Elite Commercial REIT has all the right metrics you would look for in a worthy Reit to invest in. Great looking yield, long wale, low debt to asset, freehold property and a tenant that looks like someone who you expect to be the last to default on their rent.

Sometimes it is either I overthink things or that I am absolutely right to be a little more skeptical.

Private equity firm Elite Partners is looking to IPO Elite Commercial Reit. A lot of the context for how to look at this REIT is shaped by the people associated with supporting this REIT.

My mode is wary for two reasons:

1. The guys working on these deals try to sense the market and priced it accordingly. At this point (23 Jan), we don’t even have a sensing what is the range of yield we will get. It feels to me they are trying to gauge interest from the larger investors to see how to price this. If this REIT has high-quality assets yet the IPO prices the REIT at a high yield, either the banks advising and the people themselves have a lack of confidence or that there is something we don’t know about this portfolio
2. The people behind it

That said, it doesn’t mean I am always right in the short term.

If you read the prospectus, you might pick out something you like or do not like about it. The prospectus is 750 pages at least, with half of it just valuation report. So the main bulk of it is about 300-400 pages. If you are interested in this REIT, you should read it.

This IPO has not been priced yet [23rd Jan 2020], so we do not have any idea what is the yield.

I think it will be above at an attractive 8% dividend yield.

This post is not going to be a comprehensive one. I would like to highlight some areas which I would usually check or perk my interest. You let me know whether they are relevant or not.

The Background

I managed to gather some background on what may have transpired before the IPO.

So it goes like this:

Singapore based private equity firm Elite Partners acquired a portfolio of 97 commercial properties in the UK from British developer Telereal Trillium for 282 million pounds one year ago in Nov 2018.

Elite Partners have decided to IPO these 97 properties almost 1 year later in this upcoming IPO.

Telereal Trillium started its life in 1998 when the UK Government decide to shift its property strategy. Sir Malcolm Bates concluded that government bodies are moving from being owners and operators of assets into intelligent purchases of long term services. So instead of owning or leasing offices, they decide to buy property services.

In 1998, the government executed Project PRIME, which was the out-sourcing of almost all of the Department of Work and Pension (DWP) offices to the private sector.

This includes a transfer of ownership of the freehold premises, responsibility of rental costs, maintenance and cost of upgrading the buildings. DWP retains the rights to occupy the estate for 20 years. They reserve the right to reduce the payment in the event of poor performance or if the buildings become unavailable.

This is an exercise by the government to rationalize their costs.

The 20-year contract ends on March 2018.

In January 2017, Minister of Parliament debated on the Future of the DWP estate. There were some details revealed in the debate.

The department is committed to reducing the size of its estate by 20% and increasing the “co-location” of Jobcentre Plus offices with other local services such as local authority benefit teams and mental health services.

The whole debate centers on the pace of the rationalization of space. Here are some interesting parts of the discussion:

Suffice to say, the government looks to have a mandate of trying to rationalize the space. In a Sunday Post, the newspaper reported that privatizing the job centers under the PRIME contract have resulted in some outlandish payouts by the government entity.

In 2018, a new 10-year, FRI lease commencing on 1st April 2018 was signed by the DWP at newly agreed market rents.

An FRI lease is one which places responsibility for all costs of repair and insurance of the property with the tenant. This new 10-year lease is also subjected to CPI-linked rent reviews.

Before the lease commerces, Telereal Trillium instructed CBRE to sell the 280 million “The Hayhill Portfolio”. The sale will put the net initial yield or net property income yield at 7.81%.

DWP’s delivery of services has changed significantly over recent years and, following a comprehensive review of its estate, through which the DWP has secured new leases across its UK portfolio to provide operational and occupational stability into the future, the DWP has committed to new leases on these 98 properties.

Graham Edwards, Chief Executive at Telereal Trillium said: “With the undoubted covenant of the DWP taking new 10 year leases on these 98 assets at current market rents, it is a good time to rebalance our portfolio. We continue to invest across the UK in the office, industrial, and strategic land sectors, where we deploy our asset management capabilities to create value. Over the last year we have invested in excess of £100m in new investment property, land, and residential development schemes.”

This probably coincides with a re-organization within Telereal Trillium where there are a number of high profile changes including the CEO.

