OUE Commercial REIT - DBS Research 2018-09-11: Proposed Acquisition Of OUE Downtown

OUE Commercial REIT - DBS Group Research 2018-09-11: Proposed Acquisition Of Oue Downtown OUE COMMERCIAL REIT SGX:TS0U

OUE Commercial REIT - Proposed Acquisition Of OUE Downtown

  • To acquire the office component of OUE Downtown for S$908m or NPI yield of 5.0% (including income support).
  • Valuation of S$1,713 psf is at a discount to recent office transactions in Singapore after adjusting for land tenure.
  • Near term DPU dilution from rights issue but transaction to boost medium organic growth profile thereafter.
  • Maintain HOLD, Target Price of S$0.67.

What’s New

  • OUE Commercial REIT (OUECT) announced that it has entered into an agreement to acquire the office component of OUE Downtown from its Sponsor for S$908m, which is at a 2.0-3.9% discount to the appraised value of S$945m and S$927m conducted by Colliers and Savills respectively.
  • The purchase consideration equates to S$1,713 sqft and NPI yield of 5.0% (includes rental support and adjustment for one-off expenses) or an estimated NPI yield excluding income support of mid-to-high 3%.

~ SGinvestors.io ~ Where SG investors share
  • Total cost of acquisition including stamp duty, financing related fees, professional and acquisition fees amounts to S$955.9m. 
  • The acquisition is expected to be partially funded through an underwritten and renounceable rights issue on a basis of 83 rights units for every 100 existing units of OUECT raising gross proceeds of S$587.5m. The rights price of S$0.456 is at a 31.4% discount to the last closing price of S$0.665 and 20% discount to theoretical ex-rights price (TERP) of S$0.570.
  • The Sponsor, beyond participating in its pro-rata entitlement in the rights issue, has shown its belief in the long-term potential of OUECT by acting as a sub-underwriter for the portion of the rights issue to be underwritten by Credit Suisse and OCBC (c.66% of the total number of underwritten rights unit). The Sponsor will be paid a sub-underwriting commission of 1.8%. 
  • We understand OUECT will seek to fund the remainder of the acquisition with a 3-5 year term loan with an interest rate of c.3.7%.
  • Completion of the transaction is expected to be end October/early November.
~ SGinvestors.io ~ Where SG investors share

OUE Downtown overview

  • OUE Downtown is a recently refurbished mixed-use development, comprising two high rise towers - OUE Downtown 1 is a 50-storey building and OUE Downtown 2 is a 37-storey building. The development also includes a retail podium and multi-storey carpark.
  • The Grade A office space is located between 35th to 46th floor of OUE Downtown 1 and 7th to 35th floor of OUE Downtown 2. Total office NLA stands at 529,981 sqft, comprising 88,400 sqft in OUE Downtown 1 and 441,581 sqft in OUE Downtown 2.
  • Committed occupancy as at 30 June 2018 stood at 95.1%.
  • The current office passing rent of c.S$7 psf/mth is below the current market rent for the Shenton Way/Tanjong Pagar submarket of S$8.43 psf/mth. Market rent for the submarket is expected to approach S$8.40-9.00 psf by year-end, according to the independent market research report conducted by Colliers.
  • To provide income stability and to align rental rates of the properties, the Sponsor will provide rental support of up to an aggregate amount of S$60.0m or for a period of up to 5 years upon completion if actual rents signed fall below the target rent of S$8.90, S$9.10, S$9.25, S$9.40, S$9.40 psf/mth in 2018, 2019, 2020, 2021 and 2022 respectively.
  • The property has a remaining land tenure of 48 years. The weighted average lease expiry by gross rental income and NLA both stand at 2.0 years. A large proportion of leases expire in 2019 (19.8% of gross rental income), 2020 (41.4%) and 2021 (26.7%).
  • Key tenants include Deloitte & Touche LLP (estimated to account for 23% of OUE Downtown’s revenues), Aviva Ltd (7%) and Moody’s Analytics Singapore Pte Ltd (7%). We understand Deloitte’s lease expires in 2020 with Aviva and Moody’s expiring beyond 2020.

Transaction Rationale

  • OUECT’s rationale for acquiring OUE Downtown includes:
    • Acquiring a property located in Tanjong Pagar which is expected to be transformed into a business and lifestyle hub with two upcoming MRT stations, Prince Edward and Shenton Way, within walking distance.
    • Attractive acquisition price as the property is purchased at 2.0-3.9% discount to the independent valuations and the property’s NPI yield of 5.0% is higher than the 4.0% NPI yield for OUECT’s existing portfolio. Furthermore, adjusting for the land tenure, the property will be acquired at a discount to recent market transactions.
    • Increased exposure to the recovering Singapore CBD office market with the current passing rent c.20.4% below current spot rents in the Shenton Way/Tanjong Pagar area.
    • Further diversifies OUECT’s portfolio and allows OUECT to capture demand across three major office submarkets in Singapore.

Financial Impact

  • Post the acquisition and right issue, aggregate leverage is expected fall to 39.8% from 40.3% as at 30 June 2018.
  • Based on OUECT’s estimates, proforma 2017 DPU yield of 6.7% (using closing price of S$0.665 and assuming the private placement, debt issuance and redemption of the CPPU’s were completed on 1 January 2017) is expected to drop to 6.2% (based on TERP of S$0.57). However, based on the rights price of S$0.456, the proforma yield would come in at 7.8%.

Our Thoughts

  • We believe some investors will react negatively to the near-term dilution in DPU and the rental support required for the transaction.
  • However, in the medium term, we believe this transaction provides the REIT with a stronger organic growth profile given its increased exposure to the upturn in the Singapore office market.
  • Furthermore, as Deloitte’s lease expires in 2020, one to two years before a jump in office supply in 2021/2022, we see a potential vacancy risk for the building. Nevertheless, with Deloitte potentially having to notify its intension a year in advance, we believe in the worst case, OUECT would have sufficient time to backfill the space and achieve higher rents than if Deloitte stays.
  • In terms of valuation, we believe the purchase consideration is reasonable considering the tight yields for Singapore office buildings currently, the “short” land tenure for the building as well as the potential upside in rents and occupancy.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2018-09-11
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