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Analysis of Cromwell European REIT IPO

by: Tam Ging Wien

- High Yielding Mature REIT


All examples and stocks quoted here in this article and on the ProButterflyTM site are for learning purposes; it does NOT constitute 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. If in any doubt about the investment action you should take, you should consult a professional certified financial advisor.

Update [2017-09-19]: A new article published on the The Straits Times entitled Cromwell REIT cuts IPO size and increases the sponsor's stake which reports that an updated preliminary prospectus was lodged on MAS Opera on Monday (18-Sep) indicating that Cromwell had cut their offer from 1.58bil to 1.3bil but the offer price remains unchanged.

This will increase Cromwell's stake to 25.9% from 12.7%. This gives Cromwell a greater alignment with unitholders but still lower than the average of 32.31% of our comparators. This certainly eases one of the major concerns with this IPO.

Update [2017-09-25]: Cromwell Property Group in a regulatory filing on the Australian Stock Exchange entitled Cromwell Elects Not to Register Prospectus has stated that they have decided not to proceed with the registration of the prospectus for CEREIT. The reason stated is due to "current market conditions" without further elaboration. Cromwell will re-assess the situation and provide a market update in due course.

This announcement would put on hold Cromwell's plans for the CEREIT IPO. We will need to await for further information from Cromwell.


Australian real estate investment manager Cromwell Property Group (Cromwell) aims to inject 81 of its Europeans assets into Cromwell European REIT (SGX; CEREIT). CEREIT is a Real Estate Investment Trust (REIT) which draws rental income from various real estate classes across Europe; mainly in Poland, Netherlands, Italy and France with limited assets in Germany and Denmark. The nature of the real state are a mix of offices (35.0%), light industrial/logistics (31.1%), retail (27.3%) and others.

At the time of writing, CEREIT has lodged a preliminary prospectus for a listing on the Singapore Stock Exchange (SGX) mainboard. There is a total of 1,583,955,000 (1.584bil) units on offer at a price of between €0.55 and €0.57 per unit.

This listing will be denominated in Euros (€) making it the first euro-denominated REIT listed on SGX.

Based on the indicative timetable, CEREIT plans to open its public offering at 9pm on 21-Sep-2017 till 12pm 26-Sep-2017. Balloting will take place on 27-Sep-2017 and plans to start trading on 28-Sep-2017.

Is the CEREIT IPO worth subscribing to? Let’s take a deeper look.

Indicative Timetable

Source: Cromwell European REIT Preliminary Prospectus

The Offer

The public offer has been summarised in the table below:

Units Offered

1,583,955,000 (1.584bil) (excluding overallotment)

a

Offer Price

€0.55 to €0.57 per Unit

b

Total Units

2,192,000,000 (2.192bil)

c

Net Asset Value (NAV)

€1,187,460,000

d

Net Asset Value (NAV) per Unit

€0.5417

e = d / c

Price/NAV per Unit

1.015 to 1.052

b / e

Estimated Proceeds

€871,175,250 to €902,854,350

a x b

Estimated Market Cap.

€1,249,440,000

b x c

Estimated Gearing (%)

33.5% to 36.0%

 

Estimated DPU (€ cents)

4.23c to 4.27c

 

Forecasted Yield (2018)

7.491% – 7.691%

 

Forecasted Yield (2019)

7.614% – 7.818%

 

Distribution Frequency

Semi-annual (30-Jun & 31-Dec)

 

Lease Summary

  • Occupancy Rate – 89.3
  • WALE – 5.1 years

 

Real Estate Category

Mixed European Real Estate

(Office - 35%, Light Industrial/Logistics - 31.1%, Retail - 27.3%, Others - 6.6%)

 

Geographical Locations

Poland, Netherlands, Italy, France, Germany, Denmark

 

Dividend Policy

  • 100.0% of Annual Distributable Income for the period from the Listing Date to the end of Projection Year 2019
  • At least 90.0% of Annual Distributable Income thereafter

 

The way CEREIT’s asset portfolio is structured doesn’t make it very easy to compare. It has a mix of offices, industrial, logistics and retail among other asset types. There is only one other European REIT at the moment which is IREIT Global which has assets only in Germany for offices only. This makes our comparative analysis a little more difficult due to its mixed-European assets.

