It is almost close to a year after I posted my review for Lendlease Reit. I was really excited about this IPO that I was so eager to write a review as soon as the prospectus was released.
I also read other bloggers’ reviews and decided to subscribe for this IPO. Unfortunately, the IPO subscription was so hot that it was 14.5x subscribed, highest in 5 years. I wasn’t allotted any units and was disappointed.
I have been holding LREIT for 6 months since January and I am deeply disappointed having it crashed more than 50% at one point in time. This position has since been classified as my non-core portfolio.
Today, I will analyse whether LREIT at this valuation is attractive to hold for the longer term.
Lendlease, the sponsor
The sponsor of LREIT is Lendlease Group. Headquartered in Sydney and formed in 1958, Lendlease Group is an international property and infrastructure group with operations in Australia, Asia, Europe and the Americas. Lendlease Group has three main business segments namely – Development, Construction and Investments.
For its development segment, it has a pipeline worth of developments such as urbanisation, communities, retirement living and infrastructure development that are valued close to $100 billion. Some examples of its urbanisation projects include Barangaroo South (Sydney, Australia), Melbourne Quarter (Melbourne, Australia), Paya Lebar Quarter (Singapore).
Lendlease Group has been in the construction business for 60 years and as at 30 June 2019, it has a backlog revenue of $15.6 billion. Its construction business involves project management, design and construction services for both internal and external clients across a range of sectors such as residential, office, retail.
Lendlease Group also manages $35.2 billion of funds globally on behalf of 150 investors including the world’s largest sovereign wealth funds, pension funds and insurance companies.
LREIT’s portfolio remains the same since the listing in October as it has yet to acquire properties. Portfolio comprises of 313@somerset, a shopping mall in Singapore located right at the heart of Orchard and Sky Complex, a freehold three office buildings located in Milan, Italy.
As of the latest financial result in May, 313@somerset contributes 65.9% of LREIT’s Net Property Income for the reporting period from 2 October 2019 till 31 March 2020 while Sky Complex contributes the remaining 34.1%.
313@somerset is a prime retail mall which spans across eight retail levels, comprising three basement levels and five levels above ground. 313@somerset is strategically located at the heart of Orchard Road, the mall has direct access to Somerset MRT station and it attracts an average of 45.5 million per annum for the past three financial years.
In the latest financial release, LREIT disclosed that 313@somerset’s traffic slumped 24% to 8.6 million for the period January to March 2020, while sales fell about 30% to $49.2 million. We should expect poorer operating data come 11 August 2020 as it announces its Q4 result for the financial year ending 30 June 2020.
As part of the Government to rejuvenate Orchard Road as a vibrant lifestyle destination that offers an exceptional experience beyond retail, Somerset will undergo a rejuvenation exercise to include more youth-oriented dining and entertainment offerings. One of the areas for rejuvenation will be the Grange Road car park redevelopment.
Recently, LREIT won the tender to redevelop Grange Road car park into a plug and play event space. To be operational by the second quarter of 2022, the redevelopment will be a first of its kind lifestyle experience along Orchard Road, with multiple dedicated event spaces, an independent cinema, hawker stalls serving local delights and a food and beverage attraction.
LREIT hopes that with the tender win, it will strengthen its retail and lifestyle presence in Somerset. LREIT prides itself on being able to attract online brands that appeal to younger generations such as Love, Bonito, Pomelo and Style Theory to open a brick and mortar store at 313@somerset. With this tender win, it might draw more traffic and sales for 313@somerset.
Sky Complex, comprising three office buildings, is a Milan property that is currently leased to Sky Italia, owned by Sky Limited, which is in turn part of Comcast Corporation, the largest broadcasting and cable television company in the world by revenue. The property is easily accessible via the public transport system.
The property is fully leased to Sky Italia on a single lease on a 12 + 12 year lease term since 2008. Upon the expiry of the first 12 year lease, the tenant has decided not to vacate the property. Therefore, the next lease expiry will be in May 2032. There’s a break clause at the end of the second sixth year lease in 2026. This results in the WALE for the next break option date in 2026 to be 6 years and 12 years until the second lease expires in 2032.
The lease has a triple net lease structure, where the tenant is responsible for the operating expenses of the property thus minimising operational costs and risks for LREIT. In addition, The rent is subject to an annual increase of 75% of Italian National Institute of Statistics’ consumer price index variation starting from the second year of lease.
