Recent S-REIT IPOs seem to be a competition of who’s “The First” in something. Last year, we had the first US-focused Hospitality REITs in ARA US Hospitality Trust and Eagle Hospitality Trust. This year saw the first UK-focused office REIT in Elite Commercial REIT.
This string of firsts continues with the next S-REIT IPO – United Hampshire US REIT (Hampshire REIT). The REIT brings 2 new asset classes to the S-REIT market – US-focused Grocery anchored Malls and Self-storage properties.
The question as usual is whether they are worth investing in. Let’s take a closer look.
Here is a brief overview of the offering details:
- The IPO Price will be USD0.80 or SGD1.12
- There will be 87,829,600 units on offer. 80,329,600 units are reserved for the placement tranche, with only 7,500,000 units will be offered to the public.
- This implies a market capitalisation of USD394.6m or SGD552.5m, which makes Hampshire REIT a small cap REIT.
- Applications are now open and will close on 10 March 12pm.
The IPO prospectus can be found here.
Asset Class Characteristics
As Grocery anchored malls and self-storage properties are new to the S-REIT market, I thought I’ll go through some basic asset characteristics.
Grocery anchored Mall Basics
Grocery anchored malls are what it sounds like, malls with a grocery anchor tenant. In the US, these usually come in the form of strip malls.
Some example strip malls are depicted above from the IPO Portfolio. As you can see, they are located in the suburbs with large car parks for customers to drive and park while shopping. The shopfronts of the various tenants usually face the car park.
The tenant mix usually features a grocer anchor with a mix of other essential services like hairdressers, discount retailers, bank branches and restaurants.
For Singapore investors, think of strip malls as your suburban malls like Clementi Mall and Northpoint City with your big NTUC Fairprice and other basic services.
Self Storage Properties Basics
Self Storage is a service that I think most Singaporeans rarely use. Self storage is a useful service for people who keep a lot of stuff in their homes or need to have a temporary space to store things when life situations change. The research report describes this as the 4Ds – Death, Divorce, Downsizing and Dislocation.
As you know, housing space is generally very expensive. This is where self-storage comes in by providing customers with space to store their stuff at a much lower cost.
Self Storage properties are typically industrial buildings usually located on the edge of town where the land is cheaper. One example from the IPO portfolio is depicted above.
Self Storage is immensely popular in a society in the US where internal consumption is immense. This generates a lot of stuff that needs to be stored somewhere.
Self-storage is actually not new to Singapore, with local players like StorHub who have been around for some time. You can check out this podcast by MoneyFM with StorHub’s COO if you’ll like to learn more.
Asset class resilience
Grocery anchored Malls and Self Storage are seen as essential everyday services. This makes the rental more resilient to market cycles and ecommerce trends.
The graphs above by the Independent Market Research firm shows the relative insensitivity of property prices and grocer sales to GDP.
E-commerce penetration in certain sectors like Home Improvement and Food/Drink remain low due to the difficulty in last mile delivery and a general preference to pick your own groceries.
This is consistent with trends of Ecommerce giants like Amazon venturing into grocery retail with their acquisition of Whole Foods and opening of Amazon retail stores.
Market Supply and Demand Outlook
One important area to determine stability of rent rates is to look at supply and demand outlook in the various sub-markets.
US Strip Malls
Net absorption measures the demand over the supply available in the market, with a positive net absorption indicating demand outstripping supply.
Studying this chart, the REIT’s malls are generally located in markets with flat to positive net absorption.
There is also limited new supply coming into the market, which is great.
Overall, the market outlook for Grocery anchored malls seem positive in the sub-markets the REIT’s properties are in.
For the self-storage market, the independent research report tries to paint a positive image. However, if you study it closely you’ll realise that the market is probably oversupplied.
Supply growth has picked up in the past few years.
Supply Growth is projected to pick up even further going forward.
Rent growth has been soft at best for the portfolio’s sub-markets, indicating tepid demand.
This observation is corroborated by CBRE’s 2020 Outlook indicating oversupply in the self-storage sector.
Overall, the self-storage market outlook seems negative.
