[Unreliable Large Corporation REITs] ① Lotte and SK See Declining Prices Below IPO, Dividend Cuts Expected Due to Financing Burdens

Lotte REITs Stock Falls Over 25% from IPO Price
SK REITs, Samsung FN REITs, Hanwha REITs Also Burdened by High Interest Rates
High Interest Rates, Rising Vacancies Pose Challenges... Caution Advised When Buying REITs Stocks

Editor's NoteThere is an easy way to become a landlord of a large corporation's office building: invest in publicly traded REITs that hold large corporate office buildings as assets. The price is around 5,000 KRW per share. Representative large corporate-sponsored REITs include Lotte REITs, SK REITs, Hanwha REITs, and Samsung FN REITs. These REITs are characterized by stable asset management, backed by high-quality office buildings of large corporations and long-term lease agreements guaranteed by their affiliates. However, even large corporate-sponsored REITs are not free from burdens such as high interest rates and vacancies. In particular, there is a reasonable suspicion that retail investors who invested in REITs during periods of rising interest rates and declining office building prices have become scapegoats.

"It is currently on hold."

An executive in charge of the REIT business at a major asset management company has temporarily put on hold the asset securitization project through REIT listing that had been underway with the parent group since last year. This is due to the freezing of the domestic REIT market amid financial instability and worsening market conditions, including the fallout from the U.S. Silicon Valley Bank (SVB) bankruptcy and concerns about a commercial real estate crisis. Although discussions on utilizing REITs have been active among large corporations since the successful listing of SK REITs in 2021, the atmosphere has somewhat cooled recently. While some view the current lower real estate prices as an investment opportunity, large corporate REITs require cautious approaches due to their close relationship with interest rate and economic conditions.

Rapid Growth of Domestic REIT Market Following Lotte REITs' Entry

The domestic REIT market can be broadly divided into periods before and after the emergence of Lotte REITs in 2019. The debut of Lotte REITs, the first large corporate-sponsored REIT, was a groundbreaking event. Large corporate-sponsored REITs refer to REITs in which large corporations such as Samsung, SK, Lotte, and Hanwha are key investors or majority shareholders, transferring their real estate assets to the REIT and investing capital.

Lotte Department Store Gangnam Branch exterior view.

Before the appearance of Lotte REITs, only five REITs were listed in the domestic market, with a combined asset size of 1.8 trillion KRW. However, with the launch of Lotte REITs in October 2019, the REIT market expanded rapidly. As of the end of 2019, Lotte REITs' asset size was 1.6 trillion KRW, comparable to the total of all previously listed REITs. The entry of a major player changed the market scale significantly. By the end of last year, the number of listed REITs had grown to 21, with assets totaling 13.3 trillion KRW. Following SK REITs two years ago, Hanwha REITs and Samsung FN REITs were also listed on the KOSPI this year as large corporate-sponsored REITs.

However, Lotte REITs have shown a stark contrast. While symbolizing the expansion of the domestic REIT market, its price performance has been dismal. Lotte REITs, which hold 15 buildings including Lotte Mart, Lotte Department Store, and Lotte Outlet, currently trade at 3,670 KRW per share, down more than 25% from the IPO price of 5,000 KRW. After listing at 5,000 KRW per share in October 2019, Lotte REITs maintained prices in the 6,000 KRW range during its first year. Subsequently, the price fell below 5,000 KRW, then 4,000 KRW, and has now plummeted to the 3,000 KRW range.

Investors who trusted the large corporate sponsor Lotte are understandably dismayed. Lotte Shopping holds 50% of the total shares, and the REIT's assets include 15 major corporate affiliate properties such as Lotte Department Store, Lotte Mart, and Lotte Outlet located in key metropolitan and metropolitan cities. Few expected the REIT's price to collapse so drastically.

Asset Value Decline and Loss of Leverage Effect

How did Lotte REITs come to suffer such humiliation? The COVID-19 pandemic significantly impacted the value of retail stores, which were overshadowed by online e-commerce. Additionally, a sharp decline in tourists and a high-interest-rate environment dealt a direct blow to the Lotte Group. Not only did the asset values of department stores, large marts, and outlets owned by Lotte Group fall, but the leverage effect?maximizing returns by borrowing at low interest rates?disappeared, reducing the attractiveness of real estate investments. To make matters worse, the default of the Legoland asset-backed commercial paper (ABCP) in October last year further worsened the domestic real estate market conditions.

