IREIT Global - Phillip Securities 2020-01-22: New Parent, New Acquisition, New Outlook

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IREIT GLOBAL (SGX:UD1U)

IREIT Global - New Parent, New Acquisition, New Outlook

• New shareholders provide acquisition pipeline, financial support and operational expertise.
• Attractive yield of 6.9% and recent acquisition to add scale, growth and de-risk portfolio.
• Initiate coverage with an ACCUMULATE and a target price of S$0.885.

COMPANY BACKGROUND

• IREIT GLOBAL (SGX:UD1U) primarily invests in income-producing real estate in Europe, used for office, retail, industrial and logistics purposes.
• Listed in 2014, IREIT Global did not gain much traction with investors due to limited portfolio size and growth prospects. In Nov 2016, Tikehau Capital became a major shareholder in IREIT Global’s trust manager IREIT Global Group Pte. Ltd. (IGG) with an 80% stake. Since then, IREIT Global made a series of management changes which provided IREIT Global better vantage point and control of the operations in Germany.
• Another milestone was reached in Apr 2019, when City Developments (SGX:C09) invested S$59.4mn to acquire a 12.3% stake in IREIT Global at S$0.76 per share. City Developments also purchased a 50% stake from Tikehau Capital in IGG, at S$18.4mn.
• IREIT Global continues to seek diversification and scale by leveraging on Tikehau Capital’s local presence and City Developments’s funding capabilities.
• In Dec 2019, IREIT Global announced its largest acquisition in Spain through a 40:60 joint venture with Tikehau Capital. The deal includes 4 multi-tenanted freehold office buildings across Madrid and Barcelona, which will be acquired for €138.2mn.

STRATEGIC INVESTORS: TIKEHAU CAPITAL AND CITY DEVELOPMENTS

• IREIT Global is managed by IGG, which is jointly owned by Tikehau Capital and City Developments. Tikehau Capital and City Developments each own 50% stake in the trust manager IGG, and 16.3% and 12.3% in IREIT Global respectively.

Tikehau Capital

• Tikehau Capital is an asset management and investment group which manages €23.4 bn of assets under management and is supported by shareholders’ equity of €3.1 bn as at 30 June 2019. It is listed on Euronext Paris (Ticker: TKO.FP) and employs more than 480 staff in 11 offices. Most of its offices are situated in Europe.
• Tikehau Capital operates four business segments – Private Debt, Real Estate, Private Equity and Liquid Strategies. The real estate portfolio under management is valued at €8.5bn, which is relatively on par with private debt – its biggest business segment - at around €8.6bn. Its mandate in real estate is to invest primarily in European commercial real estate in order to achieve higher returns through active asset management. This is in line with IREIT Global’s investment strategy to focus on European real estate.

City Developments

• City Developments is a leading Singapore-listed real estate operating company with a global network spanning across 103 locations in 29 countries and regions. City Developments’s key markets include China, United Kingdom, Japan and Australia. The group’s London-based hospitality arm, Millennium & Copthorne Hotels Limited is one of the world’s largest hotel chains with over 145 hotels worldwide. City Developments is also developing a fund management business and aim to achieve US$5 billion in Assets Under Management (AUM) by 2023.

THE GERMAN ASSETS

• IREIT Global currently holds 5 freehold office properties in its portfolio:
  1. Concor Park – Property with the longest WALE. The property is located in the Aschheim-Dornach commercial area within a large suburban business park about 10km from Munich city centre, the third-largest city in Germany. The 5-storey building with three independent wings and entrances was fully refurbished with a modern office fit-out in 2011. The property operates as a multi-tenanted business park with a central canteen and coffee bar.
  2. Münster Campus – Smallest property in the portfolio by valuation and GRI. Located in Zentrum Nord, one of the largest office locations in Münster approximately 2.5km from the Münster city centre, the campus is within walking distance to the nearest train and bus depot. The development comprises two independent office buildings, Münster North and Münster South. Each 6-storey building is built around an open courtyard for maximum light. The property will be undergoing light modifications to be converted from a single-tenant property to a multi-tenanted office block.
  3. Darmstadt Campus – Property has enjoyed 100% occupancy since IPO. Located in TZ Rhein Main Business Park of Darmstadt, a prime office location approximately 30km south of Frankfurt, the campus is 100m from the nearest bus stop and 1km from the Darmstadt central railway station. The development operates as a single-tenant property and forms the home to the second largest Deutsche Telekom campus in Germany. The property is well-incorporated into the overall Deutsche Telekom campus which provides canteen and other services in the surrounding buildings.
  4. Bonn Campus – Second largest property in the portfolio by valuation and GRI. Located in the Bundesviertel (federal quarter), the prime office area within Bonn. Centrally located in Bonn's prime office area of Bundesviertel (federal quarter), the campus is well-served by regular bus services with the nearest underground train station, U-Bahn, only 100m away. A dedicated footbridge links the development to the global headquarters of Deutsche Telekom. The U-shaped development comprises four 2-, 4- and 6-storey blocks that can be easily subdivided into smaller offices, or function as independent self-contained units. It currently operates as a single-tenant property with a central entrance and a canteen facility for employees
  5. Berlin Campus – Largest property in the portfolio by valuation and GRI. The campus is located in Schreiberhauer Straße in the Lichtenberg district, 6 km east of Berlin city centre. It is also located near the well-established Media Spree commercial centre. Within walking distance to the Ostkreuz railway station, the two fully connected 8- and 13-storey blocks are tailored to the requirements of Deutsche Rentenversicherung Bund, the current single office tenant. The ground floor units are leased to local retailers and service providers.