The IPO portfolio consists of 22 properties located predominantly in the US Northeast, 18 being Grocery-anchored malls, 4 being self-storage properties. 21 of them are freehold properties, with only 1 of them with a land lease of up till 2060.
As the bulk of the IPO Portfolio are Grocery anchored malls, the REIT disclosed a Top 10 tenant list based on those properties. It is no surprise to see grocers and supermarkets dominate this list. Besides Walmart, Home Depot and Lowe’s as advertised, regional supermarket players feature prominently in the list.
The Top 10 tenants contribute 66.7% of Base Rental Income, which is a fairly high tenant concentration.
Self-storage tenants tend to be individuals, as such they should not turn up on the top tenants list.
Lease Expiry and Characteristics
Hampshire REIT disclosed most details regarding the Grocery & Necessity portfolio, with not as much detail on the Self Storage Properties.
The Grocery & Necessity Portfolio has a long weighted average lease expiry (WALE) of 8.4 years by base rental income (BRI). These leases are mostly on a triple net basis with a fixed rent component with no variable component. There are also scheduled rental escalations built in to the tenancy agreements. Anchor tenancy agreements have built in rent increases from 5 – 10% at every 5 to 10 year intervals. Other tenants will have rent increases from 1 – 3% annually.
That’s quite a long time between rental increases for anchor tenants.
The Self storage leases are largely with individuals on rolling monthly basis. Hampshire REIT estimates that tenants stay for 1-2 years with 1-2 rent increases per year. Rates will vary from customer to customer as Extra Space Storage uses a yield management system to charge differential rates.
Complex Structures for certain properties
One perplexing thing about the IPO portfolio is the existence of various complex structures / caveats / leases associated with them. Let’s go through the whole laundry list.
Top up arrangements at St. Lucie West, Elizabeth Self-Storage and Perth Amboy Self-Storage
St. Lucie West is currently undergoing an Asset Enhancement Initiative (AEI) to expand the mall. The expansion is expected to complete in 1Q2021 and will be filled by existing anchor tenant, Publix Super Markets. The space vacated by Publix will then be backfilled by the REIT.
As a result of this, a rental top up arrangement is agreed with the Sponsor so as to minimise the impact of the expansion construction and subsequent backfill.
Elizabeth Self-Storage was recently completed, while Perth Amboy Self-Storage is still under construction with a target completion period in 2Q2020. As a result, these properties are still not operating at stabilised capacity. To mitigate the impact of this, a rental top up arrangement was also set up with the Sponsor.
The result of these arrangements is the artificial boost to DPU for the duration of the Top-up arrangements.
Earn-out Arrangement at Carteret and Millburn Self-Storage
On top of initial purchase consideration, Hampshire REIT is potentially liable to pay the US Sponsor another US$200k and US$500k for Carteret and Millburn Self-Storage respectively. Payment of these fees is contingent on the respective properties hitting certain Net Operating Income targets.
The rationale for these arrangements is because the properties are still in the ramp up phase and the Sponsor is only willing to sell these properties at the stabilised topped up price.
Existing Investor Arrangement at Wallkill Price Chopper
Hampshire REIT will acquire 100% of the shares of the company owning the Property, however an existing JV agreement with an unrelated 3rd party is entitled to receive 3.0% of cash distributions in perpetuity.
This is in spite of owning no equity in the company.
Waterfall Arrangement at Parkway Crossing
Hampshire REIT will own 90% of the Property Holding company owning the Property, with the remaining 10% owned by an unrelated 3rd party MCB Parkway Crossing LLC. However, by virtue of a JV agreement, the cash generated is actually paid out in accordance with a complex waterfall agreement.
I personally do not fully understand the effects of the agreement. However, the resulting effect of this arrangement is this: despite owning 90% of the property, Hampshire REIT will only be entitled to less than 90% of future cash distributions. This is because Tier 3 and Tier 4 distributions are split between the partners at a 80-20 and 65-35 proportion as mandated by the JV agreement.
I hope this has been taken into account for the property valuation.
The properties have an adopted valuation of US$599.2m. If income top up was excluded, the properties valuation drops to US$592.7m.
