Prime US REIT IPO - A Qualitative Review

ipo prime us reit reits stocks Jul 08, 2019

by: Tam Ging Wien


All examples and stocks quoted here in this article and on the ProButterfly.com and REITScreener.com site are for learning purposes; it does NOT constitute financial advice or a Buy/Sell recommendation. Contents are reflective of personal views and readers are responsible for their own investments and are advised to perform their own independent due diligence and take into account their own financial situation. If in any doubt about the investment action you should take, you should consult a professional certified financial adviser.


Prime US REIT (Prime) has just filed is preliminary prospectus with the MAS just last week Friday, 28-Jun-2019. This comes on the back of two other REITs with exposure to US based assets completed their offering – ARA US Hospitality Trust and Eagle Hospitality Trust.

For those who would like to take a peak at the IPO Prospectus, you can download it from the MAS Opera site.

Prime will be listing a total of 923mil units and making a public offer of 335.2mil units to the public priced at US$0.88 each which is expected to raise US$294.98mil in gross IPO proceeds. The remining are already placed out to cornerstone investors. This would give Prime a market cap of US$812.24mil or about S$1,101.34mil – larger than the market cap of ARA US Hospitality Trust and Eagle Hospitality Trust.

Prime had intention to list way back in 2018 but is understood to have delayed the offering multiple times due to multiple factors including negative sentiments surrounding the US tax uncertainty, more time needed to secure cornerstone investors, market volatility and tailoring their offering size to the public and placement tranche.

At the offering price of US$0.88 per unit, the yield is forecasted to be 7.4% and 7.6% on an annualised basis for FY2019 and FY2020 respectively. The NAV per Unit will be US$0.84 at point of listing giving it a P/B Ratio of 1.048x. It will list with an initial gearing of 37.0%.


Source: Prime US REIT IPO Prospectus

Will this IPO fair well in the current richly valued S-REIT environment or will the IPO succumb to investor fatigue and falter without a full subscription?

The Initial Portfolio


Source: Prime US REIT IPO Prospectus

The initial portfolio of Prime will consist of 11 Class A office assets located across the US, with a value of US$1.22nil and an aggregate net lettable area (NLA) of 3.4mil sqft. All the assets are on freehold land tenures located in the states of Atlanta, Georgia, Washington DC, and Salt Lake City, Utah, among others.

Quoting from, “Cushman defines Class A as the most prestigious, high quality standard, well-located buildings, typically steel and concrete construction, built or renovated after 1980 and competing for premier office users with above market rents”.

Generally speaking, when discussing office assets in the US, the buildings are classified as Class A or Class B. It’s a general misconception that Class A buildings are only located in prime CBD locations in tier 1 cities; in fact, they could be located at high density urban locations outside the main CBD as well or in tier 2 cities. The location of the office asset isn’t the determining factor of whether it is classified as Class A or B but rather the quality, state and size of the building.

Class A buildings are generally larger and taller buildings with high quality interiors, higher ceilings and large windows while Class B buildings are generally smaller in size and shorter in stories, lower ceiling heights, smaller windows and mid-quality interiors.

Trying to relate this to a Singapore context – Class A buildings in the CBD would be akin to MBFC, Capital Tower or a Guoco Tower. Class A buildings in high-density regions outside the CBD would be like the upcoming Vision Exchange in Jurong or Mapletree Business City in Alexandra.

Source: Prime US REIT IPO Prospectus

Its top five tenants include Charter Communications Inc, Goldman Sachs Inc, Sodexo Operations, Wells Fargo Bank and Holland & Hart. The top 5 tenants account for 29.5% of the portfolio while the top-10 tenants account for 43.5% of the portfolio cash rentals.

Other salient points to note about the portfolio as quoted from the prospectus are as follows:

  • IPO Portfolio has an existing occupancy of 96.7% and a committed occupancy of 97.3%
  • 9 out of the 11 properties have a committed occupancy of above 95.0%
  • 9 properties are either located in the key business district of their respective office market, or in prominent urban centres with proximity to mixed-use amenities
  • buildings are located in mixed-use amenity rich environments, surrounded by retail, restaurants, open spaces, recreational facilities and residential apartments
  • 8 out of the 11 properties in the IPO Portfolio enjoy connectivity to the light rail network in their respective markets

Other information specific to each asset can be found in the table extract below:


Source: Prime US REIT IPO Prospectus

Understanding KBS’ Asset Value Generation Pipeline

KBS Realty Advisors and now part of the greater KBS Group (KBS) was founded by Peter Bren and Chuck Schreiber in 1992 and have over 26 years of commercial real estate investment and management experience. Through KBS Capital Markets, distributes real estate investment products through investment professionals and operates as the dealer/manager and broker/dealer for the KBS Real Estate Investment Trust.

