Path to prosperity

SPHREIT released its 3QFY20 Business Update this evening. This comes after it shifted to half-yearly reporting; the link to the presentation can be found here. Would like to highlight a few things to take note of:

SPHREIT declared a DPU of 0.5 Scts for the quarter representing an increase over 0.3 Scts declared in the last quarter. However, it did not disclose its distributable income hence we are unable to accurately calculate what the current payout ratio is. If we take last quarter's results, this represents a payout ratio of 33%, up from 20% previously. 

In all likelihood, 3Q distributable income would have been significantly worse off than 2Q as the quarter covered Mar-May which were the months which felt the most impact from Covid-related mall closures. Additionally, SPHREIT also announced that they were giving rental waivers for tenants. Therefore, the reduced DI would mean that payout ratio is probably more than 33%. 

My original thesis was that prime district malls in Orchard//City area like Paragon would suffer substantially more than suburban retail due to the target audience. Apart from having a bigger residential catchment, suburban malls typically tend to have a larger proportion of 'essential' tenants like supermarkets and F&B. Whereas prime district malls tend to have a larger percentage of high fashion and targets discretionary and tourist spend. Therefore I expected suburban malls to be substantially more resilient. 

Looking at the visitor traffic figures, Paragon experienced a 58% decline in traffic while Clementi Mall's traffic declined 53%. Would have thought that the difference would be much bigger. My guess would probably be that pre-Covid Paragon was not overcrowded whereas Clementi Mall is frequently packed to the brim. Hence with a higher base there was much more room for traffic to fall at Clementi Mall. 

SPHREIT reported a committed occupancy of 98.8% across its malls in Singapore and Australia. Importantly, its 2 largest revenue contributors had occupancies of >99%! I think this is impressive as it probably implies only 1-2 shop lots are vacant. Going forward both Paragon and Clementi Mall have 28%/22% of lease renewals in FY21 and this will be a critical point to watch as leases do take time to expire. I also note that SPHREIT did not disclose its rental reversions in the presentation pack. We are therefore unsure if the high occupancies are a function of cutting rents. 

In the down-cycle that is coming, I believe that landlords will do well to shore up occupancy even if it is at the expense of rental rates. Unlike rental rates, occupancy is binary, either you are getting income from that shop lot or you are not. However, do hope that the REITs can be transparent in sharing such figures so that unitholders are well-informed. 

AREIT announced the acquisition of a yet-to-be-built logistics property in Sydney today (1 Jul 2020) for A$23.5m. The property will be developed by the Vendor and completed by 2Q2021. In the press release, AREIT mentioned that it managed to acquire the property at an almost 20% discount to its 'as if complete' valuation and this implies a 1st year NPI yield of 6.2%/5.8% pre and post-transaction costs. 

With a huge portfolio across Singapore, Australia and the UK, this acquisition barely moves the needle although AREIT says it is accretive to DPU. To unitholders, the REIT is also taking on development risk as the property is uncompleted and does not have a tenant. To mitigate this risk slightly, the Vendor is providing a 9.5months rental guarantee. 

REITs taking buying uncompleted assets or taking part in development means that their capital is tied up but not generating any income for unitholders (ie. not so efficient). However, as this acquisition is small, I do not think that there will be any noticeable impact on AREIT. Additionally, this method allows AREIT to gradually build up its portfolio accretively as they are unlikely to get good yields on completed (and fully tenanted) assets. The acquisition is expected to be fully funded by debt or internal resources hence the ability to get yield accretion. 

The more sizeable acquisition was made by FCT's acquisition of an additional 12% interest in the PGIM ARF Fund for S$197.2m. This brings its interest in the fund to 36.89% from 24.82%. As a recap, the PGIM ARF Fund contains 5 retail malls and 1 office property in Singapore and 1 retail mall in Malaysia. Ever since FCT and its parent, FPL, started buying stakes in the Fund, their intention was always to absorb these malls into FCT eventually. 

According to FCT, this transaction will be DPU accretive on a pro-forma basis by +0.13%. The transaction will be fully debt-funded and would cause gearing to rise from 32.9% to 36.2% on a pro-forma basis. 

I like the transaction as it continues FCT's push to eventually own the entire Fund. The properties are all sub-urban retail which plays nicely into the Covid-19 resilience theme vis-a-vis prime district malls. Looks like FCT will continue to make bite-sized acquisitions of stakes in the Fund going forward. 

As mentioned in my previous post, I like the growth pipeline for FCT. Other than the PGIM ARF fund, it also has additional stakes in Waterway Point and Northpoint City that it can acquire going forward. A possible benefit of acquiring 100% of PGIM ARF is that FCT could then do away with the Fund structure and have these assets directly under FCT. This would save unitholders one level of fees; currently, I believe that unitholders are being charged fund management fees by PGIM ARF and REIT manager fees from FCT for every dollar that the PGIM assets generate. 

Both the AREIT and FCT transactions again emphasize the importance of having a strong balance sheet. For AREIT, it is large enough that bite-sized transactions can still be done without making too much of an impact on its balance sheet. While for FCT, it had always maintained one of the lowest gearing ratios historically, which allowed it to take advantage of opportunities when they arise.