We are winding down the year end, but for industrial real estate investment trust Sabana (dividend yield 9.3%), they are not taking it easy.
We are suddenly seeing a flurry of deals happening.
This article will provide some analysis on the acquisitions and disposals and some of my thought process when I look at these deals with Sabana’s current situation.
On 5th December, Sabana managed to sell off their 218 Pandan Loop property. Since the end of the master lease, this property have been left vacant. The property was sold at a profit, much to a lot of people’s surprise. This is because the climate is not the most conducive.
I have friends trying to sell off their industrial properties and its been difficult.
On 8th, 14th and 15th, Sabana announced the potential purchase of 3 different properties. The first one was a sale and leaseback from Singapore Handicrafts, who will lease 71% of the property for 10 years.
The second was a sale and leaseback from General Cars Fleet Management, who will lease 34% of the GFA for 5 years.
The third and last property is a sale and leaseback from Vibrant Group, which is Sabana’s sponsor, who will lease 74% of the property for 10 years.
Sold with Income Support
One of the very visible traits of the deals was that, the General Cars and Vibrant purchase was carried out with income support.
General Cars Fleet Management will provide income support for the property for 5 years, which is the duration of how long they will stay. Vibrant group will provide income support for the first 3 years, due to departing tenant.
There are 2 kinds of income support, one where the future potential to renew tenant at higher rent, when the properties are not matured enough. The other is when they want to make it seem the properties are cash flowing well.
When the properties look to be cash flowing well, their valuations tend to be higher and possibly the seller gets a good lump sum cash flow from the sale of the property.
Long Lease Tenure
2 of the properties was leased for 10 years. Out of the 2, Sabana explicitly announced that there is a 1% annual rental escalation. There was no such information for the other one.
The last properties was leased for 5 years.
With this tenure, Sabana would have secured cash flow that are not tied to current difficulties in the Singapore industrial segment.
However, it should be noted, that the cash flow is as strong only if the counterparties (Singapore Handicrafts, Vibrant and General Cars Fleet) do not default on the rents.
Readers should be well aware of Technics oil and gas defaulting on their long rental lease with Soilbuild business trust.
There is another challenge of sale and leaseback which I will mention in another section.
Short Land Lease
Singapore land authority have changed the local industrial landscape by reducing the land tenures for new industrial properties. Likely we will not have 60 year land lease in the future but shorter 30 year land lease.
The effect is that this will affect the value or cost of the industrial properties.
The 3 properties purchased have short land lease.
2 of them have 24 years left while the last one have 40 years left.
Potential Performance of the Properties
My opinion is that short land lease is not a problem if you get a good performance out of the properties. Be it purchasing a cell tower, ship or property as you get a good return over the cost of capital, its all good.
This is also if its worth the time you put in management.
To give you an example, if you purchase a property with 10 years land lease left for $10 mil, and for these 10 years you can only fetch a net property income of $200k/yr, that may not be a good deal. (2% NPI Yield, negative XIRR return)
(Note: XIRR is defined as Internal Rate of Return. It is a way to give a % return on assets so as we can compare the returns of wildly different assets such as a bond against a fixed deposit or against a private property return. Do a Google for better explanation. )
However, if you lock in a reliable tenant for 10 years and it can fetch a net property income of $1.4 mil/yr, this would be like a reliable pseudo bond for you. (14% NPI Yield, 7.5% XIRR return)
Out of the three properties purchased, General Cars will provide income support, so on a 100% occupancy, Sabana is targeting the property to earn $3.1 mil/yr. Sabana have gotten General Cars very locked to pay the income support for 5 years regardless they rent from them or not.
After this 5 years is another question. General Cars could vacate, and then Sabana would need to rent out at a lower occupancy, higher or lower rent.
We could assume that in the worse case, rent and occupancy will result in a 50% fall in NPI.
The XIRR for this 24 years property will be between 2.38% to 6.85%. 2.38% is the projected return if the NPI falls by 50% for the next 19 years after the 5 years income support. It could be worse or better.
Vibrant Group will provide a 3 year income support, with the first year rent to be SG$2.1 mil. That seems to be the targeted NPI that Sabana would like to earned, or at least earned, even after the income support period. After this 3 years, due to occupancy and market conditions, the net property income might vary. We could also take a 50$ fall in NPI in our simulation.
The XIRR for this 40 years property will be between 5.9-8.9%.
As for the third property, no figures was provided.
It should also be noted that much of the performance will depend on market conditions. for all we know there is such a limited supply of industrial properties that the rent if Sabana operates as a multi-tenanted landlord, they could earned 50% higher in net property income compare to now.
In that case the performance will change accordingly.