In 2018 National Real Estate Investor ranked KBS the 8th largest office owner globally and are advisor to public and private pension plans, endowments, foundations, sovereign wealth funds and publicly registered non-traded REITs

As of March-2019, KBS has US$11.5bil AUM and 36.6mil sqft under management on behalf of clients.

KBS defines its investment strategy into 4 key stages:

  • Identification – identify through strong relationships premier properties to acquire and develop a disposition strategy and target cash returns
  • Acquisition – acquire the target asset to be injected into appropriate fund structures
  • Management – manage the target asset according to the strategies to maximize the rental income and enhance the value of the property
  • Disposition – regularly review hold and sell analysis of each property and realising proceeds

The assets acquired by the group are injected into various closed-ended non-tradable REITs and managed by KBS’ internal management. These REITs are used as vehicles to raise funds from investors and KBS received a fee in return of the management of these REITs. The aim of these REITs are to manage the assets to maximise the investor’s returns and dispose them to realise profits for their early investors.

Based on their website, KBS has been aggressively raising funds since 2006, however fund raising has somewhat tapered 2016 onwards. Why hasn’t it been raising fresh funds recently? Could it be because it is now attempting to dispose assets? Hum… certainly worth a thought here.


Source: https://kbs-cmg.com/about-us/

KBS has 2 primary strategies to realise value for all the assets it acquires:

  • Core Strategy – seeks income, growth and capital preservation while providing increased risk management as well as broad portfolio diversification by property type, geographical region, investment size, and investment risk
  • Strategic Opportunity – consist of opportunistic or value-added real estate, distressed debt, distressed equity assets or other real estate-related investments

KBS’ website also list their past REIT offerings. It would be obvious to anyone reading the names of the REIT which is the predominant strategy that the fund is taking.

Prime US REIT will have its initial injection of its 11 properties from the KBS REIT III.

You would recall that another S-REIT – Keppel-KBS US REIT has its initial injection of 11 properties from KBS Strategic Opportunity REIT.

It is clear that Prime will source its future pipeline of property acquisition from the Core Strategy portfolio while Keppel-KBS US REIT will source from the Strategy Opportunity portfolio.


Source: https://kbs-cmg.com/offerings/

At this point, it would clear to most people that KBS likely using the S-REIT entity to dispose matured assets from their close-end REIT funds to realise value from their initial investments.

A Closer Look at KBS REIT III Portfolio

Details about Prime’s source of assets can be found in their main page as the following link:


Source: REITScreener ResearchProButterfly Researchhttps://kbs-cmg.com/offerings/kbs-real-estate-investment-trust-iii/investor-information/

KBS REIT III’s portfolio was formed way back in 2011 and over the years has grown steadily through rental income growth and acquisitions realising gains for the early investors. It made a public offering in 2015 to raise more funds and continued to show growth in its value per share.

Plotting KBS REIT III’s historical value per share which could be looked at like similarly to the NAV per unit of a REIT, has grown a compounded 4.33% since 2015 to 2018. How much growth it can continue to clock by the end of 2019 remains to be seen.

KBS REIT III’s original portfolio consist of 30 assets, those that are not injected into Prime are specifically highlighted using a red box. Since the initial 11 assets are from this fund, observing the reminding assets might give us a clue to what its future acquisition pipeline may look like.

Source: https://kbs-cmg.com/offerings/kbs-real-estate-investment-trust-iii/investor-information/

KBS REIT III did not provide their asset valuations, so it will be difficult to know the exact valuations. So, we tabulated the KBS REIT III information against the Prime IPO valuations, the compilation is shown in the table below:


Source: REITScreener ResearchProButterfly ResearchPrime US REIT IPO Prospectushttps://kbs-cmg.com/offerings/kbs-real-estate-investment-trust-iii/investor-information/

The Towers at Emeryville are a bundle of 3 towers, but only one was injected into the REIT. Therefore, we have excluded this line item from our estimations as we could not obtain the breakdown of the valuations on the three towers individually.

