Sunday, 20 October 2013

Do REITs Overpay for Their Acquisitions?

REITs have been active in acquiring properties to add to their portfolios. They do this to increase the rental income and distribution to shareholders as well as diversify the sources of rental income. In addition, there is also the potential for capital gains when the properties are sold. In the process of acquiring properties, they might also raise new capital from the market and increase the liquidity of the shares. However, do REITs overpay for their acquisitions in their attempts to expand? As industrial REITs are most active in acquisitions, we look at a list of acquisitions that industrial REITs have entered into with other companies.

Below is a table listing the acquisitions industrial REITs have carried out with other companies listed on the SGX, showing the acquisition price, valuation price and premium above the valuation price.

Property Date Price Buyer's Valuation Price - Valuation % Premium
65 Ubi Ave 1 May 2003 $35.0 $35.0 - -
1 Changi Business Park Ave 1 Sep 2003 $18.0 $18.0 - -
TT Int Tradepark Nov 2003 $92.0 $92.0 - -
12 Woodlands Loop May 2004 $24.8 $24.8 - -
9 Changi South St 3 Oct 2004 $32.0 $32.0 - -
5 Toh Guan Rd East Oct 2004 $36.4 $36.4 - -
52 Serangoon North Ave 4 Feb 2005 $14.0 $14.0 - -
84 Genting Lane Jul 2005 $10.0 $10.0 - -
20 Old Toh Tuck Rd Nov 2005 $11.6 $11.6 - -
50 Kallang Ave Dec 2005 $28.6 $28.6 - -
2 Serangoon North Ave 5 Dec 2005 $45.0 $45.2 -$0.2 0%
31 Ubi Rd 1 Dec 2005 $23.0 $23.0 - -
2 Senoko South Rd
26 Senoko Way
Oct 2006 $49.0 $49.0 - -
30 Woodlands Loop Nov 2006 $10.3 $10.4 -$0.1 -1%
20 Tampines St 92 Dec 2006 $10.0 $11.2 -$1.2 -11%
134 Joo Seng Rd Dec 2006 $10.7 $10.9 -$0.2 -2%
3 Changi South Lane Dec 2006 $13.9 $14.4 -$0.5 -3%
521 Bukit Batok St 23 Dec 2006 $24.1 $24.9 -$0.8 -3%
9 Tampines St 92 Dec 2006 $11.0 $11.0 - -
31/33 Pioneer Rd North
119 Neythal Rd
30 Tuas Ave 8
8 Tuas View Square
Aug 2007 $36.8 $37.6 -$0.8 -2%
31 Int Business Park May 2008 $246.8 $246.8 - -
1/2 Changi North St 2 Aug 2010 $22.1 $22.2 -$0.1 0%
25 Tai Seng Ave Sep 2010 $21.1 $21.5 -$0.4 -2%
4/6 Clementi Loop Mar 2011 $40.0 $40.0 - -
3C Toh Guan Rd East Nov 2011 $35.5 $35.5 - -
16 Tai Seng St Mar 2012 $59.3 $59.3 - -
15 Jurong Port Rd Dec 2012 $43.0 $43.0 - -
Average
$37.2 $37.3
-1%

From the table above, we can see that most of the transactions are carried out at the valuation price. A minority of the transactions are at a slight discount, ranging from 1% to 11%. The average discount of all transactions is 1%. On this basis, REITs do not overpay for their acquisitions.

As the counter-parties to these transactions are also listed companies, the sellers might also announce the transactions on SGX. Some of the sellers would disclose their valuations of the properties, thus allowing us to see both sides of the transactions. The list of transactions with sellers' valuations is shown in the table below.

Property Date Price Seller's Valuation Price - Valuation % Premium
65 Ubi Ave 1 May 2003 $35.0 $35.0 - -
TT Int Tradepark Nov 2003 $92.0 $92.0 - -
20 Old Toh Tuck Rd Nov 2005 $11.6 $9.3 $2.3 25%
31 Ubi Rd 1 Dec 2005 $23.0 $23.0 - -
28 Senoko Dr Apr 2007 $12.0 $12.0 - -
31/33 Pioneer Rd North
119 Neythal Rd
30 Tuas Ave 8
8 Tuas View Square
Aug 2007 $36.8 $22.6 $14.2 63%
1 Kallang Way 2A Jan 2008 $14.0 $12.0 $2.0 17%
31 Int Business Park May 2008 $246.8 $246.5 $0.3 0%
29 Tai Seng Ave May 2010 $53.0 $40.0 $13.0 33%
1/2 Changi North St 2 Aug 2010 $22.1 $14.3 $7.8 55%
25 Tai Seng Ave Sep 2010 $21.1 $16.6 $4.5 27%
44 & 46 Changi South Rd Dec 2010 $16.8 $12.5 $4.3 34%
4/6 Clementi Loop Mar 2011 $40.0 $22.0 $18.0 82%
3C Toh Guan Rd East Nov 2011 $35.5 $31.0 $4.5 15%
16 Tai Seng St Mar 2012 $59.3 $59.0 $0.2 0%
15 Jurong Port Rd Dec 2012 $43.0 $33.0 $10.0 30%
Average
$47.6 $42.6
24%

From the table above, it is interesting to see that most of the transactions are carried out above the seller's valuation price, with premiums ranging from 0% to 82%. The average premium of all transactions is 24%. Note that these valuation prices are not historical costs at book value; they are obtained from recent valuations commissioned by the sellers.

So, we are back to the original question: do REITs overpay for their acquisitions? To answer this question, we need to address 2 other questions, i.e. why do buyer's and seller's valuations differ, and the relative bargaining powers of buyers and sellers.

It is not uncommon for valuations of the same property to differ. Based on the disclosure in the SGX announcements by both buyers and sellers, 2 key reasons could be distilled:
  • Buyer's valuations are more rigorous than seller's valuations. Buyer's valuations are generally based on 3 or more valuation approaches, some of which include direct comparison of recent transactions, discounted cashflow of income stream, capitalisation of income stream and replacement cost of the property. In contrast, seller's valuations (note: there are only 5 sellers that disclosed the valuation approaches used) are based on less approaches, including desktop valuation. Furthermore, some of the acquisitions need to be funded by bank loans. If the properties are overvalued, banks would run the risk of loss. On this basis, the "correct" value of the property probably lies closer to the buyer's valuation.
  • Basis used in valuations. The basis used in valuations play a key role in the eventual value of the property. In one of the sellers' announcements, it mentioned about valuations on a sale-and-leaseback basis and on a vacant possession basis. Needless to say, the valuation on a sale-and-leaseback basis should be higher than on a vacant possession basis given that the leaseback agreement provides a rental guarantee for several years.

On the relative bargaining powers of buyers and sellers, even though the seller might have a valuation price, it does not necessarily mean that the seller would be willing to sell at that price. The seller probably had been operating from the property for several years already and enjoying continual appreciation in property values. Some premium above the seller's valuation price is required to entice the seller to sell the property and give up future capital gains as well as converting from being a property owner to a property lessee.

Lastly, of all the properties mentioned above with the latest valuation, only 2 properties have seen their valuations fall below the original purchase price.

In conclusion, on the basis that (1) the acquisition price does not differ much from the buyer's valuation price, (2) the "correct" value of the property probably lies closer to the buyer's valuation than the seller's valuation, (3) a premium is likely required to entice the seller to sell the property, and (4) the current valuation of most properties mentioned above is equal to or above the original purchase price, REITs do not overpay for their acquisitions.


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