KK is the chief number cruncher at Risk N Returns where he talks to himself about Investing and Personal Finance. He likes a good investment idea as much as a great cup of bubble tea.
Singaporeans love REITs.
SGX and REIT Sponsors knows it too. As such, it comes as no surprise that the 4th SGX Mainboard IPO of the year is yet another REIT – Lendlease Global Commercial REIT (Lendlease REIT).
I’ve been reading the many rave reviews the IPO has been getting in the blogosphere and was a little surprised, considering the relatively low yield and premium valuation.
Not wanting to believe everything I read, I took a closer look at the prospectus and here is my own take on the IPO.
Here is a brief overview of the offering details:
- The IPO Price will be S$0.88
- There will be 1,168m units on offer in total, 387m of which are allocated for the public and placement tranche.
- This implies a market capitalisation of S$1,028m
- Applications is slated to open on 25 September 9pm and will close on 30 September 12pm.
- Applications can be made through ATMs / Internet Banking portals of participating banks and the DBS Mobile App.
The preliminary IPO prospectus can be found here.
You can just barely call the properties in the REIT a portfolio as it comprises of only 2 properties – 313@Somerset (313) in Singapore and Sky Complex in Milan.
Singaporeans will be very familiar with 313@Somerset, a prime retail mall on Orchard Road. It is conveniently located right on top of Somerset MRT and well integrated with neighbouring malls.
Sky Complex is a 3 building Grade A Office complex that serves as the HQ of Sky Italia, an Italian TV broadcaster. One building is designed for television production with recording studios, another is for offices and the last is an exhibition and meeting centre. The complex is well located in the Milano Santa Giulia area which is 250m from the train station, 5km from the city centre and 7km from the airport. Interestingly, the Sky Complex is actually to be acquired from 3rd parties and not from Lendlease.
The 2 properties have a combined valuation of S$1,403m, as valued by CBRE. For reference, Colliers valued the 2 properties at S$1,400m.
The desirability of the properties are evident from the consistently high portfolio committed occupancy, with over 99% committed occupancy over the past 3 years.
As at 30 Jun 2019, 313 has an occupancy of 99.6% while Sky Complex, which is master leased, has a 100% occupancy.
Lease Expiry and Characteristics
The IPO portfolio has a decently long weighted average lease expiry (WALE) of 4.9 years by gross rental income (GRI) and 10.4 years by net lettable area (NLA).
313 has a WALE of 1.8 years with leases typically having 3 year tenures with fixed base rent and variable rent based on a percentage of gross turnover. 58.9% of leases by NLA have contractual step-up rental structures that average 3% per annum.
This lease structure is typical of retail leases in Singapore, although it is unusual to see contractual step-up rental structures included in these leases.
As mentioned, the property is master leased to Sky Italia with the following key features:
- The lease expires in 2032.
- Sky Italia has the option to break the lease in 2026 by giving 1 year’s notice
- It has a triple net lease structure with Sky Italia responsible for most operating expenses
- Contractual rental step-ups based on Consumer Price Index (CPI) variations
Overall, it is a very typical master lease structure. Good to see that it is a triple net lease, but do take note of the early break option in 2026 when considering the REIT’s WALE.
Top 10 Tenants
There’s fairly high tenant concentration due to small portfolio size, with 1 being master leased to Sky Italia. As such, Sky Italia naturally is a significant rent contributor.
The good thing is Sky was acquired by US-listed Comcast recently. Looking at its latest financials, its overall business is still healthy with its Italy specific disclosures still positive.
The Sponsor of the REIT is Lendlease Group, a large international property, and infrastructure group from Australia. It is listed on the ASX and has a market capitalization of over A$9.5b.
Why is Lendlease divesting their properties?
There are potentially 2 reasons why Lendlease is divesting their properties.
Firstly, it fits their business model. Lendlease’s strategy is to build and develop properties that they will eventually manage and earn recurring income from. This asset management strategy is where the REIT comes in, giving the group an outlet to recycle capital back into their construction and development businesses.
Secondly, the Group may need funds more urgently than before.
Lendlease’s share price tanked in the past year as continued struggles in their loss-making Engineering and Services division dragged down profits.
