CapitaMall Trust: Buy the retail bond or the REIT?

CapitaMall Trust is offering $200 million worth of bonds. They will mature 7 years later in 2021 and will have a coupon of 3.08%. Is this a good thing?

Well, as the REIT has quite a bit of debt due for repayment this year, this fund raising effort is necessary and timely. The coupon of 3.08% is also lower than their average cost of debt of 3.4% as at 31 Dec 2013. So, this is a good thing for unit holders of the REIT. DPU won't be negatively affected.

As S$150 million of the retail bonds will be offered to the public with the minimum investment sum set at only $2,000, it is within reach of regular retail investors like you and me. If we look at this as a kind of forced savings, a pseudo-CPF if you will, and hold it for the full 7 years period, I think it is not that bad a proposition. Why?

Well, if we hold it for the full 7 years, we won't suffer any capital loss which could happen if we decide to sell before maturity.

You mean we might lose money if we cannot hold for the full 7 years? Yes, possibly, especially with expectations that interest rates will continue rising.

So, if the risk free rate should rise by 1%, investors might expect a 4.08% return from this instead of the 3.08% being offered now, for example. The bond price would have to fall in order to offer this higher return. How much must the bond price fall to give this return? Approximately 25%.

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Yes, 25%. The good news is that if we were to hold to maturity, then, we are safe. So, what to do? We buy the bond with money we don't need for the next 7 years. We will get back our principal when the 7 years is up, well, if CMT doesn't go belly up. (See comments by Charlie and AK71 in the comments section below.)

So, this retail bond offering could benefit anyone investing for income in two ways. Invest in the REIT for a distribution yield of 5.64% (unit price of $1.815 at closing) or to buy the bond for a coupon of 3.08% over the next 7 years.

Wah! AK71 so silly. Of course, invest in the REIT. The yield is so much higher! Well, remember that REITs are leveraged investments. Without the gearing of about 35%, the distribution yield wouldn't be so much higher and would be closer to 3.75%. Gearing is a fantastic thing, isn't it?

Wait a minute, 3.75% is still higher than 3.08%. So, investing in the REIT is still a better choice. Indeed, it seems to be the case and that would be my preference too.

Remember that this analysis has taken place in a vacuum, totally ignoring other factors which could have a bearing on the performance of the REIT or the retail bond. However, comparing the two options thus gives us a clearer picture of which option an investor for income might want to lean towards.

Read: CapitaMall Trust launches retail bond offering.

Related post:
Saizen REIT: Risk free rate and unit price.

Croesus Retail Trust and Perennial China Retail Trust.

I had a discussion with a friend over dinner last night regarding Croesus Retail Trust (CRT) and why I feel relatively good about it as an investment for income. 

In the conversation, one of the things I did was to compare it against Perennial China Retail Trust (PCRT).

When PCRT had its IPO, I said that only "Red Star Macalline Global Home Furniture Lifestyle Mall, Shenyang, which was completed on 30 Sep 2010 is income contributing at listing date. The rest of the initial portfolio is expected to be completed from 3Q 2010 to 2Q 2014. If we are investing for income, this is not very reassuring."

And I also said that a "distribution yield of 4.88% to 5.51% in the years 2011 to 2012 also does not provide enough compensation for the risks which investors are being asked to bear, in my opinion."
See: Perennial China Retail Trust.

Mr. Market sent PCRT's unit price down 12.86% on its first day of trading from its IPO price of 70c to just 61c. See: PCRT: Weak debut.

Unit price went on a continual decline and was under 40c at one stage. Pua Seck Guan increased his stake while Kuok Khoon Hong and Martua Sitorus became substantial shareholders. I initiated a long position some time later at 47.5c a piece.

"I initiated a long position in PCRT at 47.5c because the distribution yield of 8+% at that price offered a more acceptable level of compensation for the risk I would be asked to assume."
See: PCRT: 1H 2013 DPU 1.9c.

Mr. Market is rather efficient in pricing PCRT's stock. The latest reported NAV/unit is 77c which means PCRT's stock is now trading at a 31.2% discount to NAV! 

Why? Mr. Market has priced in a risk premium.

Although annualising the half yearly DPU of 1.9c will give us a distribution yield of 7.16%, most of the distributable income is from earn out deeds and I highlighted that "current DPU is being sustained by earned out deeds which will be exhausted by end 2014". 

So, what happens then? Income distributions to investors will most probably take a hit. 

See: PCRT: Progress in Q3.

Now, for readers who have been following my recent blog posts on Croesus Retail Trust, they will be able to see the difference I am trying to point out between CRT and PCRT easily. 

CRT's portfolio consists properties which are mature and generating income, all of them. The level of risk which investors are being asked to assume here is very low compared to PCRT's.

Having said this, investing in CRT is not without its risks and I blogged about it briefly before. See: Croesus Retail Trust: Motivations and risks.

I am invested in both PCRT and CRT. So, to some, it might appear silly that I am talking down PCRT but, in my opinion, I am not talking down PCRT or talking up CRT, for that matter. I just say it as it is.

PCRT could do better over time but unit holders must be prepared for a much lower DPU next year as earn out deeds are depleted by end of this year and if the properties completed are not able to pick up the slack fully by then.

CRT offers a much higher level of certainty for the next 2 to 5 years for anyone investing for income and although it is a business trust like PCRT, it is not the same as PCRT. This is why my investment in CRT is about 8x bigger than my investment in PCRT now.

Both PCRT and CRT are business trusts. Same but different. We should not over-generalise.

Related posts:
1. Croesus Retail Trust: What is my plan?
2. Croesus Retail Trust: Overnight BUY order filled.
3. Croesus Retail Trust: Initiated long position at 87c.