We found that on average, valuations had gained approximately 22.7% from KBS REIT III’s original purchase price and 13.1% gains from the cost basis. Armed with a simple estimation modal, we boosted the valuations using the average to estimate potential acquisition prices of future pipeline assets from KBS REIT III. We found that asset prices average about US$160.9mil.

We will talk about why this is important in the next section.

As the table is sorted according to the acquisition date, we expected to see a gradual increase in the valuation gains from the oldest asset to the youngest asset based on acquisition date in the portfolio. Surprisingly, this was not the case. Notice that Village Center Station II, Denver was injected with a valuation increase of 12.4% despite being acquired by KBS REIT III in Oct-2018 while another asset Reston Square purchased in Dec-2014 had hardly gained.


Source: Prime US REIT IPO Prospectus

In the largest scheme of KBS’ portfolio, the assets classified as Core Strategy are form the larger pipeline of assets future acquisition. KBS’s asset accounts in the office space is massive and there is plenty of assets to choose from.

Equity Fund Raising Required for Future Acquisitions?

Given the current asset size of US$1,250mil and a gearing of 37%, the implied debt situation stands at US$462.6mil. We like how its Debt expiry profile fairly evenly distributed with no refinancing needs until 2022.


Source: Prime US REIT IPO Prospectus

Let’s discuss a few scenarios assuming Prime acquires an average size asset of US$160.9mil.

Scenario 1a – Prime maintains 37.0% Gearing

  • In this scenario, they would have to raise at least US$101.4mil to fund the acquisition

Scenario 1b – Prime increases Gearing to 40.0%

  • In this scenario, they would have to raise at least US$59.0mil to fund the acquisition

Scenario 1c – Prime increases Gearing to 42.5%

  • In this scenario, they would have to raise at least US$23.8mil to fund the acquisition

What we notice in all 3 scenarios above are that the funding amount cannot be supported by the US$27.5mil on the balance sheet.

That leaves us with a simple conclusion, for Prime to make future acquisitions given its average pipeline asset size, it would most probably have to use equity fund raising methods – be it a rights issue, private placement or preferential offering.

Could Prime then acquire smaller assets? Possibly, let’s estimate the scenarios should they acquire another asset valued at just US$50mil.

Scenario 2a – Prime maintains 37.0% Gearing

  • In this scenario, they would have to raise at least US$31.5mil to fund the acquisition

Scenario 2b – Prime increases Gearing to 40.0%

  • In this scenario, they would be able to acquire the entire asset using debt

Running the same simple estimation on a small US$50mil asset, we come to the conclusion that it would not be possible to do so without at least moving the gearing up to 40%. After the first small asset acquisition, the gearing would likely be too high to make a second acquisition without any equity fund raising.

Given the simulated scenarios above, we think that future acquisitions for Prime are likely to require equity fund raising methods. Therefore, investors in the Prime IPO should take note and prepare extra funding and expect to have to support the equity fund raising in the near term.

REIT investors always have concerns when equity fund raising is involved due to the potential dilutive effectives of the fund-raising exercise. Of course, if the deal works out to be DPU accretive, it would be all fine for the investor.

MAS is also considering the possibility of raising the regulatory gearing limit of 45% subjected to income coverage ratios. If that occurs, Prime could possibly benefit by acquiring a sizable asset without turning to equity fund raising. Based on the forecast for FY2019, the interest coverage ratio for Prime is estimated to be between 3.5x to 4.0x.

In the end, despite the large asset pipeline from the sponsor, we see that the limiting factor in the initial growth phase of the REIT is its ability to raise funds to acquire DPU accretive assets. Something that doesn’t seem easy to do without diluting shareholders.

