by: Tam Ging Wien
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United Hampshire US REIT (Hampshire REIT) is the new REIT on the block. A grocery-led retail and self-storage REIT with assets based primarily in the East Cost of the United States (US), namely in the states of New Jersey, New York, North Carolina, Florida and Massachusetts. Hampshire REIT has been actively sussing out investor sentiments and educating potential investors on the merits of grocery anchored strip malls and self-storage through non-deal roadshows since January this year.
It seems that their efforts might have paid off, and this week they decided to lodge their preliminary prospectus and begin their book-building exercise. The lodgement pf the preliminary prospectus is likely a show of confidence that they will be able to successfully raise their target amount through the public offering.
Hampshire REIT has a portfolio of 22 properties on the east coast of the US, consisting of 18 grocery and necessity-based retail assets and four self-storage properties. 21 of the properties are freehold and the exception is Wallington ShopRite which has a leasehold term expiring in 2040 with two consecutive ten-year extensions – in other words with the extension options in place, the tenure could be as long as 2060.
According to the preliminary prospectus, the nature of the grocery-anchored retail and self-storage trade mix is recession-resistant, cycle-agnostic and defensive attributes. Grocery and necessity retail make up about 95.4% of the REIT’s base rental income while self-storage makes up about 4.6%.
The annualised yield is forecasted is expected to be between 6.5% to 7.0% and the IPO portfolio occupancy will start at 95.2% with the WALE at a comfortable 8.4 years. Its grocery and fresh food anchor tenants are household names in the US such as Walmart, BJ’s Wholesale Club, Lowes Company, Stop & Shop, Giant Food and Wakefern Food Corp. Others include Home Depot, LA Fitness and PetSmart. Together, their top-10 tenants contribute an estimated 66.7% of the base rental income of the REIT.
The REIT’s sponsors are UOB Global Capital and the Hampshire Companies; the former is the global asset management subsidiary of United Overseas Bank Limited (UOB). Hampshire is a US based real estate manager with investments in industrial, multifamily (residential), groceries and self-storage properties.
Former StarHub CEO Tan Tong Hai sits as the independent chairman of the REIT’s board.
As this is only the preliminary prospectus, the actual figures of the NAV per Unit, DPU, offer price and number of issues to be issued would have been redacted pending the outcome of the book-building exercise. The figures below are preliminary and subjected to change:
Source: United Hampshire US REIT
As over 95% of the base rental income is derived from the grocery & necessity retail asset, we would focus our attention on understanding this specific asset class. Specifically, these assets are termed as strip malls. Strip malls is a retail concept where a shopping centre design is open air and the store fronts are arranged in a row facing a sidewalk or a major road. They are usually located near sub-urban neighbourhoods and have ample parking spaces.
Source: Example of a Strip Mall – Wallington ShopRite, Borough of Wallington, Bergen County, New Jersey. United Hampshire US REIT
According to the article dated 14-Jan-2020 by the Wall Street Journal – Strip Centers Shine as Some Shoppers Sour on Malls, grocery-anchored strip malls out-shine their other retail peers due to their appeal for proximity and convenience resulting in visitor numbers increasing to strip malls in the past few years.
The tenants of such assets are typically anchored by a strong grocery store or supermarket which attracts customers staying around the vicinity due to their convenience and ample parking. As a result of the foot traffic that these groceries anchor tenants bring, other retailers which are service-based and necessity-based to serve the local community become a beneficiary of these foot traffic. For example, quick-service restaurants, discount retailers, smartphone shops, DIY/self-service retailers, barbershops, beauty salons, bank branches, medical and pharmacies.
Source: United Hampshire US REIT
Due also to their convenience-based, necessity-based and proximity-based tenant mix, they foot traffic and business tend to be more e-commerce resistant. The Hampshire REIT identifies 3 key reasons for why this is so:
We liked the detailed independent report commissioned by the REIT which provided in-depth statistics on the subject matter. The first chart shows that e-commerce penetration for drugs, home improvements, food/drink are the lowest in the US. The second chart shows the results of survey that quantifies the reasons why shoppers simply prefer to do in-store shopping for groceries, the chief reason is because they simply prefer to pick their own products. The third chart shows that the e-commerce penetration rate is the lowest in low population density countries. This is explained by the high cost of last mile deliveries.
