Investment Moats

Prime REIT. Prime REIT. Prime REIT.

If you say it fast enough, and repeat it often enough it becomes Prime Rib, Prime Rib, Prime Rib.

Not too long ago, Keppel Capital partnered with Peter M. Bren and Charles J. Schreiber, Jr’s KBS Realty Advisers to list a Grade B Office REIT called Keppel KBS in Singapore.

Keppel Capital and KBS Asia Partners (KAP) have lodged their prospectus and will go ahead to list their Grade A Office REIT called Prime US REIT.

This article will go through what I think about this REIT.

The Offer

From what we understand, there will be a Placement and public offer at a price of US$0.88.

There will be a total of 923 million units.

The breakdown:

1. Placement and Public Offer: 335 mil units
2. KBS REIT III: 228 mil units
3. Cornerstone Investors: 360 mil units
   1. AT Investments Limited: 8% of REIT
   2. KCIH: 6.8% of REIT
   3. The Schreiber Trust
   4. Credit Suisse AG, Singapore Branch
   5. DBS Bank
   6. Hiap Hoe Investment Pte Ltd
   7. SPH: 6.7% of REIT

This will give Prime US REIT a market capitalization of US$812 mil.

The sponsored wanted to list Prime US REIT sometime ago since last year but the volatility last year and all the negative USA tax situation have made listing very challenging.

From what we understand there were some changes to the configuration of the REIT listing:

1. Mainly SPH becoming a new cornerstone investor
2. SPH (Times Properties Limited) also took a 20% stake in the manager
3. KBS REIT III ramp up their stake from 16% to now 24.7%
4. The offer size (cornerstone + placement + public offering) got reduced from US$705 mil to US$612 mil
5. Gearing going up from 35% to 37%

The challenge for a REIT that wishes to enjoy Portfolio Interest Exemption (PIR) and not pay the 30% withholding tax on dividend is that each non USA resident shareholder cannot own more than 10% of the USA REIT.

And that might be a reason why each shareholding is rather small. The sponsor won’t be a substantial shareholder.

It is interesting that Prime US REIT’s largest shareholder is the fund that it bought its asset from. I am not sure how I should conclude here. I think the sponsored originally do wish to realize more of the asset sales from KBS REIT III to this entity and not hold so much units.

However, in light of the difficulty in drumming up interests, or their anxiety of how poorly Prime US REIT will do after seeing the lukewarm response of ARA Hospitality REIT and Eagle Hospital Trust, they decide to pivot.

At this point, we should really talk about who owns the manager:

1. KBS Asia Partners (KAP): 40%
   1. P Bren KAP I, LLC, which is owned by Linda Bren 2017 Trust – 33.3%
   2. Schreiber KAP I, LLC, which is owned by Charles J Schreiber Jr – 33.3%
   3. Rana KAP I, LLC, which is owned by Rahul Rana – 16.66%
   4. R Bren KAP I, LLC, which is owned by Richard Bran – 16.33%
2. SPH – Times Properties Limited: 20%
3. Keppel Capital Two Pte Ltd – 30%
4. Experion Holdings – 10%
   1. AT Holdings, Sai Charan, own by founder Arvind Tiku

You will realize that, the majority cornerstone investors, major shareholders and the managers, are almost the same people. DBS has been actively trying to bring these oversea players to come and list on our bourse.

It is as if they listed a vehicle that is primarily owned by themselves, or their partners so that minority shareholders can ride together with them. I think more likely they were unable to find the cornerstone investors that are interested and thus KBS REIT III would have to take up more. If it is for their own khakis, they could very well let this entity be unlisted and manage themselves.

A Concurrent Listing

On 8th of Jul, after the final prospectus is announced, we got news that the placement and initial public offer will take place concurrently.

Usually, these IPO placements and initial public offering are done sequentially. It is VERY RARE that this is done together.

When an IPO and placement are carried out together, if there are weak public demand, the book makers can shift the public offer to the placement. In this way, the underwriters will not need to swallow a large chunk of the IPO shares (like what happened to Eagle Hospitality Trust where the IPO was lukewarm)

If the demand is weak for the public offer, the IPO will not be priced and the applicant’s funds will be refunded and the IPO will not take place.

