Saizen REIT

[lonewolf]

Investor Central has a nice presentation and interview with Saizen Executive Director and Head, Investor Relation, Raymond Wong.

Saizen REIT: What skeletons are in the closet?

It is 20+ min clips so those who dun have the time can peruse my handy summary below.

Summary:

• Japan economy not great but not bad either
  
• Majority of Saizen Properties not damaged by Japan triple disaster
  
• CMBS market abruptly shut down in 2008, Saizen sold part of properties (26 buildings) leading to lower operating income
  
• 20% lease fall due each year. New rent rates comes down from existing tenants. Existing tenants signed lease in boom times.
  
• Properties do no remain empty as half of the the population does not own property
  
• Enterprise Value = S$380 million; NAV=S$570 million; Mkt cap = S$180 million
  
• Investor sentiment towards Japan negative after two 'lost decades'
  
• 2009 rights issue to refinance loans due after collapse of CMBS market
  
• One loan went into default but portfolio successfully averted foreclosure
  
• Fully repaid CMBS loan in June 2011
  
• Moody upgrade rating by 3 notches within a month after loan repayment
  
• Obtain 5 new loans from Japan local banks in past 6 months.
  
• Jump in dividend should restore investor confidence (from 0.5c to 0.6c)
  
• Paying 3% interest on debt, lower than CMBS
  
• 27 million proceeds from warrants - 19 million for loan repayment; 6 million will be used for portfolio replenishment
  
• Banking relationship will help bring down debt to 40%; currently only 22% leverage excluding cash in hand.
  
• 40% leverage is optimal for income and occupancy stability
  
• Only Japan REIT listed in Spore which provide access to Japan properties;
  
• Skill set of REIT manager and team focus on Japan; very good relationship with brokers, banks, asset managers, property managers and leasing agents
  
• Working hard to close deal in Japan; assets still a buyer market and Sazien in a position to buy; urgency to accelerate pace as asset market is heating up;
  
• Came across 100 different deals in the last 2 months
  
• No regret in listing in SGX; over 5000 Sporean unitholders
  

Comments: Raymond Wong came across as a candid and straightforward guy who did not flinch on answering the difficult question. And he managed to encapsulate well the problems with Saizen's loan structure in the past. Anyone who see this interview would probably feel a little more assured. (Vested)

[Toku]

Negative quantitative attributes of Saizen REIT for 2H FY2012 yield as compared with 1H FY2012 yield:

1. Dilution by 13.8% (1,250 million units in Dec 2011 and 1,450 million units in June 2012); preserves 86.2% of DPU.
2. Currency devaluation by 9.2% (1:59.6 in Dec 2011 and 1:65.6 as in March 2012 currently); preserves 90.8% of distribution in SGD.

Reference: See page 3 of 22 for 1H FY2012 financial statements that stated: "Based on S$ / JPY exchange rate of 59.6 as at 31 December 2011, which is applied throughout this announcement unless stated otherwise."

Assuming all else are not changed for the JPY distribution of 1H FY2012 and 2H FY2012, the above 2 negative attributes would reduce the SGD DPU for 2H FY2012 by a factor of 22% (100% - 78%), or preserves it by a factor of 78% (86.2% x 90.8%).

This would translate that for 2H FY2012, the DPU in SGD might decline to around 0.48 cents (0.61 x 78%), or an annualized DPU yield of 6.61%.

Apparently, if the negative attributes were manifested without enough positive attribution to neutralize it, such as the portfolio is still not optimally geared as it now is, hence the announcement of declined yield, the unit price would be under downward pressure after the ex-date for 2H FY2012. And one major uncertainly is the fluctuation of SGD/JPY exchange rate, which does not look promising in the long term because of the much overvalued JPY and Japan's US$13 trillion public debt with an aging population.

The DPU for 2H FY2012 should be positively attributed by the rental income of the two recently acquired properties, but overall it would be subjected to the final currency fluctuation on ex-date. Besides these, was there any major factor missed out for the comparison?

[corydorus]

This attracts my attention because i have been working on AUD currency investment for some time.

If we stretch our time horizon further, the current SGD/JPY rate represents a good part of 2011 which lasted for 2.5 years.
Another factor is the stronger USD that JPY is closely tracking.

Currency moves are quite hard to predict due to it's multi-ways influence. Who knows maybe the climb has come to the right level.
I would say focus on the business yield.