Coupled with weak operating cash flows of only A$60m and A$73m in FY2019 and FY2018 respectively, Lendlease may be looking to unlock more cash for its development and construction businesses.
It is for this 2nd reason that I feel that Lendlease REIT investors should expect further equity fund-raisings in the near future to acquire properties from the Sponsor.
Potential Right of First Refusal (ROFR) Assets
One key benefit of having a Sponsor is the ability to tap on their expertise and pipeline of properties to grow the REIT. While Lendlease has a global presence, given that the IPO portfolio is in Europe and Singapore, it is probably more prudent to only consider its assets in Asia and Europe.
Its Asia assets are predominantly focused in Singapore and Malaysia, with Singaporeans familiar with JEM, Parkway Parade and the newly completed Paya Lebar Quarter.
Its Europe assets are focused on retail centers in the UK, with much more assets under development than assets ready to be injected into the REIT.
Given this profile, I think it is safe to assume that the REIT will be largely Singapore focused for the foreseeable future.
The REIT employs a rather nostalgic fee structure:
- Base management fee: 0.3% of deposited property value
- Performance management fee: 5% of Net Property Income (NPI)
- Acquisition fee – 1% of the acquisition value
- Divestment fee – 0.5% of divestment value
Unfortunately, the management fee structure is largely based on asset value and NPI, and not on growth metrics. As such, the fee structure does not fully align the REIT Manager’s interest with investors.
The other unusual thing to note about fees is that the REIT Manager will be charging an IPO Acquisition Fee post-listing of 1% for Sky Complex and 0.75% for 313. This is payable in cash for Sky Complex and in units for 313.
This is personally my first time seeing such a fee and is certainly unusual.
Governance and Management
Personally, manager competence and Corporate Governance is a very important aspect of any company / REIT. As such, I usually make it a point to read up on the Directors’ background and study the REIT’s Governance structures.
Without boring you with too many details, I’ll like to highlight a small issue with the board structure and the independence of one of its directors, Mr Simon John Perrott.
The REIT has a 5 person board comprising of the following:
|Mr Anthony Peter Lombardo||Chairman||CEO at Lendlease Asia Holdings|
|Dr Tsui Kai Chong||Lead Independent Director||Provost at SUSS|
|Mr Simon John Perrot||Independent Director||Independent Director of the Manager, a subsidiary of Lendlease, and Lendlease’s Retirement Benefit fund|
|Mrs Lee Ai Ming||Independent Director||Lawyer at Dentons Rodyk & Davidson LLP|
|Ms Ng Hsueh Ling||Non-Independent Non-executive Director||MD, Singapore and CIO, Asia at Lendlease Investment Management|
As you can see, Mr Simon Perrot has independent directorships at multiple Lendlease linked entities and is also designated as an independent director for the REIT. This relationship resulted in a 1-page explanation of why the Board considers him to be an independent director.
This is an example of potential familiarity threat that the Code of Corporate Governance does not catch. While Mr Perrot probably satisfies the definition of independence according to the Code, only time will tell if he truly acts independently.
Lendlease REIT has managed to assemble quite a formidable list of cornerstone investors:
- Lendlease Group – 27.2%
- Lendlease REIT Manager – 0.7%
- Other Cornerstone Investors – 38.9%
- AEW Asia Pte Ltd – Real Estate fund manager
- Asdew Acquisitions Pte Ltd – Investment vehicle for Wang Yu Huei
- BlackRock Inc
- DBS Bank – on behalf of wealth management clients
- DBS Vickers – on behalf of corporate clients
- Fullerton Fund Management Company – on behalf of its funds. A subsidiary of Temasek Holdings
- Lion Global Investors Ltd – on behalf of its funds / clients
- Moon Capital Ltd – Independent fund manager founded by John Moon
- Nikko Asset Management Asia Ltd
- Principal Singapore – owned by a joint venture between CIMB and NASDAQ-listed Principal Financial Group
- Soon Lee Land Pte Ltd – Investment arm of property developer
- The Segantii Asia-Pacific Equity Multi-Strategy Fund
- TMB Asset Management Co., Ltd. – Fund manager majority owned by Prudential and in collaboration with Eastspring Investments
It’s been some time since I’ve seen such a strong list of Cornerstone Investors dominated by major players in the fund management space. It is also good to see that Lendlease has a significant stake in the REIT, which will help align the Sponsor with investor interests.