Therefore, we have decided to use IREIT Global to give us a sense of European real estate and compare them to 2 other office, industrial and retail REITs each based on the largest market capitalisation. This allows us to produce an equally weighted average and engineer our own pseudo-mixed REIT. As IREIT Global is the only REIT with European exposure, our pseudo-mixed REIT is still not able to give us the full European flavour to the comparison. But without a better way to compare, we decided to continue on.

We tabulated the data up with the following comparison table:

Source: Various Annual Reports and Presentation Slides

Using the largest market capitalisation method of selecting the comparison, our selections tend to be REITs which are quite well known to local investors. However, the selection is also geographically skewed to assets located in Singapore.

Looking at the averages, it appears that CEREIT is fairly valued with an offer of between Price/NAV per unit of between 1.015 to 1.052. Gearing is also fairly average between 33.5% and 36.00%. However, it offers a much higher yield of between 7.49% to 7.69% making CEREIT quite attractive compared to the average yield of only 5.92%.

We would have personally preferred that the CEREIT had a lower gearing (say lower than 30.0%) so that it would have more debt headroom to borrow and grow in the future. With an average gearing, we don’t expect future growth through acquisitions to come fast without either raising more capital through rights issue or perpetual securities. The later will not affect its gearing but will contribute to higher interest payments.

As our high level comparison appears to shows that CEREIT is promising, we will proceed to dig deeper. We did notice however that their occupancy rate is lower than 90% and this doesn’t compare as favourably as our other REITs.

A More Detailed Look at CEREIT

Real Estate Portfolio

CEREIT has a sprawling real estate portfolio across 6 countries in Europe. With a total of 81 assets and a market capitalisation of about €1.25bil (~SGD 2.0bil), CEREIT in among the top 12 REITs listed on the SGX.

Source: Cromwell European REIT Preliminary Prospectus

The breakdown of the real estate portfolio by asset classes and geographic location shows that the portfolio is fairly diversified with no more than 35% of assets in any specific class or country. While this initially was our thought, we also realised that all the 6 countries are members of the European Union (EU).

As the EU has developed into an integrated single market which allows the free movement of people, goods, services, and capital within the internal market, we think that their economies and fortunes are likely correlated. This therefore does somewhat constitute a concentration risk to CEREIT, should an adverse economic impact on the EU as a whole, it is likely to impact CEREIT as well. Future laws and policies implemented within the EU may also affect CEREIT; this may include taxes, immigration, labour and other laws that affect the demand and supply of the assets.

Source: Cromwell European REIT Preliminary Prospectus

Growth Potential

Most REITs have a developer as a sponsor. This way, the sponsor is able develop assets and then inject it into the REIT. This gives the REIT a steady pipeline of assets to grow while its sponsor is able to recycle their capital into future projects. However in Cromwell’s case, they are not a developer, but rather a real estate investment manager.

From the preliminary prospectus, it is not clear to us if they have an active pipeline of properties which they are able to inject into the REIT in the future to assist in its growth. However they certainly do have a large network in Europe which could aid in the REIT’s future growth.

However, the REIT’s acquisition is also limited by the amount of funding it is able to secure. With a high initial gearing of 33.5% to 36.0% at point of IPO, it doesn’t leave much debt headroom left to grow without a rights issue or perpetual security issue sometime in the foreseeable future.

Source: Cromwell European REIT Preliminary Prospectus

CEREIT also have embedded inflation-linked leases embedded into their contracts. This is a good clause to have in their lease contracts, however we don’t think that the growth forecast and inflation rate for Europe and those countries in the portfolio will be high. These inflation-linked leases are not likely to offer much benefit in our view in the next 1 to 3 years.

High Management Fees

Interestingly, and article on The Edge entitled “A Negative View of Cromwell European REIT from Down Under” which mentions that CEREIT’s overall management fees are on the higher side. That’s a good catch, we may not have noticed this had it not been for The Edge’s report.

The relevant paragraph is extracted from The Edge’s article:

Source: The Edge Singapore (https://www.theedgesingapore.com/negative-view-cromwell-european-reit-down-under)

Weak Alignment of Interest

The preliminary prospectus mentions that there is a “strong alignment of interest with the Sponsor to hold approximately 12.7% of the total number of Units” (assuming the Over-Allotment Option is not exercised and based on the Maximum Offering Price).