Cory

[propertyinvestor]

Kin CHAN, a well connected guy and founder of Transpac, used his Fund(Argyle Street management) to buy 5% of this reit at 14cents. That alone, is reason for me to be vested. Anyway, Im positive on Japan's property market. GLP and IPC Corp has already moved but Saizen has yet to move!

(Vested)

[Zelphon]

Me vested too..

Been holding since Mar 2010..

I too believe in the turnaround of this counter and Japan Property Mkt..

[Toku]

Following the calls made by an institutional investor might be a sound strategy for reaping an investment reward when all things go well.

Nonetheless, an institutional investor has the means to effectively hedge the risks of his investment, such as hedging on the volatility of currency fluctuation to protect his capital and yield for his investment in Saizen REIT. So, in the event if the exchange rate for JPY devalues sharply against SGD, and Saizen REIT somehow becomes an unattractive investment with not much hope for making capital gain on property appreciation, he could simply exit without suffering any loss of capital, and would gain most of the yield with the hedging instrument at a small manageable cost. Whereas for a retail investor, his investment at that event would be stuck with a substantial paper loss in SGD for capital with eroded yield, and could not just simply exit the investment for he would realize the losses.

In this aspect, a typical retail investor is not in the same league as an institutional investor.

---

The triple whammies Saizen REIT is exposed to:

Two substantial factors that affect the NAV of any REIT are its property value and gearing percentage.

Unlike most other REIT listed in SGX, the entire portfolio of properties in Saizen REIT were purchased with JPY, but denoted in SGD; it is also exposed to SGD/JPY volatility.

During the end 2008 financial crisis, at the worst moments, most SG REITs such as Suntec REIT and CMT, crashed by around 70% to 75% from their peaks; they were hit by the double whammies of property devaluation and their high gearing percentage.

However, Saizen REIT with dilutions had crashed by more than 90% and was left with less than 10% value of its IPO price. At the worst point, on top of ~30% devaluation for property value and SGD devalued to ~78% ( 1-57.7/80.1) of the IPO’s SGD/JPY exchanged rate, with the effect of ~40% gearing, its 60% equity in SGD was shaved to ~21% (60%-30%/78%) of IPO's asset value and market capitalization was thus reduced to ~10% of IPO price; this was the triple whammies that Saizen REIT had experienced.

The 2008 to 2010 financial crisis of Saizen REIT was not exactly caused by the pulling out of CMBS loans by the foreign bank as the management had so claimed; it was as a result of Saizen REIT portfolio was over exposed in its systemic failure. No bank in the world, including Japanese local banks, would comfortably lend to a portfolio of a commercialized entity without a strong sponsor and weak equity. As a matter of fact, even in Singapore, with standard practice, banks usually would only finance up to 50% of valuation for a residential properties if it is acquired by a commercial entity, and a list of stringent unheard-of requirements applies.

Although the risks for property value and exchange rate are very much subjected to market forces, its gearing ratio is a risk factor that could be managed. But, the hard-core policy for 40% gearing to optimize its portfolio is a catalyst for repeating the systemic failure of this REIT.

With equity built up from the cash calls and divestment of 31 buildings that has cut down the leverage to ~22%, Saizen REIT with loans renewed with local banks is now in its aggressive acquisition mode to buy ~JPY 4b worth of properties for setting the gearing ratio to 40% in order to mitigate the dilution effect. At some point of time in the future, in a perfectly optimized condition coupled by a much devalued JPY, and then with a cue from another inevitable disaster of any kind, even with the steep discount from NAV for its unit price, this REIT in the triple whammies could be severely crippled again from its last salvaged level and therefore would need to make another round of cash call.

I would say 40% gearing ratio is too high a risk for a foreign property REIT that denotes in local currency of the country it was listed.

[thinknotleft]

The triple whammies Saizen REIT is exposed to:

Two substantial factors that affect the NAV of any REIT are its property value and gearing percentage.

Unlike most other REIT listed in SGX, the entire portfolio of properties in Saizen REIT were purchased with JPY, but denoted in SGD; it is also exposed to SGD/JPY volatility.

I would say 40% gearing ratio is too high a risk for a foreign property REIT that denotes in local currency of the country it was listed.

