Singaporeans have a good number of REITs for them to select from, when they look for dividend yield and share price appreciation.
These REITs are split into different categories and have their own characteristic, dividend spread over the risk free rates and react differently to the demand and supply of their own categories. (You can take a look at the REITs, their prevailing prices and certain metrics at my Dividend Stock Tracker)
Australia, together with Japan, are two very large and liquid REIT markets. They tend to have a smaller spread between risk free rates and REIT’s dividend yield. The characteristics of the property assets there may be culturally different from what we normally see in Singapore.
Charter Hall will be doing their initial public offering (IPO) of their Charter Hall Long WALE REIT and this provides us with a glimpse of what is popular with investors in other parts of Asia.
Since Australia is a mature market that many REITs such as Mapletree Logistics, Ascendas REIT, Cache Logistics, Cambridge, Frasers Commercial, Starhill Global, Aims Amp Industrial have properties in, or are try to secure more properties there, it is a good case study to tweak our expectations on what may look like good assets but are rather normal in Australia.
Profile of REIT
Charter Hall Long WALE REIT is made up of 3 categories of properties, commercial, industrial and retail assets. While Charter termed them as retail assets, they can be considered as hospitality based assets, or in Australian context, pubs.
Here are the key metrics for the REIT:
- Market Cap: AUD$1,120 mil (Frasers Log Market Cap is SG$1,400 mil)
- No of outstanding shares on issue: 280 mil
- Annualized Distributable Operating Earnings Yield: 5.3-5.4%
- Balance Sheet Net Debt to Asset: 11%
- Number of properties: 66 (2 office, 10 industrial, 54 pubs)
- Weighted Average Cap Rate (WACR): 6.4% (FLT 7.0% at IPO)
- Weighted Average Lease Expiry (WALE): 12.5 Years (FLT 7.61 years at IPO)
- Weighted Average Rent Review (WARR): 2.8%
- Proportion of income subject to fixed rent increases: 58% (as opposed to rent increases based on CPI)
- Management targets a balance sheet gearing of : 25-35%
As a summary, the portfolio look like Parkway Life REIT (dividend yield 4.7%), with lower gearing then normal, lower than normal dividend, and very long lease expiry with rent review pegged to CPI.
However, the profile is better in that while the WALE is quite similar, a large part of the WARR is fixed, instead of CPI based, for Parkway Life REIT. To be fair the Singapore hospitals under Parkway Life REIT has an alternative build in revenue sharing component.
In a low growth environment, a fixed rental escalation is better than one based on CPI.
The last point I will make is that the IPO portfolio is 11% geared where they have much room to increase debt and take on more assets.
Comparing Against Other Financial Assets and Other Yield Assets
In the previous section, I have compared briefly with a competitor that is quite close to the Long WALE REIT, FLT.
The image below shows how the Long WALE REIT (LWR) stacks up versus the other financial instruments.
It is interesting that the Australia 10 year government bond is slightly higher than Singapore’s 10 year government bond, however their cash rate is much respectable.
The Australia REIT index is much more compressed versus that of the 10 year government bond rate.
Here they also compare LWR against the recently listed Viva Energy Trust. Viva Energy Trust owns 425 petrol stations, which they lease to Viva Energy, their main tenant. The portfolio have an even longer WALE at 15.3 years.
They also compare LWR against ALE property group, a trust that has a WALE of 12 years, whose assets are a portfolio of pubs. This will be close to a segment of LWR, since their retail assets are pubs.
ALE property group is at a premium, and a lower dividend yield then LWR, despite LWR having a lower gearing. Pub REITs are very popular in Australia.
If we adjust Viva Energy Trust’s IPO gearing to be equal to LWR, the dividend yield is the same. However, current dividend yield of Viva Energy Trust is lower than that of LWR, with a higher gearing.
It should be noted that if LWR is able to gear up to their full potential, they would be able to achieve a dividend yield of 6.3%.
All these dividend yield does pale in comparison to what you can get in Singapore.
The difference for Singapore REITs versus the Australia ones tend to be:
- shorter WALE
- short to medium leasehold properties versus predominately freehold for Australia
These factors does tend to affect the valuations.
Charter Hall Group’s Chief David Harrison do think that LWR is still attractive, with the main reason being how it is compared to the risk free rate. The spread to him is still wide:
“Anyone who says the bond rally is over is dreaming,” Mr Harrison told The Australian Financial Review as the roadshow for the record IPO kicked off in Australia.
The Charter Hall chief pointed to key metrics for the sector: the spread between internal rates of return and bond yields and the spread between cap rates and the cost of debt.
Across Charter Hall’s $18 billion managed portfolio the spread to bond yields is 6 per cent, well above the cycle average of 3.5 per cent.
And for the new trust, the spread to the total cost of debt is 2.7 per cent. At the height of the financial crisis, that spread was 0.7 per cent.
