Evaluating REIT IPOs
REITs are always a hot topic in the Singapore investment world. They had a stellar performance in 2019 (~25%) and have been a steady source of income for many years. However as prices have been pushed up, yields have fallen, so when a REIT IPO came to market this week (with high relative yield), our clients’ interests piqued.
Below, we talk you through our thinking on how to evaluate a REIT IPO. This is not an exhaustive list, as an IPO prospectus gives you lots of detail that can take days to go through. However, hopefully the points we listed below will, in about 30-45 minutes of digging through the prospectus, give you a sense of whether an IPO is something you want to spend more time on, or move on from.
Also sorry to disappoint, but we will not be giving our final thoughts on whether we liked/disliked the offering (we want to stay away from individual asset recommendations in a public forum), but what we will give you is a framework for you to decide for yourself.
The Elite Commercial REIT IPO
For some basic background, earlier this week we saw Elite Commercial REIT come to the market with a GBP 119.5MM – 131.2MM offering of a REIT with an indicative distribution yield between 7.1-7.4%. The REIT holds assets in the United Kingdom, and is seeking to list its shares on 6th Feb in Singapore (listing will be in GBP).
Considerations
For each of the considerations below, our goal is to quickly, in the prospectus, find the data that answers the question, and then try to judge (qualitatively or quantitatively) if the answer is a positive or a negative for the REIT and its IPO.
Consideration 1: What does the portfolio contain?
Data Point: The initial portfolio of Elite Commercial REIT will comprise 97 quality commercial buildings located across the UK
Our view: Ok – so right of the bat, we see that the REIT is quite diversified in the number of assets, but very concentrated with regards to geography. Thus to begin with, you have to consider the risks associated with the country concentration (in this case the UK). While trying to understand all the risks and possibilities related to Brexit is difficult to do, what we can safely say is that the future of UK growth is unclear.
Data Point: The IPO Portfolio is predominantly freehold. Of the 97 Properties, 96 Properties are freehold Properties and one Property is on a long leasehold tenure expiring on 19 May 2255.
Our view: This is quite strong – as all things being equal, freehold is likely a better bet than leasehold.
Consideration 2: Quality of Tenant/Leases
Data Point: Over 99.0% of the gross rental income is derived from the current leases with the UK Government via The Secretary of State for Housing, Communities and Local Government (with the Department of Work and Pensions (“DWP”) occupying each Property under a group sharing arrangement
Our View: Typically a single tenant can be a huge risk, however considering the tenant is the UK government, and theoretically one of the least risky tenants you can have in the UK (currently rated AA), you can argue that this risk is limited.
Data Point: In addition, the leases to the UK Government have in-built rental escalations every five years based on the UK Consumer Price Index (“CPI”), subject to an annual minimum increase of 1.0% and a maximum of 5.0%.
Our View: This is a positive, as in-built rental escalations will naturally grow net property income without any need for the manager to negotiate with the tenant.
Data Point: The Manager believes that the IPO Portfolio provides stable, recession-proof and Brexitproof cash flows for the following reasons. The IPO Portfolio is underpinned by a uniquely counter-cyclical occupier, which is the DWP. By design, the usage of DWP’s job centres (and therefore its need for the IPO Portfolio) is inherently counter-cyclical, with claimant counts, job centre footfall and DWP benefit spending all highly correlated to unemployment. For instance, during the Global Financial Crisis, the number of claimants increased by approximately 74.3%2.
Our View: While this may be true, considering that we’ve already established that the UK government is a good tenant and unlikely to default, this data point doesn’t shift our view very much.
Data Point: Over 99.0% of the IPO Portfolio’s Gross Rental Income is derived from full repairing and insuring (triple net) leases to the UK Government with a WALE of approximately 8.6 years.
Our View: Triple net leases are quite a positive as all taxes/maintenance/insurance is paid for by the tenant. Further, a long WALE (weighted average lease expiry) is also excellent as it gives you visibility on revenue for quite a period of time. However, it should be noted that over 90% of the properties have a break clause in 3.6 years. While the likelihood of a government agency breaking a lease early is low, it is still a risk.
Consideration 3: Quality of Assets
Data Point: Portfolio of well-located, freehold office buildings – 74.2% are centrally located within city centres, town centres and city suburbs, and 100.0% within 10 minutes’ walk from a bus stop
Typically, locations within/close to city centres with good connectivity do help support prices. So this is certainly a positive.