Inspecting the valuation report, both CBRE and Cushman & Wakefield used the Sales Comparison and Income Capitalisation methods to value the properties.
Cap rates used appear to be in line with market rates compiled by CBRE and the rates provided by the independent research report.
The valuations also take into account income support provided by the Sponsor.
The Sponsors of the REIT are UOB Global Capital and Hampshire Companies LLC. Singaporeans will be familiar with homegrown bank UOB. We would be less familiar with Hampshire Companies. As such, I shall focus on the US Sponsor.
The Hampshire Companies
The Hampshire Companies was founded by Chairman Jon Hanson in 1976. It describes itself as a full-service, private real estate investment firm based in Morristown, New Jersey. The company is now led by his son James Hanson II, who also serves on the Hampshire REIT board.
If you watch this video on the website, you realise that Jon Hanson and his company are extremely well connected in New Jersey and Republican circles. This is a good sign as real estate is very much a local business.
Potential Right of First Refusal (ROFR) Assets
UOB and Hampshire Companies have given a right of first refusal over assets managed by their joint venture as well as Hampshire’s independently managed assets. As these assets will be provided mostly by the US Sponsor, we can understand the characteristics of this potential pipeline by looking at Hampshire’s investment platform.
Hampshire Companies divides its platform into 2 strategies – Core Plus and Value Add / Opportunistic. Given the Hampshire REIT’s IPO Portfolio characteristics, it is likely that the assets came from its Value Add / Opportunistic half of their platform.
The US Sponsor manages over US$2.1b of assets, of which US$1.1b is under the Value Add / Opportunistic strategy. Of the US$1.1b, about $600m of assets is being injected into Hampshire REIT.
The US Sponsor employs different strategies for different asset sectors. For the US Northeast Grocery anchored malls, they invest in “Developer Take Outs”, which means 3rd party acquisitions from developers. For the US Northeast Self-storage properties, they internally develop the properties and use an experienced operator like Extra Storage to manage the properties.
This adds colour to the source of the properties and where the potential pipeline of assets will come from. It is interesting that the US Sponsor also has Grocery anchored mall assets on the US-East Coast, which will also form the potential pipeline of future assets to be acquired.
The REIT employs a fee structure similar to most recent REIT IPOs:
- Base management fee: 10% of annual distributable income
- Performance management fee: 25% of annual DPU increase
- Acquisition fee – 0.75% (from related parties) / 1% (from others) of acquisition value
- Divestment fee – 0.5% of divestment value
The fee structure has some alignment of interest by having a performance fee tagged to 25% of annual DPU increase.
The REIT Manager has undertaken some minor financial engineering to support IPO forecast yields. It has opted to take all its base and performance management fees in units for 2020 – 2021. These measures help to support DPU in the initial IPO period.
It is also good to note that the self storage properties under development or the St. Lucie West Expansion will not incur development management fees post IPO.
The list of cornerstone investors provides an indication of the level of support from “smart money”.
|UOB Global Capital||9%|
|UOB Private Banking Clients|
Golden Sun (China) Ltd (Dato’ Swee Lian Woo)
Kuang Ming Investments (Philip Ng and family)
Kasikorn Asset Management
Phillip Securities Clients
Helen Chow (Wing Tai Director)
UBS Wealth Mgt Clients
Chiu Hong Keong and Khoo Yok Kee (Pintaras Jaya Berhad founders)
Credit Suisse Private Banking Clients
Bangkok Life Assurance
HSBC Private Banking Clients
|Davinia Investment Ltd||3.1%|
|Steamboat Apollo, LLC||0.3%|
The cornerstone investors are largely private banking clients and high net worth individuals. Interestingly, Philip Ng of Far East Organisation fame is participating in this IPO. There is some limited institutional support from some Thai asset management companies. As such, there is relatively weak institutional support for this IPO.
The Sponsors will own about 17% of the REIT post IPO, assuming Over-allotment is not exercised. Given US tax law requirements limiting individual ownership in the REIT to 10%, there is significant alignment of interest with the sponsor.