This is a rare move by a listed company and usually the company doing the IPO would have pulled the plug. However, since Prime US REIT have tried a few times trying to list, they decide to take this challenging route.

My sources tell me that the placement was less well received, so perhaps that is why they are taking this route.

The Time Table

The Portfolio

Prime US REIT consist of 11 Class A Office Properties. Singapore investors should not be so unfamiliar with the office property scene in the USA as Keppel KBS was listed a few short years ago.

Its closest peer is probably another Class A Office REIT Manulife US REIT. I have written enough content on Manulife US REIT, the characteristics, the withholding tax situations, the nature of the leasing in that country.

I think if you are investing in Prime US REIT, you should at least read through what I have to say about it (especially if you are still not so sure about the tax shield stuff):

• My Manulife US REIT Analysis
• Manulife US REIT Reaches a Dividend Yield of 7.80%. Here’s More Insights about the REIT
• 11 Deeper Things I Learned about Manulife US REIT
• Manulife US REIT and Keppel KBS Announced Minimal Impact from Section 267A Regulations and Barbados Tax Rate Changes
• More High Yield Certainty from Manulife US REIT FY 2018 Result
• Thoughts on Manulife US REIT’s Accretive Acquisition of Centerpointe I & II

One thing I realize is that majority of the portfolio are sub-urban Grade A properties. That can explain the attractive CAP rate for the portfolio.

This is not a slight on Prime US REIT. About 50% of Manulife US REIT’s offices are located in sub-urban locations. They believe that there is a trend towards moving out closer to where the employees live, so that there are more work life balance.

Class A office can be found in the CBD or sub-urban. Cushman defines Class A as the most prestigious, high quality standard, well-located buildings, typically steel and concrete construction, built or renovated after 1980 and competing for premier office users with above market rents.

• 4 properties are in Tier I cities – 28.7% of Net Property Income
• 4 properties are in Tier II cities – 35.9% of NPI
• 3 properties are in Tier III cities – 35.3% of NPI

The properties are in good state of upkeep as the current management has systematically made necessary improvements to the building systems and added or refurbished common areas as needed over the years to enhance their appeal. (for more information on Class A, Class B and Trophy, refer to my past Manulife US REIT articles)

• Based on the listing price of US$0.88, the dividend yield in FY2020 is 7.6% and FY2019 is 7.4%
• All 11 properties are Freehold status
• The Weighted Average Lease Expiry (WALE) is 5.5 years.
• The average occupancy is 96.7%
• 10 out of 11 either are LEED Certified, Energy Star Certified, or LEED Gold, LEED Platinum, signifying their energy efficiency
• Average 2.1% annual rental escalation
• Management fee: 10% of Annual Distributable Income and 25% Performance fee based on the improvement in Dividend per Unit

The WALE is relatively long, the yield is attractive and the gearing is reasonable. I think some investors would like this portfolio if the managers is able to grow this portfolio.

Prime US REIT versus Manulife US REIT

Investors here have about 1 year plus to be acquainted with the manager’s capabilities in acquisition and ability to renew existing leases, leased out new leases.

Depending on how comfortable you are with KBS, your other question is how Prime US will measure up against another pure Class A portfolio.

The table below shows how Prime US and Manulife US compared against one another:

Prime US REIT looks more attractive in terms of dividend yield. What is not reflected in this comparison is that both REIT is paying 100% of their manager’s fees in units, so that is a rather fair comparison.

The property portfolio value for Manulife US REIT is lower than the latest figures because I want to gauge the property management fees and manager’s base fee as a percentage of the property value. Both REIT is paying roughly the same percentage in terms of property management fees. Manulife US REIT, surprisingly have a lower base fee as a percentage of AUM compared to Prime.

One comparison that I missed out, and I would include it in writing is that both Class A office REIT average 2.1% in annual rental escalation (if you combined organic rental escalation and mid term review)

If we were to compare the profile of properties, 75% of Manulife US REIT’s properties are in Tier I cities, while the rest are in Tier II. Whether that matters or not is another question all together.