The Cornerstone Investors

Here is a quick mention and tabulation of the cornerstone investors:

  • KBS REIT Properties III – 7%
    • REIT spun-off by KBS in 2015
  • AT Investments Ltd – 0%
    • wholly-owned by Auctus Investments Ltd, controlled by Sai Charan Trust, whose beneficiaries are Mr Arvind Tiku and his immediate family members
    • Mr Arvind Tiku is the founder of AT Capital Group
    • Sai Charan Trust also indirectly owns 10% of the manager through Experion Holdings
  • KCIH – 8%
    • wholly-owned by KCH, the asset management arm of Keppel Corp. Ltd
    • KCH also indirectly owns 30% of the manager through Keppel Capital Two Pte Ltd
  • Times Properties Pte Ltd – 8%
    • wholly-owned subsidiary of Singapore Press Holdings
    • SPH also indirectly owns 20% of the manager through Times Properties Pte Ltd
  • Linda Bren 2017 Trust and The Schreiber Trust – 2%
    • Linda Bren 2017 Trust – sole beneficiary is Linda Bren, the spouse of Peter M. Bren.
    • The Schreiber Trust – beneficiaries are Charles J. Schreiber, Jr. and his family members
  • Hiap Hoe Investment Pte. Ltd. – not mentioned
    • wholly-owned subsidiary of Singapore mainboard-listed Hiap Hoe Limited is a regional real estate group

You will notice that from the above, about 60% of the manager is also co-owned by the same cornerstone investors. The remaining 40% of the manager is co-owned by KBS Asia Partners (KAP) which are in-turn co-owned by:

  • P Bren KAP I, LLC, which is owned by Linda Bren 2017 Trust – 3%
  • Schreiber KAP I, LLC, which is owned by Charles J Schreiber Jr – 3%
  • Rana KAP I, LLC, which is owned by Rahul Rana – 66%
  • R Bren KAP I, LLC, which is owned by Richard Bran – 33%

In other words, the cornerstone investors get a chunk of both the REIT income and the REIT management fees!

Clearly Keppel and KBS has shown to have a great relationship with regards to listing of US based assets here in Singapore – starting first with Keppel-KBS REIT and now Prime US REIT.

Mr. Arvind Tiku, an indian-born Singapore resident deserves a brief mention here. He is ranks 13th on Forbes Singapore rich list with a net worth estimated to be $2.1bil and has stakes in oil and gas, property and renewable energy. According to Forbes “he owns a stake in London-listed Nostrum Oil & Gas along with steel magnate Lakshmi Mittal and Timur Kulibaev, son-in-law of Kazakhstan's president.”.

In general, we think that the cornerstone list is made up of fairly well-known Singapore brands and names which seems to indicate a strong support for the REIT.

There were however some rumours (which we are not able to ascertain the source or the accuracy) that seem to suggest that KBS initially intended to divest a much larger state but decided to later to take up a much larger stake. The possibilities of why they had a change of heart could be numerous perhaps because of poorer market response, inability to secure more cornerstone investors, lukewarm response to ARA US Hospitality Trust and Eagle Hospitality Trust…etc. The actual reason is anyone’s guess, but read this with a pinch of salt since it is also based on unverified market rumours.

Occupancy and Leases Profile

Historically, Prime’s portfolio has shown good growth and a strengthening occupancy rate.


Source: Prime US REIT IPO Prospectus

Going forward, the occupancy rate is forecasted to strengthen to 97.5% providing an upside for organic growth.


Source: Prime US REIT IPO Prospectus

Based on the prospectus, it mentions that rental reversions for Prime’s assets are likely to be positive going forward giving that their contractual rents are currently 24.6% below the average market rents for FY2019. The rentals are expected to be boosted in FY2020 to narrow the gap to 8.8%.

We also however wish to point out that growth in the average market rents going forward from FY2019 to FY2020 is forecasted to be fairly stagnant. So while there may be upside within the portfolio, investors should take note that the overall macro-economics does not appear to be showing growth in the coming 2 years.


Source: Prime US REIT IPO Prospectus

From the perspective of its geographic and tenant mix, we can see that Prime is fairly diversified with very little concentration in any trade sector or US cities. However investors should note that, during the Global Financial Crisis of 2008, it was shown that the entire US could plunge into a real estate crisis regardless of the location of city within the US.


Source: Prime US REIT IPO Prospectus

With regards to its tenant mix, approximately 43.5% of its cash rentals are derived from its Top-10 tenants. This gives it a little bit of concentration risk to the anchor tenants should any adverse situation arise. The probability of this occurring is fairly low in our point of view, but it still remains an investment risk point to note for investors.


Source: Prime US REIT IPO Prospectus

Based on the amount of contractual leases, we can expect rents to be fairly stable and predictable for both FY2019 and FY2020. We also like how the lease expiry profile is evenly distributed with a long WALE of 5.5 years. This is expected since most of its leases that it signs with these businesses are generally between 5 to 10 years.


