by: Tam Ging Wien
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This week, Australian-listed developer Lendlease Group and sponsor has launched its IPO of Lendlease Global Commercial REIT (LGC-REIT) on the Mainboard of the Singapore Exchange. The REIT will be internally managed by Lendlease Global Commercial Trust Management with RBC Investor Services Trust Singapore Ltd as the trustee.
The REIT is offering 387.5mil units at an offer price of $0.88 each. The offer consists of:
The initial portfolio will consist of 2 buildings; a 99-year leasehold prime retail asset in the heart of Orchard Road, Singapore ([email protected]) and a freehold grade A office asset in Milan (Sky Complex) tenanted exclusively on the triple-net-lease basis to Sky Italia.
At the IPO price of $0.88, the key figures of LGC-REIT are as follows:
After a brief run-through of its 542-page prospectus, we share our views of what we like and dislike about the REIT and identify the opportunities and risk present to help investors make an informed decision with regards to this IPO.
The IPO opens on 25-Sep-2019 (Wed) 9am and closes on 30-Sep-2019 (Mon) 12pm. The balloting results will be known on 01-Oct-2019 (Tue) and expected to begin trading on a “ready” basis on 02-Oct-2019 (Wed) 2pm.
Due to the timing of this IPO, ProButterfly.com has decided to release this article outside our normal publishing schedule so that investors have enough time to decide on their investment decisions over the weekend.
The list of cornerstone investors in LGC-REIT absolutely stands out! I can recall any recent REIT IPOs this year with such an astounding list of cornerstone investors!
Considering how they managed such an extensive list of cornerstone investors, its quite possible that they spent a significant effort to building up the following. This is a great IPO strategy as it gives confidence to the public to subscribe knowing that there are a lot of “smart monies” already vested in this REIT.
This is the most outstanding strength of this IPO compared to the last few that we saw this year. If this IPO does well, I would attribute a significant weight to this one single reason.
Lendlease Group, the sponsor of LGC-REIT is a multinational construction, property and infrastructure company headquartered in Sydney, Australia. Being a developer with presence in multiple gateway cities around the world creates a strong pipeline of assets which could feed the growth of LGC-REIT.
According to the IPO prospectus, Lendlease Group has a “global development pipeline value approaching A$100 billion comprising activities across urbanisation, communities, retirement living and infrastructure development” with a “backlog revenue of A$15.6 billion globally”.
Among some of its prominent urbanisation projects include:
The sponsor Lendlease Group will grant the LGC-REIT the rights-of-first-refusal to all future pipeline of assets as set out in the Right Of First Refusal Agreement. This means that if Lendlease Group or any of its subsidiaries decides to dispose of an asset, they must first give LGC-REIT the option to purchase. Only unless LGC-REIT decides not to proceed with the acquisition can they dispose the asset to other 3rd parties.
The IPO prospectus identifies some assets that Lendlease Group currently owns in Singapore and Europe which are likely to be assets that could be acquired by the REIT in due course. Amongst them are familiar names in Singapore such as Parkway Parade, Jem and Paya Lebar Quarter.
The “force” is strong with this one! Considering that the portfolio’s rental income is predominantly exposed to the 99-year leasehold [email protected], the prime retail sector making up 71.1% of the REIT’s gross rental income is the most important consideration for investors. Hence, investors need to be aware that LGC-REIT is predominantly exposed to the Singapore prime retail.
The 99-year leasehold of [email protected] commenced 21-Nov-2006; therefore, there is approximately 86 years remaining in the lease. This is more than enough for most investor’s time horizon.
I like how [email protected] is serviced by the Somerset MRT Station which naturally pipes foot traffic directly to the property.
Considering how [email protected] has achieved above average occupancy rates at 99.6% – higher than its peers and the 94.8% Orchard Road average occupancy – I am impressed.
The WALE however is quite average at 1.6 years based on gross rental income considering most retail leases are usually around 3 years. This could work out both ways, the short leases work to the advantage when rentals are rapidly increasing allowing the landlord to step-up their rentals in-step with the growth. On the other hand, when there is a crisis, the prime retail are likely the first to be hit and the short leases quickly step-down with each renewal.