Many businesses see Tier II and Tier III cities as desirable destinations, particularly in times of economic strength. These areas present opportunity for growth and development and allow businesses to expand and provide employment to people in growing cities. Additionally, the cost to operate in prime Tier I real estate is expensive, and companies often see underdeveloped areas as a way to expand and invest in future growth.

In contrast, businesses tend to focus more on the established markets in Tier I cities when the economy is in distress, as these areas don’t require the investment and risks associated with undeveloped areas. Though they are expensive, these cities feature the most desirable facilities and social programs.

Investopedia

While Tier I tends to be more developed, they also tend to have lower CAP rates. I tend to think that much of their value is in their perceived lower downside volatility in property value while in other Tier cities, there are more for rental yields to grow, but also more volatility in property demand and supply.

The rest is almost the same except that the weighted average debt to maturity for Prime US REIT is vastly higher.

Given the size of Prime US REIT’s portfolio, and the ownership structure, I think there might be a rights issue coming our way in the future.

The possible lack of liquidity might work against the REIT in raising non-renounceable rights issue or placements, which are typically to institutional investors, family offices.

Manulife US REIT are starting to reach the size where they can carry out acquisitions, finance by equity raising that are at slight discounts. Prime US REIT can place out as well, if they place it to some very rich individual or entity, and the current shareholders are willing to subscribe to even more of Prime US REIT’s units.

The possibility of future rights issue might put a ceiling to the share price of Prime US REIT.

Reviewing the Past Revenue and Profit Performance

Prime REIT presented some data regarding the properties’ past revenue and net property income figures.

I thought the data will at least enlighten us how well the properties have been performing.

In the first table, I compare the year on year performance of the revenue. There are some properties that have interesting results:

1. Village Center Station I: despite a drop in occupancy recently, revenue growth was strong, which may indicate strong leasing
2. Promenade I & II: despite a drop in occupancy in 2017, revenue was up
3. 171 17th Street: This property shows some improvement in occupancy but the revenue revision is very good

I wanted to see if there are some real operating leverage for the properties.

In theory, the cost of operation should not increase proportionately as rent increase via organic escalation (in Prime US REIT’s case, it is an average of 2.1% a year increase).

Majority of the leases, I suspect are on modified gross rent. We keep seeing in the prospectus recoveries income, which is likely the expenses that the REIT was able to recover from tenants. So these leases should be something rather close to like double net leases at least.

We can analyse this by looking at the difference in growth year on year between the revenue and net property income.

It is not always a one to one relationship. For Village Center Station I, in 2017 to 2018, the revenue went up but the NPI went down. Same for Reston Square.

However, in a lot of cases, we see majority of the revenue increase directly passed to the bottom line (net property income):

• A 400k rise in revenue in 2018 at Village Center I resulted in an almost 400k rise in NPI
• A 1 mil rise in revenue in 2018 at South Hanley resulted in a 800k rise in NPI
• A 1 mil rise in revenue in 2017 at Tower 909 resulted in a 700k rise in NPI
• A 1.7 mil rise in revenue in 2017 at 171 17th Street resulted in a 1.4 mil rise in NPI

The conclusion is that in terms of income, it is not a 100% pass through from revenue to NPI, but baring any exceptional costs, a large portion should be passed to the income.

To the extreme right of the table above, you can see the net property income yield progression over the 3 years. They are measured against the latest valuation of each individual property that Prime US REIT’s shareholders will be acquiring it at.

You can compare it against the CAP rate published by CBRE CAP Rate Survey for the second half of 2018.

I have tabulated for easy comparison:

Those rows market in red are the buildings where the Valuer’s CAP Rate, based on their Dec 2018 Net Operating Income, is less than what CBRE surveyed in 2H 2018.

Do note that the surveyed CAP Rate is based on properties whose income is stabilized and with a certain level of occupancy.

Emeryville occupancy was rather low which explains the low yield versus market, Village Center Station II just completed not too long ago so the data is incomplete.