Lotte REITs conducted refinancing in the second half of last year, but due to rapidly rising interest rates at that time, interest expenses increased significantly. According to disclosures by Lotte REITs, they refinanced 200 billion KRW in short-term bonds and 458 billion KRW in long-term borrowings in the first quarter of this year. Financial costs in the first half of this year are expected to increase by 39% year-on-year to 28.5 billion KRW. Consequently, the dividend per share (DPS) is expected to decline sharply this year. Looking ahead to the next two years, refinancing of 360 billion KRW is scheduled for the second half of this year, 205 billion KRW for the first half of next year, and 285 billion KRW for the second half of next year. Considering recent interest rate levels, rollover (loan maturity extension) rates are predicted to be in the 4-5% range. As of the end of last year, total borrowings and bonds amounted to 1.1 trillion KRW, with refinancing targets accounting for about 75%. The refinancing risk is significant.

Lee Eun-sang, a researcher at NH Investment & Securities, explained, "Lotte REITs are expected to gradually improve their financial cost burden as they refinance short-term borrowings and bonds from 2023 to 2024, but it will take time to recover to past levels. In the past low-interest-rate environment, they took long-term fixed-rate borrowings, but recently, they have taken short-term variable-rate borrowings, causing financial costs to rise sharply since the second half of last year."

The high-interest-rate risk is not unique to Lotte REITs. Currently listed SK REITs, Samsung FN REITs, and Hanwha REITs also face this challenge. SK REITs, which traded above 7,000 KRW in the first half of last year, have now fallen below their IPO price. SK REITs hold three office buildings?SK Seorin Building and SK Jongno Tower in Jongno-gu, and SK Yu Tower in Bundang?as well as 116 gas stations. They face interest expense burdens due to rising borrowing costs and concerns about equity dilution from a rights offering. Moreover, refinancing of 460.8 billion KRW in the second half of this year and 1 trillion KRW in the second half of next year is scheduled. Rollover interest rates are expected to be between 2.9% and 3.8%. A rights offering of 124 billion KRW is also planned this year to repay convertible short-term bonds for the inclusion of Jongno Tower. The dividend per share is expected to decrease slightly compared to last year.

Due to unfavorable market conditions, Samsung Group's first publicly offered REIT, Samsung FN REITs, which was listed this month, traded below its IPO price of 5,000 KRW on the first day. Hanwha REITs, listed last month, also closed trading at about 4,510 KRW, down approximately 7.96% from the opening price on the listing day, tarnishing its reputation. Samsung FN REITs and Hanwha REITs have barely surpassed their IPO prices.

Market experts point out that large corporate-sponsored REITs have inherent limitations as products. They argue that these REITs inevitably follow the parent company's business logic and affiliate funding objectives rather than maximizing returns based on market logic.

Both recently listed Hanwha REITs and Samsung FN REITs are related to affiliated insurance companies. In the case of Hanwha REITs, Hanwha Group's financial affiliates Hanwha Life Insurance and Hanwha General Insurance transferred their real estate assets to the REIT and reinvested in the REIT to become the largest shareholders. Similarly, Samsung FN REITs' largest shareholders are Samsung Group's financial affiliates Samsung Life Insurance and Samsung Fire & Marine Insurance, which transferred their real estate assets to the REIT. From the insurers' perspective, transferring owned assets to a REIT secures cash while maintaining a level of control over the real estate similar to direct ownership. This arrangement avoids situations where landlords arbitrarily raise rents or tenants must suddenly relocate. They also benefit from corporate tax deferral on in-kind contributions.

Attractive as Stable Dividend Products but Subject to Price Decline Risks

From an investor's perspective, since REIT businesses tend to align with the parent company's business direction rather than operate independently, maximizing profits based on market logic is challenging. General REITs can increase rents or sell assets when values rise to maximize returns. In contrast, it is difficult for large corporate-sponsored REITs to make such decisions regarding buildings housing multiple affiliates. While stable management is an advantage, the process of acquiring, managing, and liquidating assets in the market is more likely to depend on the parent company's business operations and funding needs than market logic. A senior industry official explained, "If affiliates occupy the buildings, conflicts of interest may arise when raising rents. Also, if the real estate is occupied by affiliates, would it be easy to freely sell at market prices to increase REIT returns? Probably not."

From a longer-term perspective, the increase in vacancy rates and decline in building values due to reduced office demand relative to supply following the spread of remote work after the COVID-19 pandemic also make it difficult to recommend investing in large corporate-sponsored REITs. Kim Pil-gyu, senior researcher at the Capital Market Research Institute, pointed out, "Large corporate-sponsored REITs are certainly attractive as stable dividend products, but there are definite risks associated with declining real estate prices." He added, "Although it is impossible to predict real estate prices, it is true that large corporations are suspected of dumping buildings into REITs at high prices when office building values are falling."