On March 12, Bloomberg reported that investors in China have reasons to believe that the market is bottoming out. These included Beijing&rsquo s determination to end the stock rout, signs that the economy and earnings are picking up, and a return of foreign inflows.

 

&ldquo The shift reflects how investors are coming to terms with China&rsquo s attempts to restructure its economy, with some betting that President Xi Jinping&rsquo s attempt to drive high-tech growth and end a property crisis will start to bear fruit. Equity benchmarks have rebounded more than 10% from a February low, a performance that likely shows there were buyers beyond state funds,&rdquo Bloomberg says.

 

However, CapitaLand China Trust AU8U -0.68% (CLCT), the pure-play China REIT listed in Singapore, has not been invited to the equity party yet. Its unit price is trading at a 10-year low as sentiment around China remains tenuous despite the recent rally.

 

Although CLCT was listed on the Singapore Exchange S68 0.21% (SGX) at a time when the China REIT (C-REIT) framework was not in place, its assets are very much a proxy for the &ldquo China for China&rdquo theme. CLCT owns nine malls, five business parks focused on local technology and e-commerce tenants, and four logistics parks.

 

Last year, as China struggled to recover during its full post-Covid reopening, CLCT&rsquo s malls were doing well. Shopper traffic rose by 45.8% y-o-y, tenant sales were up 41.5% y-o-y and committed occupancy was 98.2% as at December 2023 compared to 94.8% as at December 2022, with the retail portfolio at the highest occupancy level since 2019.

 

One of the properties, Xuefu in Harbin, recorded shopper traffic growth of 71.1% y-o-y, tenant sales growth of 60.5% and occupancy of 99.8%.

 

Lost in translation

 

Another China for China proxy could be Sasseur REIT, which owns four outlet malls in tier-2 cities such as Chongqing, Kunming and Hefei. It too experienced a year of recovery with its financial statement in renminbi registering gains, which were lost in translation when converting to the Singapore dollar.

 

Investors appear to be more accepting of Sasseur REIT&rsquo s entrusted management agreement (EMA), where the rental income rose by 21.1% y-o-y to RMB170.6 million ($32.4 million) on the back of an 81.7% rise in the variable income to RMB58.7 million.

 

See also: FCT' s private placement to fund additional stake in Nex 2.5x subscribed

 

The main part of the EMA rental income is the fixed portion, accounting for about 65% of the RMB170.6 million. Even in Singdollars, in FY2023, EMA rental income rose by 3% y-o-y to $124.9 million.

 

However, distributable income fell by 5.8% to $83.4 million and distributions per unit (DPU) declined by 4.6% to 6.249 cents.

 

In the past two years, Sasseur REIT&rsquo s committed occupancy was relatively stable at 97.6%. CLCT&rsquo s retail occupancy bounced around a bit because of asset enhancement initiatives (AEI). In 1HFY2022 ended June 2022, CLCT&rsquo s retail occupancy dipped as low as 95.5%.

 

Now, with most of the AEIs completed, Tan Tze Wooi, CEO of CLCT&rsquo s manager, says: &ldquo Most of the AEIs have been completed and they are driving improved occupancy. In the second half of last year, the momentum continued to improve because the AEIs started contributing to sales. For instance, at Grand Canyon Mall in Beijing, we have just reopened the basement which should contribute to this year&rsquo s performance.&rdquo

 

Tan adds that the growth in shopper traffic and tenant sales are a function of improved trading conditions and &ldquo our own efforts at AEI&rdquo .

 

In terms of retail concepts, Tan says CLCT is adding more net lettable area exposure to F& B, beauty and care, and jewellery and watches. &ldquo We saw a shift and these concepts attract spending.&rdquo Leisure and tech experienced a rebound as well.

 

Although retail rental reversions were a mere 0.2% higher in 2023, portfolio occupancy costs fluctuated from the high teens to the low 20s. The lower the occupancy cost, the more attractive it is for tenants.

 

&ldquo As tenant sales improve further, we are likely to see retailers moving into a healthier cost range. We are happy the efforts in strengthening the portfolio and weaning off the weaker assets have moved the portfolio to a firmer footing,&rdquo Tan says. CLCT has divested Qibao, a master leased mall in Shanghai, and Shuangjing Mall after the end of 2023.

 

New Economy challenges

 

CLCT&rsquo s challenges are in its New Economy assets. To diversify out of retail assets and following the merger between CapitaLand and Ascendas-Singbridge, CLCT acquired five Ascendas business parks. These were Ascendas Xinsu Portfolio in Suzhou, Ascendas Innovation Towers and Ascendas Innovation Hub in Xi&rsquo an and Singapore-Hangzhou Science & Technology Park Phase 1 and Singapore-Hangzhou Science & Technology Park Phase II.

 

In terms of occupancy, the business park portfolio rebounded to 91% q-o-q but was as low as 89.8% in 1QFY2023.

 

Phase 1 of the Hangzhou park is problematic. The occupancy has been consistently below 80% and ended FY2023 at just 72.4%.