If you take out Village Center Station II, 36% of the portfolio seemed to be bought below market rent. You can look at it two ways:

1. The shareholders purchased assets that are below market performance
2. There are opportunities that the results can be improved upon

KBS REIT III’s Profits

The properties that were sold into Prime US REIT were from an unlisted REIT KBS REIT III. KBS REIT III would still own 24.7% of Prime US REIT.

If we look at some of the presentation of KBS REIT III we can get some information such as the purchase price of these properties, how much work was put into them, and when was the purchase.

The table below presents some of these information.

I am rather puzzled why I cannot find the data on the latest valuation of these properties. It is as if the unlisted REIT did not revalue the properties.

My hunch is that to minimize taxes, the properties are treated as plant, property and equipment and are accounted at cost minus depreciation. Thus, I cannot find that information there.

I did tabulate the CAGR for some of those properties since their purchase. The Atlanta, Dallas, St Louis property have some pretty good CAGR.

However, I don’t think it is fair to say these properties are not cheap. A fairer comparison would be the appraised value of these properties in 2018 versus the price shareholders buy it at. I could not find this information.

The Growth Potential of Prime US REIT

Prime US REIT do look like it has an organic growth angle.

There is this rough office market cycle clock, which is to help the investors visualize where in the property cycle, the various markets are in.

Somehow, majority of the properties, are in cities that are in accelerating growth. Graphics like these are always subjective and should be taken with a pinch of salt.

From the residential property podcast that I have been listening to, things are getting extremely cautious over there.

The opportunity for Prime US REIT is good if the growth is really there. Prime US REIT’s lease expiry is well staggered like a bond ladder.

In this way, the risk that the leases are expiring in a year where the market is in a downturn is diversified away. On the flip side, as the expiry is well staggered, it allows the manager the opportunity to lease out or renew leases at higher rents.

This is something bonds do not have, which is the ability for your dividends to grow.

In the illustration above, Prime US REIT average market rent is below that of the market rent.

My friend, Caveman, will say that perhaps some properties are so difficult to rent out at market rate, thus they are forever somewhere below market rate.

However, at least there are some potential of organic growth from a low base (low occupancy, low passing rent, expiring rent), compared to their competitor who have less of it.

Room to Pull Back Paying Management Fees in Units

Prime REIT presented a section where they show the sensitivity analysis, if the manager do not take their management fees in units. For a lot of the REITs, the dividend yield is attractive because they paid out all their fees in units. This increases available distributable income and thus dividend per unit.

In the case of Prime US REIT, we can see that if they do not pay any management fees in units, their dividend yield will be the same as Manulife US REIT now.

Long Average Debt Expiry

What I noticed about the debt structure is that their debt are concentrated firstly, but not too different from when Manulife US REIT start off at IPO. Overtime, these REITs should be trying to “ladder” out their loans to minimize refinancing risks.

The second thing is, man, the average debt maturity is 5.6 years. That is very long! Which is a good thing as it minimizes uncertainty there.

I think shareholders will appreciate this, especially when their debt interest is reasonable at 3.45% and 85% fixed by hedging.

Tax Structure and Risk

The following illustration shows how the REIT is set up.

If we compare to Keppel KBS and Manulife US REIT, the main difference is the lack of a Barbados intermediary company, which both of them have.

The Barbados structure is to address some of the potential tax complications brought about by the major tax change in the US in 2017 called the Tax Cuts and Jobs Act (TCJA). By having the Barbados entity, the two REITs tried to address the problem that they will be classified as a “Hybrid Entity” (the Section 267A). If they are, then they cannot use the shareholder loans, loan from the parent in Singapore to the child company in USA as a tax shield, to minimize the taxes.

Without the tax shield, this means the shareholders potentially is going to get a 10-15% cut in their dividend. That is massive.

However, since end Dec 2018, the clarification to the TCJA do not show that Manulife US REIT and Keppel KBS’s structure will be classified as a Hybrid Entity.

The final all clear is suppose to be announced some days ago, but it seems that it has been delayed.

