A Fresh start for Sabana REIT – Replace the current REIT Manager with a newly set up internal manager.
Unitholders are proposing to remove the current External REIT Manager (“External Manager”), Sabana Real Estate Investment Pte Ltd, and to replace it with a newly set-up Internal REIT Manager (“Internal Manager”) owned by all unitholders. This process is known as “internalization”.
The internalization is projected to increase the dividend paid to unitholders by more than ~7.2% to S$0.0327 per unit (~7.6% Dividend Yield1) once the External Manager is removed.
This increase would mainly come from cost savings from the* ~S$7.25 million of fees (of which S$4.4 million are management fees, equivalent to ~14% of distributable income) and net profit which unitholders currently pay to the External Manager and its shareholder, ESR Group.
The removal of the External Manager will also likely eliminate all other fees such as performance, acquisition, divestment, lease and property management fees which needs to be paid by unitholders to the External Manager.
As the Internal Manager will be fully owned by and aligned with all unitholders, its sole goal will be to increase dividend growth, unit price and corporate governance for unitholders as fast as possible.
MAIN GOAL OF THE NEW INTERNAL MANAGER IS TO INCREASE DPU AND UNIT PRICE ABOVE S$0.53 (NAV)
The new Internal Manager will be owned by and work for the benefit of all unitholders with the sole goal of increasing dividend and unit price above S$0.53 by quickly executing on key strategies.
The new Internal Manager can immediately execute on the following key strategies to potentially increase DPU and unit price by ~30% to more than ~S$0.55 (potential dividend yield of >9.2% at current price):
- Immediate cost savings of ~S$2.43 million per year through the internalization of the REIT manager (Additional DPU of S$0.0022 with upside of ~7.2%);
- Complete the asset enhancement of 1 Tuas Ave 4 and rent out ~90% of the asset at net rent of at least S$1.45psf/month (Additional DPU of S$0.0017 with upside of ~5.4%);
- Increase occupancy rate at NTP+ to ~90% by capitalizing on excellent location (next to MRT) and innovative space usage e.g., subdividing space to increase rentability to technology (software development, electronics) and E-Commerce clients (Additional DPU of S$0.00324 with upside of ~10.5%); and
- Undertaking S$~85m of acquisitions funded with yield of ~7.2% fully by debt (Additional DPU S$0.002 with upside of ~6.7%).
In addition, the Internal Manager can execute other attractive and executable mid-term strategies which can potentially further drive Sabana REIT’s unit price beyond S$0.55, such as the following:
- Develop ~200,000 square feet of new space at NTP+ (Additional DPU of S$0.00485 with upside of ~15.7%); and
- Develop more than 1 million square feet of untapped GFA/landbank with focus on sizeable key assets such as 33&35 Penjuru Lane, 26 Loyang Drive which can be transformed into New Economy ramp up logistic hubs or data centres (Additional DPU of S$0.00396 with upside of ~12.9%).
The Internal Manager’s complete execution of all the above catalysts in the short and mid-term can deliver a potential total DPU upside of almost ~60% to S$0.0483 (potential dividend yield of ~11.2%).
IN ADDITION, THE RESOLUTION ALSO SEEKS TO EMPOWER UNITHOLDERS TO APPOINT, APPROVE AND RE-ELECT DIRECTORS TO REPRESENT THEIR INTERESTS. THIS RESULTS IN THE COMPLETE ALIGNMENT OF INTERESTS BETWEEN THE INTERNAL MANAGER AND UNITHOLDERS.
By removing the current External Manager and appointing an Internal Manager, unitholders will finally benefit from a “win-win” solution which potentially results in higher DPU, unit price and better corporate governance!
UNDERPERFORMANCE OF SABANA REIT AND THE EXTERNAL MANAGER
Sabana REIT is the only SGX-listed REIT with predominately Singapore industrial properties that is trading at a substantial discount of ~20% to its NAV of S$0.53.
Since ESR Group took control of the REIT manager in 3Q2019, the occupancy rate of Sabana REIT has constantly been below its REIT peers as well as the JTC national average.
Sabana REIT’s Dividend per unit (“DPU”) in 2H2022 has already declined by more than 7% and 8% when compared to 2H2021 and 1H2022, whereas its SGX-listed peers have either nearly flat or increasing DPUs.
Despite the favourable industrial market in 2022, occupancy rates in key buildings with higher rental rates in Sabana REIT’s portfolio have fallen significantly in 4Q2022 (e.g., Frontech Centre 94%→66%, 8 Commonwealth Lane 100%→82%, 10 Changi South St 2 80%→74% and NTP+ (81%→77%).
