The much awaited announcement by the Securities Industry Council (SIC) that the Singapore Code on Takeovers and Mergers will apply to Reits

The much awaited announcement by the Securities Industry Council (SIC) that the Singapore Code on Takeovers and Mergers will apply to Reits (real estate investment trusts) came late last week. This makes a consolidation in the Singapore Reit (S-Reit) sector easier, although there are unlikely to be many immediate mergers.

The run-up on the Singapore Exchange (SGX) in the past year has eased the pressure on even the poorer-performing Reit managers. It would have been a different story had the takeover code been extended to Reits last year. Back then, some S-Reits were trading below their initial public offer issue price, putting pressure on those Reit managers seen as not delivering returns to unit holders, and making their Reits ripe for takeover by rival trusts. The stock market will inevitably quieten down at some stage, renewing the pressure on the weaker Reits.

Another point to note is that Reits are relatively new instruments to investors here. The first Singapore Reit, CapitaMall Trust, was floated just five years ago.

CapitaMall Trust is run by a strong management team that has delivered growth, which has helped enchant local investors with the idea of Reits as a class. Some new Reit issuers, even those with weaker growth stories and managements, have been able to ride on this positive sentiment.

As the S-Reit market matures, however, investors will become more discerning, with the smart money leaving some of the less well-run Reits. As the unit prices of such Reits fall, they will become more liable to takeover.

Potential Reit acquirers will have to be sure of improved results from a merged company, possibly by extracting greater value from the assets of the Reit they take over. If this does not happen, the merged Reit could itself be a takeover target.

Mergers and acquisitions (M&As) among S-Reits will become inevitable only when saturation point is reached and there are no further growth avenues for Reits other than acquiring rivals. That has been the case in markets like Australia.

As Goldman Sachs said in a note this week: ‘Singapore’s Reit market . . . is still relatively young and has abundant opportunities to acquire (properties) in Singapore and abroad . . . Singapore Reits, many with developer sponsors to provide a pipeline of acquisitions, are far from reaching a point where the potential to grow assets substantially can only be via M&As.’

The investment bank does not expect M&As to be a major theme in the S-Reit market over the next 12-18 months. Indeed, it expects more new Reit listings and secondary equity raisings to fund asset acquisitions to be the major theme for the rest of 2007 and in 2008.

In the longer term, though, Goldman Sachs does see consolidation as a major theme.

This could be in the form of bigger players making hostile raids on smaller players or Reits merging to bring about economies of scale. There may even be parties that could attempt to take public-listed Reits private. Goldman Sachs suggests that Reits with fragmented shareholdings - such as Suntec Reit or MacarthurCook Industrial Reit - could become potential takeover targets.

Market watchers reckon that one factor that could fuel M&A activity in the S-Reit sector, even in the short term, is the sheer liquidity being created by overseas investors keen to get their hands on a piece of the action in the Singapore real estate sector.

A consolidation of the S-Reit sector, when it takes place, could mean a higher quality of S-Reits. But even with mergers, new Reits will still be created. Many players are keen on floating Reits here, given the tax savings - Reits do not pay corporate tax at the vehicle level if they distribute all their income to unit holders. That has created a great financial incentive for property owners to put their assets into Reits.

This rule, and other Singapore Reit guidelines, are seen as making these property trusts among the most attractive in the world.

In either case - the merger of existing Reits or the creation of new ones - there will be handsome fees for the investment banks, in addition to the fees for the Reit managers themselves.

These factors provide fertile ground for breeding S-Reits of varying quality - but a consolidation leading to weaker Reits being acquired by stronger players will strengthen the S-Reit market.

Last Friday’s announcement sets the stage for that.

Source: The Business Times, 14 June 2007