As a comparison, SPH REIT’s occupancy and WALE figures stands at 99.0% and 1.9 years and Starhill Global REIT’s Singapore retail assets occupancy figures 99.4% while its WALE is estimated by be around 2.5 to 3.0 years thanks primarily to long leases from Toshin (Takashimaya S.C.).
Besides the high occupancy rate, 58.9% if the portfolio has step-up lease structures with an average rental escalation of 3.0% for FY2020. The lease expiry profile is fairly well staggered.
Based on the Singapore vacancy rate trends, it seems to show a declining vacancy from a high of 9.2% to the current 5.8% in Q2-2019. A declining vacancy rate is a good sign as that means that floor space demand is increasing fast than supply which tends to put upward pressure on the rental prices.
The Singapore retail price index and rental index seems to be also showing signs of stabilisation after multi-year declines. Data quoted in the IPO prospectus also indicates a sharp decline in new supply in retail floorspace.
Is this the bottom of the prime retail market and there is only up from here? Perhaps, but it does seem that [email protected] is getting listed into a REIT at a perfect time.
The Milan office asset comprises of three freehold Grade-A office buildings in the Milano Santa Giulia office precincts – collectively known as Sky Complex. The 3 buildings are 100% leased to Sky Italia on a single lease on a 12 + 12 year lease term.
Sky Complex serves as Sky Italia’s headquarters. Sky Italia is an Italian satellite television platform operated by Sky, itself owned by US-based Comcast. Comcast Corporation is the second largest broadcasting and cable television company in the world by revenue.
The lease structure is on a triple-net-lease basis where tenant is responsible for the operating expenses, property tax and insurance of the property. This minimises investor risk associated with maintenance of the building.
Given that the buildings are part of Sky Italia’s headquarters with fitted office spaces, television studios and technical rooms, they are likely to be loyal tenants and it would be difficult to find another building with similar specifications and needs for the broadcasting industry. Therefore I expect Sky Italia to remain a loyal tenant in Sky Complex for a foreseeable future providing stability to the portfolio.
The lease with Sky Italia commenced in 2008 and will expire in 2032. There is a break option exercisable by Sky Italia in 2026 with 12 months of advance notice which readers should take note in the risk section of the article below.
Besides the triple-net-lease basis, the lease contract embeds a rental rate step-up clause with an annual increase of 75% of the Italian National Institute of Statistics’ (ISTAT) CPI index variation starting from the second year of the lease.
I have taken the liberty to source out the historical year end Consumer Price Index as tracked by ISTAT and found that the index change is pretty small, with changes for 2017, 2018 and latest Aug-2019 figure at 0.90%, 1.09% and 1.27%. So a 75% increase on the latest figure would mean a rental escalation of just 0.95%.
Here is a question to ponder, what is if the CPI index was negative? Would that mean that the leases will be reduced or does it floor at zero like Parkway Life REIT? I wasn’t able to find confirmation of a zero floor; hence I would have to assume that there is a possibility that the CPI index could be negative. It has been negative before in 2016 compared to 2015.
All investment carry risk. While LGC-REIT’s IPO does possess many positives and opportunities, these perspectives must be balanced with the risk observed.
While data appears to show that the Singapore prime retail sector stabilising after years of decline, investors still must be aware that the nature of the REIT’s IPO portfolio exposes investors to some level of concentration risk. With 71.1% of its gross rental income derived from just [email protected], investors are exposed to the cyclic nature of prime retail.
We also think that having 2 assets is hardly any diversification.
Sky Italia is LGC-REIT’s single largest tenant accounting for approximately 28.9% of the REIT’s gross rental income. They are also the sole tenant in the Sky Complex Milan with tenancy stretching all the way to 2032. Sky Italia has held this lease since 2008.
Sky Italia’s long lease gives the portfolio a very high WALE of 4.9 years.
However, Sky Italia has a break option exercisable in 2026 with 12 months of advance notice LGC REIT. Exercising this option gives Sky Italia the right to terminate the lease in 2026 which may adversely affect rental revenue if a new tenant is not found within 12 months of the termination notice.
Sky Italia being a broadcasting company with offices and television studios makes the building unique. It is also their present headquarters. They are therefore unlikely to exercise the break clause in 2026.