Overall Occupancy Rate for LREIT currently stands at 99.8%. Occupancy rate at 313@somerset remains stable as at March 2020. Moving forward, due to the pandemic impact to the retail industry, I foresee that occupancy rate should be lower. The occupancy rate for Sky Complex has been 100% as it is entirely leased to Sky Italia, owned by Comcast Corporation for its main headquarters.
WALE by Gross Rental Income and Net Lettable Area (NLA) stand at 4.9 years and 9.9 years respectively. This figure remains unchanged from its prospectus last year. The NLA figure is higher as the Milan property has a WALE of 12.9 years. However, the Milan property only contributes about 35% of Net Property Income, so it is important to look at the Gross Rental Income of 4.9 years instead.
Comparing the Lease Expiry Profile from the prospectus and the latest financial result, it seems that the majority of the leases that will expire in 2020 would have already been renewed. In my view, I think that managers are prudent in only trying to renew leases that will expire in a year. As the latest result figure’s reporting period is in March, which is before circuit breaker kicks in, I do not foresee that rental reversion for lease expiry for FY2020 to be really bad.
Overall, I am a big fan of higher WALE as this means that the management does not need to find tenants thus providing stability in rental income. In this poor market outlook, it is really a blessing for the WALE based on Gross Rental Income to be that high as it gives managers sufficient time to negotiate with tenants when the industry is better after Covid’s impact subsides.
I have to stress that even though Milan property lease only expires beyond 2024, for it to contribute only 35% of Net Property Income, I feel that the stability effect that high WALE offers is quite negligible.
Top 10 Tenants
LREIT has over 150 tenants across 14 sectors. LREIT’s top 10 tenants contributed 51.5% of Gross Rental Income as of the month of June 2019, with Sky Italia contributing 28.9% of the Rental Income.
313@somerset has 149 committed tenancies as of June 2019. The mall positions itself as a shopping destination and a meeting place for the fashion forward individuals. It focuses on three main trade sectors which include Food and Beverage, Fashion and Accessories and Entertainment. 38.6% of leased NLA is Food and Beverage while Fashion and Accessories and Entertainment leased NLA stand at 29% and 8.8% respectively. 313@somerset has three major tenants that contribute more than 3% each of LREIT’s GRI, they include Zara, Food Republic and Cotton On.
Rental Reversion and Escalation
As Sky Complex leases expire beyond 2024, any rental reversion data from LREIT belongs to 313@somerset. According to its latest financial result, 313@somerset registered positive rental reversion of 0.6% for YTD ended 31 March 2020.
As stated in their prospectus, 90.8% of LREIT’s NLA has an escalation component built in place to provide a stable and growing rental income stream. This means that the REIT can grow organically for the next few years without the need to acquire properties to increase its gross revenue.
The main focus should be on 313@somerset where 58.9% of the 313@somerset’s NLA has an average annual built-in rental escalation of 3%. Nothing wrong in this statistics as I find it impressive that the mall can command such built-in rental escalation for close to half of its NLA. In view of the pandemic situation, the issue we should look at is how much of a positive or negative difference is the price of new leases signed compared to the rental rates previously.
In this section, we will look at the balance sheet of LREIT. Debit is very important for every REIT as this is one of the few methods that REITs finance to acquire properties.
We will first look into the Gearing Ratio of LREIT which is standing at 35.9%, slightly higher than the 34.9% as at 31 December 2019. MAS immediately raised the leverage limit for Reits in April to 50% from 45%. This is so that REITs have greater flexibility to manage their capital structure amid the pandemic.
For REITs to raise their leverage limit to 50%, REITs have to maintain a minimum ICR of 2.5 times before doing so. However, MAS has deferred this requirement to 1 January 2022 as it is likely that the REITs’ ICRs are likely to come under pressure in the near term due to the impact of pandemic on their earnings and cash flow.
LREIT’s Interest Coverage Ratio is one of the highest among REITs in Singapore, where it stands at 11.2x as of 31 March 2020. Interest Coverage Ratio means how much times its EBIT can cover the interest expense. It also determines how easily a company can pay interest on its outstanding debts. Therefore, a higher interest coverage ratio will be preferred. Furthermore, LREIT’s is comfortable in raising its leverage limit to 50% as its ICR is healthy.
Measures taken by Lendlease Reit and the Government
Tighter measures were implemented after DORSCON level was raised to Orange in early February to minimise further spread of COVID-19.
Safe distancing measures were introduced on March 13. Safe distancing measures were further enforced one week later. For example, both Retailers and Food and Beverage outlets have to ensure that there is sufficient space in between so as to practise safe distancing.
Circuit Breaker period was announced in April which ran from April 7 to 1 June. Only essential services continued to operate. During this period, the Prime Minister urged citizens to stay at home as much as possible and only leave the house for essentials needs and wear a mask outside.