We found this claim a little puzzling as our comparisons all have much higher sponsor interest in the REIT. On average, our comparators would have a 32.31% sponsor interest. The lowest sponsor interest is Ascendas REIT with 19.88%, which is still much higher than CEREIT’s 12.7%.

If the overallotment option is exercised, then their shareholdings would fall to 8.7%.

This is the lowest percentage of sponsor alignment we have seen so far and our comparisons confirms it. Coupled with the offer price just higher than its NAV per Unit, it seems to give us the impression that Cromwell would like to monetise as much of the asset value as possible. If the reports on the high fees is true, it would seem that Cromwell in more interested in profiting from the fees than the performance of the REIT for the unitholders.

This weak alignment of interest is a big negative for us.

Having said the above, it would be also fair to point out that the fee structure is such that the performance fee is pegged to the performance of DPU. This somewhat balances out the previous “mis-alignment”.

Income Support

So far, we only managed to find income support present in one of its properties “Milano Piazza Affari” which is a freehold property located in Milan. There is a 3 year income support on this property valued at €3.540mil annually less the effective rental income of the property.

We think that this is fairly small matter but still worth mentioning. “Milano Piazza Affari” is about 6.88% of the total portfolio and this income support is quite insignificant when compared to the total rental income.

More information can be found in the extract below and from Page 261 in the preliminary prospectus under the heading “RENTAL GUARANTEE ARRANGEMENT” if readers are interested.

Source: Cromwell European REIT Preliminary Prospectus

Lease Profile

CEREIT’s preliminary prospectus mentions that it is well diversified across more than 1000 leases and top 10 tenants contributes only 40.6% of total headline rent. No single tenant contribute more than 15.2% of the total rental.

This diversification allows CEREIT to spread its risk so that adverse scenarios affecting a few tenants will have a limited impact across the entire portfolio.

However with more than 1000 leases to manage, it would also likely be costly for CEREIT to manage so many tenants across so many geographic regions. Tenancy changes and renewals can sometimes take longer than expected and with more than a thousand leases to manage, that effect can also compound. We think this is a small risk but a risk no doubt with regards to cost controls on the manager’s part.

Source: Cromwell European REIT Preliminary Prospectus

The lease profile is also very well distributed with no more than 12.0% of the leases expiring in the next 5 years. Majority of the leases are locked in till well beyond 2022. The Weighted Average Lease Expiry (WALE) and Weighted Average Least Term (WALT) is 5.1 and 5.8 years respectively. When broken down into the constituent asset classes, we notice that the WALE was dragged down due to Light Industrial/Logistics component.

Despite the lower WALE from the industrial component, its overall WALE is still generally higher than some of the listed SGX REITs. For some perspective, IREIT Global has 5.5 years WALE and this is lower compared to CEREIT’s to 6.9 years for its office portfolio. Capitaland Mall Trust, Mapletree Commercial Trust, Capitaland Commercial Trust and Ascendas REIT has a WALE of 2.1, 2.7, 6.5 and 4.3 respectively.

This long WALE gives investors a sense of certainly, but a long WALE may also work against the REIT as it may not be able to take advantage of rental increases if the leases are locked in for too long. But in the current European economic climate, we would think that a longer WALE is more favourable to investors.

Source: Cromwell European REIT Preliminary Prospectus

We also observe that CEREIT has a fairly low occupancy rate compared to other SGX listed REITs. At 89.3%, it is the lowest among all the REITs in our table used for comparison. Based on the breakdown of the IPO Portfolio, it is obvious that the low occupancy rate was dragged down again by the industrial component:

  • Office – 94.8%
  • Light Industrial/Logistics – 82.9%
  • Retail – 96.9%
  • Others – 100.0%

Industrial real estate assets typically have lower occupancy rates. As shown in our comparators, Ascendas REIT and Mapletree Industrial Trust only has an occupancy rate of 91.6% and 92.6% respectively much lower than other comparators. However, CEREIT’s Light Industrial/Logistics only had an 82.9% occupancy rate. Is this aligned with other European peers or does CEREIT have trouble filling up these leasable areas? The preliminary prospectus mentions that the management expects the occupancy rate to increase 91.3% and 93.6% for Projection Year 2018 and 2019.

