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Morningstar | Link Seeking More Capital Recycling Opportunities, but Likely to Take Longer and Be Less Accretive

Since the closing of the last round of asset disposal in February, Link Real Estate Investment Trust has continued to seek capital recycling opportunities. The company announced a portfolio review in late September. At the same time, there had been press reports about a potential acquisition in Shenzhen. The likely scenario would be from the same playbook we had seen before, disposing noncore Hong Kong assets at a low cap rate and acquiring higher yield assets in China. However, we expect this process to be more time-consuming and less accretive than before, given the current capital market condition and the ongoing trade war. Against the backdrop of rising interest rates and tighter liquidity, we believe the company is entering a period of slower growth. As such, we maintain our fair value estimate of HKD 64, as well as our narrow moat rating.

The company recently amended the trust deed to allow investing up to 10% of its gross asset value into listed equity, listed or unlisted debt securities, government and public securities as well as property funds. It also made changes to the calculation of distributable income to eliminate the noncash impact of unrealized losses. While these modifications are not usual among REITs, it is reflective of the management’s view of more subdued property market going forward. We expect fewer acquisition opportunities along with longer transaction time frames. And the balance sheet, bolstered by strong valuation gains in the past, may see such a trend stopping and unwinding.

REITs are generally viewed as inflation-hedging given their ability to grow rental incomes. However, this does not mean REITs are immune to a rise in nominal interest rates. Recent rate hikes in the U.S. were partially prompted by the higher inflation expectation. However, in Hong Kong, there were prolonged periods of higher inflation in the aftermath of the global financial crisis. By setting the nominal interest rate in line with that of the Fed, Hong Kong had negative real interest rate. Now as the nominal interest rate rises in Hong Kong, the result is a higher real interest rate, translating into higher required return for REIT securities. We believe there is substantial risk as the company’s shares are trading at near 3.5% and 4% dividend yield for fiscal 2019 and 2020, a very tight spread over the U.S. 10-year treasury.

During the first quarter of the fiscal year, the company’s Hong Kong portfolio saw retail sales up 8% year on year. While this is behind the overall market’s growth of 11%, this is reasonable given the portfolio’s nondiscretionary focus. Rental reversion is likely to be strong but with smaller lease expiry, so the impact on rental income may be small. The company had initially targeted to buy back 80 million units in order to neutralize the loss the rental income due to the disposal. To date, the company has acquired about half of the target amount for HKD 3 billion.