From its initial public offering (IPO) in 2007 till 31 July 2018, this real estate investment trust (REIT) has produced an annualised total return of 20.6%. At that rate, your money would double every 3.5 years.
The phenomenal return has real backing. Since 2007, the REIT’s gross revenue and net property income have each grown by 14.7% per year. Its distributable income has increased from S$19.3 million in 2007 to S$66.7 million in 2017, an impressive annual growth rate of 13.2%.
The REIT I’m talking about is First Real Estate Investment Trust (SGX: AW9U), Singapore’s first healthcare REIT. First REIT currently owns 20 properties — mostly healthcare-related — that are located in Indonesia, Singapore and South Korea. In Indonesia, it has 16 assets.
First REIT’s past growth has been great. However, there’s one risk investors should be more wary of going forward, and it involves First REIT’s sponsor, PT Lippo Karawaci.
Key tenant risk
Lippo Karawaci, which is also Indonesia’s largest listed property company by total assets and revenue, is First REIT’s key tenant. In 2017, the property outfit contributed 82.4% of First REIT’s rental income.Source: First REIT 2017 annual report
All of First REIT’s properties are on master leases, and the Indonesian properties are mostly master leased to Lippo Karawaci. The Indonesian tenants pay their rent in Singapore dollars. So, there is no foreign exchange risk for First REIT, which reports its financials in Singapore dollars.
Currency exposure for Lippo Karawaci
However, there is currency risk for Lippo Karawaci. On Wednesday (19 September), Moody’s downgraded the corporate family rating of Lippo Karawaci to B3 from B2, with the rating outlook at negative. The rating outlook signals the potential direction for future rating changes.
Moody’s said that the downgrade “reflects our expectation that Lippo Karawaci’s operating cash flows at the holding company level will weaken further over the next 12-18 months, such that the company’s ability to service its debt servicing obligations will be subject to its ability to execute asset sales.”
Lippo Karawaci recently proposed two divestments: a) a full sale of its shareholding in First REIT’s manager, Bowsprit, to OUE Ltd (SGX: LJ3) and OUE Lippo Healthcare Ltd (SGX: 5WA); and b) 10.63% of its total unitholdings in First REIT to OUE Lippo Healthcare.
The divestments should inject some cash into Lippo Karawaci, but Moody’s said that the sales do not “address the fundamental weakening of Lippo Karawaci’s operating cash flows.” Without the ownership over Bowsprit and a lower stake in First REIT, Lippo Karawaci would no longer receive management fees from Bowsprit and is also entitled to lesser distributions from First REIT.
Lippo Karawaci’s debt is mainly denominated in US dollars while its cash flow is in Indonesian rupiah. A strengthening of the US dollar against the Indonesian rupiah could put further strain on Lippo Karawaci’s business — with a weaker rupiah against the dollar, Lippo Karawaci has to pay higher interest expenses.
The Foolish takeaway
To be sure, the risk surrounding Lippo Karawaci was always present for First REIT. In 2007, Lippo Karawaci contributed to 85.9% of First REIT’s rental income. In its IPO prospectus, First REIT flagged out the risk surrounding its sponsor:
“First REIT’s revenue and ability to make distributions to the Unitholders will depend solely upon the ability of the Master Lessee [referring to Lippo Karawaci] to make rental payments. As such, the prospects of the Master Lessee’s other businesses, aside from those relating to First REIT, could impact on the Master Lessee’s ability to make rental payments to First REIT.”
With the recent rout in the Indonesian rupiah against the US dollar, the currency risk has been amplified. Investors should be mindful of this risk when investing in First REIT.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended units of First REIT. Motley Fool Singapore contributor Sudhan P doesn't own shares in any companies mentioned.