Tenant Profile

The tenant profile is certainly very diversified and there is little concentration risk in any specific industry.

Source: Cromwell European REIT Preliminary Prospectus

Exchange Rate Risk

According to the Preliminary Prospectus, CEREIT receives majority of its rental income denominated in Euros (€) while a smaller proportion is received in Danish Krone. Since borrowings are also denominated in Euros (€), there is minimal exchange rate risk here owing to the limited exposure to Danish Krone.

However, since the units are denominated in Euros (€) but the distributions is paid out in Singapore Dollar. Investors who are converting their native currencies to Euros for the purposes of applying for this IPO are exposed to exchange rate risk. There is also exchange rate risk in the conversion of the distributions per unit in Euros into Singapore Dollar.

Source: XE.com (http://www.xe.com/currencycharts/?from=EUR&to=SGD&view=2Y)

The Euro has been strengthening against the Singapore Dollar over the course of 2017. The EUR/SGD 5-year high was at $1.76 while the low was at $1.44. At the current rate of $1.61, we close to the mid-point of the 5-year EUR/SGD range. It would be difficult to predict how the EUR/SGD will move in the coming months or years.

Interest Rate Risk

The interest rate cover has been estimated at 7.8x and 7.7x for projection year 2018 and 2019 respectively. This is a fairly healthy level.

Further, approximately 95.4% of its interest rate risk is hedged using a combination of interest rate swaps and caps. Majority of the amount are hedged for 1 to 2 years. CEREIT’s all in effective interest rate (including the cost of interest rate hedging facilities) is estimated to be 2.2% per annum for the forecast period 2017, projection year 2018 and projection year 2019.

Source: Cromwell European REIT Preliminary Prospectus

We think that CEREIT has locked in a favourable interest rate cost for the next 1 to 2 years and at a good interest cover. Therefore we think that the interest rate risk is fairly low.

Valuation

Discounted Dividend Model

We have chosen to a value CEREIT based on Discounted Dividend Model as the projected growth rates of 1.02% is provided by the preliminary prospectus for Forecast Period 2017, Projection Year 2018 and 2019 with an annualised figure of 4.18c, 4.25c and 4.32c respectively.

We have also chosen a discount rate of between 2.5 to 3.0% as this represents the premium that we demand over the risk free rate of the CPF ordinary account interest rate of 2.5%.

We have also chosen to a flat 15-year period to sum with no terminal value. We believe that these assumptions account for both the benefits and stability that CEREIT brings as well as the risk that investors take on.

Using the dividend discount modal, we get a range between €0.54 and €0.56. This is just 1c lower than the range of the €0.55 to €0.57 in the offer.

“Pseudo-Peer” Comparison Method

While there is no REITs that we are aware of with the similar characteristics of CEREIT, we have chosen to create our own pseudo-mix REIT using an equally weighted average of IREIT Global and 2 of each office, industrial and retail REITs each based on the largest market capitalisation. The result of our comparison is summurised in the table in the early section of the article.

Based on the comparison, we conclude that the valuation is fairly priced.

Together with the information from the Discounted Dividend Modal, we think that Cromwell has priced this REIT at its most optimal point taking into account the positive sentiments of the REITs and pricing them at fair value both from a Price/NAV perspective and Dividend Discount Modal.

We think that the upside for investors therefore is fairly limited.

Summary and Conclusion

We are particularly like CEREIT for its high yield compared to the approximate peers listed on SGX despite having similar gearing and Price/NAV. However the long term growth prospects appear quite low with a forcasted growth in DPU at only 1.02%. Certainly, CEREIT is being listed as a fairly mature REIT owing to its large asset side and somewhat higher gearing, therefore it is likely not going be a fast growing DPU REIT.

