The addition was timely because you don’t often get such opportunity to add quality reits into your portfolio, unless there are some fundamentals issue or rumors that are spreading. For me, I pounce onto the latter.
In this post, I will not be covering on the fundamentals of the reit because I think it has been covered quite substantially by other bloggers in the past and everyone seemed to know the strengths and weaknesses of the company.
Based on my experience previously working for one of the two reits involved, and also given my native background, maybe I’ll offer something else that are different and may be value adding to readers.
I think by now everyone is already familiar to the news that Lippo Group might be planning to delist the two Reits and move them back to Indonesia where they can potentially save on the tax breaks. You can read the news here. But let’s take a deeper dive into what that really means to the group and to investors.
The decision to remove the tax breaks by the Indonesian government is in fact a policy move in a bid to spur economic growth over time. This decision started with the intention for developers to revalue their assets, which many companies have not done so based on the recommended IFRS because they were using the Indonesian GAAP reporting. The policy involves encouraging companies to submit proposals for fixed asset revaluation in order to increase the firm capacity so that they get a higher valuation and can take on more leverage to boost the company’s return and hence the economy. The specific tax breaks is as follows:
- Companies that submit their proposal before 31 Dec 2015 would only need to pay 3% tax on the increased amount.
- Companies that submit their proposal in the first half of 2016 would pay 4% tax on the increased amount.
- Companies that submit their proposal in the second half of 2016 would pay 6% tax on the increased amount.
If you see across how the Indonesian developers compare against Singapore developers, you can see a vast different across how much is premium these developers are trading above their book value and how much DISCOUNTS they are trading below their RNAV. This is almost as if the company revalued all their assets, their market cap can almost double in value. In this case, property developers would almost certainly record a huge amount of accounting gains in their books once they revalued their assets.
In addition to the tax relief in asset revaluations, the latest economic policy package also removes double taxation on portfolio investors who invest in Reits using the collective investment contract system. This system would enable investors to pool funds in a collective investment vehicle, without being liable for double taxation. This is similar to the setting up of a Special Purpose Vehicle (SPV) we have in Singapore. At present, the investment method is subject to double taxation on its dividends and on the activities because the vehicle itself is considered a corporate body. You can immediately see how the Indonesian government is replicating a similar model when the same set up was done in Singapore many years ago to remove the tax breaks.
Borrowings and Earnings Done In Indonesia
Every investors of First Reit and LMIRT would have known that the companies made their borrowings in SGD at a rather low costs of borrowing since we are in a stagnant zero percent rate environment. The difference between the two is that First Reit earnings and assets are being earned and reported in SGD while LMIRT earnings and assets are being measured in IDR.
For the purpose of this article, I’m just going to touch on First Reit.
First Reit dividend yield based on 100% distribution are currently at 6.6% based on current price while costs of borrowings are in the range of 3% (higher because First Reit does not have credit ratings). Risk free rate in Singapore are at around 2.8%.
Now let’s think what happens if they decide to list the reit in Indonesia.
Based on the table appended below, you can see that loans made from banks are in the range of 11%. Sure, they might deviate a little amongst the different banks, but I can confirm that is the average interest rates for mortgage home loan payments taken by most Indonesians. The risk free rate, which in this case I have taken the Indonesian Treasury Bonds as reference, is currently yielding a Yield to Maturity (YTM) of around 5.3%. The fixed deposits, offered from various banks (yet to confirm on this one) is currently yielding 5% to 6% based on the table below.
|Costs of Borrowings|
|Fixed Deposit Rates|
|Indonesian Treasury Bonds|
Now, ask yourself this question. If you are an investor in Indonesia and are looking to invest in First Reit, given that you are able to obtain a risk free rate of around 5.3% and fixed deposit north of 6%, what is the premium yield you are looking for before you are willing to invest in First Reit? Surely, in this case, a 6.6% dividend yield would not be attractive anymore and they would have to priced it way such that the reit is yielding a dividend of around 10% to make it at least attractive for investors. Of course, Lippo could always provide an income support to these reits like what they did with OUE here with the other reits but that is not organic and sustainable. Question still remains if it is a viable option to list them down in Indonesia.
Given that the Indonesian market is not as established in the one we’ve had in Singapore, I seriously doubt if the listing would take place in the near term.
Based on my arguments above, there are simply too many things to consider if they decide to list the reit in the Indonesian market.
This is not a case where the parent is taking the company private. This is about delisting them in an established market and then list them again in a not established market. To me, at least it doesn’t look like it is going to work out for now. Maybe I’m wrong.
I am betting that Lippo would not take First Reit back to list them in the Indonesian market, though the scenario appears to be more likely for LMIRT because all of their assets, liabilities and earnings are already measured in IDR. Even if I am wrong, I am assuming that this will not take place in an instant and much still needs to be discussed over delisting the two Reits with a lot of floating shares around (Lippo only owned about 30% so far). At least, we could be looking beyond 2016 and 2017 before this could take place.
I’m betting I’m right, but don’t trust my word for it.