Nevertheless, with the way Prime US REIT is structured, which is similar to how KBS and Manulife US REIT originally structured during their IPO, it more or less means that management strongly believe that there are no issues there.

This tax stuff is rather cheem, but if you are putting your money in, perhaps you are interested to read about it. You can read my two articles:

• 11 Deeper Things I Learned about Manulife US REIT
• Manulife US REIT and Keppel KBS Announced Minimal Impact from Section 267A Regulations and Barbados Tax Rate Changes

If you are a shareholder, you need to submit your W8-BEN form.

This is to firstly identify you as a non-resident USA citizen, so that you can qualify for Portfolio Interest Exemption (PIR), that your dividends will not subject to a 30% dividend withholding tax.

Secondly, it is also for the REIT to track the level of shareholdings of each shareholder to be less than 9.8%, so that they will not be in violation of the PIR.

One thing that is interesting is that, to not violate the PIR, each shareholder holding cannot be more than 9.8%.

Then how come KBS REIT III can own 24.7% of Prime US REIT?

This is answered in the Prospectus, and it was explained right at the start of the prospectus:

Fxxking wall of text.

No wonder no one reads the prospectus.

I think the general idea is that while KBS REIT III owns 24.7% of Prime US REIT, the manager have obtained an Automatic Waiver such that it will not disqualify Prime US REIT’s USA Subsidiary from qualifying as a US REIT for federal income tax purpose as long as it is advised by an independent tax adviser and let the shareholders know of the risk that this Automatic Waiver may be forfeited in the future.

This Automatic Waiver provision protects KBS REIT III from losing its US REIT status. A US REIT cannot be held by more than 50% by less than 5 or fewer individuals

Prime REIT have put in place the process of identifying substantial shareholders. The moment that a substantial shareholder crosses the threshold, the shareholder’s units will be transferred out so that the shareholder will not violate the PIR.

If you think about it, the unlisted KBS REIT III, probably are made up of shareholders that, each have smaller shares that would make up less than 9.8% of Prime US REIT if they directly own it. So this waiver probably make sense.

The risk is if this structure (as advised by an independent tax consultant) is not recognized or illegal, then the manager might be looking for at least 3 substantial shareholders!

Conclusion

I think with the recent run up in REIT prices, with the yield compressing, and the recent IPO of USA hospitality REITS ARA Hospitality and Eagle Hospitality Trust, many are thinking this is a bubble.

Sentiments wise, a sponsor will not bring a REIT to the market if they cannot get a good showing out of it. So IPO are usually released when the times are better. It will not be cheap.

However, there are REITs where it makes sense to buy at IPO because of the potential for growth. Not just that, they are recognized by the larger funds, investors as a REIT that is under good management, good growth potential, less risk (in terms of surprises), good quality assets. They will do well.

I just think that right now there are 2 REIT market, the blue chip larger capitalized ones and the smaller ones. The first market has been running, the second one, not as much.

My sensing is that due to its initial IPO size, it might be languishing for a while. Acquisitions will come in. And likely using debt and rights issue to grow it to US$ 1.2 bil. Without it being big enough, there should be limited price appreciation.

The recent lukewarm REIT IPO response certainly worked against them.

But the portfolio is not too bad. The portfolio is mainly sub-urban based Class A office, which explains the higher dividend yield, and so it looks attractive to investors. From what I see, they are all located with recreational and retail amenities.

I am still thinking about getting IPO assets with some below the market CAP Rates and what I should think about that.

There are potential for yield improvement for Prime US REIT in the future and that is where we can access the competency of the manager and their potential to organically improve the portfolio.

I also like the longer average debt expiry as this reduces some uncertainty.

I write more about REITs in Learning about REITs below:

Here are My Topical Resources on:

There has been a few placements, non-renounceable rights issues and acquisitions by REITs that I cannot get through all (well by my own standards). But I thought I will just do the Cromwell European REIT one. 

After the burnout work in the office in the past 2 weeks, I really do not feel like doing anything. 

So this one will probably be a short one. 

I have not do much homework on Cromwell, so decide to treat this as a relaxing homework of mine. 