This affected the retail industry significantly as tenants saw lesser crowd in Shopping Mall thus affecting its sales. Before Circuit Breaker was introduced, LREIT disclosed that 313@somerset‘s traffic slumped 24% to 8.6 million for the first three months of 2020, while sales fell about 30% to $49.2 million during the same period.
LREIT, like many other retail REITs, introduced their own Tenant Support Package. The Tenant Support Package, will be granted to eligible retailers of 313@somerset, which includes up to 1 month of rental rebate, flexible rental payment scheme, conversion of cash security deposits into banker’s guarantee and an option to take up the atrium and advertising spaces on a complimentary basis.
The Government has stepped in during this period. Under the Resilience Budget, owners of retail malls will be granted rebates of up to 100% on their property tax payable, which is equivalent to slightly more than one month’s rental. Landlords are required to unconditionally and fully pass on to their tenants the rebate.
Under the COVID-19 (Temporary Measures) Act, tenants who cannot fulfil contractual obligations are able to seek temporary relief from paying rent for a period of up to six months from April to October, which may be extended for up to a year depending on the COVID-19 situation. This may result in rental payments to be deferred thus resulting in LREIT’s financial performance to be under pressure for the coming quarters.
Further Rental Relief for SME Tenants had been introduced in the Fortitude Budget. SME tenants which do not have more than $100 million in annual turnover with qualifying leases commencing before 25 March 2020, will be entitled to a cash grant of about 0.8 months of rent to offset their rental cost. Landlords are required to pass on the benefit to their SME tenants.
Together with the Property Tax Rebate announced earlier for 2020 which property owners are required to pass on fully, this brings total government support to about two months for SME tenants of qualifying commercial properties.
What’s next for Lendlease Reit
The start of phase 2 on 19 June has benefited the retail industry as the majority of trade sectors such as fashion, fitness and education will be allowed to resume operations. In addition, consumers can now dine-in at food and beverage outlets. This results in more than 90% of all retail tenants in most malls to resume operations. Cinemas resumed its operations on 13 July 2020, with safe management measures in place such as the one meter safe distancing seat configuration.
Retail malls landlords such as CapitaMall Trust and Frasers Centrepoint Trust are seeing sharp rises in traffic ever since the lift of circuit breaker. For CapitaMall Trust, it reported that traffic almost doubled after circuit breaker ended in June and traffic is now recovered to 53% of January 2020 level. On the other hand, Frasers Centrepoint Trust saw its traffic increased by close to 80% to about 1.7 million shopper traffic. However, this is still 38.9% lower compared to a year ago due to safe distancing and traffic density measures still in place.
I believe that 313@somerset will experience similar recovery as those malls owned by CapitaMall Trust and Frasers Centrepoint Trust. To recap, 313@somerset is strategically located at the heart of Orchard Road, the mall has direct access to Somerset MRT station. About 39% of NLA are leased to Food and Beverage sector where it will greatly benefit from the phase 2 re-opening.
On the brighter side, data from CBRE suggests that the retail supply pipeline will fall sharply to 0.25m sqf per annum from 2020 to 2023, significantly lower than the 5 year historical average of 1,37 mil sq ft per annum. Only 10.3% of the retail supply pipeline will be located in Orchard sub-market. Due to demand and supply, the low supply will soften downward pressure in rental rates and cushion a hike in vacancy rates which is now intensified by the pandemic.
At the last closing price of $0.63, it is trading at a discount of 30% off its Net Asset Value of $0.81. Looking back at its share price history since January, the extensive sell off of 50% is in line with other weaker retail commercial REIT such as Starhill Global Reit.
I believe that at this current valuation, LREIT presents itself as an attractive REIT investment that still has plenty of room to grow. This is because it has access to a secured development pipeline through right of first refusal provided by its Sponsor, Lendlease Group or through third party.
For potential investors, I believe that at this current valuation, LREIT presents itself as an attractive REIT investment that has plenty of room to grow. This is because it has access to a secured development pipeline through right of first refusal provided by its Sponsor, Lendlease Group. LREIT can also source for third party properties if the property ticks all the boxes for accretive acquisition.
For current investors like myself, depending on how long your investment time frame is, I would suggest to hold on to it even though it is down 32% YTD. I am confident that Covid will be eradicated in months or a year’s time. This presents an opportunity to average down to lower your cost price. However, I have to warn that since this REIT has a lot of ROFR properties to be injected, you have to set aside extra capital to participate in equity raising activities when the time comes.
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