Weathering 2022 with locked-in income, capital management
This is not the right year to be investing in REITs because of the yield curve. Risk-free rates as represented by the yields of both 10-year Singapore Government Securities and 10-year US Treasuries are on a rising trend. As a result, to maintain the yield spread, REIT unit prices may retreat. The US Federal Reserve’s increasingly hawkish stance indicates four rate hikes this year, with the first one kicking off in March.
Interestingly, ParkwayLife REIT’s (PLife REIT) unit price has already retreated from a high of $5.13 to $4.91. PLife REIT owns three hospitals in Singapore, where IHH Healthcare is the master lessee, and an IHH unit is the operator. PLife REIT owns 52 nursing homes in Japan, operated and tenanted by 27 operators and master lessees. The portfolio was last valued at $2.29 billion.
Last July, PLife REIT’s manager negotiated a new master lease agreement with sponsor IHH Healthcare, raising its weighted average lease expiry to more than 17 years. As part of the new master lease agreement, PLife REIT has the right of first refusal to Mount Elizabeth Novena.
Under the new master lease, PLife REIT will inject a one-time renewal capex of $150 million to renovate and upgrade the three Singapore hospitals, most of which will be spent on Mount Elizabeth Hospital between 2023 and 2025. During this period, IHH, the master lessee, will get a total rent rebate of $60.9 million.
Despite the rent rebate to IHH, there will be a 3% uplift in rents per year over the downtime period (2023–2025). By year 4 (2026) when the tiered rent rebate drops off, there will be a 25.3% increase in rent to $99.2 million at the end of 2026. This signifies 39.6% growth over year 15 of the old master lease rent of $71 million.
In addition to the uplift in rents, the new master lease rents paid by IHH are likely to be no more than 15% of the revenue IHH receives as operator and master lessee of the hospitals, as stipulated in PLife REIT’s 2007 prospectus. Hence the REIT’s occupancy cost for the three hospitals, which is the equivalent of Rent/Ebitda for the tenant, is likely to remain in the 18%–20% range even after the new master lease kicks in. This compares extremely favourably with its S-REIT peer.
Japanese nursing homes are an important component of PLife REIT’s assets too, as the average length of stay ranges from three years to five years. This compares with shorter stays at hospitals which are usually a few days. PLife REIT is one of the largest owners of Japanese nursing homes. Hence the two asset classes actually complement each other.
By year 4 of the new master lease agreement, Singapore could account for as much as 70% of net property income (NPI) and assets if there are no further acquisitions. Before the new master lease agreement, the Singapore hospitals and Japanese nursing homes contributed around 60% and 40% to NPI, respectively.
Capital management is an important part of managing a REIT. Around 70% of PLife REIT interest rates are hedged and it has no debt renewal till June 2023. Therefore, the REIT should stay resilient this year, even if the Fed raises rates four times by 25bps each this year.
In addition, PLife REIT’s manager hedges its income from Japan regularly. This is to ensure DPUs are stable. Since Japan’s interest rates are usually lower than Singapore’s, hedging costs are low, and the REIT often has realised gains from these hedges.
Operationally, PLife REIT should be able to see through the year with its income more or less protected, and its debt cost locked in. As at Dec 31, 2021, PLife REIT’s cost of debt was 0.52% and interest cover ratio was 21.5 times.