A distorted risk free rate, have perhaps made valuation difficult. The risk free rate today may have been kept low for far too long and in a normal environment the spread right now between LWR and a normalized risk free rate might be much smaller, and dare I say similar to that of the GFC times.
About Charter Hall Group and Management Fee Structure
Charter Hall Group (ASX:CHC) is one of Australia’s leading fully integrated property groups, with over 25 years’ experience managing high quality property on behalf of institutional, wholesale and retail clients.
This is their second REIT listing. They bought over the REIT platform of Macquarie Bank post Great Financial Crisis when the bank deem the platform to be non core.
The first REIT was taken over from Macquarie Bank and focuses on suburban malls. They took over Macquarie Office REIT and delisted it.
Charter Hall will be providing the REIT manager, and the REIT manager will be an external manager just like most Singapore REITs.
This means that they have an incentive to grow the assets under management.
The following are their base fee and performance fee:
Their base management fee is close to what the Singapore investors pay of around 0.5% of NAV.
Surprisingly, there is no performance fee. In Singapore, there is a shift towards pegging performance to how much you can improve the dividends per unit, compared to last year, or the distributable income.
You can tell this is not really useful since the LWR have a pretty standard rent review.
However, the purpose of a trust, is to typically attract investors with dividend yield and stability, but to grow their assets under management.
The bonus will come from the acquisition fee.
With plenty of experience heading Charter Hall’s transactions team, Mr Anger is aiming to match that growth rate of funds under management in the new vehicle he will run.
Last year Charter Hall increased its FUM by 29 per cent, or $3.9 billion, most of it coming from acquisitions. Growth in FUM has averaged about 15 per cent in the past six years.
“There’ll be a strong focus on sale and leasebacks because that’s where a lot of product has come from,” Mr Anger said.
The following table shows the summary of assets break down:
Largest percentage of gross passing income comes from the industrial segment. The largest footprint was surprisingly the retail pubs. The retail pubs have a seriously long lease with an average of 18 years.
The cap rate of the industrial segment, it should be noted, is quite close to that of FLT’s freehold industrial assets that were recently IPO.
The above section shows the breakdown of key tenants. A lot of the tenants are key operators that are listed on the ASX such as Westfarmers, Coles Group and Woolworths Limited, who sees this as part of their asset light strategy.
In this way, they can expense the premise cost in their income, remain asset light and boost their return on equity.
The more visible tenant risk lies in their tenant Metcash, which have not been doing very well recently, and incidentally is also a main tenant of Cache Logistics Trust.
Pubs for drinking in Australia is doing well, and highly regulated, where license are not easily issued. If you look at some of the earlier slides, you would see that ALE Group and Hotel Properties Investments (HPI) trading at a big premium to NAV.
Some of the lease terms are very long indeed.
Different forms of Rent Review
Majority of the lease expiry will probably take place 8 years later.
In the prospectus, independent valuers have noted down various different rent reviews of the property assets.
This property have a 17 years of lease left. From what I understand of point 6, every year, the rent will tune up by either the CPI or 4%, whichever is higher (!).
There will be a rent review every 5 years in 2017, 2022 and 2027 where the rent will be negotiated by either the CPI, 4% or market rent, whichever is higher (!).
Australia is a land geared towards inflation.
This rent review only takes place mid term in a 10 year lease in 2021 which is between 2% and 5%. Compared to the previous, this one pale in comparison.
In this case the rent review do not take place annually but every 5 years and the review is a maximum of 10% and minimum of 10%.
They say that Ratcheting Rent Review is rather unlawful. When that is set in place, the rent cannot be lower than the preceding year. For this property it is mostly taking the CPI but capped at 5%.
Taxation for Non-Resident Investors
You may ask whether as a Singaporean or a USA citizen, whether you can purchase the REIT.
If you have a brokerage that allows you to trade in the ASX, you may do so. However do note that as this is a foreign stock, your brokerage is likely to charge you for dividend handling, custodian and corporate action fees, should there be rights issue involved. (For more information, do read How to buy and sell stocks, bonds, REITs and ETFs for Beginners)
If you are a non Australian investing in Australian shares, you may face:
- Capital Gain Tax
- Dividend Withholding Tax
From the above information taken from the prospectus, if you purchase the trust, it is likely you are not subjected to capital gains tax.
In the above paragraph, it explains that if your dividends is fully franked, the taxed is paid by the company you invest in at the corporate level and you will not be taxed when you received your dividends.
However, if your dividends is unfranked, you be subjected to a 30% dividend withholding tax, or 15%, if your country have a tax treaty with Australia.
Singapore have a tax treaty with Australia, and so if the dividends is unfranked you are subjected to a 15% dividend withholding tax.
Whether your stock is franked or unfranked, you have to check with the company.