Source: United Hampshire US REIT
Source: United Hampshire US REIT
Source: United Hampshire US REIT
Enough said, the data speaks for itself and it confirms what most of us investors suspect about suburban necessity-based retail.
Back in 2017, the Amazon acquired Whole Foods in a US$13.4bil deal. With this deal, the world’s largest online retailer is now an owner of a chain of hundreds of physical stores across the entire US. For close to a decade, Amazon has been trying to convenience its loyal customers to buy their groceries online and finally threw in the towel in an acknowledgement that customers simply prefer to buy fruits, vegetables and meat in store.
In a similar move, China’s largest online retailer Alibaba has also opened a string of new concept Hema Fresh (盒马鲜生) stores across the mainland. Customers use the Alibaba app to scan barcodes of products, get information on the produce and recipe ideas and check-out and pay for their groceries with minimal human labour. Alibaba uses customer data and profiling to understand a customer’s preference and allows a quick order in the future or push suggestions. This is seen as an effort to merge artificial intelligence, online and offline retail in the segment of fresh food and produce. Alibaba is betting that fresh produce will continue to be an offline preference and instead of trying to change customer behaviour to move online, they instead took the approach of enhancing the customer’s offline experience.
Both the Amazon and Alibaba’s move clearly tells us that the largest online retails have tried and failed to move the needle on e-commerce for necessity-based groceries and fresh produce. We therefore think that for Hampshire REIT’s tenant mix would likely be here to stay for the foreseeable future.
For readers who are more familiar with S-REITs, we liken Hampshire REIT assets to the suburban malls portfolio of Fraser Centrepoint Trust (FCT) and CapitaLand Mall Trust (CMT) portfolios in Singapore.
After a deeper look at the nature of its assets, we are attracted to the profile of this REIT’s portfolio. However, other factors surrounding this REIT warrants a deeper look.
A traditional REIT model is designed to optimise for receiving rentals, paying its expenses and then distributing the differences to its unitholders. It would own the assets through a trustee who will represent the interest of shareholders. We had previously reviewed Elite Commercial REIT and we like how the REIT was cleanly structured and simple to understand.
For Hampshire REIT, investors need to watch out for these few structuring issues which may put some risk on the predictability of the DPU. Cumulatively, these various top-up arrangements outlined below will contribute an estimated US$2.08mil and US$1.70mil to FY2020 and FY2021 respectively or 6.2% and 4.1% respectively to the NPI.
There is presently enhancement works on St. Lucie West which is expected to be completely by Q1-2021. Upon completion of the expansion, the floor space will expand by 57.3% and committed to be occupied by anchor tenant Publix Super Markets Inc (Publix) which presently occupies one of the existing buildings. Once they vacate the old building, the management is committed to backfill the vacancy. Due to this, a top-up arrangement has been set aside to cover the shortfall in the interim before the completion of the new building and the backfill of the tenancy expected to complete by 31-Oct-2021.
This would be liked to temporary income support, but why not then just make the asset a rights-of-first-refusal from the sponsor and acquire it when the asset is stabilised? Why risk the unitholder’s funds to pay for capital expenditure for development work right from the onset in the IPO portfolio?
We can only say that the REIT has been transparent to list down the actions that it is committed to take to notify unitholders on impending expiry of both top-up arrangements and changes to the arrangements.
Elizabeth Self-Storage would have just been completed in January 2020 while Perth Amboy Self-Storage will still be under construction with the target completion period in Q2-2020. As these assets are still immature and in stabilisation, funds have been set aside to for a four-year period.
Similarly, to the above, to save investors from unexpected project delays and other unpredictability’s of a new development, why not just make this a rights-of-first-refusal asset and acquire it later? Similarly, why risk unitholders funds for assets under construction?