What we like about CEREIT:

  • Established sponsor who has experience with European real estate
  • High yield of at least 7.5%
  • Long WALE of 5.1 years
  • Does not make use of income support to artificially increase the yield
  • Geographic locations, asset mix, lease and tenant profile highly diversified
  • Hedged interest rate risk

What we see as risk factors to CEREIT’s investors:

  • Fairly valued and leaving investors with limited growth in capital appreciation
  • Low DPU growth as REIT is somewhat mature
  • Weak sponsor alignment with unitholders with between 8.7% and 12.7% of sponsor ownership
  • High fees according to 3rd party reports on The Edge
  • Large initial offering leading to fulfilled demand for the IPO and low secondary demand when publicly traded
  • Low occupancy rate of 89.3%
  • Limited growth potential due to fairly high gearing
  • Exchange rate risk between EUR/SGD
  • Potential concentration risk as all geographic locations are European Union members

We had performed 2 methods of valuation for CEREIT and we summarised our entry price based on the different methods below:

  • Discounted Dividend Model Method: €0.54 and €0.56
  • “Pseudo-Peer” Comparison Method: Fairly valued at €0.55 and €0.57

It appears as if Cromwell engineered a REIT with fairly mature characteristics to be perfect on all fronts showing a highly diversified REIT, with long WALEs, average gearing, high yield and priced at the optimal point.

However our major concern is the low sponsor alignment and the high fee which gives us the impression that Cromwell wants to monetise as much of its assets as possible.

We would probably stay away from the IPO and watch on the sidelines how the price action performed in the near term after going public. If the prices falls by €0.05 or yield pushes above 8.5%, we might consider adding it to our existing REIT portfolio. We are not in a hurry to buy into this REIT as we are already holding other REITs in our portfolio with 7.5% yields at our purchase price.

 

 

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

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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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Disclosure Statement

The views and opinions expressed herein are those of Tam Ging Wien (“the author”) and do not necessarily reflect the official policy, position or view of the author’s employer, organization, committee, Unicorn Financial Services or other group(s) or individual(s).

The author does not intend to subscribe to the Singapore Public Offer of Cromwell European REIT.

The author at time of writing does not hold any stake in Cromwell Property Group.


 

Positioning to Ride the Recovery

Opportunities and Risk Post-COVID-19 Pandemic in the various S-REIT Sectors

The COVID-19 crisis has brought about an unprecedented economic shock to many sectors, and yet it has also generated opportunities in others.

The tech sector has been a major beneficiary and along with that, S-REITs exposed to the Data Centre sector such as Keppel DC REIT and Mapletree Industrial Trust gained phenomenally.

But are the investment opportunities in REITs now gone? Personally, we do not think so. There are still many REITs below their pre-COVID-19 levels poise to recover strongly in the coming quarters – and now it is the best time to prepare to capture the post-COVID recovery.

Join us as we discuss the opportunities and risk in the S-REIT space sector-by-sector as we try to uncover recovery opportunities for FY2021 and beyond. Real estate sectors that we will be covering include the Retail, Hospitality, Offices, Healthcare, Industrial and Data Centres.

Our speaker Tam Ging Wien will be sharing his knowledge and experience including:

  • Part 1: A Survey of the REITs Landscape Around The World
  • Part 2: Key Metrics in Identifying Strong REITs
  • Part 3: Real Estate Sector Review Amidst the COVID Crisis
  • Part 4: Screening for Opportunities
  • Part 5: Q&A

Some key highlights that will be covered includes:

  • Real estate sector-by-sector review on COVID-19 impact and recovery opportunities. Sectors covered include the Retail, Hospitality, Offices, Healthcare, Industrial and Data Centres.
  • Opinion on which sector will continue to stay resilient and which are poised to recover quickly post-pandemic
  • The right metric to use when screening for high quality REITs
  • Case studies of REITs which are considered high quality
  • Step-by-step demo of how to screen for high quality REITs on your own

During the sharing session, various Singapore-listed REIT examples will be used.

There will also be a Q&A so that members of the investing community may engage in open dialog and discussions in order to deepen their understanding of REITs. Do prepare your writing materials for note taking.

Please note that the duration of the on-site seminar is 7pm to 9:45pm Singapore Time (GMT +8).

The details of the event are as follows:

  • Seminar: Positioning To Ride The Recovery
  • Date: 5th May 2021 (Wed)
  • Time: 7:00pm to 9:45pm
  • Venue: RNN Conference Centre - Kyoto Training Room (Level 4), 137 Cecil Street, Cecil Building #04-01, Singapore 069537
  • Fees: S$10.00
  • Sign-up Link: http://reitessentials.eventbrite.com/

To learn more about REITs, we recommend the article: What are REITs?

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