I guess that why Saizen fell badly in the financial crisis was due to:
a) liquidity squeeze ie it was not able to borrow and roll-over its loans
b) insufficient risk premia investors demanded during its IPO. (Saizen IPO offer was around 5% yield.)

I think that exchange rate risk is a non-factor in the financial crisis, as its loans and cashflow are both in yen.

Yes, Saizen do have exchange rate risk, as its payout and asset value are affected by S$/yen exchange.

Nonetheless, positives are its low price/book value and its intention to gear up (ie increased prospects of higher dividends). And if I am not wrong, while its dividends may seem low compared to other reit, the cashflow may be higher as Saizen pays down its loan principals.

I do not think that a yen-denoted property REIT that trades in S$ is a major risk factor, if one demand sufficient risk premium.

If yen-denoted property REIT borrows in S$, that is a larger risk factor to me.

[Toku]

I guess that why Saizen fell badly in the financial crisis was due to:
a) liquidity squeeze ie it was not able to borrow and roll-over its loans
b) insufficient risk premia investors demanded during its IPO. (Saizen IPO offer was around 5% yield.)

I agree with (a); but was that not a consequent of over borrowing that had crashed their credit rating for them to be able to swap lenders at all?

How could investors demand for higher risk premium and how does that help during the financial crisis with a highly geared portfolio in default?

I think that exchange rate risk is a non-factor in the financial crisis, as its loans and cashflow are both in yen.

Yes, Saizen do have exchange rate risk, as its payout and asset value are affected by S$/yen exchange.

I agree with exchange rate risk is not a direct factor in the financial crisis from the operation side. But, like you have pointed out, this risk exists at the investors’ end.

Particularly, the debt was purchased by investors during IPO when SGD/JPY was ~79 level, and the YK Shintoku loan was returned at ~65 level with ~S$63 million worth of properties sold at ~70% of their values; the losses of buying high and selling low in property value as well as in exchange rate were realized.

The Singapore investors on the SGD trading platform during the credit crunch were facing a debt that had increased by 22% because of the weakened SGD in SGD/JPY exchange rate. Although the amount of debt in JPY had remained the same as far as the operation side in Japan was concerned, the debt on IPO date was S$ 357.7 million, and before the divestments it was expanded to S$ 458.6 million.

Nonetheless, positives are its low price/book value and its intention to gear up (ie increased prospects of higher dividends). And if I am not wrong, while its dividends may seem low compared to other reit, the cashflow may be higher as Saizen pays down its loan principals.

The price/book value was indeed attractive.

When the pro forma statements for Q3 FY2012 releases, with the weakened JPY by ~9% as compared to 1H FY2012, it would inevitably cause its NAV and earnings in SGD to come down significantly with the combo effect of the full dilution. So far only two new properties were acquired and one of the acquisitions was just completed very recently, so its positive attribute in the forthcoming statement would be very limited. It was mentioned in the IPO’s prospect that the management would hedge the distribution against currency fluctuation for its payouts, but I doubt they have done so at all. Else, there would be some cushioning effects.

I do not think that a yen-denoted property REIT that trades in S$ is a major risk factor, if one demand sufficient risk premium.

IMO, investing in a cross-broader REIT is subjected to the risk of exchange rate, and it is therefore prudent to insure against the risk by hedging. But this REIT management is obviously not practicing risk aversion at all; else they could have avoided the divestments completely. BTW, were the properties insured against damages that are caused by natural disasters? Not doing so is like sitting duck on time bombs that were set by nature to go off at unkown locations on unknown dates and times with the certainty of negative financial impacts with unforeseeable magnitudes.

If yen-denoted property REIT borrows in S$, that is a larger risk factor to me.

Ironically, with hindsight, had Saizen REIT borrowed in SGD, during the financial crisis, the debt would have shrunk by 22% in JPY instead of expanded by 22% in SGD, and they might have kept the loan-to-value ratio below the default level and therefore would not have suffered on the refinancing issue. The operational exposure of borrowing in SGD could be hedged for its risk with a relatively small insurance premium with their financial resources. I believe the REIT managers are driving their cars with a small premium for accident insurance in placed for all sorts of major financial protection.

[thinknotleft]

Ironically, with hindsight, had Saizen REIT borrowed in SGD, during the financial crisis, the debt would have shrunk by 22% in JPY instead of expanded by 22% in SGD, and they might have kept the loan-to-value ratio below the default level and therefore would not have suffered on the refinancing issue.