Cromwell European REIT will be purchasing 

• 3 Freehold French Office Buildings in Greater Paris
• 2 Freehold Office buildings in Krakow, Poland
• 1 Freehold Office building in Poznan, Poland  

The numbers look good, particularly impress with the kind of net initial yield that they can still garner in the market like this.

I am not particularly familiar with the markets in Europe, so I am not going to pretend that I know that, but if you go out to a lower tier markets, or countries deemed to be more risky, you can get CAP rates that are higher. However, they usually come with some costs, be it more volatile economies, leading to more volatile occupancy or more volatile market rent. 

The WALE for Poland looks on average rather short, and we can see similarities with the portfolio of Poland retail assets that was suppose to go into Cromwell’s initial IPO but was taken out (you can read my write up of that here)

Majority of the property are freehold and this would refine the quality of Cromwell’s portfolio in that aspect.

Cromwell European REIT’s shareholders would need Eur 248 mil to finance these 6 acquisitions.

What does this do to Cromwell REIT’s existing portfolio?

Well not much. It does make it bigger.

And geographically, it diversifies to two more countries.

What we have are:

1. a lot of properties (103)
2. diversified across 7 European countries, and across even more cities
3. a lot of tenants
4. primarily free hold assets

You might like something like this. I do wonder if Cromwell really have that established team in Europe, and in so many countries, that they can manage to keep the properties well rented.

Adding more properties would also reduce the concentration on top tenants, in case one major tenant not renewing will cause a large drop in dividends per unit. 

While based on tenants, properties, geography, Cromwell looks very diversified, when you purchase, you are hoping that this diversification smooths out the rent and occupancy volatility across the 103 properties.

For example, if a region goes into a cyclical downturn, another region that is in a upturn buffers the drop in occupancy and rent. 

It would be good if the management have a “clock” that shows for each country, and each property segment, where they are in the cycle, so that we can appreciate whether this diversification is a strong point of Cromwell.

Capital Financing: Just Dividend and DPU Accretive after Placement

To finance this rather big acquisition, Cromwell’s initial plan was to use Eur 150 mil in debt and Eur 100 mil through placement.

If they went through with this, the deal would have increase the dividend per unit by 6.5%.

One thing I notice is the low existing borrowing cost of 1.4%, which makes a lot of these deals look very good. There is a huge spread between the debt borrowing cost and the CAP rate (or net/gross initial yield, reversionary yield)  of the property, be it 4% to 9%.

Placement price at EUR 0.46

However, the placement was very popular.

During the acquisition announcement, Cromwell announced that the placement price would be between EUR 0.46 to 0.47. 

Eventually, the private placement was oversubscribed and placed out at EUR 0.46. 

Due to the over-subscription, Cromwell European REIT managed to place out an additional Eur 50 mil in equity. (Total Eur 150 mil)

A total of 326 mil new units will be issued at Eur 0.46, which will raise Eur 150 mil.

This placement price represents:

1. a 5.9% discount to the average volume weighted price for the day before trading, adjusted to the Eur 0.0205 advance dividend
2. a 9.6% discount to the average volume weighted price  without adjustment for the Eur 0.0205 advance dividend

The placement discount, if you factor in the 1% sales charge that placement share subscribers paid, is rather tight. (A less than 6% discount is rather tight, and 6-10% discount to last adjusted price is rather fair)

It would have been better if it was more leveraged

With these stuff becoming clearer, let us plug in the data and see how Cromwell European REIT looks like before and after this acquisition.

The DPU forecast in these rights, or placement documents are not accurate going forward. This is because they are usually using historical distribution income for the existing portfolio and comparing it to the new addition during the same period.

A lot of things might have change. Your REIT might have bought or sold some properties during this period.

So for example, they might be assuming the distribution income to be from June to December of last year and comparing that with the new acquisition. That is useful to show you the level of DPU accretion. ( in the case of Cromwell, they listed a full year income, so they do not have this problem)

However, if you wish to find out what is the projected future DPU, dividend yield, if they have purchase or have not purchase this 6 properties, this might not be helpful. 

