REIT analysis series: Suntec REIT (31 December 2018)

1. Snapshot Property

Property Valuation (million) Gross Revenue (million) Net Property Income (million) NPI yield NPI yield on market
Suntec City                             5,436.60 313.3 209.1 67% 3.8%
ORQ                             1,273.00                                    54.2 28.8 53% 2.3%
MBFC                               1,693.0 69.1 53.6 78% 3.2%
Pacific Highway 605.5 40.9 35.4 87% 5.8%
Southgate Complex 173.9 7.2 7.3 101% 4.2%
                            9,182.00                                484.72                                           334.20 69% 3.6%

As implied through the name of the REIT, the various performance metrics listed in the table showed the level of importance Suntec City has over the Suntec REIT. This for one is not a bad thing as the unique value proposition of having retail, office and convention centre placed within short distance from key locations such as the Marina Bay, Bugis/Rochor and Central Business District has allowed it to continue to stay relevant despite being in the market for at least 2 decades.

The other key asset which Suntec REIT holds is their one-third stake they hold on ORQ and MBFC which are located in the prime location in the old and new CBD respectively.

The key operating metrics I would like to highlight readers in on the last column of the table which is the relatively low NPI yield numbers relative to the DPU yield of Suntec REIT. ORQ deserve special noting as the NPI yield falls below 2%. Investors probably need to monitor this closer in coming months to ensure this under performance at ORQ do not persist. For those who might not be aware, the other one third stake of ORQ and MBFC is also held by another S REIT – Keppel REIT.

Based on the closing price at 5 April 2019 of $1.95 and FY18 dividend of 0.09988, we will arrive at approximately 5.1% yield. However, the blended portfolio NPI for FY18 for Suntec REIT is only 3.5%. I will highlight where reason for the gap.

2. Characteristics of Singapore office market

The Singapore office transactions has been characterised by low capitalisation rate. Capitalisation rate represent the rate of return which the investors is willing to accept on its investment (i.e. a 3% cap rate imply that if I put $100m on an office building, I am willing to accept a return of $3m a year). See below for an extract of the Suntec REIT 2018 annual report for valuation:

Capitalisation rate: (2018: 3.5% – 6.25%) (2017: 4% – 6.25%)

As you can see, the lower band of the capitalisation rate likely represents the capitalisation rate of the grade A office building within Suntec REIT’s portfolio (i.e. Suntec City office tower, ORQ and MBFC). Hence, based on the above metrics, it is reaffirmed that ORQ (NPI yield of 2.3% vs cap rate of 3%) has fall short of market standards. Another point to note is that you would notice that the lower band of the capitalisation rate decreased (or in real estate language compressed) by 0.5% to 3.5% in 2018 compared to 4% in 2017.

The compression of capitalisation rate represents increased optimism in the office market in Singapore as the rent on grade A office building seemed to have turned the corner and are experiencing positive rental reversion. The possibility that Oxley could potentially flip a prime location office building they just bought about a year ago for a cool S$300m profit highlight the level of positive sentiments we are seeing in the Singapore office market.

https://www.businesstimes.com.sg/companies-markets/hot-stock-oxley-up-3-after-s103b-offer-for-chevron-house

However, office REIT investors often get the best of both world on being able to own a piece of prime Singapore office real estate, receiving tax-free dividend income and yet at a discount from market value. Reason being, the share price often gravitates towards an implied DPU yield of about 5% to 6% (depending on the mood of Mr. Market) which means the share price would have to be below the NAV of the REIT. For your information, Suntec REIT’s NAV is approximately $2.1 as at 31 December 2018.

3. Capital Distribution forms a portion of Suntec REIT’s DPU

See below for the composition of Suntec REIT’s DPU over the past 4 years:

DPU (cents) FY18 FY17 FY16 FY15
from operations 8.529 8.907 9.057 9.249
from capital 1.459 1.098 0.946 0.753
Total 9.988 10.005 10.003 10.002
DPU (S$’000) FY18 FY17 FY16 FY15
from operations        227,811        234,017   229,726   232,967
from capital           39,000           29,000     24,000     19,000

DPU from operations are what I would like to call the usual DPU where it originates from the rent paid from tenants deducting relevant property expenses, finance costs, other operating expenses and management fees. The continued performance of DPU from operations will be dependent on the performance of the assets which investors can measure by looking at the property’s net property yield and also the ability of Suntec REIT to obtain competitive funding rate.

DPU from capital represents capital gains locked in by Suntec REIT on its previous investment in Park Mall. We can see that DPU from capital in FY18 has almost doubled from FY15. On a back of the envelope estimate, Suntec REIT can only continue with its capital distribution for another one to two years. This would mean, the ‘distribution cliff’ would have to be filled by its pipeline assets.

Excluding the propping up of DPU through capital returns, DPU yield at FY18 will be about 4.37% while the DPU yield is 5.1% if capital distribution is included. Based on Suntec REIT’s FY18 annual report, the trading yield of Suntec REIT has been trading between 4.8% to 6.45%. (i.e. Suntec REIT would be deem overprice at a trading yield of 4.8% and under valued at a trading yield of 6.45%.

4. Pipeline assets – 30% redeveloped Park Mall and 50% of 477 Collin Street

The pipeline assets which will be used to replenish the void from capital distribution for Suntec REIT is the REIT’s 30% stake in the redeveloped Park Mall (Suntec REIT retain a 30% stake with the majority of the other stakes in the hands of local listed group Singhaiyi) and 50% stake in the office building in 477 Collin Street. Penang Road is expected to complete in end 2019 while 477 Collin Street is expected to be complete in mid-2020. On a high-level analysis, it seems that Suntec REIT might not be able to fully fill the void left behind by the absence of the capital distribution especially on the initial years. But I would like to commend management for finding a diversified source of revenue following the divestment of Park Mall to reduce the level of concentration risk to the Singapore market.

5. Valuation

The current market price of $1.95 might present some downside risk for investors especially if the capital distribution void is not filled by the pipeline assets over 2020 and 2021. However, the other mitigating factor could be the positive rental reversion for Suntec REIT’s office portfolio as their office properties are generally well located and in demand.

The above analysis was done before the Quarter 1 FY2019 results announcement as well as 2 significant news which I will leave readers to digest which will leave Suntec REIT in a better financial position (with lower gearing) as well as visibility over the income of pipeline at Park Mall.

1. Net proceeds of $195.9 million raised for issuance of 111,111,000 new units

http://www.suntecreit.com/admin/dir/2019042501043020190425%20-%20General%20Annct%20-%20Close%20of%20Placement.pdf

2. UBS taking up the full space of Park Mall which I mentioned above.

https://www.businesstimes.com.sg/companies-markets/singhaiyi-suntec-reit-sign-ubs-singapore-for-all-office-space-at-redeveloped-par

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