This is a hindsight on one event. If Saizen borrow in S$ and S$ rise severely against yen, the reit may find itself insolvent.

In response to your qns,
1) Saizen purchases limited earthquake insurance.

Its 2Q12 statement says 'Insurance expenses increased by 19.0% in 2Q FY2012, due mainly to the purchase of earthquake-related insurance. Previously, Saizen REIT did not have any earthquake insurance. This is consistent with the industry practice in Japan for residential investment properties. Even if obtained, earthquake insurance in Japan in many cases does not cover the whole damage suffered. Following the earthquake in northeastern Japan in March 2011, the Management Team re-examined the issue of earthquake insurance. While it remains generally in concurrance with the industry practice, it had decided that a limited form of earthquake insurance would be purchased for Saizen REIT’s properties to provide certain coverage in a “worst case scenario” event.'

2) Saizen does not seem to hedge exchange rate. Its latest quarterly statements only has interest rate swaps.

How could investors demand for higher risk premium and how does that help during the financial crisis with a highly geared portfolio in default?

3) Investor can demand higher risk premium by not buying a share when it's expensive.

[Toku]

Ironically, with hindsight, had Saizen REIT borrowed in SGD, during the financial crisis, the debt would have shrunk by 22% in JPY instead of expanded by 22% in SGD, and they might have kept the loan-to-value ratio below the default level and therefore would not have suffered on the refinancing issue.

This is a hindsight on one event. If Saizen borrow in S$ and S$ rise severely against yen, the reit may find itself insolvent.

In response to your qns,
1) Saizen purchases limited earthquake insurance.

Its 2Q12 statement says 'Insurance expenses increased by 19.0% in 2Q FY2012, due mainly to the purchase of earthquake-related insurance. Previously, Saizen REIT did not have any earthquake insurance. This is consistent with the industry practice in Japan for residential investment properties. Even if obtained, earthquake insurance in Japan in many cases does not cover the whole damage suffered. Following the earthquake in northeastern Japan in March 2011, the Management Team re-examined the issue of earthquake insurance. While it remains generally in concurrance with the industry practice, it had decided that a limited form of earthquake insurance would be purchased for Saizen REIT’s properties to provide certain coverage in a “worst case scenario” event.'

2) Saizen does not seem to hedge exchange rate. Its latest quarterly statements only has interest rate swaps.

How could investors demand for higher risk premium and how does that help during the financial crisis with a highly geared portfolio in default?

3) Investor can demand higher risk premium by not buying a share when it's expensive.

Thanks for your respond with the infos.

The interest rate swap indicates they had hedged their operational liability on variable interest rate.

With the above inference, had they borrowed in SGD, the SGD/JPY exchange rate risk at operation end would surface and therefore the need for the management to hedge it arises. In circumspection, they would have to hedge the risk and that negates the exchange rate risk for the debt. The hedge fund would also substantially bring down the gearing ratio to a safer level while the portfolio is being optimized.

Instead the management negated their operational risk for SGD/JPY fluctuation by exposing investors to it with no effective corporate measure to protect it at all. The fact that this IPO was listed in Singapore and the JPY investment was funded with SGD speaks volume for the requirements for protection of the invested capital.

No amount of higher risk premium could have protected investor from the risk of SGD/JPY fluctuation in the last crisis. Even if IPO price was halved as it was, with its gearing it could not have prevented the physical losses in the ~S$63 million worth of properties sold at ~70% of their inveseted values with the debt secured at ~79 level for SGD/JPY and returned at ~65 level. The lost in the debt would still be materialized and the "Bonus" of higher risk premium (if any at all) in equity would also be lost during the financial squeeze.

This is a very high risk REIT.

IMO, the average retail investors going for long term consistent yield in SGD with no knowledge or resources for hedging their risks, should stay at bay from this.

This REIT pays substantial income tax to the Japanese government. For Q2 FY2012, with a gross rental income of JPY 849.63 billion, the income tax was JPY 23.76 billion for a taxable income of JPY 434.37 billion, and this was on top of an exorbitant property tax of JPY 63.48 billion for that quarter. This defeats the very purpose of a REIT structured investment in Singapore especially for retirees who are not paying any personal income tax at all.