US REIT IPOs have not performed well this year.
ARA US Hospitality Trust began trading below IPO price before it ultimately recovered. Other the other hand, Eagle Hospitality Trust has been a horror show, collapsing 10% on opening day and staying there ever since.
As such, when I heard that Prime US REIT had filed a preliminary prospectus to list soon, I was sceptical.
Will this REIT IPO outdo the other 2 listings and give investors a high?
Or will it give investors severe indigestion from US REIT overload?
Let’s take a closer look.
Here is a brief overview of the offering details:
- IPO Price is likely to US$0.88.
- There will be 923m units on offer in total, 335m of which are allocated for the public and placement tranche.
- This implies a market capitalisation of US$812m
If you would like to follow along on this review, the IPO Prospectus can be found here.
Some key observations about the IPO Portfolio:
- The Portfolio consists of 11 Office properties in 9 states with a diverse mix of Tier 1, Tier 2 and Tier 3 cities.
- The Portfolio is provided by KBS REIT III, a public non-listed REIT managed by the sponsor.
- 100% of the Portfolio are Freehold Class A Offices. Class A buildings are well-built buildings with the best infrastructure and good locations.
- The Portfolio is valued at US$1.22b, which the average of 2 valuations performed by JLL and Cushman.& Wakefield.
- The properties are located mainly in suburban locations
Interestingly, these offices are largely located in suburban locations and not in the CBD area. This is not necessarily a bad thing, as suburban buildings tend to offer higher yield, which is evident in this REIT.
Most properties have been well-leased over the past 3 years, with occupancy consistently above 90% for most of the properties. The notable exception is Tower I at Emeryville, which saw a lease expiry of a tenant that occupied 4 floors in 2017. It’s occupancy as at 31 December 2018 has recovered to 81.1%.
The portfolio will be at 96.7% occupancy at IPO.
Lease Expiry & Characteristics
The leases are reasonably long leases with a Weighted Average Lease Expiry (WALE) of 5.5 years (By Net Leasable Area).
96.9% Leases have annual rental escalations of about 2.1% and are on a triple-net or modified/full-service gross lease. This means property expenses are largely passed on to lessees, highly beneficial to shareholders.
Lastly, current leases are significantly below the market rate. This offers the REIT opportunity for significant positive rental reversions when leases are renewed. This will, in turn, provide higher gross revenues in the future.
Based on these portfolio characteristics, we can see that the IPO portfolio is of very high quality and very much investible.
Sponsor and Management
Understanding the sponsor of a REIT is important in understanding management style and behaviour. The sponsor can also provide a pipeline for acquisitions by Prime US REIT and understanding that pipeline can be crucial in determining growth potential.
Prime US REIT’s Sponsor is KBS Asia Partners, which is affiliated with KBS Realty Advisors, a privately held commercial real estate investment manager based in the US. Singaporean investors will know them for their earlier partnership with Keppel Capital to list a Grade B US Office REIT – Keppel-KBS US REIT – back in 2017.
KBS is an established real estate investment manager founded in 1992 by Peter Bren and Charles Schreiber. It has completed more than US$38b of real estate transactions since founding and currently have US$11.6b in assets under management. Prime US REIT will be able to leverage on the KBS platform and experience for property management services and inorganic growth via acquisitions.
Is Management Aligned with Shareholders Interests?
KBS has exhibited a mixed history during their 1.5 years of managing Keppel-KBS US REIT. This is evident from the price performance of Keppel-KBS US REIT since IPO.
Keppel-KBS US REIT IPO-ed at USD0.88. As you can see from the chart, the REIT suffered a drastic drop in share price in Sep-Oct 2018. This was mainly due to 2 factors:
- Uncertainty over US tax regulations that could potentially subject the REIT to a dividend withholding tax of 30%
- A highly dilutive rights issue to fund the Westpark portfolio acquisition
While unit prices are on the mend, IPO investors are still facing losses as the REIT is still trading below IPO price. More concerning is the fact that management decided to push ahead with a dilutive rights issue under terrible market conditions is an indication of management’s attitude towards investors.
Whether management’s behaviour will carry over to Prime US REIT remains to be seen.
Handling Conflicts of Interest
One question I had regarding Prime US REIT’s listing was on how it intended to handle potential conflicts of interest with Keppel-KBS US REIT. After all, both REITs specialise in US Office properties and may end up competing with each other for the same properties.
This is answered in the prospectus in several ways:
- There is a Chinese wall between Keppel-KBS US REIT and Prime US REIT. This means no information sharing between managers, separate management teams and separate reporting lines.
- With regards to conflicts between Prime US REIT and KBS’ non listed US REITs, they will be given the right of first refusal on deals that satisfy the following criteria:
- Class A office building
- Purchase price at least US$125m
- Average occupancy above 90% for the next 2 years
- Stabilised property investment yield is supportive of yields.
As such, don’t expect Keppel-KBS US REIT to collaborate with Prime US REIT anytime soon.
Studying the fee structure of a REIT lets us know if the REIT manager is properly incentivised and aligned with investors. The management fee structure employed by Prime US REIT is as follows:
- Base Management fee – 10% of Distributable income
- Performance Management fee – 25% of y-o-y increase in DPU
- Acquisition fee – 1% of acquisition value
- Divestment fee – 0.5% of divestment value
The REIT Manager has committed to receiving 80% of their base fees in units for the 1st 2 years. As such, the REIT Manager will have some room to boost yields by taking more fees in units.