Sabana REIT’s NAV has also plummeted by ~8% from S$0.57 in 4Q2019 to S$0.53 in 4Q2023.
Due to these failures in maintaining occupancies, Sabana REIT’s DPU and unit price are forecasted to further decline in 2023. The current performance of the REIT as described above is already costing unitholders substantial loss in terms of DPU and unit price.
If substantial unitholders have not increased their stakes over the last 2-3 years, Sabana REIT’s unit price might have potentially decreased to <S$0.40 given the worsening DPU, NAV and continuing bad performance of the External Manager
If such performance continues, this may result in a further decline of DPU and unit price, especially when measured against the NAV of S$0.53.
POTENTIAL CONFLICTS OF INTEREST ON THE PART OF THE EXTERNAL MANAGER
ESR Group has 100% ownership in the External Manager of Sabana REIT. Yet at the same time, ESR Group is the 99% owner of the manager of ESR Logos REIT. It is also the largest unitholder in the REIT with a 16.4% stake.
As both ESR Logos REIT and Sabana REIT primarily invest in Singapore industrial properties, ESR Group’s significant ownership of the managers in both REITs results in the overlap of investment mandates which can potentially cause critical conflicts of interest issues relating to asset acquisitions, divestment, and strategic decisions between the REITs.
These potential conflicts of interest can seriously and negatively impact Sabana unitholders’ unit price and DPU.
In addition, ESR Group’s stake in ESR REIT at ~S$401m7 is ~4.1x more than its ~S$98m stake in Sabana REIT. ESR Logos REIT’s manager also earns nearly 5 times of the management fee as compared to Sabana REIT’s External Manager.
As a HK listed company with fiduciary duties towards its own investors, it is unsurprising that ESR Group would prioritise the interests of ESR Logos REIT over those of Sabana REIT which, if true, would be to the detriment of Sabana REIT unitholders.
One such example was in 2020, when Sabana REIT had been offered what was, in our view, an unexpectedly low implied price of S$0.308 to merge with ESR Logos REIT, which potentially benefited ESR Logos REIT and ESR Group at the expense of Sabana REIT unitholders.
The potential conflicts of interest and corporate governance flaws can depress Sabana REIT’s DPU and unit price.
The removal of the current REIT Manager and the setup of a new Internal Manager will immediately end this issue relating to corporate governance. With an independent mandate, an Internal Manager can make strategic decisions that would serve unitholders’ interests and achieve a higher DPU and unit price for unitholders.
THE EXTERNAL MANAGER MODEL PRESENTS A POTENTIAL MISALIGNMENT OF INTERESTS BETWEEN THE EXTERNAL MANAGER AND UNITHOLDERS
More than ~97% and ~90% of REITs in the US and Australia with market capitalizations exceeding ~S$1.4 trillion9 are managed by Internal Managers. By comparison, the Singapore-listed REIT market only started in 200210 and has a total market capitalization of ~S$100 billion11.
As the REIT market in US and Australia have been in existence since 1970s, the general investors’ sentiments backed by numerous academic studies is that the External Manager Model tends to underperform the Internal Manager Model, especially in terms of DPU and unit price.
This is because the External Manager Model suffers from a misalignment of interests between the External Manager in question and unitholders of a REIT.
While an Internal Manager works to increase the DPU and unit price of unitholders, an External Manager tends to serve the interests of its owner, namely the Sponsor, by increasing its profitability where possible.
An External Manager can increase the profitability of its Sponsor by:
- increasing Acquisition Fees from doing more acquisitions;
- increasing Management Fees by acquiring and enlarging the portfolio; or
- acquiring the Sponsor’s properties at a profit for the Sponsor’s benefit.
The External Manager could increase its fees by acquisitions, which is funded by increasing borrowings and/or doing placements and rights to raise capital from unitholders and new investors.
However, excessive acquisitions financed by borrowings and higher leverage levels can put the REIT on a weaker financial footing.
Consistent placements and rights offerings, which are often done at a discount from the market price, may cause downward pressure on the unit price.
Both such options may lower DPU and unit price and, would be in direct conflict with unitholders’ interests.
Due to the above and the preference of investors towards the Internal Manager Model, many REITs in the US and Australia have converted from External to an Internal Manager Model.
