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AA REIT explains purchase of Optus Centre

Source: The Edge Singapore By: Goola Warden

George Wang politely chats with unit holders of AIMS AMP Capital Industrial REIT after an EGM, during which a proposal to acquire a 49% stake in Optus Centre Macquarie Park in Sydney was overwhelmingly voted through. Once reviled for his rescue of what was originally known as MacarthurCook Industrial REIT that resulted in minority investors’ suffering massive dilution, the chairman of AA REIT’s manager is now something of an authority on the whole business.

Indeed, AA REIT is poised to deliver the fastest DPU growth from 2014 to 2016 among Singapore-listed industrial property trusts, according to research by Standard Chartered. And, while units in AA REIT have declined in the past year, in line with the rest of the REIT universe are still trading only slightly below book value of $1.48 and offer a forward yield of 7.7%.

Now, Wang figures he can keep AA REIT on a winning streak with the Australian investment that unit holders have just approved. AA REIT will pay A$184.43 million ($207.84 million) for Optus Centre, in a deal funded mostly by debt. “Australian interest rates are at a five-year low and there may even be more room to drop the rate. There is no pressure to raise rates,” Wang tells The Edge Singapore in an interview. The way he sees it, with the Australian economy having slowed in the last 18 months on weaker demand for commodities from China, the Reserve Bank of Australia is likely to lower interest rates even as the US Federal Reserve winds back its quantitative easing programme.

Looser monetary policy and a weaker Australian dollar could keep fuelling interest in high-quality Australian properties such as Optus Centre, Wang adds. “This property has good tenants, a good position, and also it’s next to Macquarie University. It’s like a garden, done in campus style.” Moreover, with more and more residential property coming up in the area, the value of the commercial space at Optus Centre ought to rise. “In future, Macquarie Park will become the second-largest office area after the Sydney CBD. I think the value of this property will go up over time.”

Optus Centre comprises six buildings sitting on a 7.6ha site, with a total net lettable area (NLA) of 84,194 sq m, plus 2,100 car parking spaces. The area is zoned as a business park and includes six cafeterias, a Laundromat and convenience store. The acquisition involves three leases over six properties. “We have staggered expiry dates ranging from 7.7 years to 9.7 years. The weighted average lease to expiry is 8.6 years,” says Koh Wee Lih, CEO of AA REIT’s manager.” The whole lease is guaranteed by Optus and there is an option to renew for a further five years.” Optus is a unit of Singapore Telecommunications, the largest of Singapore’s listed companies.

Excluding Optus Centre, AA REIT has a property portfolio worth some $1.1 billion. Among its assets are 1A International Business Park, 20 Gul Way and 27 Penjuru Lane. AA REIT’s sponsor and the co-owners of the REIT’s sponsors and the co-oweners of the REIT’s manager are Australian-based companies. AIMS Financial Group is a diversified non-bank financial company whose core business is mortgage lending, but has diversified into securitisation and property fund management. AMP Capital is an asset manager with a focus on real estate.

Impact of Acquisition

Optus Centre will be AA REIT’s first freehold asset. Prior to the acquisition, the property was owned by Australian property group Stockland, and affiliated unit called Stockland Director Office Trust No 2 and an Australian superannuation fund. The Stockland Director Office Trust’s life was coming on to an end, and AA REIT acquired its 49% stake. Stockland in turn bought out the superannuation fund and raised its stake to 51%.

The deal is being funded mainly by Australian dollar debt. “This creates a natural hedge,” Koh explains. The all-in cost is 5%. “The five-year loan pushes out our debt maturity profile from 2.8 years to 3.4 years. “AA REIT’s debt-to-asset ratio will rise sharply, to 37.4% from 25.2%. “Although it is on the high side, it’s not anything we can’t manage,” Koh says. “There is no pressing need to raise money now.”

On that basis, the acquisition is accretive to AA REIT’s net property income (NPI) and distribution per unit (DPU). “The NPI yield for the business park is 7.9%, so we get a positive pickup,” Koh says. The yield on the current portfolio is 6.3%, and the pro-forma yield on the enlarged portfolio will be 6.6%. That potentially raises AA REIT’s DPU from 5.12 cents to a pro forma 5.4 cents for 1H2014 (the trust has a March year-end), translating into a yield of 7.37%.