INVESTMENT MERITS

• We find IREIT Global attractive at for several reasons:

1. Attractive dividend yield supported by stable leases.

• We can expect IREIT Global to deliver dividends at yields of 6.9% in FY20 and FY21 driven by the following portfolio attributes:
  • Blue-chip tenant mix - IREIT Global’s current portfolio is largely made up of single-tenanted leases, with key tenants such as GMG* and Deutsche Rentenversicherung Bund (DRB)** that contributes 86% of the portfolio’s GRI. Both are blue-chip tenants with leases secured on an initial tenure of 15-years coupled with various options for extension. (*GMG is a wholly-owned subsidiary of Deutsche Telekom which is one of the world’s leading integrated telcos. **DRB is Europe’s largest statutory pension insurance company. )
  • Long WALE - The portfolio exhibits an average portfolio WALE by gross rental income (GRI) of 4.4 years, which is higher than the average WALE of 2-3 years for commercial S-REITs. In terms of the portfolio WALE profile, only 0.4% of the leases are due to expire in the next 2 years and only 2% of leases are eligible for a lease break. This structure will provide income stability in the portfolio for at least 2 years.
  • High occupancy levels - Münster Campus (which had a vacant floor since 2017) is currently 100% occupied as at July 2019, bringing the average occupancy of the portfolio up to 99.70%.
  • Healthy gearing levels - IREIT Global’s gearing stands at a healthy level of 36.5%. Interest rate swaps were entered at an all-in cost of debt of 1.5% p.a over 7 years to hedge 100% of the interest of the new loan facilities. There will be no refinancing for its existing debt facilities till FY26.
• IREIT Global is currently leasing its properties at market rates - We do not expect to see positive rental reversions when the leases expire. However, we do expect rental step-ups for the properties when they are due. Rental escalations for most of the properties are based on an inflation mechanism tagged to Germany’s Consumer Price Index (CPI), with the exception of Berlin Campus which is based on fixed step-up rates. The hurdle rates for these properties range between 5-10%. CPI inflation is recognised on a cumulative basis and rental uplift is registered when the cumulative inflation meets the respective hurdle rate. For instance, if inflation increases at 1% per year and the property has a 10% hurdle rate, rental for the property will only see an uplift of 10% at the 10th year. The next rental step-up for Berlin Campus is expected to be 2.5% at 2022.
• With high cashflow visibility stemming from IREIT Global’s long portfolio WALE (4.4 years), high portfolio occupancy levels (99.7%) and blue-chip tenants locked in for the next 2 years, we can expect IREIT Global to deliver dividends at yields of 6.9% in FY20 and FY21.

2. Ability to leverage on financial support, expertise and acquisition pipeline from Tikehau Capital and City Developments.