This is a big plus for the REIT going forward in terms of unit price stability, access to institutional capital and potential external acquisition pipeline.
Financial Highlights and Valuation
Having examined a lot of the qualitative factors, let’s take a look at the easy part – the financials.
Forecasted Property Performance
Due to reasons disclosed in the prospectus, the REIT is unable to or decided not to disclose the portfolio’s historical performance. We will have to trust that their forecasting prowess is accurate.
Based on their forecasts, they expect an NPI of 63.8m (annualised) and 65.8m for FY2020 and FY2021 respectively. This works out to a portfolio property yield of about 4.55% and 4.69% respectively.
The REIT has taken out S$533.9m in unsecured loans – a 3 year S$99.3m term loan and a 4-year €285m term loan at floating rates. The Manager intends to enter into swaps to convert at least 50% of the debt to fixed rates post IPO.
The gearing of the REIT at listing will be 36.4% with a weighted average debt tenor of about 3.8 years.
Using the indicative IPO price of S$0.88, the REIT is priced at a premium to book at 1.08 and has an indicative yield of 5.8% and 6.0% in FY2020 and FY2021 respectively.
To me, the valuation is fair given the quality of the assets, which leaves limited upside for IPO participants.
Given how unique of the portfolio is (SG Mall + Italian Office), there is some difficulty in determining a close peer on the SGX. Given that I believe that the REIT will be largely Singapore retail focused given the ROFR pipeline, the peers I’ve chosen for comparison will be largely SG Retail REITs.
|WALE (GRI)||4.9 yrs||5.4 yrs||2+ yrs||2.2 yrs|
|WA Debt Maturity||3.8 yrs||2.8 yrs||1.8 yrs||4.9 yrs|
Comparing the 4 REITs, Lendlease REIT certainly seems to have a slight edge in valuation and profile against its smaller retail REIT peers.
It is actually quite similar to Starhill Global REIT in many metrics. Starhill’s portfolio also shares similarities in having an iconic Orchard Road property anchor the bulk of the REIT’s distributions. The only major difference between the 2 is the higher relative valuation accorded to Lendlease. This may be justified due to the relative strength of Lendlease as a sponsor and superior quality of its properties.
SPH REIT is also similar in profile but suffers in comparison to Lendlease from a valuation standpoint.
Given these metrics, I can see that Lendlease REIT has done a good job at benchmarking and pricing itself against its peers.
To summarise, here are the good, the bad and the risks.
- Quality IPO portfolio that is well located and occupied.
- Leases have rental step-up structures which give visibility on future income growth
- Strong sponsor with ready pipeline of ROFR assets to tap on for growth
- On balance, strong alignment of interests between sponsor and investors largely due to significant stake in the REIT.
- Formidable set of cornerstone investors to provide price stability and sources of capital post IPO.
- Attractive relative valuation to its peers.
- Highly concentrated portfolio with only 2 properties
- Uncommon IPO Acquisition Fee charged to unitholders
- Potential governance issue; in my view, the debatable independence of one of the independent directors
The Key Risk
- Potential for equity fundraising is high given the Sponsor’s likely desire to unload more properties into the REIT. Whether these deals will be structured in a manner that is beneficial to shareholders remains to be seen.
My Personal Take
On paper, if you dismiss the bad points as me nitpicking, I can see why there is so much positivity and hype surrounding this IPO. I can certainly see myself applying for the IPO if I have the cash.
That said, whether this REIT is suitable for you as an investor really depends. The key questions I think investors should ask themselves before deciding to apply for the IPO are:
- Do you think Singapore Retail REIT valuations is at fair value?
- This is important as while Lendlease REIT may be attractive on a relative basis, it may just be a symptom of the overvaluation of its peers.
- Is 5.8% yield sufficient for you as an investor?
- Are you prepared to fork out more cash down the line to participate in future equity fund raisings?
If your answer to these 3 questions is a resounding yes, then maybe this REIT IPO is for you. I am certainly tempted.
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