Review of Prime US REIT’s Maiden Acquisition

by: Tam Ging Wien


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Prime US REIT (Prime, OXMU.SI) requested for a trading halt in the early morning on 12-Feb-2020 (Wed) before the markets opened. They were due to release their quarterly results on the same day, but it would be unusual to call for a trading halt for quarterly results release. This kept the markets guessing for a few minutes before the formal announcement was released at less than 30mins later on their proposed equity fund raising and maiden acquisition of Park Tower in Downtown Sacramento, the capital of California for US$165.5mil (S$229.4mil).

Park Tower is a freehold 24-storey Class A office tower built in 1961 and extended in 1992. It was last refurbished in 2019. It has a five-storey mixed-use retail or parking garage with a net lettable area of 489,171sqft.

To fund the acquisition, Prime is proposing an equity fund raising through a private placement at a price of US$0.928 and US$0.957 per unit of to raise gross proceeds of no less than approximately US$100.0mil. The placement closed the same day with a with the exercise of the upsized option raising US$120.0mil, with 125,392,000 new units issued priced at the top-end of the range.

The total cost of the acquisition is estimated to be about US$170.1mil, comprising the US$165.5mil purchase price, a US$1.7mil acquisition fee to be paid to the manager in cash. A further US$3.0mil is estimated for professional fees and other transaction fees, financing and equity fund-raising related expenses, due diligence cost, land transfer taxes and costs to be incurred in relation to the valuation.

Park Tower will be the first asset in Sacramento for Prime.

We have previously covered the IPO of Prime US REIT in our article entitled Prime US REIT IPO - A Qualitative Review and we suggest that readers refer to this article if they are unfamiliar with Prime.

About Park Tower

Designed by Kaplan McLaughlin Diaz, Park Tower after the completion of its extension in 1991 was then the tallest tower in the city of Sacramento. The building was formally named the U.S. Bank Plaza until U.S. Bank moved to U.S. Bank Tower in 2008. It was formally owned by the Shorenstein Company who bought the building in Jan-2003 for US$112.5mil and later sold it to Hines Interests Ltd Partnership in Jun-2017 for US$120.5mil.

Hines is a privately owned global real estate investment firm founded in 1957 with approximately US$124.3bil of assets under management in over 200 cities around the world.

Located at the 1010 8th Street and 980 9th Street, Park tower features a sandstone-coloured precast concrete panels, aluminium and glass exterior façade, and a three-story atrium lobby with granite panels at the pedestrian level. The 3-story atrium lobby features murals by artist Richard Piccolo depicting Sacramento's history in polished marble and limestone.

Park Tower was originally built in 1961 on the 1010 8th Street and extended in 1992 on the 980 9th Street. The sale of Park Tower to Prime for US$165.5mil represents a 37.3% gain for Hines since in mid-2017. The building was refurbished in 2019 before being put up for sale by Hines.

The Property is located in the downtown area of Sacramento, surrounded by abundant lifestyle amenities, including Downtown Commons, Golden One Arena, Convention Centre, hotels, retail and restaurants as well as multifamily housing.

The building was awarded the GOLD LEED Status by the US Green Building Council.


Source: Prime US REIT

What We Like About the Acquisition

Favourable Micro-Fundamentals Supporting Rental Upside

Data from independent research has shown that comparable buildings to Park Tower is experiencing a large surge in rental prices over the last 5 years with vacancy rates at an all-time low of 4.7%. Absorption rates have been generally positive in the last 5 years which suggest that demand is constantly outstripping supply.

The largest jump in rentals came in 2019 compared to 2018 and if this trend keeps up, it implies that upcoming renewals in 2021 and 2022 will contribute positive growth for Prime.


Source: Prime US REIT


Source: Prime US REIT

Supported by Highly Educated Workforce, Amenities and Public Transport

Park Tower is just a stone throw away from the California State Capitol and surrounded by other recreational, cultural and educational offerings. Nearby, a new entertainment and leisure venue – Downtown Commons (DOCO) – a shopping complex with 630,000 sq. ft of retail, including popular eateries, department stores, cinema and gym. The Sacramento convention centre is along the same street just a few blocks away.