For the Carteret Self-Storage and the Millburn Self-Storage, there is an earn-out arrangement of US$200k and US$500k respectively subjected to the assets meeting a net operating income of at least US$954,117 and US$1,145,703 for any 12-month period on or before 30-Jun-2021 and 30-Apr-2020 respectively. In other words, if the target NOI is met on the assets, the REIT will pay a higher price for the asset.
Why this complex arrangement, is there some unpredictability about the asset that the manager had to negotiate the uncertainty into the contract?
Hampshire REIT will own a 100% of Wallkill Price Chopper asset but pay a reduced 97% price in exchange for paying a 3rd party for an unlimited time of 3% of the distributions per year. This seems like a strange arrangement, then why not just form a 97%-3% joint venture instead and split this up cleanly?
A 3% one-time purchase discount is not the same as an infinite 3% distributions payment every year!
We will just acknowledge that we actually read and reread the IPO Prospectuses and we couldn’t really understand this special arrangement. However, investors who are interested should consult the IPO prospectus to understand this aspect better. Personally, we couldn’t understand it very well so the lack of knowledge to assess this risk is to us an investment risk itself.
Strip malls while defensive currently tend to have a low cost of construction. As a result, new assets could spring up quickly in the surrounding neighbourhood which could bring competition to Hampshire REIT existing assets. They just need to poach the anchor tenant over and the food traffic in the strip mall may suddenly fall resulting in other tenants also possibly moving out.
As an example of competition, we handpicked 3 assets and located them on Google Maps using the Google Map Red Pin. We then highlighted the retail competition in a red box within a 1km distance. The 3 assets we handpicked are:
For investors, it would be important to review major lease expiries and whether Hampshire REIT is able to renew those leases at favourable market conditions along with a long lock in period. This would give an indication of how the competitive the landscape is.
Cost of redevelopment or AEIs in the US are extremely expensive owing to the limited ability to import cheaper foreign steel and materials and the use of high cost local labour. Any AEIs are also not likely to increase foot traffic since they are suburban assets and depend on the growth in population of the respective area they serve. Observe from the charts below that the revenue and NPI from FY2017 to FY2018 declined for the portfolio which does suggest that rental reversions do vary from year to year. Fortunately, the figures from FY2018 to FY2019 grew.
Source: United Hampshire US REIT
Therefore, the growth of Hampshire REIT will likely have to be driven by the minority storage space portfolio or acquisitions of new assets rather than enhancement to existing assets. And this leads us to the next risk, the high gearing at IPO of 37%.
Due to the high gearing of 37% at point of IPO, it means that the debt headroom of the REIT is pretty limited (baring the possibility that MAS will raise the gearing limits for S-REITs). With a 45% gearing limit, most REITs will attempt to stay at a 5% buffer, and it is likely that Hampshire REIT will do the same. Therefore, in our opinion, it’s likely that Hampshire REIT will need to growth through acquisition yet at the same time lack the debt headroom to do so which could only mean one thing, an equity fund raising down the road.
The sponsors have granted Hampshire REIT a rights of first refusal to their relevant assets for acquisition. However, we could not find any information on the nature and quantity of these assets. Looking at The Hampshire Companies website, these assets where also not publicly disclosed. Therefore, the acquisition pipeline from the sponsor is not as clear. However, we do expect that not all future acquisitions will necessarily come from the sponsor, there are abundant strip malls and self-storage facilities around the US that could potentially be acquisition targets.
We really like the nature of assets that are presented in the IPO portfolio of Hampshire REIT. The groceries anchored assets and necessity-based trade mix makes the portfolio e-commerce and recession resistant. We do however see risk within the portfolio and investors should always invest with their eyes wide open understanding these risks.
A mild discomfort we have is over the complex structuring of some of the assets coupled with partial completion of developments works meshed with top-ups akin to income support.
In the end, the decision to invest or not will depend on the final figures – the offer price and the institutional take up. We will hold any investment decision until more information becomes available post book building exercise.
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