Financial Highlights and Valuation
Now, let’s dive into the numbers.
Historical and Future Property Performance
As the sponsors have owned the properties for some time, this is one of the rare recent IPOs where we get to see the portfolio’s historical performance.
Some key assumptions made by the Sponsor in preparing the historical information:
- Does not include contributions from Lawnside Commons as the property is only acquired from a third party vendor on listing date.
- Elizabeth Self-Storage and Perth Amboy Self-Storage do not contribute to historical performance as they were not completed during the period in question.
- The following properties only contributed to performance from the following dates:
- St. Lucie West – 8 January 2016
- BJ’s Quincy – 21 September 2016
- Wallkill Price Chopper – 30 Dec 2016
- Arundel Plaza – 15 Feb 2017
- Carteret Self-Storage – 17 Jan 2018
- Millburn Self-Storage – 10 Oct 2018
In light of these assumptions, in my computation of historical Net Property Income (NPI) Yield, I will adjust my property valuation accordingly. I’ll also be using NPI that excludes IFRS straight line adjustments and top-ups for comparability.
|FY||Annualised NPI (‘m)||Property Value (‘m)||NPI Yield|
Historical NPI yield paints a horrible trend for Hampshire REIT, with declining NPI yield year on year. Do note that this is even before Top-ups.
This causes the forecast to seem priced to perfection, as it assumes they will be able to execute on the ramp up of the newly developed and completed properties.
The REIT has taken out US$239.5m in loans. The loans seem to be a mix of revolving credit, term loans and mortgage loans secured against individual properties. The mortgage loans have a rather high fixed rate interest of 3.42 – 4.23%. Hopefully the REIT can refinance those at the trust level (which tend to have a lower interest rate) in the future.
The gearing of the REIT at listing will be 37% according to the prospectus.
The balance sheet provided indicates an NAV per unit of US$0.75. Using the IPO price of US$0.80, the REIT is priced slightly above book with a PB ratio of 1.06.
This implies a yield of 7.4 – 7.6% (with top-up) or 6.4 – 7.0% (without top up) in FY2020 and FY2021.
These valuation metrics indicate that Hampshire REIT’s IPO price is at best fair. However, when taken together with historical property yield, it is highly likely to be grossly overvalued.
What I liked about the REIT
- Largely freehold IPO portfolio located in markets with good dynamics for grocery anchored malls.
- Relative portfolio resilience to E-commerce and economic cycles.
- Mostly triple-net leases with step-up structures which give some visibility on future income growth
- Good combination of sponsors with a strong Singapore sponsor (UOB) and a sponsor with local property expertise (Hampshire Companies)
- Ready pipeline of ROFR assets to tap on for growth
- On balance, strong alignment of interests between sponsors and investors due to significant stake in the REIT and DPU growth based performance fees.
What I’m concerned about the REIT
- Potential fall off in income if the REIT fails to execute once income support goes away.
- Unattractive valuation with historical NPI yield indicating overvaluation.
- Self-storage market oversupply may dampen the REIT’s ability to ramp up its newly developed properties
- Weak institutional support for the REIT
- High gearing leaves little debt headroom for acquisitions, which may indicate further equity fund raising in the future to fund growth.
The Key Unknown
- Market volatility arising from the Coronavirus, US Election year and potential recession.
My personal take
Long story short, I will not subscribe to this IPO.
While the portfolio fundamental characteristics are quite attractive in a time of volatility, I really doubt the REIT’s ability to execute on its forecast.
The historical NPI yield performance over the past 4 years has not been anywhere close to their forecasts. Given the lease characteristics for their grocery malls, which have about 1% rental step ups when straight-lined, I really doubt that the fundamentals can improve as dramatically as forecast.
Part of the growth anticipated comes from the ramp up in self-storage properties. With the oversupply and rent weakness in the self-storage market, I wonder if the REIT can ramp up those properties as anticipated.
Throw in transient issues like the Coronavirus, a potential recession on the horizon and it being a US Election year, I am very much inclined to adopt a wait-and-see attitude.
I’ll only revisit it at much lower valuations.