After close to 4 years of zero interest rates policy and quantitative easing, just this month the European Central Bank (ECB) dropped interest rates by 0.50%, bringing interest rates in Europe into negative territory. To top it up, it will restart its quantitative-easing (QE) scheme, which it halted just last year. From Nov-2019, the ECB it will buy €20bn-worth of bonds a month.
Amidst the current macro-economic climate in Europe, we expect capital flight and a further weakening of the Euro against the USD in the foreseeable future.
This is likely to translate into a weakening Euro against the SGD in the short term. However, the jury is still out on how Singapore’s central bank will decide on the SGD’s policy come Oct-2019.
Given that the Net Property Income transacted in Euros accounts for approximately 34.9% and 34.1% of the IPO Portfolio’s Net Property Income for Forecast Year 2020 and Projection Year 2021 respectively, there could be a significant impact.
According to the IPO prospectus, the Manager is expected to enter into foreign exchange hedges for Forecast Year 2020 and Projection Year 2021 post-Listing. These hedges are crucial for without them we would have rated this risk High, but in view of potential hedges for the next two years, we have decided to downgrade this risk to Medium.
A ±5.0% sensitivity analysis is also presented in the IPO prospectus and reproduced below:
According to the IPO Prospectus, the management fee is paid based on the following:
Our first impression is that the fee structure does not align with the interest of unitholders. Unitholders want the REIT to grow its DPU and nowhere in the management fee structure does it account for DPU growth.
Based on the components above, we estimate that 0.3% of the deposits property value of $1,402.3 works out to $4.2mil. For the performance fee, 5.0% of the FY2021 NPI of $65.8mil works out to be $3.3mil. This gives an estimate of the total performance fee of $7.5mil or 11.4% of NPI – putting it among the top 5 most expensive S-REIT management fees, just displacing Frasers Centrepoint Trust.
According to REITScreener.com’s data, currently the REITs that take the highest management fee as a percentage of NPI are Keppel REIT, Frasers Commercial Trust, Suntec REIT, Mapletree Logistics Trust.
The balance sheet as of listing date shows gives a total asset value of $1,417.7mil after accounting for negative retained earnings. With 45% gearing limit, the REIT could utilise up to $638mil in debt. It has already utilised $516mil leaving it with a further $122mil debt headroom.
We have done a simulated $100mil and $200mil acquisition based purely on debt and we found that such an acquisition would easily move the gearing to 40.6% and 44.3% respectively.
Given that most of the pipeline assets from Lendlease Group are likely to be more than $200mil, we think that there is insufficient debt headroom at the current IPO valuation and gearing that it would necessitate the need for equity fund raising be it a rights issue, private placement or preferential offering.
Therefore, investors who are holding this REIT at IPO price could likely see an equity fund raising within 12 to 18 months. This is especially so if the P/B ratio continues to remain elevated, it would be likely that the REIT along with the sponsor would take the opportunity to raise funds at a good cost of equity.
From the investor’s perspective, one should ensure that they have set aside a pool of spare cash to deploy should a rights issue or preferential offering is called.
The indicative timetable is pretty self-explanatory, hence investors that are interested to bid for this IPO should note the important deadlines.
Investors need to take note that LendLease Global Commercial REIT is predominantly a Singapore prime retail sector exposure with the Milan property added in to provide stabilisation to the portfolio. As the 2 properties are very distinct in their characteristics, it makes sense to analyse both the assets independently rather than as a portfolio. For example, the quoted WALE of 4.9 years is purely because of Sky Complex’s long 12+12 year leases terms; when looking at the retail WALE on its own, the figure is 1.6 years which is simple average.
There is much to like about this REIT including strong cornerstone investors, strong pipeline of assets, and favourable macro-economics. However, investors should also take note that there are risk involved in this IPO including potential equity fund raising activities, weakening of Euro against SGD and management fee that is not aligned with unitholder’s interest.
Given the single factor of having strong cornerstone investors and with a very small public trench, we expect that this IPO is likely to do well.
With current forecast yield of 5.8% and 6.0%, its certainly not enticing enough for us to participate at the IPO stage as we could potentially get higher upside in our other REIT investments.
If the prices fall to a favourable level, we will be happy to take a small position. If the price performs well and keep climbing, there is no loss to use we have other REITs to invest our funds.
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