AA REIT will be hedging 100% of the income from the property, and 50% of the interest costs. “We will hedge future income on a rolling basis,” Koh says. “We have income and expenses in Australian dollars, so we are hedging the accretion [to DPU] coming back to Singapore which is $3 million.”

Koh also emphasises that AA REIT has “negative control” over certain decisions related to the property, even though it holds only a 49% stake. “There must be unanimous agreement by the shareholders. Stockland can’t just push through any capex they want. We must agree, although they have 51%. This is to protect shareholders’ interests. Operationally it’s a 50:50 joint venture.”

De-risking AA REIT

Why is AA REIT buying assets outside Singapore? Isn’t that likely to add to overall risk of the REIT? “It’s difficult to buy in Singapore. That’s why we’ve been focusing on redevelopment – because we find asset prices a bit toppish,” Koh says. He adds that while AA REIT continues to hunt for suitable acquisitions in Singapore, it has yet to find an industrial property in Singapore for sale at a price that would be accretive to its DPU.

However, Optus Centre does not necessarily make AA REIT a riskier investment for investors in Singapore. The REIT’s portfolio will increase from $1.1 billion to $1.3 billion, of which about 17% will be exposed to Australia. The acquisition will also raise AA REIT’s exposure to business parks to 30% from 15.5%. “Business parks in industrialised countries like Singapore and Australia are no longer about producing cheap widgets. They are about logistics warehouses and house knowledge-based industries,” Koh points out.

The acquisition of Optus Centre will also raise AA REIT’s WALE (weighted average lease to expiry) to four years from three years. “It rebalances our portfolio towards master leases, from multi-tenanted lease, which will increase to 53%,” Koh says. Master leases provide the portfolio with assured cash flow, although growth is likely to be lower. “It’s more than likely we are going to have more certainty from master leases,” he adds.

What of rising interest rates, shrinking liquidity and a fall in asset prices? “There are factors we can control, and factors we can’t control,” Koh says philosophically. “What I can do is to improve my occupancy, lease out to good tenants with long leases, increase the rental where possible.” AA REIT can also control its bank covenants, he adds. At the moment, eight assets owned by AA REIT are unencumbered. “In the event that cap rates start to rise and asset values drop, we effectively have the flexibility to go to the bank to say we can put these eight assets back in the security pool,” Koh says.

As for the impact of rising interest rates, he says there is little to fear. “If the Fed tapers, it means the US economy is strengthening and Singapore are an export-led economy will benefit. Of all the asset classes, industrial probably tracks GDP growth the most closely. And, if you are afraid of inflation, which asset class would you rather be in: real estate or bonds?”

Expanding organically

With a larger portfolio size, AA REIT will also be able to take on larger development projects. Under Singapore regulations, REITs are allowed to have up to 10% of their assets exposed to development properties. At present, AA REIT is redeveloping two properties. One is the Phase Two Extension of 20 Gul Way, which consists of a ramp-up warehouse that will be completed by year-end and is being master-leased to CWT. The other is 103 Defu Lane, which is scheduled to be completed in May. Its anchor tenant is Focus Network Agencies, a distributor of chocolates and confectionery.

“We have at least 12 properties out of 25 excluding Gul Way and Defu Lane where the current plot ratio is underutilised,” Koh says. The biggest discrepancy between current plot ratio and maximum plot ratio is built up to a plot ratio of just 0.88, well below the maximum allowed 2.5. “We are committed to unlocking value within the portfolio, and Singapore is our main focus,” Koh says.

Standard Chartered Bank forecasts DPU growth at AA REIT of 4.5% from 2014 to 2016, and has retained an “outperform” rating on the trust. “We expect this growth to be driven by the completion of asset enhancements as well as the new Optus acquisition,” Standard Chartered ways in a report. It forecasts a DPU of 10.89 cents for 2014 and 11.2 cents for 2015, giving forward yields of 7.7% and 7.9% respectively.

Perhaps more reassuring for investors than those forecasts is the fact that chairman Wang has been gradually raising his stake in the REIT through his privately held companies, from 6.25% as at last May to 7.06% currently. “The fundamentals, like the quality of assets, are good,” he says, explaining his purchases.