This may highlight the shift in strategic direction:

The changes coincide with the conclusion of Telereal Trillium’s 20-year PRIME property outsourcing contract with the Department for Work and Pensions (DWP) on the 31st March 2018. They are in line with the company’s increased appetite to find and complete on new investment opportunities, to invest in its own estate, particularly in the areas of strategic land and residential development, and to continue the effective management of its existing £6.5bn property assets, and strategic property partnerships with BT, Aviva, DVLA and Royal Mail.

On top of the Hayhill Portfolio, Telereal Trillium is also putting other government outsourced portfolios such as the Bruton and Stratton Portfolio up for sale.

We can read this Hayhill portfolio in a few ways but I think Telereal Trillium may think this isn’t the future direction of how the firm is going.

It may very well be that they see the government’s direction to be constantly optimizing this portfolio and downsizing it. The WALE of this portfolio is rather long at 8.6 years. However, if the government is going to rationalize the portfolio, what happens after the lease ends?

1. They do not renew the lease
2. The Manager will need to lease to someone else
3. The place is hard to lease out and stays vacant. The property value drops since the majority of the property value is tied to the strength of the tenant lease
4. The new tenant moved in could not pay as high of a rent as a government with deeper pockets

These are some of the risks that I do foresee. There are a few properties in the portfolio that may be able to break their lease within 3.6 years so we may see some actions before this.

Some Details of the Portfolio

The portfolio consists of 97 properties that are distributed across the United Kingdom. Except for one, the rest of the properties are freehold.

The appraised value is about 319 million pounds. At an exchange rate of 1 GBP to 1.75 SGD, this portfolio is valued at S$558 mil. The expected debt on the balance sheet should be approximately 97.5 million pounds. This bring the debt to asset to roughly 30%.

One of the unique nature of this portfolio is that 99% of the gross rental income is derived from UK Government as tenants. There are rental escalation yearly based on consumer price index (CPI) adjustments.

The portfolio is basically very close to triple-net lease in that the maintenance, insurance costs are borne by the tenant.

The manager describes this portfolio has “stable, recession-proof and Brexit-proof cash flows”. The manager forecast that in 2020 the net property income (NPI) yield is 7.1%.

We have no idea what is the dividend yield yet, as the IPO has not been priced.

The Sponsors, Managers, and Cornerstone Investors and Lock-up Periods

There are likely to have 95 million units in issue.

Out of these, UBS AG’ Singapore and Hong Kong Branch, Bank of Singapore and CIMB’s Singapore branch have agreed to subscribe for about 77.83 million units at the offer price on behalf of their private banking clients.

So this REIT IPO would likely be heavily tilted towards the private banking clients of these cornerstone investors (UBS, Bank of Singapore and CIMB).

From what I read, there are no lock-up periods for the cornerstone investors.

The REIT will be managed by Elite Commercial REIT Management.

The sponsors for the REIT are:

1. Elite Partners Holdings (EPH)
2. Ho Lee Group, which is a property and construction firm
3. Sunway Group, a Malaysian conglomerate group

There are also a few characters associated with this IPO if we take a look at the unit lenders and those who would eventually be the substantial shareholders:

It feels very different from the REIT IPO that usually get a lot of good fanfare, where they garner the support from major institutional investors, fund houses or banks.

The prominent name here is Tan Kim Seng, who over the years have put together a few other IPO. It feels that there was a massive support gather exercise to find enough interest parties to roll out this IPO.

Together with a push to private banking clients tells me in the future, the REIT would have a lot of major shareholding volatility.

Details of Taxation

Whether we are dealing with overseas properties or local, we have to accept that there is always some risks when it comes to changes in existing taxation policies.

A REIT with overseas properties will be more complex because we have to navigate a few layers of country taxation, tax shielding.

There are a few layers of possible taxes:

1. Taxes on Income in the UK
2. Withholding taxes when money flows from UK to SG entity
3. Capital gains tax during disposal in the UK
4. Using interest expenses as a tax shield to reduce the taxable amount
5. Withholding taxes when money flows from SG tax offices to the REIT
6. Taxes on Income in Singapore
7. Taxes to shareholders

#1 – UK companies will be subjected to UK corporate tax on their worldwide income at the prevailing rate of 19%. Dividends received by another UK entity is exempted from UK corporate tax.

#2 – There is no withholding tax flow for UK Companies to other UK companies whether it is a dividend or interest income.

#3 – There are corporate taxes on capital gains made by non-residents in the UK. However, if unitholders are tax-resident of Singapore and a few more countries, they are exempted from this tax.

#4 – This one concerns whether the UK entities can use interest expense to reduce taxable income. Like the Singapore REITs with USA assets such as Keppel Pacific Oak, Manulife US REIT, the government wants to prevent UK companies from headquartering overseas so as to gain tax advantages. To not be considered as a hybrid entity, Elite Commercial REIT or RSIL will need to sufficiently held by an entity with at least 10% of the entity’s units.

The independent tax adviser assessed and believes that Elite Commercial REIT is not a relevant entity, and RSIL is treated as the ultimate parent.

#6 – Elite Commercial REIT has received exemption of a 17% corporate tax on income accrual in Singapore, income derive from overseas received in Singapore. Their income includes interest income on bonds issued by Elite UK Commercial Holdings Limited (ECHL) to Elite REIT, dividend income from Regal Sheen Investment Limited (RSIL) and any proceeds from the redemption of bonds.

RSIL also received an exemption of taxes on dividend income it will received from ECHL. Singapore does not impose capital gains taxes.

#7 – The tax-exempted dividend, after-tax income, capital distributions unitholders will receive from Elite Commercial Trust will be exempted from taxes.

Singapore GST on Elite Commercial REIT and RSIL can be claimed back.

RSIL is incorporated in the British Virgin Islands (BVI). There are no BVI income tax and withholding tax applicable here.

Properties in UK are subjected to Value added tax (VAT), Stamp duty land tax (SDLT) and Land and Buildings Transaction Taxes.

As a summary of this taxation section, we do see that in the proforma statements, there were tax expense charged. This is a mixture of deferred taxes and current taxes.

Deferred taxes were recognized as temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amount used for taxation purposes.

The current tax refers to the corporate taxes incurred at the current tax rate of 19% (mentioned in #1) as well as deferred taxes

If we look at the distribution adjustments, which is made up of 100% management and trustee fee paid in units, Elite Commercial REIT is likely subjected to some form of taxes.

The important one is that it is likely there are no withholding taxes when the income flows from UK to BVI to Singapore.

The Buildings

Majority of the portfolio builds are old.

Like the 1960s, 1970s, and 1980s old. This is not new as in the United States, we will also have a lot of very old properties that are still around today. I could not find much information when these older buildings have been improved upon.

You can read more about them in the second half of the prospectus.

Pay attention to the valuation section. In that section, you can find information about the Initial Yield, Equivalent Yield, and Reversionary Yield.

• The Initial Yield will show the yield based on first-year rent
• The Reversionary Yield will show the yield of the property it will eventually rose and fall to
• The Equivalent Yield will be somewhere in between these two and show probably the average yield you will get overtime

By reviewing these three figures, we can have a direction of whether the market rent Telereal renewed in 2018 is above, below or roughly similar to the market rent now.

If Initial Yield is higher than Reversionary Yield, the current rent is higher than market rent. A worrying sign.

If it is the other way, then there may be a higher potential for higher rental reversion when the rent gets renewed in the future.

This property shows the current rent is vastly above the market rent. The initial yield is much higher than the equivalent and reversionary yield.

This property shows current rent vastly below-market rent.

I tried to categorize the properties based on whether the current rent is above or below the current rent.

1. Number of properties where current rent is greater than market rent: 76
2. Number of properties where current rent is below the market rent:19
3. Almost the same: 2

78% of the properties have current rent higher than market rent. It does indicate to me that the properties are being rented above their current potential rent as assessed by the valuer.

If the properties do not get renewed, re-leased rent might be lower. For some, you could see a 2-3% yield gap.

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Mapletree North Asia Commercial Trust has gone through some tough months. Their main revenue-generating asset, Festive Walk, was caught in the middle of the Hong Kong unrest and was damaged to a certain extent.

This uncertainty, have corrected its share price to as low as $1.12 from a high of $1.46.

2 days ago, the REIT announced its 3rd quarter results. There were no surprises that the revenue and income was down.

Festive Walk had to close for 48 days in total and the office have to close for 13 days. The mall and the office has since reopened, and by all reports, the first few days were rather busy.

The dividend per unit this quarter was 1.67 cents, which is 13.3% lower than the 3rd quarter last year.

The management decided to top up the distribution from Mapletree North Asia Commercial Trust’s capital base (likely the cash). This makeup partly of the loss of Festive Walk office revenue and retail revenue. It is to mitigate the impact as rental from tenants is not collectible over these periods. If I am right, this 1.67 cents to be distributed in the recent quarter factors in this top-up.

The loss of revenue is covered under insurance and claims will be filed and recovered in due time.

The table above was taken from their 3rd quarter results. We can observe the extent of the reduction. There are probably 92 days in the last quarter. So a 48 days impact on retail would be roughly 52% of their revenue or their income. 13 days impact on office will be 14% of their revenue or income.

If we compute 48% of 3Q FY18/19 revenue, we will come up with $27 million. This is more than the $23 million in gross revenue this Q3. If we look at the net property income, the result is coherent ($16 mil this quarter versus $22 mil if we take 48% of 3Q FY18/19 net property income)

This is a bit puzzling because the only major retail asset would be Festive Walk. The rest of the REIT’s assets were mainly commercial offices.

Shareholders may enquire with the management whether there is a good reason for this. Here is my suspicion: A part of the rent is as a percentage of retail revenue, and December, is a traditional festive period that brings in a larger proportion of income.

The following slide shows the rental reversion year to date for Festive Walk:

The occupancy looks splendid and the average rental reversion year to date looks just as good. However, this figure includes all the reversion carried out in the financial year.

This unrest have lasted for months, so could we find out whether there were new renewals?

The slide above is taken from the Q2 result. The reversion for both retail and office looks similar to Q3. The % of leases is lower, indicating that there were some renewals or new leases.

It is great that the renewals did not bring down the rental reversion.

At this point, the strong assets for the REIT is Festive Walk and Sandhill’s strong rental growth. Gateway in China and the Japanese properties are not measuring up.

Mapletree North Asia Commercial trades at about 6.2% dividend yield, with a net debt to asset of 35%. This unrest should be an opportunity but the issue with investing is that when it is dark you do not know if it will get darker or it will turn bright. For a lot of investments, it is not easy to discern if the problem is a long term problem or this is just a short term issue.

For me, I do think that a lot of its assets have a land lease that may expire in 2047. That will prevent me from having it as a long term hold. As an investment, I may not hold it for more than 2 years so why worry!

Lastly, if we do away with quarterly reporting, this would be a good case study of what we will missed out. If there is quarterly reporting, it allows us to glimpse at certain metrics that would show us if the business is doing well or not.

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I break down my resources according to these topics:

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I cannot remember when was the last time IREIT Global made an acquisition.

It was such a long time ago. So long that I forgot when. But fret not the management finally made an acquisition. This time they have acquired a portfolio of Spanish properties from Blackstone‘s Spanish REIT Corona Patrimonial.

Is this a good acquisition? Let us find out.

From my High Yield Dividend Stock Tracker, IREIT Global gives a 6.8% dividend yield.

That does not tell the whole story because they retained 10% of their income available for distribution (even though I could not detect why they retained it. Cash is the same, debt goes up).

Together with a rather low debt to asset, long debt to maturity of more than 6 years, very low cost of debt, I like to see how this acquisition can augment their portfolio. The black mark is that due to the exchange rate, dividend yield has come down a fair bit.

This is also the first deal done since CDL came on board to own 50% of IREIT’s manager and 12.4% of the REIT.

A Spanish Portfolio

This acquisition was structured in the form of a joint venture between IREIT Global’s parent Tikau Capital Management and them.

REIT’s share of the joint venture is 40%. Tikehau will take the other 60%. Tikehau has given the REIT a call option within 18 months to purchase the other 60% of the portfolio. If Tikehau sells to a third party, they can exercise a “Drag-a-long” option to IREIT to sell their portion of shares too, but not less than NAV. If Tikehau does not exercise the option, the REIT can “Tag-a-long” on the deal as well.

The interesting thing is that it says CDL fully supports the acquisition and extended to IREIT a EUR 32 mil bridging loan.

Somehow seeing this bridging loan gives me the feeling they have to end this deal fast.

From this paragraph, it looks that way.

This acquisition is one-tenth the size of its current portfolio.

The portfolio consists of 2 buildings in Madrid and 2 in Barcelona. They are all multi-tenanted.

You can view some snippets of the portfolio in this video here.

The occupancy of the Barcelona is low. I wonder whether the manager sees this as a portfolio they can improve upon.

If it is so hard to rent out by previous owners, what are the chances we do better than them?

Since this is only one-tenth the size of the portfolio, I do not expect it to have a great diversification impact.

Clece, a cleaning company with footprints in UK, Portugal, and Spain, and Digitex are their key tenants.

Past Occupancy

The occupancy for Lumina and San Cugat Green is not ideal right now. I wonder why Corona Patrimonial could not increase the occupancy.

Here are some of Corona Patrimonial historical occupancy figures:

The occupancy looks really volatile. Delta Nova improved massively from the past while Illumina and San Cugat occupancy has declined.

Management has said the passing rent is lower than market rent. Thus, if they could improve the occupancy or re-leased the property at market rent, there will be some upside.

However, judging by how volatile is the occupancy, I wonder if shareholders would like this to be added to their portfolio.

Method of Financing this Acquisition

The size of the consideration to IREIT should be around EUR 57.6 mil.

Part of this EUR 57 mil will be financed by the EUR 32 mil bridging loan first. This loan looks to be pretty high-interest relative to IREIT’s current loans. There is another EUR 25 mil of loan, probably on the Target Entities level which is eventually attributable to IREIT.

I suspected that this loan at the Target Entities level is amortizing, which means you are paying part of the principal.

IREIT has 2 different ways of financing the acquisition.

The first way is to fully finance with a CDL Loan and IREIT’s share of the mortgage financing.

The second way is through a 62.7 mil equity issue at an illustrative issue price of S$0.7979. They will also take on their share of the mortgage financing.

If you ask me, it is weird that you would issue equity at last week’s closing price.

The document is short of details.

If they are using that illustrative price, I wonder if they can get a tight placement instead of a rights issue. Usually, the illustration communicates what they would like to do.

The way they structured this seem to indicate a preference for a placement, lightly discounted offering.

This might be a reason why they could only take 40% of the portfolio instead of 100%. A rights issue could have taken the whole thing.

In any case, if it is fully funded by debt, the acquisition is accretive. If the second scenario is selected, the dividend per unit does not improve.

In fact, the DPU is lower after the equity issue.

I ran some of the figures and it does indicate this is correct.

Can the Cash Flow be Improved?

If we take the difference between distributable income of EUR 26.72 mil – 25.15 mil, we get a distributable income EUR 1.57 mil. Based on an equity of EUR 32 mil, that is about a 4.9% yield.

I could not figure out the net property income yield if the portfolio of properties is not leverage due to the lack of information.

They do provide the discount rate used to value the property. The discount rate is usually higher than the NPI yield. The higher the discount rate, it means the investor is looking for a higher return to compensate for the risk.

I was able to find the latest interim six-month financial statement and balance sheets.

The annualized net operating profit in 2018 was EUR 4.76 mil and in 2019 was EUR 4.15 mil. We add back the annualized depreciation & amortization of EUR 2.2 mil. The annualized operating cash flow should be EUR 6.35 mil. IREIT’s attributable operating cash flow should be EUR 2.54 mil

If the acquisition is done at EUR 138 mil, the NPI yield is 4.6%? That looks a bit low if you ask me.

Corona is paying a total of EUR 4 mil in interest expense on EUR 105 mil in loans so the interest rate is about 3.8% a year.

I suspect only EUR 52 mil is attributable as mortgage financing loan, with IREIT’s share being EUR 21 mil. If the loan rate is 3.8%, then IREIT’s interest expense is EUR 0.8 mil.

We get a net free cash flow after interest of EUR 2.54 mil – EUR 0.80 mil = EUR 1.74 mil.

EUR 1.75 mil is pretty close to the EUR 1.57 mil in available distributable cash flow. The difference is 10% and pretty close to the management fee paid in cash.

I think the question is whether they could:

1. Improve the occupancy. This might boost EUR 0.5-0.6 mil
2. Re-leased at higher market rent
3. Re-finance 3.8% bridging loan at less than 2%. This might boost EUR 0.375 mil

Despite doing this, based on my math, it would just be about under the current DPU of EUR 3.59 cents.

In other words, if IREIT took the equity raising route, it will still be not accretive.

If they re-finance the loan and keep leverage above 40%, this would be accretive.

Why Can’t Corona Patrimonial Improve it?

Corona Patrimonial does not look like a company that has been around for a long time. It looks like it was set up to purchase properties that are in distressed in 2015. Other than these 4 properties, there were at most 6 properties in this portfolio before they were sold off.

I noticed this on Corona’s home page:

The Company, via its subsidiaries, has acquired office buildings in Spain at a good point in the cycle, and expects to benefit from the recovery of the property market. The Spanish market is improving in economic terms and seeing a change of cycle; this is reflected in macroeconomic indicators and is a sign of recovery.

The Company has a board of directors comprised of three directors whose areas of professional experience -including participation in processes for the acquisition of assets in Spain and abroad, the management of real estate companies or the implementation and supervision of management platforms in those companies- complement each other.

The Group’s leases are based on the selection of clients with economic solvency that provides security and visibility of long-term income, the aim being to increase the current occupation percentage.

The assets are located in the main business and consolidate offices areas of Madrid, Alcobendas and Barcelona (Sant Cugat del Vallés and Espluges de Llobregat) and have an average age of less than 14 years.

They probably have 4 years to stabilize this portfolio but from what we see, I wonder if it is improving (I cannot read Spanish btw).

Some More Information on Corona Patrimonial

Corona is listed on the stock exchange. Here is some information I could gather:

This is likely Blackstone’s way of exiting this distressed deal (when they listed the company). The way they sell off this portfolio part by part reminds me of my MIIF heyday.

After this sale, there will be no more of this listed entity.

Tikehau and IREIT will purchase these assets at EUR 138 mil. Based on this information, last year, it was probably valued at EUR 146-149 mil. Currently, the REIT is traded at EUR 100 mil.

So through this sale, the listed REIT can wind up closer to their net asset value.

Summary

Whether this is a good deal for shareholder or not will depend on 3 factors always

1. Whether the portfolio is operationally sound or provides upside for improvement, or the place where the property is situated is going to experience low to high employment, population growth, better demand, and supply dynamics
2. The quality of the manager
3. The valuation

You can read more about this here in an article in my REIT Training Center.

IREIT’s current portfolio is rather concentrated tenant wise. Thus adding a portfolio of multi-tenanted does help, if they eventually also buy the other 60% of the portfolio.

But when I look at the volatile nature of the Spanish portfolio’s occupancy from 2014 till 2019, I wonder if IREIT will get their hands full managing it.

There could improve the cash flow but you wonder what could they do that the previous owners could not.

An equity raising would not be accretive, even if debt is refinanced, and rental occupancy is improved to a certain extent.

I cannot determine if the portfolio is a bargain or not. On Corona’s 2019 interim statements, the net equity is listed as EUR 131 mil. Not too long ago it was nearer to EUR 145 mil. A lot of the valuation is determined by whether the properties are well leased out.

This deal feels underwhelming. Unless the manager can explain what a blue ocean the demand and supply dynamics are in Madrid and Barcelona. For well-informed readers, you might have a different perspective of this.

If the demand and supply dynamics, and there is a shift in the Spanish economy, this deal might be more worthwhile.

I write more about REITs in my Learning about REITs section. It is free.

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I break down my resources according to these topics:

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3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
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5. Free Stock Portfolio Tracking Google Sheets that many love
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7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for first meeting to understand how it works

Frasers Logistics and Industrial Trust (FLT) announced that they will be merging with Frasers Commercial Trust (FCOT).

The benefit of this deal looks rather straightforward to me, but I thought sometimes it is good to exercise some investing brain juice. If you failed to use it, you will lose it faster.

This article will be rather short (hopefully).

How the Acquisition Will be Done

The merger will be done by FLT acquiring FCOT through a combination of issuing new FLT shares for FCOT and paying cash to FCOT shareholders.

For each FCOT shares, FLT will swap 1.233 FLT shares at an issue price of S$1.24. FLT will also pay FCOT shareholders a sum of S$0.15 per share in cash.

The entity will be managed by FLT’s management team.

The joint entity will then acquire the other 50% interest of Farnborough Business Park from Frasers Property Limited that FCOT did not own.

This deal looks straightforward until I considered this acquisition. Was it meant as a sweetener so that this deal will appeal to both FLT and FCOT’s shareholders?

Let us examined.

FLT and FCOT’s Current Situation

Here is how both company looks like before this acquisition. The dividend yield is pretty similar. What is not shown here is that FCOT is less leveraged and also closer to fair value (in terms of Mkt Cap/Total Equity) than FLT.

Deals like these may benefit both parties or one side. The way I would look at this is to assess from both FLT and FCOT’s perspective to see if each of them got the better part of the deal.

FCOT Unitholder’s Perspective

As an FCOT unitholder, you will now be an FLT shareholder.

Suppose you own $100,000 worth of FCOT units. You will have 59,880 units.

After this deal, you will own 73,772 FLT units at $1.24. Your $100,000 becomes only $91,478.

Sounds like a bad deal at this point. But wait.

For each FCOT units, FLT will pay you $0.15 in cash. So for this unit holder, the difference between $100k and $91.5k is $8.5k.

This is equivalent to $0.142 per unit. So this $0.15 per unit is to make up for the difference.

As a unitholder, you swapped a portfolio with a lower dividend yield. At this point, on a long term basis, it does not make a lot of sense as an FCOT shareholder.

Perhaps that is where the Farnborough Business Park acquisition comes in. This will boost the DPU of FLT so that it make sense.

FLT Unitholder’s Perspective

From the FLT Unitholder’s perspective, they were diluted, but some new investors were brought on board, together with a portfolio of assets.

We can treat this as a placement for new shareholders. What you wish to know is whether this acquisition is accretive to the DPU or dividend yield.

Unfortunately, the information on the acquisition is very short in the announcement. I could look up FCOT’s existing Farnborough Business Park’s results to see how much additional income the acquisition will bring in.

No matter how I think the effort is not quite worth it. FLT says that this acquisition of FCOT and asset acquisition will be accretive.

Why FCOT Needed This Deal

FCOT’s current portfolio is more concentrated.

Their WALE is part long part short.

However, what many feel is that the REIT is not sturdy enough. The short leases are in Singapore. The rent is close to the market rent and demand Dynamics is ok but not good for this segment.

Merging and exchanging for this FLT portfolio reduces the vacancy impact of a single FCOT property. When HP left Alexander Technopark, the vacancy created uncertainty over whether FCOT could successfully leased out a large part of the spaces.

Google eventually took over. And the Microsoft terminated their long 5 year lease.

Numbers-wise, FCOT will be converting to a REIT that is quite above its book value. Some will view it as exchanging a fair value company with a pricey company. FLT gearing is higher.

The yield looks almost equal, so you do not lose much income.

But whether this is a good deal, you cannot just evaluate the dividend yield.

My assessment is always based on

1. the economy/ market outlook for their operations going forward
2. valuation
3. management quality

You can read about these 3 criteria in this article.

This deal I feel helps their operations by providing more diversification and risk management. Valuation will improve due to greater stability. I don’t think we can detect any significant difference in management.

Why FLT Needed This Deal

Honestly other than currency diversification, I do not see many advantages.

FLT is already diversified across Euro and AUD. FCOT is mainly SGD and AUD. Not much significant help there.

What works for both is that if they have the size, they can have more capital to do development, AEI, step by step acquisition without impacting debt to asset ratio and distributable income too much. With scale, they can also get a better deal when it comes to financing.

Numbers-wise, FLT shareholders is acquiring a portfolio that yields almost the same. This is like a placement of their shares to the third party. They get diluted but gain an asset with similar net property income.

The gearing of FCOT is much lower after the sale of market Street. We can say this is attractive to FLT in that they acquired a less geared portfolio.

This is one of the reason that they could gear up and pay the shareholders $0.15 in cash. Fcot shareholders can take this as a special div or capital reduction to you, then purchase of FLT shares.

In terms of the three evaluation category, FLT perhaps gets poorer in their exposure to an office portfolio that do not have visible upside, but the new portfolio looks cheaper and more asset trading potential, management is the same.

Summary

Ultimately, this deal might be to just get bigger.

The main advantages are:

1. Save on personnel
2. Potentially easier in raising capital and at a more attractive borrowing rate
3. Greater room for AEI and development without impacting existing DPU

For both sets of unitholders, they will have to think. There are unitholders who held both REITs. I think this does not change much. In fact, this synergy might be better for both.

If you own only one REIT, the reason you did not invest in the other now may be that it is unattractive to you. This could be due to valuation or the quality of the portfolio or the manager.

If that is the case, you might not like this deal. The appropriate action is to see if you want to sit with this for a period of time to assess. If not you should just sell it because this is not what you wish to own.

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