by: Tam Ging Wien
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Elite Commercial REIT (Elite C-REIT) called for a trading halt on Monday, 19-Oct-2020 before market open, and lifted the halt at 1pm after it announced its maiden acquisition proposal to buy 58 commercial buildings located across the UK for £212.5mil (S$372.9mil) from its rights-of-first-refusal (ROFR) pipeline of assets from of Elite UK Commercial Fund II at an agreed valuation of £212.5mil.
The 58 assets have a total net lettable area (NLA) of about 1.3mil sqft. About a third of the assets are in London, and some of the rest are located in other major UK cities such as Manchester, Edinburgh, Liverpool and Cardiff.
Out of the 58 assets, 54 are freehold while the rest are on a long leasehold tenure ranging between 83 and 983 years.
Elite UK Commercial Fund II presently holds 62 assets and after these 58 are acquired, Elite C-REIT continues to hold the ROFR to the remaining 4 assets held by Elite UK Commercial Fund II.
Specifically, it intends to acquire 100.0% of the share capital in Elite Amphora Ltd and Elite Cask Ltd which are subsidiary special purpose vehicles (SPVs) belonging to Elite UK Commercial Fund II. Both these SPVs hold the targeted 58 commercial assets.
The total acquisition outlay is estimated to be £218.5mil including the acquisition fee of approximately £2.1mil (payable to the manager) and estimated professional and other fees and expenses of approximately £3.8mil.
The agreed consideration of £212.5mil is the higher of the two independent valuations by Colliers International and BNP Paribas which reported a valuation of £212.5mil and £205.2mil respectively which was stated in their respective reports dated 14 August 2020. The key valuation method used by the two appointed valuers is the income capitalisation approach.
The 58 commercial assets are 99% leased to the UK government with 82% occupied by the UK Government’s Department for Work and Pensions (DWP) while the remaining 17% are occupied by other UK Government occupiers including the UK Ministry of Defence, National Records of Scotland, HM Courts and Tribunals Service, Natural Resources Wales and the UK Environment Agency. The Department for Work and Pensions (DWP) is the UK's largest public-service department responsible for crucial welfare, pensions, and child maintenance policy and serves over 20 million claimants.
While the manager’s main objective is to pursue an equity fundraising to pay for the acquisition, it has structured agreement with the seller/vendor – Elite UK Commercial Fund II to also issue consideration units at a minimum of £0.68 a unit, above the traded market price at the point of announcement. These consideration units can be issued as payment if the manager found that market conditions are unfavourable to executing a successful equity fundraising. This way, regardless of the outcome of the equity fundraising, Elite C-REIT is guaranteed to have sufficient internal resources and financing to complete the acquisition.
We found that the use of the consideration units above the presently traded market prices to pay for the acquisition was particularly creative and are rather impressed that the manager has managed to negotiate this agreement and that the vendor and its investors accepted the payment in consideration units. At time of writing, the market price is presently £0.63, lower than the minimum £0.68 per consideration unit.
Before we dive into the specifics of why we think this acquisition is favorable to unitholders, we strongly suggest that readers first get familiar with Elite C-REIT through the following articles:
Traditional equity fund raising typically involves creating new shares and issuing them through a private placement to 3rd parties or significant unitholders or via a rights issue distributed according to the fractional ownership of each unitholders.
For more details, we recommend readers to review this article that we have published detailing how REITs raise funds via equity and the various scenarios impacting the DPU:
By placing out new shares to existing unitholders, it would necessitate unitholders to cough-up cash to subscribe. In some cases, especially in the case of rights issue, there is usually an underwriter that would guarantee that a certain minimum amount would be raised. The final issue price is typically measured against a volume weighted open market price which are subjected to volatility and sometimes impacted by unfavourable news or market conditions.
However, in Elite C-REITs case, they have managed to negotiate a possibility of structuring the acquisition to be paid to Elite UK Commercial Fund II (the vendor/seller) using consideration units within a range of £0.68 to £0.76. Up to £89.4mil could be raised via this method where the price per unit will be calculated based on the volume weighted average price (VWAP) traded in the SGX for the period of 10 trading days immediately preceding the date of the issue of the consideration units.
However, if the final VWAP is below £0.68, the consideration units will be issued at a minimum of £0.68. If the final VWAP is above £0.76, the consideration units will be issued at a maximum of £0.76. Only if the VWAP falls within the range of £0.68 to £0.76 will the VWAP be used to price the units.
According to the manager, the arrival of the range is on the basis that Elite C-REIT’s IPO price was £0.68 and the highest price the Units have ever been traded the open market is £0.76.
If the use of the consideration units is decided as the option for equity fund raising, the vendor (seller) will be paid in the newly issued consideration units.
Elite C-REIT has clarified that it is their primary objective to still pursue an Equity Fund Raising. However, should the market conditions be non-conducive, they may decide in the interest of Unitholders to fund the total acquisition outlay through issuance of the consideration units without the equity fund raising. This guarantees that Elite C-REIT will have sufficient internal resources and financing to complete the proposed acquisitions.
The announcement has set-out an illustrative issue price of £0.68 per consideration unit and assuming 100% of the purchase consideration is satisfied with the issue of consideration unit, the aggregate unitholding of Elite UK Commercial Fund II will increase from 0% to approximately 25%. Elite UK Commercial Fund II will thus become a controlling unitholder.
Elite UK Commercial Fund II, upon receipt of the consideration unit, will do a distribution in specie of such consideration unit to its investors, which would result in the largest investor of Elite UK Commercial Fund II, being Partner Reinsurance Company Ltd (“PartnerRE”), holding up to 24% of the units. All other remaining investors of Elite UK Commercial Fund II will, upon receiving its respective proportion of consideration unit, hold less than 5% of the units. According to the announcement documents, PartnerRE has provided an undertaking to restrict selling 100% of the units held by it following the distribution in specie of the consideration units for 6 months and 50% for a further 6 months after that.
