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First REIT inflation risk explained again

So I wrote in to First REIT’s in the past to enquire about earthquakes and inflation, 2 very common thing in Indonesia. Victor from First REIT gave me a good breakdown on that here.

One of my readers Nick mentioned that Parkway Life REIT have a somewhat uncapped inflation protection mechanism. This means that the rent lease escalation of ParkwayLife REIT tracks inflation well.

So we know that Singapore’s inflation have been fluctuating at around 5%, Parkway Life REIT’s growth this year have been 5.3% as well. Perhaps that is why it is so resilient in these tough times.

So is this the same as First REIT? I know that they have an inflation rent lease escalation mechanism in placed as well, but it seems to be capped at 2%. I queried Victor again to see if it is the case.

One thing I gotta hand it to Victor is that he spends time clearing up your doubts about First REIT. If he feels its better to talk to you over the phone he will do that. The same as the good lady from CapitaCommercial Trust.

Indonesia’s inflation rate is roughly 4.6% recently and throughout the past 10 years have reached a high of 17%.

Singapore’s inflation rate have been high at 5.2% (yikes! higher than Indonesia) but throughout the last 10 years we have another spike in 2008 at 7.8% if not its been below 2%.

  1. First REIT’s income from properties in Indonesia is not paid in Rupiah but in Singapore dollars. Billing is done in SGD. Rental Income in SGD. Base rent, ascertain during IPO, is in SGD. This means that the currency risks are borne by the renter themselves, in this case Lippo Group. This ensures that whatever currency movement between the 2 currency have little impact on First REIT. Income of South Korea assets are in USD.
  2. First REIT’s Indonesian hospitals have 3 rent component: The base rent, established during start of lease, a variable component (sort of like a bonus) should the hospital cleared an annual earnings target of 5% and a CPI component.
  3. Since we explained the base rent is in SGD, the variable component is in Rupiah. However, the earnings are pegged to a pre-agreed currency exchange rate. The peg for the IPO asset is roughly 1 SGD : 5330 IDR and their recent 2 acquisition at 1 SGD : 6600 IDR. This would mean that should First REIT’s ipo hospital earns IDR 10000, they actually made more since the current exchange rate is 1 SGD : 6994 IDR.
  4. It would mean that should SGD continue to strengthen, it would bode well for First REIT and vice versa.
  5. The third component, the CPI component follows the current CPI of Singapore not Indonesia, since almost all the income is in SGD. It has an upper bound of 2.0% which means that if inflation runs rampant at an average of 5%, First REIT will not be able to keep up.
  6. Why such a low cap? First REIT actually did a study on historical inflation trend and it shows that it didn’t exceed 2%, hence the low marker. If you look at the chart hyperlink above under Singapore’s inflation rate, you would have agreed. Still going forward there is little way that First REIT can renegotiate this term for these existing assets but to be more prudent in their forecast for future purchase.
  7. There was a lot stressed on extensive insurance bought up to the renters. Under Triple Net Lease, these insurance costs (we being kiasu Singaporeans) are being forced on Lippo to comply. This assures us when it comes to damages from earthquakes, terrorism.

All in all, a good confirmation of what we knew previously that Parkway Life REIT probably had one great inflation mechanism and that First REIT wasn’t so shrewd to put in place.

I hope this clears up some of your doubts as well.

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