Data Point: Qualitative aspects of the Colliers and Knight Frank (the Appraisers) reports
Our View: While often missed, these reports can be found at the end of the Prospects. We highly recommend at least scanning through them. As we reviewed the reports, a few things jumped out at us that gave us pause (see above for screenshots).
Properties are very old, most are built in the 1970s and some have structural issues. This will make any sort of sale, without major capex for upgrades, difficult.
Several of the properties are rented out at above market prices. While this is a positive in the short-run, in the long-run we may see negative rental revisions.
Consideration 4: Valuations
Data Point: The REIT is looking to achieve a marketcap of GBP 214.5MM to 226.2MM and has Net Assets of GBP 198.2MM as of August 2019
Our view: This puts Price to Book Value at around 1.08 to 1.14. Which is somewhere around where other Singapore listed REITs are trading (As of 24th Jan, average is 1.12)[1]. So one could argue that this valuation is fairly valued, but you should also consider the quality of assets, the strength of the sponsor, and some of the other facts we discussed here to come to a conclusion on if you think this IPO is over/undervalued.
Consideration 5: Sponsor and backstory
Data Point: Elite Partners Holdings Pte. Ltd. (“EPH”), Ho Lee Group Pte. Ltd. (“HLG”) and Sunway RE Capital Pte. Ltd. (“Sunway”), (EPH, HLG and Sunway collectively, the “Sponsors”),
Our View: Traditionally we are used to REITs sponsored by large Real Estate stalwarts such as Mapletree, Keppel, and Capitaland. This gives us comfort due to the depth of experience as well as deep portfolio of the sponsor. However in this case, the Sponsors are less familiar. Further a quick google search shows that EPH was only established in early January 2018 (albeit founded by ex-Viva Industrial Trust executives). The Prospectus states that it holds AUMs of $650, a bulk of which include the assets in this IPO, which implies that its pipeline post-IPO could be a bit shallow. The positive news is that each of the other sponsors have given the REIT a “ROFR” on all future UK acquisitions (ie if they decide to sell, the REIT gets first dibs). We highlight “future” as its unclear what those assets will be.
Data Point: Elite Commercial REIT completed the acquisition of all the Properties on 16 November 2018 from an unrelated third-party vendor, being a subsidiary of Telereal Trillium Limited.
Our View: Seems that the assets were acquired a little more than a year ago by the sponsor, and is now looking to IPO, which is quite a quick turnaround. On its own that’s not a huge issue, but at least some of the proceeds will be used to cash out current investors.
Consideration 6: Manager incentives
Data Point:
Base Fee: A base fee of 10% per annum of the Annual Distributable Income
Performance Fee: 25.0% of the difference in DPU in a financial year with the DPU in the preceding financial year
The Manager has elected to receive 100.0% of the Base Fee in the form of Units for the period from the Listing Date to the end of Projection Year 2021.
Our View: We like that the base fees, for a while, will be paid in units, which helps protect cash-flows, and aligns incentives between the manager and the unit holder. Further, we tend to view performance fees paid as a % of DPU (distribution per unit) growth very positively as well.
Consideration 7: Who is backing the IPO
Data Point: The cornerstone investors being UBS AG, Singapore Branch (on behalf of certain Wealth Management clients), Bank of Singapore Limited (on behalf of one or more of its private banking clients) and CIMB Bank Berhad, Singapore Branch (on behalf of certain clients of its Private Banking Division)
Our View: Typically we like seeing a big marquee name here (either a well-known real estate player or large fund). However in this case it seems that the cornerstone investors will be mostly private banking clients, which in our view, is not ideal. This again makes us wonder how the IPO will perform upon listing, and whether the Sponsor is chasing sophisticated or just yield-hungry investors (not saying those are mutually exclusive!).
In Conclusion:
There is a lot to like about this REIT; Long WALEs, high-grade tenants, attractive relative yield. However the lack of a marquee investor, UK uncertainty, the shallow future pipeline, and aged assets are detractors (in our humble opinion).
While we won’t give you our conclusive view (we save that for our clients!) we hope that we’ve given you 1) A framework on how to evaluate REIT IPOs and 2) Food for thought on this particular offering.
Happy Investing!