With this current numbers, my heart is not very excited. For short lease, or short concession assets, such as ships with Singapore Shipping, I seen unleveraged XIRR of greater than 10%. The hurdle for the toll roads at delisted China Merchant Pacific is also greater than 10%.
In my numbers, I tend to realize that the difference in XIRR numbers tend to be less after 40 to 45 years, where the XIRR doesn’t deviate far be it 45 years, 70 years or 100 years, due to time value of money.
Acquisition Financing Still Unknown
I suppose there needs to be some shareholder approval for the deals.
Sabana have provided some simulations on how the net tangible assets and dividend per share will look if different levels of equity and debt financing are chosen.
Whichever way, Sabana have some refinancing issues upcoming. They do look to be one of the industrial REITs that are in a more edgy position.
Net of the sale of Pandan Loop, the new properties will cost $67 mil.
Should Sabana choose to finance by debt, this will bring their net debt to asset to 44% based on my calculation. This is just below the guardrail set up by MAS on how much the REITs can leveraged.
It is likely Sabana will ask for an equity issue.
The Motivations for Selling and Buying
In these deals there are winners and there are losers. There are also deals that when you look in hindsight both did well.
Industrial properties are something that is described as closest to 4 walls. They are not in prime locations and for general industrial properties very similar.
A good manager with better resources could rent out better then another.
Sometimes, it is not about performance, but for other intangible business reasons such as expansion in a good location, or complementary location.
Sale and Leasebacks, to me are often seen as owners wanting an asset light structure. They want to treat occupancy as an expense. Whether they are leasing or owning, they will enjoy the benefits to minimize taxes paid on profits.
Being asset light also improves return on equity.
However, given the current challenging conditions, I would suspect whether the sellers would want to monetized the properties to get a lump sum in cash for working capital purposes or redeploy into their business in other ways.
Without the income support, I wonder if the valuation of the properties will be as high.
The income support and long lease appeased the REIT investors to accept such a purchase. I do question whether the manager can lease the unoccupied space well considering they are struggling to lease out Pandan Loop and another vacant property prior to this acquisitions.
Why won’t LHN Managed the Sub Lease?
Singapore Handicraft is a subsidiary of listed Space optimization player LHN.
LHN listed not too long ago and from what I can determine, they have been managing spaces for the longest time, helping landlords manage property which they sublease to other subtenants.
The reason for their IPO is perhaps to do with the thin margins of trying to manage the spread between what they pay landlords and what they earned from subtenants.
With the IPO money, they went about acquiring properties to earn a better deal.
So they do have competency in being landlords so why would they sell?
One possible reason is that if they do not sell, LHN cannot monetize a lump sum of money. Singapore Handicraft is a business that, if my information is right, the father started. The business will be there.
By selling, LHN can monetize a lump sum of cash so as they can deploy into something that they can rent out.
Net net, i am not sure whether this will work out, paying rent while receiving rent.
It is likely they believe they can deploy the cash in a better yielding asset.
Freight Links Selling
Sabana’s parent have got to one of the more questionable sponsor, that likely see the REIT as a way of offloading risks to other people.
We derive this conclusion, from their past decisions and actions.
Prior to these 4 acquisition and disposals, Sabana also announced the renewal of Master Lease for 3 of their properties.
The master lease is renewed for 1 year term, and they have options to renew for 4 successive 1 year term. I wonder why their sponsor won’t give them a good deal by just managing for 5 years at a good rental rate.
It should be noted that this is not the first time I wrote about this master lease. I wrote about it one year ago.
The master lease was part of the IPO and back then the gross revenue was SG$12.5 mil. One year ago, the master lease was renewed at SG$10.5 mil. This current announcement will renew at SG$10.1 mil.
While master lease should reflect on current challenging operating conditions, these short one year deals does not give me the confidence that the new building purchase from Freight Links will end up well after the 10 years tenure.
As of now, 10 years is still very far away.
Rights Issue when Sabana’s Equity is Cheap
What I will be interested will be to hear the narrative presented to the Sabana shareholders. They aren’t a happy bunch these few years.
Share price have been down, due to dividends per unit down.
To make additional purchases, in this challenging industrial climate, some good justifications need to take place.
When you carry out a rights issue, it is as what Bobby Jayaratham said in his book on Investing in REITs. The management is not taking back your dividends, but to ask whether you would partner them in a new exciting venture.
Your track record will provide a certain level of confidence to your shareholders that you know what you are doing. If the track record is poor, then it will take much convincing for shareholders to part with even more money.
Right now, Sabana’s share price is traded at a 40% discount to their book value. The rule of thumb is, you raise equity when your equity or share price is expensive, so that you can raised more money, and perhaps use debt financing when your equity is cheap, to buy back shares.
Given this discount, raising equity does not seem the most logical step. The only justification that can be given is that the equity raising will bail the REIT out of implosion, or that these properties are very good deals.