The Eur 13.5 mil difference in distributable income is helpful for us to find out the projected yield after interest cost for the additional debt taken up. (in reality, it should be higher, since now we know that we are just taking Eur 100 mil in additional debt instead of Eur 150 mil)

Cromwell, in their slides, explained that the DPU accretion would be 2.4% but somehow when I put in the figures, I did not get the same thing. I get a DPU accretion of 0.92%. 

The dividend yield will be 8.49% versus 8.41% now. 

The gearing is slightly higher, going from 36.6% to 37%.

The book value per share went down, probably because they are acquiring this portfolio below their current portfolio book value (do correct me if I am wrong about this)

This deal looks good for the shareholders, only if the properties are of value (when I say this, it also means the tenants in the properties are quality)

Operation Management of Existing Portfolio

From this point, it is less about the placement and acquisition but on what I think of the REIT itself.

I think I mentioned I am not sure how great the manager is able to manage such a portfolio that spans so many locations. 

A portfolio of this diversity in the hands of a great manager is going to be great. There are a lot of things they can do with it. 

However, it might be very challenging for a sub-par management or perhaps it is just not feasible at all to manage such a diverse set of properties.

The best way is to check out some of the metrics that may show these kind of things. 

There are 2 main segments:

1. Office
2. Light industrial and Logistics

And in these 2 segments there are sub-divided into geographical segments. 

In this table above, I have tabulated the occupancy, office and industrial rental reversion, new leases and renewal and retention rate. 

I was rather disappointed that Netherlands offices, which was part of the IPO, was getting weaker and weaker. We do understand that there was some asset enhancement initiative in the first quarter 2018 report, but it might not have to do with the economy. In the same country, the logistics and light industrial occupancy have been doing very well. 

It feels like their light industrial segment will have a lot of tenant changes. This is during better times. We will have to see during poorer economic times, whether there will be less new leases and the lower retention rate will work against Cromwell.

For now it feels that the whole portfolio, despite the better average WALE, look like our Singapore general and light industrial REIT segment. High CAP Rate, but also more cyclical.

Just that at least, the properties are not 30-40 year land lease properties. 

And we will see if the diversification allows the overall portfolio to maintain its DPU or there is no benefit in diversifying in Europe at all.

Concentrated Debt Risk

The slide above shows the debt maturity profile for Cromwell European REIT. It is very concentrated.

And they are in negotiation to get it renewed. They might have an opportunity there to renew at a low interest rate. But they better ensure that they renew. Because if they don’t, then it will get real ugly.

In my opinion, they should spread out the debt maturity. We are in a situation where the debt cost in Europe is favorable. However the more sensible thing is to “ladder” the debt maturity so that to ensure we do not get unlucky, and have a year where there is a credit crisis and majority of your debt is maturing in that one year. 

French Government will not Take Possession of Parc des Docks

In an earlier announcement, Cromwell European REIT also announced that the French government will not take possession of Parc des Docks. This dispute have been going since Cromwell put in their prospectus during their 2017 IPO. The french government had earlier the intention to develop a hospital, university complex and school on the 10 hectare freehold site. 

The government will thus compensate the Reit Eur 907k for the marketing and leasing activities that were placed on hold for the Parc desk Docks site during its deliberations for the proposed expropriation.

The Reit manager expects the property’s occupancy rate, which stands at 83 per cent, to increase substantially over the rest of 2019 together with significant positive rental reversion due to its accessibility and proximity to the Paris central business district.

Parc des Docks is a last-mile logistics property situated on a 10-hectare freehold site in an industrial area close to the River Seine in Paris. Last-mile logistics fulfilment refers to the final leg of delivery to the end user.

It has a NLA of 73,371 sqm of warehouse and ancillary office space. It was independently valued at Eur 114.1 million as at Dec 31, 2018, which is 16.4 per cent higher than the Eur 98 million that Cromwell E-Reit paid for it in 2017.

Parc des Docks is also the Reit’s third-largest asset by value.

With this announcement, Cromwell will be able to try and lease out the space and they have received encouraging inquiries. 