In the case of LWR, the dividend is unfranked, and if you are a Singaporean, you won’t be getting 5.3%, but 5.3% x (1-0.15) = 4.5%
If you are purchasing foreign stocks, keep this dividend withholding tax in mind. Most country have at least some of these.
How Charter Hall Long WALE REIT can Grow
While the dividend yield and stability is what attracts investors, it is likely the growth in capital appreciation is important to the investor as well.
Remember your total return is equal to dividend yield + capital growth.
LWR’s gearing is rather low, and they do have room for acquisition.
The prospectus also flags an expectation the new trust will establish $350 million debt facility “which can be drawn to fund future return enhancing acquisitions”.
Growth is a key theme for the fund, which will begin with a portfolio of 66 office, industrial and retail assets valued at $1.253 billion.
“The REIT intends to acquire additional Australasian real estate assets in the future that satisfy its investment objectives and strategy to provide further diversification and enhance the performance of the portfolio for investors,” according to the prospectus.
“The REIT will not invest in assets located outside of Australasia.”
“Future acquisitions may be sourced from third parties or members of the Charter Hall Group,” the documents said in a nod to the potential to use the fund as a means of the group’s unlisted trusts tipping their assets into a listed fund.
Another avenue of expansion may be through the trust boosting its interests in properties that it co-owns. – CEO David Harrison of Charter Hall Group
If they manage to tap to the maximum 35% of balance sheet gearing, and push for an inorganic dividend growth to 6.3%, assuming the share price appreciates such that the market yield is 5.3%, the share price would need to rise to $4.75 from $4.00 or an 18% growth.
If we look at the current market cap rate of office at 6%, industrial at 6.7% and pubs at 6.2%, they are all higher than LWR current dividend yield of 5.3%. Even if you factor in a 10% increase in management fee, the acquisitions will be accretive.
Australia and Japan’s REIT market tends to be more price responsive, and if you look at the premium ALE and HPI trades at, it does make equity placement and acquisition a much easier prospect, compared to Singapore REITs.
The problem for LWR, is where are you going to find Long WALE asset pipeline that stay core to the theme of Long WALE, and accretive enough to purchase.
Comparing Total Returns to a No Growth 7% REIT
The yield does look low, after factoring in the dividend withholding tax, but if we look at the total return angle, in a low growth environment, the rent review does provide a capital growth.
This is in comparison to a local REIT yielding 7%, but due to a mixture of negative rent review and low positive rent review, the rental growth is 0%.
In the above simulation, we compare this no growth 7% REIT (A) to one that yields 4.5% initially but growing by rent escalation of 3% (B) to another that yields 4.5% but growing by organic rent escalation and inorganic acquisition of 5%.
The total return of B and C is 7.5% and 9.5% respectively, which should outperform A, mainly from share price growth.
In this illustration, it will take 15 years for the dividend yield of B to catch A, and 9 years for C to catch up with A.
What is not reflected could be that there is yield compression taking place for B and C, in a price sensitive market, causing a rise in share price.
This has been an interesting exercise, but more than anything else, LWR and Viva Energy do look expensive by valuation standards, if we use price to book.
However, the premium to price to book does make acquisitions easier (read How does a REIT grow), in a more responsive market, if there are good pipeline of assets to be acquire.
While long WALE assets are not always the best (check out the problems with Starhill Global), in a low growth environment, the long WALE and good rent review does make a powerful combination.
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Monday 3rd of October 2016
Hi Kyith, Thanks for the detailed analysis. What was the problem with Starhill global? I was going through your old posts but couldn't really pinpoint. thanks Ming
Saturday 8th of October 2016
hi Ming, sorry i don't have one specific post on it. I think its not a problem with Starhill but using them as an example because a major tenant is Toshin at Taka and they been trying to raise their rent but are struggling to do it. the place for toshin is under rented and toshin probably rent to others at a better margin. if you are in some places where the demand is great like hong kong this long wale will kill. just my thoughts.
Sunday 2nd of October 2016
Keith, having done all that wonderful research, If you were to be in Oz and if you have decent access to Funds, would you invest in this IPO for a Stag only like VIVA. Not for long term. That's what I want to know.
Sunday 2nd of October 2016
The honest answer is I have limited experience in Australia. The culture of REITs is different as well and markets look to be more vibrant. My metrics will differ. If I look at Viva Energy's asset quality, I would embedd some premium for it. But in this rate environment, the spread against risk free rate in a normal rate environment, might not be fair value. I would break my purchase into 3 stashes with the first stash going in now, and to see if there are opportunity to get it at a much more attractive valuation.
However, if its shorter term speculation, my question is, what is the catalyst? Would they have ready assets to acquire that is accretive? Do bear in mind, that what makes a REIT run in Oz might be very different from Singapore.
Hope this helps.