Within the city of Sacramento, places of higher education such as UC Davis and California State University and other educational institutions contribute to a supply of highly educated workforce which in turn leads to demand by corporates seeking talent in the city.

Looking at the Sacramento Regional Transit map, we can see that Park Tower is well serviced by multiple public transport stations and lines.

Together, the amenities, highly educated workforce and services by good transportation, we are positive that these factors will help Park Tower maintain its demand for its floor space.

Source: Sacramento Regional Transit

DPU and NAV per Unit Accretive

According to the pro-forma results, the acquisition of Park Tower is expected to be DPU and NAV per Unit Accretive to unitholders. This is good news for minority unitholders who do not have the opportunity to participate in the private placement.

We have done our own pro-forma estimates for this acquisition taking into account the upsized option was exercised during the private placement. Based on our estimated, we expect that the gearing will decline from 36.4% to 35.5% post-acquisition assuming all else remains constant. The NAV per Unit is expected to growth by 0.3% from US$0.891 to US$0.894.

With regards to the DPU accretion, it will be approximately 3.20c instead of the 3.24c as illustrated in the slides due to increase unit base due to the offer’s upsized option being exercised. This represents a pro forma DPU accretion of growth of 1.59%.


Source: REITScreener ResearchProButterfly ResearchPrime US REIT

Note: Prime US REIT Investor Relations has gotten in contact with us with regards to the estimation of the gearing. We wish to notify readers that the Prime US REIT's gearing as at 31 December 2019 was 33.7% and the resulting gearing ratio is presently not available as yet, pending completion of acquisition on 24-Feb-2020. The finalised gearing will be announced in due time. The above remains our own estimates and should not be taken as the final figure.


Source: Prime US REIT

Quality Tenants Comprising of Government and Public Service Administration

We especially like that governments and public service administration contribute about 48% of the rental income of Park Tower. Other quality tenant names such as Deloitte, ICF Consulting and Regus brings comfort to the investors knowing that there is some level of certainty and predictability in the tenant mix.

This contributes to its long WALE of 5.6 years and a well spaced-out lease expiry profile.


Source: Prime US REIT

Strong Institutional Support

Considering that the private placement was closed on the same day with the offer 4.8x over-subscribed, it indicates to us that there is a strong institutional support for Prime’s units. This usually will bode will in the long term for the stock as institutional support provided market liquidity for the stock.

What We Dislike About the Acquisition

Matured asset with limited asset enhancement potential

As Park Tower was already refurbished in 2019 before being sold to Prime, there will be very little asset enhancement potential for a while. This would favour investors seeking stable and predictable income, however for investors seeking growth, this asset unfortunately has limited redevelopment of enhancement upside.

Occupancy Could Be Higher in the 95% Range

Considering the centrality of the location in Sacramento, we would have expected the occupancy to be aligned with the vacancy rates of the comparables in the city at about 4.7% (or 95.3% occupancy rate).

The occupancy rate of 92.2% was a little lower than expected. On the bright side, it means there could be some upside potential to increase the occupancy rate and therefore the rental income. A 100% occupancy rate would also not be favourable as it does not give buffer for existing tenants to expand their spaces if required which may result in a drop-out of a large tenant during renewals.

No Chance for Minority Shareholders to Participate

Prime decided to go on a private placement route instead of a preferential offering to its existing shareholders. There are pros and cons of either method and some S-REITs have tried to bring the best of both worlds by doing both simultaneously. Unfortunately for Prime’s minority unitholders, they will not get a chance to participate in this private placement but can still take comfort in the fact that they will enjoy a DPU and NAV per Unit accretive acquisition. Perhaps next time when there is a much larger acquisition, we hope that Prime would have both a simultaneous private placement and preferential offering when raising funds.

Conclusion

There is much to like about this acquisition including DPU accretion, strong rental growth potential, supportive micro-fundamentals of the city and finally stable, predictable and quality tenants. We only wished we had more upside potential from future asset enhancement initiatives, but it looks like it would be quite a while before we will see any refurbishment works.

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