 

Although the overall reversions at the business parks were positive in 2023 at 1.6%, Tan acknowledged the challenges the REIT faces. &ldquo We have five assets. Each one is facing a different set of challenges. Hangzhou&rsquo s [Phase 1] occupancy is lagging because of supply and it takes time to backfill the SMEs. We have signed more tenants but we are seeing the falling away of some business models.&rdquo

 

Many tenants and former tenants were SMEs in the e-commerce supply chain. E-commerce trends are abating as evidenced by the share prices of JD.com and Alibaba Group, which are at five-year lows and way off their 2020&ndash 2021 highs. Demand for space, in particular in Hangzhou, the home of Alibaba Group and its famous founder Jack Ma, has fallen. On the other hand, Tan says supply has burgeoned.

 

Xi&rsquo an has a better outlook. &ldquo In Xi&rsquo an for our two projects, we have been very focused on what the local government would like to promote. We are working very closely with them as we shift some of these tenants in line with sectors the government wants to incubate. In doing this, we also enjoy some government incentives. We continue to see a focus on deepening the base for manufacturing, technology and biomedical sciences,&rdquo Tan says. Suzhou is also still strong, he adds.

 

On the other hand, logistics warehouses, which are also part of the e-commerce supply chain, are facing challenges as well. CLCT owns four logistics parks, one each in Kunshan, Shanghai, Wuhan and Chengdu. The Shanghai logistics park&rsquo s occupancy is down to 60.3% and the Chengdu logistics park is at 67.8%. Tan says he is also concerned about the Wuhan and Kunshan leases as these are single-tenant assets.

 

&ldquo In most of the cities that we are located, the vacancy rates are trending at closer to the 20%&ndash 30% range and tenants are shrinking some of their business demand in terms of the space expectations,&rdquo Tan acknowledges. As a start, he is looking to fill the Shanghai logistics park.

 

REIT managers are unable to provide DPU guidance. However, Tan expects the upside from retail to outweigh the downside from logistics. &ldquo For logistics, we are guiding for lower contributions because of occupancy downtime and negative rental reversions,&rdquo Tan says.

 

Capital management

 

CLCT&rsquo s aggregate leverage as at the end of December 2023, although lower q-o-q, remains elevated at 41.4%. This may be why it is trading at almost the same valuations as Sasseur REIT, whose aggregate leverage is just 25.3%, and the lowest among the S-REITs. Sasseur REIT&rsquo s interest coverage ratio of 4.3 times is healthier than CLCT&rsquo s 3.1 times.

 

S-REITs (Singapore REITs) and property trusts with Chinese assets have had a rough ride in the past two to three years. This is because of the issues with EC World REIT and Da­ sin Retail Trust, a business trust. Their refinancing and leasing challenges were highlighted by The Edge Singa­ pore from 2021.

 

Among the concerns some investors have are intercompany creditor agreements (ICA). Here, onshore lenders for Chinese S-REITs are likely to have ICAs with the offshore lenders. Onshore lenders&rsquo loans are secured and based on Chinese regulations, they tend to be amortising, which means over time, the onshore loans get lower.

 

On the other hand, offshore lenders&rsquo loans are unsecured and they are usually bullet loans. This implies that the credit risk for offshore lenders is higher than that of onshore lenders as offshore lenders have no recourse or access to the assets in China.

 

CapitaLand is a trusted Singapore name so it has more offshore loans currently. The only way for the offshore lender to recover the loan is when the asset is divested. CLCT had mainly offshore loans when it was listed in 2006. Gradually, these are being converted to onshore loans as the REIT divested some of its IPO properties.

 

With the 3.8% RMB600 million ($114 million) free trade zone offshore bonds due 2026 issued in October 2023, CLCT&rsquo s RMB loans comprise around 20% of its total debt with no refinancing of either RMB or Singdollar loans this year.

 

Sasseur has no refinancing due this year either. Its next maturity is an unsecured sponsor loan of RMB308 million due in 2025. In 2026, Sasseur has to refinance a $125 million loan and a US$54 million ($72 million) loan representing 46.6% of its total debt.

 

As at March 12, both Sasseur and CLCT are trading at DPU yields of 9%, and at modest discounts to their NAVs (see table). Their valuations probably speak to CLCT&rsquo s weaknesses in its New Economy portfolio more than just the strength of Sasseur&rsquo s retail portfolio.

 

CapitaLand Investment&rsquo s (CLI) management has always reiterated its support for its REITs and this was no different during its results briefing on Feb 28. Commenting on CLI&rsquo s $3 billion divestment target in 2023 versus the $2.1 billion that it did, group CEO Lee Chee Koon says: &ldquo We landed on making sure we did the right thing. We have many investors with us. We have investors in our listed REITs, in the headstock (CLI) and our private funds. We have many vendors and partners that depend on us, and we must think of their interests as well as those of the company, and the investors that rely on us.&rdquo

 

Once Tan can get the occupancy of his New Economy assets up, which would prove China&rsquo s economy is on the mend, CLCT&rsquo s price could recover.