In summary, we found that Elite C-REIT has managed to negotiate the possibility to pay for the acquisition in units directly to the seller. This reduces advisory cost and puts a guarantee on the completion of the acquisition at a certain price without the need for underwriting. On the investors side, they would not be unnecessarily burdened to cough up more money should market conditions be unfavourable. On top of that, this brings some level of alignment of interest between the REIT and the seller since they are being paid in units rather than in cash. Finally, we think this brings a certain level of stability to the open market share price during the acquisition period as traditionally prices trade very volatile when a REIT’s conducts an equity fund raising.
Besides creatively structuring the acquisition using consideration units that is already extensively covered above, there is also much to like about this acquisition.
What we have always liked about Elite C-REIT’s portfolio is the counter-cyclic nature the UK Government’s Department of Work and Pensions (DWP) as a tenant and the 100% exposure to a sovereign tenant with AA-ratings affirmed by S&P.
While the new acquisition is not 100% exposed to the DWP, it does bring in a new set of tenant profile including the Ministry of Defense, the National Records of Scotland, the HM Courts and Tribunals Service and the Natural Resources Wales and the UK’s Environment Agency, all which are agencies of the UK Government.
For the proposed acquisition of the 58 new assets, 35.9% of the assets by value are located in London. If this acquisition completes, it will bring Elite C-REITs overall portfolio exposure to London's 14.0%. Exposure to London is favourable from a number of perspectives.
Firstly, as a result of the COVID-19 pandemic, from January 2020 to August 2020 London saw its number of Universal Credit claimants (which includes unemployment claimants as well as other claimants) increase by 128.8%, the highest of any other region in the UK, thereby underpinning the continued need for Jobcentres and DWP in London.
Secondly, London is the UK's capital, largest city and economic engine. Elite C-REIT believes that London properties have higher potential for rental and capital growth, as well as redevelopment and cites 2 case studies of Medina Road and Oates House properties in its presentation slides which we will not further elaborate here.
Amidst the COVID-19 pandemic, the unemployment in the UK rose during the period of June to August 2020 to 4.5%, according to the Office for National Statistics (ONS). This represents an increase of 0.4% over the previous three months with over 1.5mil people unemployed. From the perspective of the claimants, it had rose 220% from 1.2mil in Mar-2020 to 2.7mil in Aug-2020.
As DWP is responsible for welfare and pensions, it is by nature a uniquely countercyclical occupier. The worse the economy, the greater the need for the services of the DWP due to the increase unemployment and claimant count. Jobcentre Plus locations which are also categorised as essential services remained open to process and disburse benefits.
According to Elite C-REIT, the DWP currently employs 13,000 work coaches, and has plans to add 4,500 more work coaches by October 2020 and a further 9,000 by March 2021. This is likely to have a spill over effect on the expansion of Jobcentre Plus locations.
Should this acquisition complete as expected, there would be a 66.6% increase in portfolio valuation, from £319.1mil to £531.6mil. The market cap would also increase 57.0%, from £213.3mil to £334.8mil.
The increase in portfolio size will also increase Elite C-REIT's debt headroom, increasing its scope to pursue further accretive acquisitions. The increase in market cap would also increase its free float and liquidity allowing larger institutional investors to participate in the future which likely would be beneficial to its stock price in the long term.
Assuming that the final structure of the acquisition would be partially funded by the £0.68 per consideration unit and the remaining raised from a £30m equity fund raising, the DPU accretion would be 3.2%. However, if Elite C-REIT assesses that the market conditions are not favourable for an equity fund raising, assuming the acquisition is funded by a drawdown of loan facilities and the vendor’s loan totalling £125.5mil, the DPU accretion could be 8.3%!
The existing portfolio provides a rental yield of 7.3% but the existing portfolio does not include any properties located in London. The new properties’ portfolio provides a rental yield of 8.0% when the London properties are excluded. On a direct comparison basis, the new properties provide an average of 70bps higher rental yield to the existing portfolio. The new properties' London assets provide a rental yield of 4.3% and account for 35.9% of the new properties’ portfolio by asset value.
There is certainly much to like about this acquisition including an expansion of assets, market cap, portfolio valuation while still retaining a 100% exposure to the UK Government which is a sovereign entity and has an affirmed AA-rating.
As a result of this acquisition, the UK’s Department of Work and Pensions (DWP) will remain the predominant occupier and tenant of Elite C-REIT’s portfolio. As DWP is responsible for welfare and pensions, it is by nature a uniquely countercyclical occupier. The worse the economy, the greater the need for the services of the DWP due to the increase unemployment and claimant count. Jobcentre Plus locations which are also categorised as essential services remained open during the COVID-19 pandemic to process and disburse benefits.
Finally, what makes this acquisition particularly special to us is the fact that the manager has negotiated an option to pay for the acquisition with consideration units above the market price at the point of the announcement. From an investor’s perspective, we see this as favourable as we would not be unnecessarily burdened to cough up more money should market conditions be unfavourable. At this point of time with the US elections looming, the global markets do appear weak. We also like the fact that this structure brings alignment of interest between the REIT and the seller. We also anticipate that this will bring stability to the share price trading during the acquisition period and we can expect lower volatility in Elite C-REITs traded prices during this acquisition period.
Perhaps this could set the precedence for more REIT acquisitions to be structured creatively with their sponsor while according some level of protection to minority unitholders.
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:
Some key highlights that will be covered includes:
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:
To learn more about REITs, we recommend the article: What are REITs?
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