exchange in 2017 with 74 properties valued at EUR1,354 million.
The year 2018 was a turning point for Cromwell Property Group. Redefine, a South African company that was the major shareholder of the company had to divest its stake because of the falling rand. ARA Asset Management bought an initial 19.5% stake for A$405 million. As ARA tried to collect a larger stake, a board tussle developed between the management led by former CEO and founder Paul Weightman and ARA. In 2019, following a bruising battle, ARA gained control of Cromwell Property Group.
In a twist, ARA itself has been acquired by ESR Cayman in a largely share transaction. Where does that leave Cromwell Property Group and CE REIT? All Garing would say was a repeat of what happened in 2018.
“Redefine acquired the stock in 2011 and got to 23% of the register. With the collapse of the rand, ARA acquired its stake, paid the price, bought the stock,” Garing confirms.
In 2020, CE REIT announced that it planned to raise the portion of light industrial and logistics assets to 50% of assets by valuation. It has not escaped market watchers that CE REIT’s new sponsor is focused on new economy assets — mainly logistics, data centres and life science assets. “We started reconstituting in 2020,” Garing points out.
On Jan 5 this year, CE REIT’s manager announced the acquisition of three light industrial and logistic properties in the UK and the Netherlands for EUR57.8 million. In an announcement, the manager says the purchase price is a 3.9% discount to the valuation At this price, net operating income yield is 5.6%, the announcement says. The acquisition is likely to be part-funded by $100 million of perpetual securities raised in 2021.
The Singapore dollar perps are priced at 5%, but the REIT entered into currency swaps to convert the Singapore dollar perps into the Euro at 3.55%. Garing proudly says the swap is accretive to perpetual security holders. CE REIT’s swap consisted of a green forex swap with Oversea-Chinese Banking Corp.
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“We get lower interest rates should we hit green-related milestones,” Garing says. The REIT’s total cost of debt as at Sept 30, 2021, was just 1.6%; its aggregate leverage stood at 37.8% and interest coverage ratio at 5.8 times.
Logistics assets in demand
According to the Jan 5 announcement, the three properties are fully-let on long-term single leases (with blended weighted average lease expiry of nearly eight years) to three high-quality tenant-customers. The acquisition takes CE REIT’s portion of light industrial and logistics assets to 41% of total assets, up from 39%. Commercial property falls to 54% from 56%. The remaining 5% — others — comprises hospitality and retail.
Logistics assets in Europe are in demand and experiencing a contraction in capitalisation rates. Vacancy rates are low in Western Europe. For instance, vacancies in places like Germany and Denmark are down to 2% as at end-September last year.
“Cap rates are still higher in logistics [than office]. There is a 50 basis point gap,” Garing says, acknowledging that in the Netherlands, logistics is more compressed than office. “If you look at yields and rents, where you have lower cap rates, [you get] higher market rent growth and a good return,” he adds.
CE REIT’s strategy is to buy properties with higher vacancy rates, and below replacement cost. “We are keen to buy below replacement cost. It’s difficult for other developers to build near us and we are better protected,” Garing says. In addition, if the REIT buys with a vacancy, it is cheaper, and then the REIT gets the upside when the vacant space is leased out.
“We buy assets with vacancies because we’ve a strong asset management team on the ground,” Garing says. “We have bought assets at 50% vacancy, but it’s typically around 80% to 85%. We have a blend of core assets and some core-plus where we need capex to reposition the building but we are confident of their ability to lease out.”
Moving east
In December 2020, CE REIT announced the proposed acquisition of 11 logistics properties for EUR113.2 million, the Czech Republic and Slovakia. Of these, six were in Czech with five in Slovakia. Increasingly, Western European economies are moving east to take advantage of lower land and labour costs. Both Czech and Slovakia are linked to the German and other Western European economies. Slovakia is the auto supplier for many European manufacturing companies.
“Places like Poland and Czech are used for near-shoring as companies look for lower labour costs in a cultural setting that is similar to Western Europe. They are lowrisk geographies to outsource. They have stable economies and safe, regulatory frameworks,” Garing says. Property yields are higher and CE REIT acquired the Eastern European portfolio at a net operating income yield of 6.7%.
One of the properties, Uherské Hradištê Alfa CZ Asset, is situated near Uherské Hradištê, a town in South Moravia. Its only tenant is Forschner, a German manufacturer of precision parts, electromechanical components, cabling systems and onboard wiring systems for commercial vehicles for clients such as Audi, BMW, Bosch and Daimler.
The Slovakian properties are generally well situated. For instance a couple of properties are in Lovosice, an important transportation hub in Slovakia. Lovosice is situated on the D8 motorway, which is part of the European E55 route. Lovosice is also a cargo port on the Elbe River connecting to Hamburg and sits on the Prague–Dresden route railway corridor connecting Budapest, Vienna and Berlin. It also has an important high-speed railway station and includes a large container terminal and a marshalling yard.
Cromwell Property Group has a team in Europe through its acquisition of Valad. That enables the sponsor to assess the risk-reward metrics of the Eastern European properties. As Garing sees it, the yield of 6.7% is superior to similar class properties in Western Europe where yields are a lot more compressed.
“We have a competitive advantage because very few [Asian REITs] have investment managers within Europe, including people on the ground in these smaller European countries,” Garing says.
The other advantage for CE REIT for the time being is that the European Central Bank (ECB) is on a separate timetable viz-a-vis the US Federal Reserve. The ECB has indicated there is no change in interest rates till 2023, unlike the Fed which has communicated at least three rate hikes this year. US investment banks like Goldman Sachs are forecasting up to four rate hikes this year and this will inevitably impact risk-free rates for REITs including S-REITs.
For European assets, with the ECB on hold, cap rates and cost of debt are unlikely to change. As a result, Garing’s aims for CE REIT to be an income-driven REIT with the ambition to grow net property income and DPU in the long term should meet with little resistance. Now, only if the manager and sponsor agree to taking fees in units to make for better alignment of interests, the REIT could have a lower cost of capital.