The REIT has chosen to employ a fee structure that is similar to ARA US Hospitality and Eagle Hospitality Trust, probably on advice from DBS, who is the lead bookrunner for all 3 IPOs. It is good to see that there is some alignment of interest between REIT manager and Investors as the performance fee is computed based on DPU growth. If DPU suffers, so does the management. In other words, investors and management will sink or swim together.
Cornerstone investors give us an indication of how well-supported an IPO is and gives us an idea of what “savvier investors” think of the IPO. These investors also provide stability to unit prices as they are subject to lock-ups. This means they are not allowed to sell their positions post-IPO for a certain period of time. The Prime US REIT ownership structure post IPO will be as follows:
- KBS REIT Properties III – 24.7%
- AT Investments Ltd (SG-based Indian Billionaire Arvind Tiku) – 8%
- Keppel Capital – 6.8%
- Times Properties Pte Ltd (Singapore Press Holdings) – 6.8%
- Other cornerstone investors -17.4%
- Linda Bren 2017 Trust (KBS founder’s estate)
- The Schreiber Trust (KBS founder’s family trust)
- Credit Suisse private banking clients
- DBS Bank private banking clients
- DBS Bank
- Hiap Hoe Investment Pte Ltd
This means 63.7% of the REIT’s units are taken up by cornerstone investors, way more than ARA US Hospitality Trust and Eagle Hospitality Trust.
Notable amongst the cornerstone investors is KBS REIT Properties III being a significant unitholder, creating a “REIT owning a REIT” situation. Based on prospectus disclosures, no individual investor owns more than 1.35% of KBS REIT Properties III as at 31 March 2019. As such, its effectively a collection of individual investors investing in Prime US REIT.
This is also the second time SPH joined Keppel in co-investing in a deal, the first being the general offer to take M1 private.
Long story short, Prime US REIT is much better supported than the other 2 US REIT IPOs this year. This could provide a much more positive trading performance post-IPO.
Financial Highlights and valuation
After reviewing most of the operational factors, let’s dive into financial factors.
Historical portfolio performance
The Portfolio net property income (NPI) saw a small drop year on year in 2017 before rebounding upwards in 2018. This is mainly due to poor performance of Tower 1 at Emeryville which suffered significant occupancy reduction in 2017.
The other properties generally saw steady increases in NPI across the 3 years.
The REIT’s aggregate leverage will be 37% at IPO, with a weighted average debt maturity of 5.5 years with 85.1% of debt effectively on fixed rates. This insulates the REIT from interest rate risk as well as the threat of expiring debt. A good thing for investors.
Using the indicative IPO price of USD0.88, the REIT is priced at a slight premium to book at 1.05 and has an indicative yield of 7.4% in 2019. FY2020 yield is projected to be 7.6%.
To me, the valuation is fair, which leaves limited upside for IPO participants.
To better understand whether an IPO is worth investing in, a good way is to compare it to similar peers already out in the market. The closest peer listed on the SGX is Manulife US REIT, with Keppel-KBS US REIT being another potential candidate for comparison.
|Description||Prime US REIT||Manulife US REIT||Keppel-KBS US REIT|
|Property Type||Class A||Trophy / Class A||Class B|
|No. of properties||11||8||13|
|Average cost of debt||3.45%||3.28%||3.76%|
|Weighted average debt maturity (years)||5.5||2.5||3.6|
|Price to NAV||1.05||1.08||0.99|
Comparing the various metrics between these 3 REITs, there is little that separates them.
Differences between Prime US REIT and Keppel-KBS US REIT can be downplayed to asset quality (Class A versus Class B, 96.7% occupancy to 92.1% occupancy, etc). As such, it is appropriate that Prime US REIT commands a premium valuation over Keppel-KBS US REIT.
When comparisons are made between Prime US REIT and Manulife US REIT, differences are even more indiscernible. The fact that Manulife US REIT is accorded a premium valuation is also justified due to its larger portfolio, market capitalisation and longer track record.
After going through an absolutely massive amount of information, let’s wrap it up with a summary of the good, the bad and the risks.
- High quality portfolio with high occupancy of 96.7%
- Relatively long leases with fixed step up rates provide good income visibility
- Large sponsor that unitholders can leverage on for expertise and acquisition opportunities
- Strong support from cornerstone supporters taking up 63.7% of the IPO
- Fair valuation provides limited upside for IPO investors.
- Offering comes hot on the heels of 2 other US REIT IPOs, which may result in lukewarm investor reception.
The Main Risks
- KBS has acted unfavourably against investors in the past.
- Potential for further equity fundraising post IPO is very high. Only time will tell whether it will be structured favourably for investors.
- US-China trade war escalation may trigger an economic downturn.
My Personal strategy
The high-quality portfolio and strong cornerstone support for the REIT are the main attractions for me for this IPO. As such, I can understand if investors are willing to give the REIT a chance at IPO.
What holds me back is the fair valuation and the potential for future equity fundraising.
As somebody who loves things that are cheap and good, I would personally give this IPO a miss as a result. I’ll revisit it if it ever trades below book value in the future.
Prime US REIT IPO’s 8th July. Subscription closes on the 15th of July.
IPO Balloting Results
The Prime REIT IPO balloting results were released on 16 July 2019. As you can see from the table, applicants who applied for up to 99,900 units got their full allocation at US$0.88 (or S$1.20) per unit.
At the release, management allocated 40,909,000 units for the Public Offer, instead of the 16,761,000 units stated in the Prospectus. The additional units were most likely re-allocated from the Placement Tranche – as no new funds were raised.
The IPO starts this Friday (19 July) 2pm, it would be interesting to see how prices perform. Will it soar successfully? Or will it disappoint like the recent Eagle Hospitality Trust IPO or ARA US Hospitality Trust IPO? This will be an interesting one to look out for!