This slides make it sound so good, but I wonder do the REIT holders own the full 10 hectare! I re-read the prospectus and it did not say so. 

However, if they develop the surrounding, it can only be good for the property occupancy and rent. 

Placement as a form of Financing is a Big Plus to Cromwell REIT

Cromwell European REIT should enjoy this financing as a big win. This is their first placement and it is also oversubscribe. 

I have tabulated Cromwell’s history of capital financing history here:

** click to view larger table **

Cromwell tried to IPO in Sep 2017, but have to go back to the drawing board when things did not work out so well. Eventually they IPO at Eur 866 mil market cap. 

From there, they bump up the number of properties from 74 to 103!

There were some small acquisitions, but the biggest was undoubtedly the Oct 2018 38 for 100 rights issue.

Renounceable Rights Issue has to be more heavily discounted but when your REIT is small, it is difficult to gain institutional support to do a placement.

Rights issue is a necessity. Unless your asset value appreciate a lot.

This is what a lot of investors don’t understand. They kept saying rights issue is dilutive, and management should not use it.

But sometimes… they don’t have a choice!

Cromwell’s original IPO size looks big, and with that, and with adequate liquidity,  they should have able to garner institutional support that they do not need to do a rights issue. But I think they have to take out the Polish retail assets.

The rights issue was not DPU accretive if you are a shareholder and you did not subscribe to the rights. However, that is the nature of rights issue. 

This placement is a win for the management because

1. they can bring in more family offices and institutional investors
2. they do not have to rely on rights issue, which places stress on their share price, killing their future cost of capital for future acquistions
3. they are big enough that they can make these regular Eur 100 mil to Eur 200 mil acquisitions (Eur 200 mil is like 10% of total assets and 20% of market cap, we can think of a 50% debt 50% placement acquisition on a frequent basis)

For the management they can grow their AUM and earn greater fees. 

Hunting Third Party deals

One of the worry we often have, when we have an unknown sponsor, creating a REIT and listing in Singapore is that there will be some asset dumping.

In the case of Cromwell, the sponsors should have some properties that they can unload to the REIT. After all, the original IPO portfolio was formed from properties in the funds they managed for third party investors.

We have seen about 4 acquisitions of different size to date, and if I am correct, all of them are from third parties. This can be good and bad. If you purchase from some funds who are looking to exit their properties for their own investors, then this might not be cheap. 

However, it does show the ability of the manager to find yield accretive properties to add to their portfolio without the help of the sponsors.

At least the ability for the REIT to grow is not capped.

Why is IREIT Struggling to Acquire?

Cromwell, in a short span of 1.5 years have made enough acquisitions through debt, rights issue and placement. It is with this that I thought about one of its Singapore competitor IREIT Global.

The cash flow yield on IREIT is near to 8.2% but its dividend yield is likely in the low 7% range. While its debt to asset have been in the 42% range for some time, recent property value appreciation have brought down its gearing. 

It should be able to make acquisitions. 

When I look at the CAP rate of the properties that Cromwell acquire, it makes me wonder whether it is the case that

1. IREIT chose not to acquire because it does not fit the profile of properties that they are looking for
2. These properties that Cromwell acquire are inferior in grade or quality that they steer away
3. They are not good managers
4. They do not have the liquidity to do less deeply discounted non-renounceable rights issue or placement 

Summary

I think the dividend yield of Cromwell REIT is attractive enough. The grade of properties reminds me of the smaller Singapore industrial REITs (even the yield feels similar!)

The good thing going for it is that its portfolio is primarily freehold, versus the local industrial ones which have limited land lease.

The downside is that as an investor, you take on currency risk with Cromwell being in Euro.

However, given the trend, the local industrial REITs are trying to acquire properties overseas, so this will narrow the difference.

I think Cromwell European REIT is rather speculative for me at this point. Let me know your thoughts (or whether I missed out on something important, if you have studied it longer)

I write more about REITs in Learning about REITs below:

Here are My Topical Resources on:

1. Building Your Wealth Foundation – You know this baseline, your long term wealth should be pretty well managed
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free