Source: Prime US REIT IPO Prospectus

The part we like most is in the certainly of the organic growth locked in through the contractual leases. About 96.9% of the leases by NLA as of 1 January 2019 are on triple-net or modified/full service gross basis. 98.3% of the contracted leases have built-in escalation clauses providing a predictable organic growth ranging between 1.0% and 3.0%, and averaging 2.1%.


Source: Prime US REIT IPO Prospectus

Established Alignment with Unitholders

The management fee for Prime is as follows:

  • base fee of 10.0% per annum of the Annual Distributable Income
  • performance fee of 25.0% per annum of the difference in DPU in a financial year with the DPU in the preceding financial year

Forecast Period 2019 and Projection Year 2020, elected to receive 80% of the Base Fee in the form of Units.

We like how the management has its performance fee aligned with unitholder’s interest by pegging it to the growth in DPU. It would also be reasonable to receive 80% of its fee in units giving the manager some form of alignment with unitholder’s interest.

What We Like and Dislike About Prime

We summarise the key points about what we like about Prime:

  • High quality Class A Prime Offices
  • Predictable organic growth going forward in its tenancy escalations
  • Potential mark to market rentals during renewals
  • Strong pipeline of assets to acquire from sponsor
  • Well diversified in terms of geography and tenant mix
  • Well-staged lease expiry and debt expiry profile
  • Alignment of management performance fee with unitholders
  • Reasonable interest cover
  • Significant number of well-known cornerstone investors

While there are many good points to note, there are also some concerns and risk that investors should take a note of:

  • US REIT IPO Fatigue in Singapore – none of the more recent US REIT listings of Keppel-KBS, ARA Hospitality Trust, Eagle Hospitality Trust have had a flying start in their share prices. If so, why not be patient wait and see how the stock price performs in the open market and make a decision then?
  • High Gearing with low Debt Headroom – at 37% gearing and the simulated scenarios we had above, we strongly suspect that it will be difficult for Prime to acquire assets that are DPU accretive without diluting shareholders through equity fund raising exercise.
  • Risk of larger than expected CAPEX – While this might be a risk, it is somewhat negated by the fact that a large percentage of the leases are on triple-net-leases or modified/full service gross basis. However this could be looked in a different light, the possibilities of enhancing those assets through AEIs to extract more value.
  • Are the assets injected already matured? – This is one key concern that we have, since the assets are from KBS REIT III who is divesting those assets according to their profit realisation strategies, doesn’t that imply that they likely already matured and would like to lock in gains for their early investors?
  • Limited upside in average rentals – Based on the average market rental forecast, it would seem that the markets for Prime’s assets are likely already at the late stage of the cycle .

What’s Our Personal Take on Prime?

Personally, at this stage, we would likely take a patient wait and see approach and observe how the book building exercise with the placement tranche with the institutional and high net worth investors go. Will Prime close the placement tranche quickly like ARA Hospitality Trust or will it take an extended period like Eagle Hospitality Trust?

We would also observe if they retain the indicative issuance price of US$0.88 or did, they modified it in the final offer. Together with the duration of the book building exercise, this may give us a clue to how receptive the investors were during the placement tranche.

Would there be any new significant cornerstone investors or noteworthy investors from the placement tranche?

So, while there is much to like, we also note several risks to observe. These are not trivial risk and are certainly are strong considerations in whether an investor should take the plunge.

Perhaps playing spectator for this event wouldn’t be too bad an idea.

 

After another sold-out session in May and June 2019, readers  have been asking for another run of our most value for money REITs investing seminar!

We are hosting our next new and refreshed The Essentials of REIT Investing seminar on the 31st July 2019 (Wed) from 7pm to 10pm at the Singapore Shopping Centre, 190 Clemenceau Avenue, #02-20A, Singapore, Singapore 239924.

For just $15, this is by far the most value for money REITs investment seminar available in Singapore!

For more details and registration, check out our EventBrite page:


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Meanwhile, do also check out the book REITs to Riches: Everything You Need to Know About Investing Profitably In REITs available at all major bookstores around Malaysia and Singapore. To purchase the eBook (PDF) copy, navigate to http://aktive.com.sg/store/reits-to-riches/.

 

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