• Post-acquisition of the 80% stake in IGG, Tikehau Capital has provided IREIT Global with a local footprint and experienced ground team to manage existing properties in terms of asset, tenant and property management. Leveraging on Tikehau Capital’s reputation and presence, IREIT Global is also offered real estate deal flows in France, Italy, Spain, Germany and Netherlands for prospective acquisition opportunities.
• With City Developments’s acquisition of a 50% stake in IGG and 12.4% in IREIT Global, we believe IREIT Global is part of City Developments’s strategic move to build up the real estate fund management business given their target to achieve US$5 billion in AUM by 2023. We are hopeful that City Developments may be able to offer IREIT Global with a European pipeline of assets. In particular, City Developments’s UK properties (Aldgate House and 125 Old Broad Street) offer yields of 4.5-5%.
• The recent acquisition of the Spanish portfolio showcases the multiple layers of support provided by both shareholders to build IREIT Global as their European REIT platform:
  • Tikehau Capital
    • IREIT Global was able to secure the properties at a collective discount to their valuations by taking advantage of Tikehau Capital’s network and knowledge of the local markets.
    • Offered IREIT Global a call option to acquire the remaining 60% of the portfolio at market price with a floor price. The call option is for 1.5 years.
    • Can possibly provide IREIT Global with an experienced team in Spain to manage new properties in terms of asset, tenant and property management.
  • City Developments
    • Extended a bridging loan of €32.0mn to IREIT Global in order for it to secure the properties, as the sale process required speed and execution certainty.

3. Acquisition to add scale, growth and diversification to IREIT Global.

• Post addition of the Spanish portfolio, the enlarged REIT will provide greater diversification in terms of location, asset and tenants. The valuation of the enlarged portfolio is expected to increase by 10.5% to €581.7mn. The acquired properties are all freehold properties, which compares favourably with other S-REITs which properties are leased up to 99 years. The properties also have a yearly rental step-up linked to the Spanish CPI.
• Post-acquisition of the 40% stake, IREIT Global will shed its German-pureplay status and will have a 9.5% exposure to Spain by AUM. The largest asset by contribution (Berlin campus) will also see a reduction of 4% by valuation within the enlarged portfolio. The multi-tenanted Spanish properties will introduce 28 new tenants, increasing tenant and trade diversification to IREIT Global’s portfolio.
• The overall occupancy rates for the Spanish portfolio stands at 80.9%. This brings the average occupancy rates of the enlarged portfolio to 92.6%. Therefore, there is a potential for IREIT Global to increase occupancy rates through active leasing efforts and bring the under-rented properties closer to market levels. Aggregated for the portfolio, the passing rents for these properties are approximately 7.5% below the current market rents. IREIT Global will also be able to benefit from positive rental reversions when current leases are renewed at potentially higher rental rates.

RISK FACTORS

1. Concentration risk by country, asset and tenant mix:

• All the properties in IREIT Global's current portfolio are based in Germany, with GMG holding more than 50% of the tenant mix. Post-acquisition, the enlarged portfolio still has an exposure of 90.5% by valuation to Germany. Berlin Campus, which is IREIT Global’s largest asset, contributes 32% of the portfolio’s GRI.

2. Less organic growth opportunities:

• Rental escalations for most of the properties are based on an inflation mechanism tagged to the Germany’s Consumer Price Index (CPI), with the exception of Berlin Campus which is based on a fixed step-up rate. Most of the leases are also locked in till 2022. German CPI remains muted, averaging at 1.1% p.a. over the past 7 years. This can weigh on rental escalation rates.

3. Foreign exchange risk:

• Significant depreciation of EUR/SGD beyond our estimates will impact forecasted DPU, as approximately 20% of the distributable income to be repatriated back to Singapore is unhedged.

VALUATION

• We initiate coverage on IREIT Global with an ACCUMULATE rating and a DDM-derived target price of S$0.885. Our valuation assumes that the acquisition of the Spanish properties will be fully funded by debt. With a DPU yield of 6.9%, this implies a total upside of 15.4%.
• Our target price is based on a four-year projection, cost of equity of 7.1% and terminal growth rate of 1%. In our models, we estimated a 2-3% annual escalation rate for the leases. We assume a EUR/SGD exchange rate of 1.52 and 1.50 for FY20 and FY21 respectively given that interest rates are hedged one year ahead for approximately 80% of the distributable income.
• We conducted a sensitivity analysis to anticipate the impact of changes in EUR/SGD on IREIT Global’s forecasted distributable income to unitholders. Based on the analysis, every 2% increase in EUR/SGD will result in an 0.1% increase in dividend yield.
• Continue to read the attached PDF report for detailed analysis.
• See also IREIT Global Share Price; IREIT Global Target Price; IREIT Global Analyst Reports; IREIT Global Dividend History; IREIT Global Announcements; IREIT Global Latest News.

Tan Jie Hui Phillip Securities Research | https://www.stocksbnb.com/ 2020-01-22

SGX Stock Analyst Report ACCUMULATE INITIATE ACCUMULATE 0.885 SAME 0.885