EXAMPLES WHERE THE EXTERNAL REIT MANAGER MODEL HAS NEGATIVELY IMPACTED THE UNIT PRICE AND DPU OF UNITHOLDERS
Manulife US REIT, Eagle Hospitality Trust and Dasin Retail Trust are three such examples of how the misalignment of interests between an External manager and unitholders can substantially reduce unit prices by more than 80%.
As pointed out in a BT article by Ben Paul12, the current high leverage problem at Manulife US REIT can be attributed to its External Manager’s persistence in acquiring properties despite the already high leverage of 41% in 2021. Since its IPO in May 201613, the External REIT Manager has collected more than S$80m14 of management, performance, and acquisitions fees from unitholders. This is while unitholders suffered a plunge of ~80%15 in their unit price.
Despite the distressed situation which the REIT is currently in, its External Manager, instead of supporting the REIT, is now currently in discussion with Mirae to enable the sponsor and the External manager’s owner to cash out at a substantial profit.
Over at Eagle Hospitality Trust, the sponsor who owned the External Manager injected their hotel assets into the REIT at inflated valuations through the usage of master leases with the sponsor.
The sponsor subsequently defaulted on these master leases, which resulted in financial distress to the REIT and it was eventually wound up.
While unitholders’ investments were completely wiped out, the sponsor and the owner of the manager of Eagle Hospital Trust benefited from monies used to purchase the properties even though the REIT closed down.
At Dasin Retail Trust (“DRT”), Mr. Zhang Zhencheng, a minority shareholder of DRT’s trustee-manager, and major unitholder of DRT filed a claim in the High Court against the lead independent director of the DRT’s External Manager. Zhang alleged that the lead independent director pushed for a legally binding MOU which required DRT to buy assets in China from the foreign seller. This is when the REIT is potentially in distress with the unit price collapsing by more than 80%16 since IPO and should be disposing assets to repay bank loans.
SUCCESSFUL EXAMPLES OF THE INTERNAL MANAGER MODEL IN SINGAPORE
Similar to Sabana REIT, Croesus Retail Trust’s unit price had consistently traded at a sharp discount of ~20% to its book value of ~S$0.95 prior to their internalisation.
Croesus Retail Trust conducted the internalization of its manager in August 2016 to align the manager’s interest with its unitholders and to increase DPU, unit price and corporate governance.
Croesus Retail Trust saw its 4Q2017 (Quarter end June 2017) DPU increase by more than 18% year-on- year as its internal manager worked hard to increase rental income and reduce interest cost.
In less than 10 months after the manager was internalized, Croesus Retail Trust sold itself to Blackstone at a premium of ~23% to its book value and a premium of ~38% to its VWAP in the last 12 months.
Another example is NetLink Trust, which also has an internal Trust Manager since its IPO. NetLink Trust has outperformed the benchmark FTSE ST REIT Index by more than 25% and has also successfully grown DPU without any need for acquisitions and with low net gearing level of ~20%.
The Trust has been ranked No. 1 in ASEAN Corporate Governance Scorecard as well as the Governance Index for Trusts.
ARE THE RISKS REGARDING THE CHANGE OF CONTROL PROVISIONS AND THE BANK LOAN “REAL”?
The current External Manager, in its desperation to make unitholders continue paying fees, may resort to ‘scare tactics’ such as ‘change of control provisions’ to preserve its own interest.
This is despite the Internal Manager being able to deliver dividend and unit price upside to unitholders fairly quickly in the near future.
Sabana REIT’s leverage, at only 33.1%, is the 6th lowest leverage level among ~40 SGX-listed REITs. With the low leverage, it would take Sabana REIT less than 6 years to pay off the entire loan from Sabana’s net property income (“NPI”). In comparison, it will take Keppel and Suntec REIT more than 11 years to pay off its entire loan from NPI17.
The loans are backed by strong rental income from its property portfolio which is entirely in Singapore.
Singapore is a highly transparent and attractive market with a substantial number of institutional investors and sovereign funds looking to invest in attractive and high yielding industrial assets with similar attributes to properties owned by Sabana REIT.
All these further improve the high-quality collateral of Sabana REIT to UOB, HSBC and Maybank, which are the Trust’s main financiers.
As such, we are highly confident that Sabana REIT’s current financiers which strongly uphold ESG (Environmental Social and Corporate Governance), will choose to support good corporate governance and ~10,000 Sabana REIT unitholders (many of whom are Singaporeans and also their clients) over an External Manager, especially if the latter is removed by unitholders via the EGM due to potential corporate governance concerns and conflicts of interest.
