Keppel-KBS US REIT - DBS Research 2018-09-25: Maiden Acquisition In Seattle

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KEPPEL-KBS US REIT SGX:CMOU

Keppel-KBS US REIT - Maiden Acquisition In Seattle

• Acquires Westpark portfolio in Seattle for US$169.4m or initial NPI yield of 6.80-6.85%.
• Yield-accretive transaction to be funded via rights issue or preferential offering.
• Under rented portfolio in a rising Seattle market leveraged to the technology sector.
• Maintain BUY, Target Price of US$0.95.

What’s New - Deepens exposure to growing Seattle market

• Keppel-KBS US REIT (KORE SP) announced its maiden acquisition with the signing of an agreement with KBS Strategic Opportunity REIT (SOR), the REIT that originally seeded Keppel-KBS US REIT, to purchase the Westpark Portfolio for US$169.4m, a 4.8% and 6.6% discount to two independent valuations by Cushman & Wakefield and JLL respectively. The acquisition price translates into an initial NPI yield of 6.80-6.85%.
• The Westpark Portfolio is a business campus comprising 21 freehold buildings in Seattle- Tacoma-Bellevue Metropolitan Statistical Area (Seattle MSA).
• Strategically located in Redmond, the property is within the strongly performing Eastside office market in Seattle MSA, where Keppel-KBS US REIT’s two other properties, The Plaza Buildings and Bellevue Technology Center, are located. Redmond is a key technology hub with the headquarters of Microsoft Corporation and Nintendo America’s headquarters.

~ SGinvestors.io ~ Where SG investors share

• According to Cushman and Wakefield, Seattle MSA is experiencing strong leasing demand from the technology and professional services sectors. ~ S G investors . io ~ Where SG investors share Coupled with a supply-constrained market with limited available site for new development, it is expected to be one of the strongest US office markets with steady rent growth of c.4% by 2020.
• The acquisition is expected to be funded via an equity fund-raising, debt (all in borrowings costs of c.4.5% fixed for five years) and internal cash resources.
• The acquisition is subject to EGM approval with the structure of the equity fund-raising to be determined at a later date.

Westpark Portfolio Overview

• Westpark Portfolio a freehold property has a total net lettable area of 781,966 sqft with a current committed occupancy of 97.7%. The weighted average lease expiry (WALE) stands at 4.3 years with the top 10 largest tenants having a WALE of 5.3 years. In the near term, 7.2%, 12.0% and 17.9% of leases by cash rental income (CRI) are due to expire in 2018, 2019 and 2020 respectively. ~ S G investors . io ~ Where SG investors share
• All leases at the property have inbuilt rental escalations of between 2% and 3% p.a.
• Since the acquisition of KBS SOR in February 2016, the Westpark Portfolio was repositioned with extensive capital improvements including the conversion of under-utilised space to an amenities centre. This has resulted in increased demand from the technology and professional services sector.
• The high growth technology sector now contributes 34.8% of the property by NLA, with professional services forming 38.2% of its NLA. The top ten tenants contribute c.44.1% of June 2018 CRI, with the largest tenant being Oculus VR Inc, an American Technology company backed by Facebook Inc, at 15.6% of CRI.
• As Oculus only entered into three leases on 10 August 2018, as per the terms of the lease agreement, it has not commenced paying rent. Thus, KBS SOR and Keppel-KBS US REIT have entered into a free rent agreement whereby KBS SOR will pay Keppel-KBS US REIT from the date of the closing of the acquisition until the lease commence dates of December 2018 and by May 2019, a total rent of US$145,390, as compensation for the period prior to the commence of the leases. In addition, as the three leases with Oculus contains three months of free rent, KBS SOR will pay Keppel-KBS US REIT an amount equal to the agreed free rent of US$463,058. ~ S G investors . io ~ Where SG investors share
• We understand in place rents are 8-10% below market rents, which presents potential positive rental reversions going forward.

Financial Impact

• Based on Keppel-KBS US REIT’s estimates, under two equity-raising scenarios, it expects the transaction to be yield accretive.
• Under a rights issue scenario with a rights price of US$0.59 per unit that would raise c.US$102.3m, its annualised proforma DPU yield is expected to increase to 7.2% (based on TERP of US$0.7854) up from 7.1% (based on unit price of US$0.84). ~ S G investors . io ~ Where SG investors share
• Under preferential offering of new units at US$0.78 that would raise c.US$101.3m, its annualised proforma DPU yield is expected to increase to 7.2% (based on unit price of US$0.84) up from 7.1% (based on unit price of US$0.84).
• Under both scenarios, its aggregate leverage is expected to increase from 33.1% to 34.1%. NAV per unit is expected to fall to US$0.88 should Keppel-KBS US REIT undertake a preferential offering and US$0.83 for a rights issue, from US$0.89 currently.
• Following the acquisition of Westpark Portfolio, it will contribute c.17.2% and c.13.0% of Keppel-KBS US REIT’s enlarged portfolio by valuation and CRI respectively.
• In addition, the Seattle MSA will represent c.55.2% and c.42.9% of Keppel-KBS US REIT’s enlarged portfolio by valuation and CRI, respectively, up from c.45.8% and c.34.4% previously.

Our Thoughts

• While the transaction is yield accretive, we believe some investors may be cautious on this transaction should Keppel-KBS US REIT decide to undertake a rights issue given the expected decrease in absolute DPU. Nevertheless, this is offset by the Westpark Portfolio being under rented, which provides for healthy rental reversions going forward and enhances Keppel-KBS US REIT’s visible organic growth profile. ~ S G investors . io ~ Where SG investors share
• Furthermore, while we are positive on the deepening of Keppel-KBS US REIT’s presence in Seattle MSA given the favourable demand/supply dynamics and expectations of rising market rents over the next few years, we do acknowledge some potential investor concerns over the increased concentration risk to a single market, which Keppel-KBS US REIT may need to address in the medium term.
• We maintain our BUY call and Target Price of US$0.95 as well as our earnings/DPU estimates for now, pending more clarity on the details of Keppel-KBS US REIT’s equity funding plans.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2018-09-25

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