Anticipating, accelerating, accentuating

Source : Business Times – 22 Aug 2009

CapitaCommercial Trust shares its ‘triple-A strategy’ for riding through challenging times
FOR a sector that looked extremely vulnerable during the worst of the credit crisis, most real estate investment trusts (Reits) in Singapore managed to turn in steady results in the second quarter of this year.

CapitaCommercial Trust (CCT) was one that met or exceeded analysts’ expectations. Riding on higher rental income and better operating margins, its Q2 distributable income and distribution per unit (DPU) each rose around 33 per cent from a year ago.

But are the skies clear for Reits? Analysts have flagged other challenges to maintaining distributions in a subdued economy – rents are likely to keep sliding and acquisitions may still be hard to carry out.

CCT adopts a ‘triple-A strategy’ in such times, says Lynette Leong, CEO of trust manager CapitaCommercial Trust Management. ‘We anticipate, accelerate and accentuate.’

Debt refinancing

Some Reits borrowed to buy assets in recent years, and funding became a big concern after credit markets froze. According to a DBS Vickers report in December last year, the sector had some $4.9 billion due in 2009 alone. CCT saw credit illiquidity coming and prepared for it, says Ms Leong. ‘We looked at our debt maturity profile and saw there were large chunks of debt due for refinancing. Anticipating the credit weakness ahead, we refinanced the debt well ahead of maturity and at relatively attractive terms.’

CCT had about $740 million of debt maturing in 2009 but had completely refinanced it by June this year, she adds.

Besides CCT, several other Reits rolled over their debt or raised cash through rights issues. The broad demonstration of funding availability has eased market fears.

But one other dark cloud looms – the prognosis for the office sector is bleak because of weak demand for space during the downturn, as more supply comes on stream. Prime office rents here have plunged almost 50 per cent from the peak in Q3 2008.

But CCT prepared for this. ‘If office rents decline, distributions will decline as well,’ says Ms Leong. ‘We had to see how we could supplement our income.’

To expand its income stream, CCT acquired One George Street for more than $1.1 billion last year.

The Grade A office building was a ‘compelling’ buy because it fitted well with the existing portfolio, she says. Also, the seller and trust sponsor CapitaLand offered five-year yield protection until July 2013.

Lease renewals

Expecting rents to soften, CCT also engaged tenants to renew their leases early, Ms Leong says. ‘The intent was to lock in rental income in advance and maintain a high occupancy rate. This in turn helps to maintain a well-spread lease expiry profile so there is no lumpiness in any given year.’

For instance, as at June, CCT had renewed more than half of the leases expiring this year.
CCT is also working to rein in costs. It has deferred non-critical capital expenditure and obtained bulk discounts on utility charges. The efforts are showing through improved operating margins – for the first half, net property income rose 42 per cent year on year as gross revenue grew 36 per cent.

CCT also has a pro-active capital management strategy, says Ms Leong. The trust raised $828 million through a rights issue in June and used $664 million to repay debt. It also earmarked a significant portion of the balance to further reduce borrowings. This will lead to a drop interest costs.

The move has cut CCT’s gearing to 31 per cent. ‘Market conditions are still uncertain,’ says Ms Leong. ‘We don’t know what’s going to happen next year, so the most prudent way is to de-leverage and maintain our gearing at the low end of our target range of 30-45 per cent through market cycles.’

Lower costs are critical to offset any decline in revenue from weaker rents. Some analysts are expecting negative rental reversions in 2010 as leases signed at the peak of the property market come up for renewal. ‘While rents – the top line – may decline, if we’re able to save on operating expenses and interest costs, then we are able to deliver on the stability and DPU,’ Ms Leong says.

Tenant retention

Then there is customer service, which contributes to tenant retention and ’should not be compromised, especially in weak market conditions,’ she says. As part of its customer service focus, CCT’s property manager has ISO 14000 and S-Class service certifications.

While Singapore’s economy may have got through the worst, ‘we are still not completely out of the woods’, Ms Leong reckons. As a result, CCT will remain cautious about expanding its portfolio. ‘Any immediate acquisition will be counter-productive to our rights issue,’ she says. ‘We will continue to monitor the markets for acquisition opportunities but will not proceed unless there is certainty of market recovery and the acquisition is compelling.’