Once an Internal Manager is appointed that solely focuses on quickly improving occupancy rate and dividend per unit above all else, this will be a win-win for the banks as they will be supporting a REIT with an even stronger portfolio and cashflow.
ESR GROUP IS THE “BIGGEST LOSER” IF A CHANGE OF CONTROL PROVISION PROBLEM OCCURS
If the “threat” of the change of control provision materializes, ESR Group, as the largest unitholder with a ~21% stake (valued at ~S$98million), would be the biggest loser as they have more than ~S$130million at risk including the Sabana External Manager.
The potential loss of Sabana REIT Manager will also cast serious doubts on ESR Group’s entire REIT management business model where it and its associates own more than 13 REIT Managers.
It may also potentially result in ESR Group ‘ESG hungry’ capital partners such as GIC, OMERS and APG to reconsider and/or stop new and existing investments with the firm given the negative corporate governance implications.
This can potentially result in the further substantial loss of ESR Group’s market capitalization and valuation. ESR Group’s share price has already collapsed nearly -30% and -55% since its IPO and late 202118.
RETAINING EXISTING STAFF AND HIRING BEST CANDIDATES IN THE MARKET
Once unitholders cease all payment of fees to Sabana’s External Manager, it is very likely that the External Manager will have to terminate most of its employees. This is as 100% of all revenue and profits of the External Manager are contributed by Sabana REIT and unitholders.
The new Internal Manager welcomes all management and staffs who prioritise the interest of and are aligned with unitholders to join the refreshed team.
In addition, Singapore is the 3rd largest listed REIT market in Asia Pacific with a ready and deep talent pool of professionals. The ongoing consolidation in the SGX-listed REIT market with more than 10 mergers and the privatization acquisitions in the SGX-listed REIT space over the last 7 years have resulted in highly qualified personnel being let go due to duplicity, despite their substantial REIT expertise.
We look forward to the new Internal Manager hiring the best and the brightest from this strong talent pool, complemented by hires from the old External Manager, so that it is best placed to achieve the goal of increasing DPU and unit price with a target of at least S$0.53.
UPHOLDING HIGH STANDARDS OF CORPORATE GOVERNANCE VIA INTERNALIZATION
The MAS has previously affirmed that “high standards of corporate governance, characterised by strong accountability and transparency, are critical in upholding investor confidence in our Singapore’s capital markets”.
ESR Group has had nearly 4 years to resolve the potentially critical overlapping investment mandate which leads to conflicts of interest issues.
However, they seem to have shown little to no interest in resolving these issues besides a ‘lowball’ merger offer from ESR Logos REIT at an implied price of S$0.3019 which is at a ~42% discount to the NAV of Sabana REIT then.
The External Manager’s board of directors actively promoted the offer to the benefit of ESR Group and ESR Logos REIT despite its hugely negative impact on Sabana REIT unitholders.
The External Manager then passed on the entire cost of the failed merger to unitholders. This is despite unitholders already publicly informing the Manager that the transaction will be overwhelmingly voted down by unitholders due to its inferior price.
In April 2022, the board of the External Manager attempted to appoint Mr Charlie Chan as an ‘independent director’ despite him receiving a substantial premium of ~S$22 million over market price from ESR Group. This appointment was rejected by more than 77% of unitholders at the AGM.
Additionally, in April 2023, even though about 90% of all unitholders at the AGM rejected the endorsement of Ms Elaine Lim, instead of respecting the votes of unitholders and upholding corporate governance, the board of the External Manager decided to go through a convoluted process of appointing her as a ‘non independent director’.
The internalization of the Sabana REIT Manager will once and for all resolve the above corporate governance issues. It will also substantially improve accountability and corporate governance at Sabana REIT.
The regulators, by supporting this Internalization proposal, may also clearly demonstrate to existing External Managers of REITs listed on SGX that actions which damage unitholders’ interest and confidence of investors, as well as lower the corporate governance standards and the reputation of Singapore’s financial market, will no longer be tolerated.
We are confident that MAS and SGX RegCo will safeguard the interest of unitholders’ interest and act swiftly if the board and the owner of the Sabana REIT’s External Manager were to prioritise the interest of ESR Group and protect the value of their stake in the Manager over those of independent unitholders.
VOTE FOR THE REMOVAL OF THE CURRENT EXTERNAL MANAGER
VOTE FOR THE SETUP OF A NEW INTERNAL MANAGER THAT IS ALIGNED WITH ALL UNITHOLDERS’ INTERESTS TO INCREASE DPU, UNIT PRICE AND CORPORATE GOVERNANCE