First REIT: Not Out of the Woods Yet

Investors would naturally assume that some of the most resilient assets would be hospitals and clinics. Especially during a pandemic.

After all, countries are allowing essential services such as healthcare, food and beverage and data centres to continue operating, unlike many other businesses.

Many industries, such as hotels, travel and tourism, to name a few, have been adversely impacted.

That said, investors in First REIT (SGX: AW9U), an owner of Indonesian-based hospitals, have seen their investment shrivel by 40% year to date, as the REIT’s share price tumbled from S$1.00 to S$0.60.

The REIT’s portfolio comprises 16 properties in Indonesia (12 hospitals, two integrated hospitals and malls, one integrated hotel and hospital and one hotel and country club), three nursing homes in Singapore and one hospital in South Korea.

These assets were valued at S$1.34 billion as of 30 June 2020.

Being a healthcare-focused REIT, investors may assume that First REIT was not too badly impacted by the pandemic.

However, that assumption could be breaking down due to several recent events.

Rental support and property valuations

First REIT had to temporarily close its two shopping malls (integrated with its hospitals) apart from essential services for Lippo Plaza Kupang and Lippo Plaza Buton.

Both malls have resumed operations since 27 May.

For its two hotels, Hotel Aryaduta Manado and Aryaduta Country Club, these have been closed until further notice.

As a result of this financial stress, First REIT has granted rental relief of two months (i.e. May and June) amounting to S$19.6 million.

Further rental relief may be announced in the second half of 2020 depending on how the pandemic evolves.

The REIT issued a profit guidance due to these reliefs, warning that there will be material declines of 40% to 50% for distributable income and distribution per unit (DPU).

Also, the REIT manager highlighted that there may be uncertainty with regards to property valuations for the portfolio as valuations are only conducted once a year (at fiscal year-end).

Carrying amounts of the assets have not accounted for the impact from the COVID-19 pandemic and could result in downward revisions in asset values.

Gearing ratio for the REIT stood at 34.9% as of 30 June 2020, and the Monetary Authority of Singapore had raised the gearing limit for all REITs to 50% in light of this crisis.

If the property values face a significant decline, it could bump up the gearing level and make it tougher for the REIT to undertake acquisitions (using debt) or to borrow more.

Looming lease expiries

The REIT’s weighted average lease expiry (WALE) as of 30 June 2020 is seven years.

However, around 22% of the portfolio’s master leases by gross floor area is set to expire in the second half of 2021.

The REIT manager continues to engage the tenants for the renewal of these leases, but with the pandemic raging, the rental rates may likely be negotiated downwards.

Potential rental restructuring

The biggest risk, though, to the REIT’s income stream is the potential rental restructuring process that PT Lippo Karawaci Tbk (IDX: LPKR) intends to initiate.

As a recap, the bulk of First REIT’s portfolio is operated by PT Siloam International Hospitals Tbk, a subsidiary of Lippo Karawaci.

In early June, Lippo announced that it was seeking to renegotiate its rental agreements with First REIT as COVID-19 has significantly impacted Siloam’s revenues and led to a drastic decline in patient volumes across Indonesia.

Siloam’s revenues fell by as much as 40% to 50% year on year in some hospitals, and the dire situation has forced Lippo to cough up additional rental support to guarantee a certain rental income level for the REIT.

Should the restructuring result in a significant decline in rental rates for First REIT’s 16 hospitals, it could materially impact the rental income for the REIT moving forward.

Get Smart: Not in the clear yet

First REIT announced in its first half 2020 earnings that rental and other income fell 33% year on year to S$38.6 million.

The distributable amount and DPU plunged by 46% and 46.5% year on year, respectively, in line with the REIT’s earlier profit guidance.

Unitholders looking for some respite may not be getting any anytime soon, as the above challenges continue to exert an overhang on the stock.

DPU will also continue to be under pressure in the near-term.

They should continue to monitor First REIT for material developments on the above issues.

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