Keppel REIT has been in headlines recently – not for reasons I personally would hope for.
What struck me was this Singapore REIT’s series of surprising moves – the dilutive purchase of MBFC Tower 3, acquiring a 75% stake in an Australian retail mall and announcing to diversify up to 20% of its portfolio to retail assets.
So far, shares have been going nowhere. And general sentiments haven’t agreed with Keppel REIT’s moves.
To be perfectly honest, Keppel REIT is kind of stuck in a place I don’t like to be in.
With current 5-6% dividend yield, is this Keppel REIT still a buy today?
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Why is Keppel REIT diversifying into retail?
First things first, I can understand why management feels compelled to do this.
Singapore’s offices are near peak valuations. Growing unitholder’s value is becoming harder.
I mean, its recent MBFC Tower 3 acquisition was dilutive precisely because Keppel REIT had to buy this asset from Hong Kong Land at a high valuation.
When property prices are high, the yield on current market values is often not enough to justify the funding cost. This results in a unitholder dilution.
Obviously, this explains why Keppel REIT is looking at diversifying overseas for growth. But what I struggle to understand is why retail.
Retail properties are brutal unless you already dominate prime locations (think Frasers Centrepoint Trust and Link REIT).
The best landlords have locked up these locations in their respective home markets. What’s more, these established property operators have deep, local expertise.
Sure, buying Australian retail may quickly boost DPU. But this instant gratification risks becoming a collection of unrelated assets, rather than a focused REIT strategy.
In my personal view, foreign entrants usually end up buying “secondary assets”, or what’s left, or normally at much higher valuations. However, this alone isn’t my real concern.
The big problem with Keppel REIT
The real concern is Keppel REIT’s debt. As a practical matter, Keppel REIT is absolutely handcuffed by its high gearing ratio.
To put things in perspective, recall, when Keppel REIT got listed in 2006, Keppel injected office assets into the Singapore REIT at much lower low cap rates – meaning high valuation.
That left little room for capital appreciation for unitholders right from the start. The outcome was predictable.
Shares of Keppel REIT went nowhere after the 2007 global financial crisis. There was no valuation upside to unlock.
Today, this same constraint still exists. Keppel REIT will continue to pay steady rental income from its current offices. Except, Keppel REIT now wants to expand its properties by adding up to 20% of its portfolio to retail assets.
This means it must raise new capital. It’s really not hard to imagine. At current gearing ratio, Keppel REIT can raise another ~S$1.2 billion of debt before hitting MAS gearing ratio limit. But it can’t just raise debt only.
To meaningfully increase its retail asset exposure, given its total assets of ~S$8.4 billion, it must also issue new shares to keep up with future acquisitions. And you can’t ignore the fact this could force a dilutive effect on the REIT.
In other words, there’s little wiggle room for Keppel REIT to grow its current high-quality portfolio assets. And it must carefully raise both debt and equity in balance.
You see, Keppel REIT has one of the best Grade-A offices in Singapore. But I’m not optimistic it’s now stuck between a rock and a hard place.
The good news is Keppel REIT’s debt maturity profile is still well-staggered across the next few years…
Keppel REIT still a “bond-like” dividend payer
At current 5-6% dividend yield, Keppel REIT’s biggest pluspoint is its bond-like income secured by high-quality Singapore office assets.
In fact, over the past years it has been paying steady dividends. Not too bad for the long-term investor.
However, based on Keppel REIT’s high debt and pivot toward retail, going for growth is going to be very, very tricky from here.
My final thoughts
The good thing is with Fed cutting interest rates, this would be a tailwind for Keppel REIT to acquire properties.
However, the meat of the problem is Keppel REIT’s already high gearing ratio, considering this could force the Singapore REIT to dilute shares just to acquire new retail assets.
Not a big problem for investors with deep pockets. But it could be frustrating to keep participating in new share issues.
It’s not unusual for Singapore REITs to diversify their assets. But it also has to be within an investor’s circle of competence.
Having said that, Keppel REIT’s competitive advantage is its portfolio of high-quality, grade A office assets.
Can it become a retail landlord? Sure. But good enough to make unitholders happy in the long-term? Don’t be so sure.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan
