I realize I have not written any updates on Manulife US REIT’s latest acquisition. So here it is.

Just a short update.

This year, majority of the REITs have seen their share price appreciating. With the share price appreciation, the cost of equity (which in this case, is the dividend yield the REIT pays to you) have gone down.

This makes equity raising much attractive and for them to bring acquisitions on board. This increases the AUM, the net property income and therefore the fees earned.

Manulife US REIT made the acquisition of Centerpointe in the Washington sub-market in April this year. I have a hunch that if they have the opportunity, there will be further acquisitions.

In their latest quarter results slides, there was an emphasis on how close their liquid market capitalization is from an incursion to FTSE EPRA NAREIT Developed Asia Index.

More of less, something is coming.

Sacramento as a City

Manulife US REIT’s latest acquisition is in Sacramento, California.

Out of the 10 largest city in California, Sacramento are sixth largest and growing the fastest in 2019. (Top 10: Los Angeles, San Diego, San Jose, San Francisco, Fresno, Long Beach, Oakland, Bakersfield, Anaheim)

The appeal of Sacramento could be that housing in LA, San Diego, San Jose, San Francisco are getting too expensive.

On average, the price of a home in San Francisco is about US$1.25 mil while the average price of similar home in Sacramento is only around US$310,000.

Sacramento is still very close to San Francisco but housing is much cheaper.. for now.

Sacramento as a city, have not been doing well from 2006 to 2016. Perhaps they are currently enjoying the spill over from the tech companies around the region.

If you would like to read a little about the economic history and the future prospects of Sacramento, you can read this article here.

The Acquisition of 400 Capitol Mall

This acquisition will cost roughly US$206 million and will be funded by a mixture of debt, share placement and preferential offering.

I think from this point forward there will be less rights issue, and I do agree preferential offering is the way to go.

Starwood Capital Group decided to sell 400 Capitol to Manulife US REIT. Starwood Capital Group bought this building in 2016 for US$175.5 million.

Back then, the occupancy was 85% and the average rent ranges from $2.95 psf to $3.5 psf.

This acquisition does not look so different from the management’s other proposals. The WALE is relatively long at 5.9 years, with built in 2.3% rental escalations. The property’s occupancy is rather high. This is likely because recently, they managed to secure some large leases.

The first thing that shout to me was the Platinum LEED Status. LEED, from what I understand, is a grading of how environmentally friendly and energy efficient it is. Out of all their current buildings, most are either Gold or Silver. Thus, 400 Capitol stands out. What stood out further is that this build is at least 27 years old. I have no idea how that work.

Other than being the tallest building in the city, 400 Capitol is also closed to the Golden 1 Center. Golden 1 Center is the home of NBA team Sacramento Kings.

There was quite a bit of controversy as well because the Maloof family, who used to own the Kings, lost much of their fortune and was no longer able to run the NBA franchise. They were shopping the team around to other cities such as Seattle, Virginia, Anaheim.

Sacramento Mayor Kevin Johnson, with the help of local business owners and a rabid fan base, was successful in saving the franchise and persuading the NBA to force the Maloofs to sell the team to the Vivek Ranadivé group.

Sacramento have always not been a big market but in order for things to be a success, both the Kings and the city need to rejuvenate. I kind of like the team they have with De’Aaron Fox, Buddy Hield, Marvin Bagley, Bogdan Bogdanovic and Harrison Barnes. Last season was a surprise. Let us see what next season brings.

Under their existing portfolio, Michelson is the unique one where the market rent is on par if not lower than passing rent. 400 Capitol’s passing rent looks lower than the market rent.

The previous owners Starwood Group managed to renew some leases to beyond 2024 so that they can sell it off.

The Sacramento Office Market

Based on the little I know, the office supply of Sacramento is currently rather tight. Landlords are still able to take advantage and get some pricing power.

Per Cushman and Wakefield, net absorption for the past years have been positive. The asking rent is trending up. However, the average rent looks comparatively low versus 400 Capitol’s average rent.

There were some crazy vacancy last time.

Space available have also come down.

Again, the average asking rent by Class A and Class B are trending up, but I suspect that the asking rents are much lower than what 400 Capitol could command.

Troubled Startup WeWork is a Large Tenant in 400 Capitol Mall

If you review 400 Capitol’s tenant base, you observe that majority of the tenants are in sectors that Manulife US REIT is familiar with.

Perhaps due to recent news, their tenant, WeWork sticks out prominently here.

WeWork was going to be listed in an IPO at US$47 billion valuation but possibly have to settled for as low as US$10 billion in valuation. This puts both landlords in an uneasy position because it calls to question whether they are going to have a lot of vacancies on their hands.

Financial Times wrote that “a large Singaporean investment firm has walked away from an £850 million ($1.04 billion) deal to buy Southbank Place, an office building near London’s Waterloo Station that boasts one of the largest WeWork spaces in the world.”

Landlords are beginning to see this master lessor to be more risk than opportunity.

Manulife US REIT’s management knows all about the co-working space. They were the one who educated yours truly on the relationship between property valuation and the amount of co-working space within the building.

It is a question you may have for them if they see this as a risk.

When taken alone, this tenant represents almost 1-1.5% of the whole REIT’s gross rental income.

At this moment, I do not wish to go too much into this. This article is starting to get long.

The Capital Financing for the Acquisition

Ok, now we are at the fun part.

As stated earlier, Manulife US REIT was intending to fund the US$206 mil acquisition with a mixture of debt, preferential offering and placement. US$142 should come from the equity raising (preferential and placement).

This will give the acquisition a debt to asset of 31%.

An advanced dividend distribution was also paid to existing shareholders. At this current point of writing, Manulife US REIT have already gone Ex Dividend, which means those that are eligible for the advanced dividend distribution have been recorded.

The placement have already been carried out, which was rather oversubscribed. It was priced at US$0.876. 91.3 million units is placed out.

The preferential offering will come next.

The management wanted to placed out 73.3 million units via preferential offering. The offering price is currently fixed at US$0.86, which represents a 4% discount to last traded price. 4% is a rather competitive discount.

How Accretive is this Acquisition?

The challenging thing about computing this acquisition is that Manulife US REIT made another acquisition in April.

The acquisition, according to management is 2.3% accretive over the pro-forma 1H 2019 financials.

If we annualized the difference in Distributable income available for unit holders, it works out to be US$12 mil. I am not sure how tainted is this but I think it should be correct to assume this.

Let me layered on another check. The CAP rate of this property is 7.2% so the Net Property Income works out to be 206 x 7.2% = US$14.8 million.

If we assume a debt cost of 3.5%, the interest expense will be 64 mil in debt x 3.5% = US$2.24 mil. If we assume an AUM fee of 0.4% on the new asset, this takes away US$0.8 mil.

This works out to 14.8 – 2.24 – 0.8 = US$11.76 mil.

Looks like I am pretty close.

The following table shows my computation in April after the acquisition of Centerpointe:

What we can do is build on the estimated full year data here and add on the placement, preferential offering and debt financing.

I will take the Aggregate section and put it as the new Current Section:

The new dividend per unit should come up to 6.28 cents. This represents a DPU growth of 1.69% from Manulife US REIT, with Centerpointe’s acquisition. Centerpointe’s growth is higher at 2.3%.

With these 2 acquisition, the estimated DPU should grow from 6.04 cents to 6.18 cents to 6.28 cents.

The leverage will fall from 37.35% to 36.43% to 35.89%.

At current share price near US$0.90, this represents a dividend yield of 6.97%.

I am done with my analysis.

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LendLease Global Commercial REIT is going ahead with their IPO.

However, the number of properties that will be injected into the IPO will only be 2, contrary to what I have speculated in my first article.

The Australian based group LendLease will be looking to a placement and public offer of 387 million units.

The IPO price is set at S$0.88.

In total, there will be 1,167 million units outstanding. This will make the market capitalization of LendLease Global Commercial REIT to be close to S$1.56 billion.

This IPO is a strange for the following reasons:

1. I struggled to find what is the indicative dividend yield of LendLease Global Commercial REIT
2. It is a mixture of office and retail REIT
3. LendLease Global Commercial REIT’s portfolio have a fair bit of concentration risk. You can liken it to IREIT Global’s portfolio concentration
4. LendLease Global Commercial REIT’s 2021 dividend yield of 6.01% is not a screaming buy (2020 dividend yield forecast yield is 5.8%)

In most cases, if you look at this profile, you would have given this IPO a miss.

However, I think this IPO is going to be received well. For probably 2 reasons.

1. The Cornerstone Investors

Out of the 1167 million units:

1. LendLease Global Commercial REIT’s manager will take up 8 million
2. Cornerstone investors will take up 453 million
3. LendLease Group, the sponsor will take up 28% of the units or 318 million units
4. Public and Placement will take up 387 million units

If you compare the reception of this IPO to that of the last REIT IPO, Prime US REIT, you can see a big difference.

For one, they do not need to conduct cross placement and public offer.

Secondly, look at the cornerstone investors:

1. AEW Asia Pte Ltd
2. Asdew Acquisitions Pte Ltd: Wang Yu Huei’s investment company
3. BlackRock, Inc
4. DBS Bank (on behalf of their wealth management clients)
5. DBS Vickers Securities (on behalf of their corporate clients)
6. Fullerton Fund Management
7. Lion Global Investors Limited
8. Moon Capital Management
9. Nikko Asset Management
10. Principal Asset Management
11. Soon Lee Land
12. The Segantii Asia Pacific Equity Multi Strategy Fund
13. TMB Asset Management

LendLease may have spent enough time building up their cornerstone. But I believe that if you have sometime that people in the industry find iffy, no matter how hard you tried, people would just avoid it.

It has been some time since I see a cornerstone list like this.

2. The Sponsor: LendLease Group, may be the Jewel

I felt that biggest appeal of this IPO is that this is a REIT from LendLease Group. LendLease Group was formed in 1958 and currently has a market capitalization of A$9.5 billion.

LendLease has development, construction and investment around the world. Their development pipeline is approaching A$100 billion, construction backlog of A$15.6 billion and funds under management of A$35.2 billion.

Lendlease has won major jobs this year, including a $21bn deal with Google in the US it struck to develop three mixed-use communities in the San Francisco Bay Area.

We may be betting that in the long term, investors want access to Lendlease Group’s $30 billion international commercial development pipeline.

A REIT may wish to change its name next time when it expenses its mandate. However, if LendLease Global Commercial REIT calls itself… a global REIT, the sponsor might have some big dumping ambitions.

In the section above, LendLease Group gives us an idea that they might wish to use this REIT as a platform.

The IPO Timetable

Comparisons

LendLease Global Commercial REIT’s closest competitor could be the Starhill Global REIT and Suntec REIT. These are either a close by competitor, or a REIT will a retail + office REIT.

You may also consider Mapletree Commercial REIT as well.

In any case, its Price to Book and Dividend yield both look more attractive currently.

The Inverse Relationship Between Size and Value

Majority of the asset value comes from the 99 year lease 313 Somerset. Less comes from the Freehold Sky Complex.

Yet when it comes to size of the properties, [email protected] is only 288,277 sq ft NLA while Sky Complex is 999,116 sq ft NLA.

The Location of Sky HQ Complex and [email protected] is Pretty Good

The Sky Italia is located in southeast area of the Milan Municipality, which is the main office, industrial and retail center of Milan.

LendLease as an engineering and construction company, engages in many of these rejuvenation or reinvention of large spaces around the world.

One of the project is in the district of Milano Santa Giulia. They are to build 2,500 residential apartments and a large park.

Most of us are familiar with [email protected], which is a shopping center at the mouth of Somerset MRT station in Orchard.

LendLease Commercial REIT have a 99.9% Committed Occupancy with 4.9 Years WALE

The lease to tenants for LendLease Global Commercial REIT is pretty long compare to the average.

Sky HQ is fully leased to Sky Italia, an Italian satellite television platform own by Sky Limited (owned by Comcast). This master lease lasts for 12.9 years. This was a continuation of a 12 + 12 years lease starting in 2008. If we look at it, most likely Sky Italia is going to continue renting it to go into the second 12 year lease.

Note however, that Sky Italia have the option to break their lease in 2026 (7 years later)

The leases have a built in CPI-adjusting escalation. Given the low inflation environment in Europe, this is currently unexciting.

It would seem, tenants are able to sub-lease their units to others.

[email protected] have an average lease of 1.6 years.

The lease agreements for Singapore 313 Somerset is 2 to 4 years typically. Major tenants can lease up to 5 years.

The freaking crazy thing is that 58% of LendLease Global Commercial REIT’s Singapore leases have built in 3% rental escalations.

This short lease is not something new. Local retail malls have similar lease structure. When you invest, you got to know what you are getting yourself into. If there is a tourism boom, better economy, you can capture a better rental. If the economy tanks, your portfolio will be subjected to greater fluctuations.

LendLease Commercial REIT has Relatively Long Land Lease

This portfolio have a rather long land lease.

[email protected] was built in 2009 but its land lease starts in 2006 and will last till 2105.

Sky Italia is freehold.

Sky Italia have a first option to purchase the Milan Property

The tenant has a contractual clause to the right to purchase the Milan property should LendLease Global Commercial REIT wishes to sell.

If they choose to exercise the option, they would have to match the price LendLease wishes to sell to the buyer.

LendLease Global Commercial REIT’s Management

The CEO Kelvin Chow Chung Yip used to be the Chief Financial Officer of Keppel REIT. Prior to that, he was the Chief Financial Officer of Soilbuild Business Space.

The general manager Liaw Liang Huat is a banker who used to work LendLease and Standard Chartered Bank.

LendLease Global Commercial REIT’s Management Fee

I do find that this REIT have the most nostalgic fee structure.

1. A base fee of 0.30% a year of LendLease Global Commercial REIT’s deposited property
2. A Performance fee of 5.0% of a year of LendLease Global Commercial REIT’s NPI

For the first 2 years, LendLease’s management will choose to receive the fee in units.

Most of the newly listed REITs will base their base fee on 10% of distributable income and performance fee on DPU improvement. The way LendLease Global Commercial REIT structure their fee, they will almost always earn.

NPI is higher than distributable income, so it makes sense to charge 5% instead of 10%. But in this case, it is as a performance fee rather than base fee.

Whichever way, whether it is 10% of distributable income or as a percentage of asset, typically the base fee usually work out to 0.4% of the asset value for most REITs.

You can compare LendLease Global Commercial REIT’s fee against the others.

There should not be Withholding Tax Levied by Italy

LendLease Global Commercial REIT structure their Milan property with a common AIF structure in Italy.

This AIF will pay the dividends back to the Singapore company.

When we deal with overseas property, you have to contend with volatile taxation laws.

The prospectus list out the conditions in which the AIF will be exempted from withholding tax. LendLease Global Commercial REIT have updated that the AIF constitute as an undertaking for collective investments that is established in a state included in the white list.

Thus, the rental income send back to Singapore should not be taxed for withholding tax.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

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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

The tenant leases for commercial properties in China, Hong Kong and Singapore are rather unique in that they are shorter.

There are no rental escalation. Typically, the tenure is less than 5 years. In Singapore and Hong Kong, the commercial offices and shopping centers have 3 to 5 year leases.

When real estate investment trusts (REITs) that owned foreign commercial properties came over to Singapore, their leases looked pretty unique to the Singapore investors.

The investors welcome the longer leases, which also usually comes with annual rental escalations. If there were no annual rental escalations, there are typically mid term reviews. However, we might have missed some of the drawbacks with these different lease structure as well.

The Differences between USA and Singapore Office Leases

Manulife US REIT announced their 2nd Quarter 2019 results in mid August 2019. In their slide desk, they appended one slide that explain this difference.

I manage to sit down with them to listen to Jill Smith, the CEO, and the management explain about this, as well as their results (I will talk a little about the results later)

You grow to appreciate that management gives you access to these details. It makes you frame similar REITs in a certain way. It builds your conviction or tear them down.

The lease tenure and incentives are not new to me. But this slide gives some deeper stuff.

1. The lease tenure are longer.

Typically, the average leases are 5 to 10 year versus 3 year for Singapore office leases.

This is an advantage from the landlord perspective because there is less volatility in vacancies. You do not have to renew or re-leased the property so frequently.

Many investors may not be aware of is that the quality of the leases affect the valuation of the property. This affects the landlord’s capacity to borrow as well as a host of covenants. In United States or other countries for example, it is less land scarce. The price appreciation factor, or the anticipation of future price increase is less baked into the valuation of the building.

You can think of the valuation of a property being made up of:

1. The physical building value. The physical building go through wear and tear and will go down in value
2. The land value. Either long leasehold, short leasehold or freehold. This do not go down in value
3. The quality of the leases. If your tenant is listed, well established with long history, and the leases are long, it enhances the value of the property. From the finance perspective, the value of the property is the aggregate of the discounted net cash flow of the property. So if the net cash flow is very sturdy and predictable, the value of the property is higher.

Singapore and Hong Kong are land scarce so there is a bigger premium to the land value, although it is leasehold. However, in other countries, it is less scarce.

So a larger part of the value is in the quality of the leases. So if you have a lot of short leases, the valuation of the property is affected.

Landlords would rather want less vacancies than to always fully maximize rent I feel. One month or 6 months not rented is equal to if not lower than an overall lower rent per square foot.

The flip side is that if the place is red hot, you missed out on the opportunity cost. People in the market can earn $55 psf, you end up being locked in at $48 psf for 10 years.

2. There are Annual Rental Escalations or Mid Term Reviews.

If your leases are longer, your rent may be vastly below the inflation rate. Thus, these long leases typically come with either a 1-3% a year rental escalation or a Consumer price indexed (CPI) based rental escalation.

If not, like the Washington property, there is a mid term rent review.

Investors will need to discern this because there is a tendency for the current rent, before renewal (we call this the passing rent) to be ABOVE the market rent. This happens because the rental escalation is so much higher than the current price appreciation of the rent in the period.

For example, for Michelson in Manulife US REIT, which has a few large tenants that renewed this year. Their passing rent should be very much above the market rent.

Thus, in this quarter’s result, you can see the dip in Michelson’s net rental income. This is bad for unit holders.

But if you ask me, as a landlord who has owned this for 10 years, what will you do? Not take more rent because it ran too much versus the market rent? Don’t make sense right? The unfortunate thing is that because we are new holders, we do not get to “enjoy” these 10 year of greater rent appreciation. We were left holding to this dip.

While the net rental income of Michelson will dip, because they secured an average of 8 years of tenant lease with 3% escalation, it will take probably 2 to 4 years for the rental income to get back to where it is currently.

3. Tenant improvements (TI) is paid by the landlords instead of tenants.

In Singapore, the office tenants tend to have to put in a large amount of capital expenditure (capex) to do up the place. This can be in 10 to 20 million for large tenants.

If they put in so much capex they will typically stay there for at least 2 rent cycles (6 years).

In other places like the States, the TI is paid jointly by the tenant but majority by the landlords. However, this is selective in a certain way. For example, they might propose to the landlord to do the lobby or certain fittings in a certain way.

The difference between the office in Singapore and the States is that in Singapore, the space comes fully empty. In the States, the majority of the fittings are still there.

While the TI is paid by the landlord, Jill explains that we can see this as an AEI to the property. I do agree since they are not going to put a chandelier in just because the tenant wants. It has to be rationalize. Some of these TI is better for the property in the long run.

So the way investors should look at it financially is also how to account for this TI. Which is that this capex is investment capex rather than maintenance capex. And typically if that is the case investment capex is funded with debt, or working capital. As the building value is enhanced, the valuation goes up, which balances this debt increase.

If this is a maintenance capex then it is a one time cost in a long time to the REIT.

4. Free Rent or Incentives.

This is the big one that investors typically missed out. While we get all the good stuff of long WALE and rental escalation, typically, tenants will pay no rent for different amount of periods.

So basically, I will look at this as a discount to the tenant. Tenants pay no rent. So I can also say this is a reduced market rent. Or a reduced WALE. When market conditions is poor, this incentive or discount is larger.

This is applicable to your REITs operating in Australia such as FCOT, FLT, Cache, Soilbuild, MINT as well.

Manulife gave a guidance that this is typically 2 weeks to 4 weeks per year of lease. So if Manulife renewed their Michelson tenant for 11 years this quarter (they did), the rent free for this contract can be 22 weeks to 44 weeks.

This works out to be on average 1 month per year free. So they are renting out for only 11 months.

Typically, this is spread out over the tenure of the lease. Will probably talk about this later.

5. Lease Commissions.

Broker agents help market the leases, and they are given incentive in different way.

The Singapore agents typically are paid only on new leases not renewed. And they are paid 1 month for the entire tenure of leases.

The USA one are typically paid 2 to 3 weeks in fees for the first 5 years and 1 week thereafter. This is for both new and renewals.

6. The Different Rental Lease Agreements.

In one of my previous Manulife US REIT article, I have explained a little on the differences between popular lease agreements in the USA.

This is not explained in the thought leadership but I will like to put it here again. (Note, I cannot cover all today, and I think I will revisit this to add more next time)

1. Triple Net Lease or NNN Lease or Net Lease. This is the favorite. Tenant pays all the three different common costs of real estate taxes, insurance and maintenance. The landlord gets a rent.

The revenue is almost equal to the EBITDA. The margin is like above 90%.

Take a look at First REIT and Parkway Life REIT financial statements, they are under this structure.

The landlord is almost like a financing company. They borrow from banks at a lower interest to buy a property that have a higher net rental yield. They don’t worry about the inflation of costs.

2. Full-Service Gross Lease. This is the opposite to triple net lease. The landlord quote a rent to the tenant and the tenant pays this.

All the costs (taxes, insurance and maintenance) are paid by the landlord. Usually the rent paid by the tenant embeds an assumed value for these costs, and quoted to the tenant.

The landlord takes on the risks of overestimating or underestimating the costs.

Think of this as most of the local REIT’s lease structure.

3. Gross Base Stop Lease. From here on there are a few modifications to #1 and #2. You can view these as in the middle.

In gross base stop leases, the landlord pays all the expenses in the first year.

However, any of the expenses over the first year expenses (when it goes up with inflation) is recovered from the tenants.

For example, the rent is $100 psf and the cost is $15 psf for the first year. If the cost goes up to $17 psf in the second year, the extra $2 is recoverable by the landlord.

In this way, if expenses go up with inflation, the landlord is protected. I do see this as very similar to Triple net. It is just the margin and accounting to be different.

The margins for the triple net can be 90% and the margins for Manulife is around 62%. But you will notice in Manulife’s older statements they will embed the cost recovered in the revenue.

Michelson, Penn for Manulife US REIT is on this structure.

4. Modified Gross Base Stop. You will have some modified version of these rents.

In Manulife’s Plaza and Exchange, Electricity and Utilities are fully recoverable while remaining expenses are base stop.

Does TI, Rent Free Periods and Leasing Commission go into the Implied CAP Rate

One of the question that I have is whether the CAP Rate that was published includes how much of these indirect costs.

These CAP Rates that is communicated to us in terms of:

1. Valuation of the property at purchase
2. Valuation of the property on the ongoing basis
3. Valuation of the market

This is the Implied CAP Rate.

The calculation is based on:

1. 1st year Net Operating Income
2. Do not include Capital Expenditure
3. Do not include TIs
4. Do not include Leasing Commissions
5. Includes Free Rent

Since free rent is the biggest part of the indirect cost, it is good to know the CAP Rate includes that. This is especially if the property is a new purchase.

I don’t like the idea they bought the property for a CAP Rate/net rental yield of 7% only to know that on average, the cash flow yield we will get is like 5%.

A Framework to Think About These Different Cash Flows

Whenever these things get confusing, I thought an example to tie everything together would be great.

We will try to use the example of the latest renewal of Manulife US REIT’s Michelson. But we will extrapolate as if Michelson is wholly rented to this one tenant:

1. 100,000 sqft
2. Purchased at Implied CAP Rate of 5%
3. Rent renewed at $50 psf
4. Rental Escalation or Growth of 3% a year
5. Lease tenure is 11 years
6. A Gross Base Stop lease agreement
7. TI assume to be not included
8. Total 44 weeks of rent free
9. Total 21 weeks worth of leasing commissions

The difficulty is to model the cost.

Manulife US REIT’s Gross Operating Margins is for a long time around 62% there about. So 38% of it is the maintenance, property tax, insurance costs,  free rent, leasing commission and TIs.

They have also given me enough guidance (according to an example I gave) that in the example: Assuming the total rental revenue for a full lease tenure is US$500 per sq ft (for the entire period)

1. free rent is ~7% of US$500 (for both new leases and renewals)
2. leasing commission is ~6% of US$500 for new leases and ~3% of US$500 for renewals.

So that is about 10% to 13% of the revenue.

So instead of a margin of 62%, let me take it that after only maintenance, property tax and insurance cost, the margin is 70%. I give back 12% for rent free and leasing commission. This is to compute the implied CAP Rate of how much this property is purchased at.

In the table above, we can see the progression in net rental income after all cost over the 11 year tenure. Using only rental cost + an average free rent of 4 weeks, and 5% implied CAP rate, we come up with a property price of $22 million.

The net rental yield on the purchase price for the first year is 4.18%. This will slowly be recovered to 5.39% in the third year. Then 11% in the last year.

So you lose in the start than make it back.

This may be how the cash flow will progress but I have to check whether it is right for me to assume the rent free and leasing commission is like this.

Typically, the REITs will straight lined the revenue. This means that they will average out the revenue escalation, taking the mid-point as the revenue in the income statement.

Thus, the income and cash flow will look very different.

So I attempt to straight line-d the revenue. What I did was to average out the rent (at $58 psf). The rental cost is still based on the first year rent of $50 still. The property purchase price is slightly cheaper, because the free rent cost is a bit higher.

We can see then, that the net rental yield over the property purchase price is around 7.89% over this 11 years.

This looks pretty good. We probably see the appeal of the longer lease in this case.

I also did attempt to compute the internal rate of return (IRR) for both the sequence of cash flow. The IRR is around 7% to 7.5%. That is not too surprising.

If you leverage the property up with 30% debt, the IRR gets juiced to 8.55% to 9.4%. I think this looks disappointing may because the leverage factor is not so high.

Conclusion

REIT investors should at least be aware to some of the terms. This is so that next time you can Google and look up some of these details in lease agreements more.

I have gone through what I think are rather generic information. Different REITs in different regions, will have different flavor of these leases. Thus, don’t treat what I wrote as the absolute truth.

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