Suntec REIT - DBS Research 2020-10-12: Maiden Purchase At London’s West End


Suntec REIT - Maiden Purchase At London’s West End

  • Suntec REIT's first foray into London West End with the acquisition of Nova Properties for GBP430.6m (c.S$766.5m) and NPI yield of 4.6%.
  • Plans to deleverage over time possibly via issuance of perpetual securities and/or asset divestment; equity fund raising unlikely at this price, in our view.
  • On route to recovery - Suntec Mall tenant sales have returned to c.70% of pre-COVID levels but Suntec Convention still faces challenges due to the current social distancing restrictions.

Suntec REIT's maiden purchase at London’s West End

  • Suntec REIT (SGX:T82U) makes its entry into London with the acquisition of a 50% stake in Nova Properties, comprising two Grade A office buildings with ancillary retail (Nova North, Nova South and The Nova Building) located in the heart of Victoria, West End, London for GBP430.6m (c.S$766.5m) from Canada Pension Plan Investment Board (CPPIB). The remaining 50% stake will be held by Land Securities Group, the developer and asset manager of the Nova Properties. See Suntec REIT Announcements.
  • Based on media reports, CPPIB had been in talks previously with ARA Asset Management Ltd on the former’s planned sale of its 50% stake in the GBP900m development but was put on hold in March 2020 due to the COVID-19 outbreak. This marks Suntec REIT’s first foray into the UK office market.
  • Key Highlights of the Acquisition:
    • The agreed property value is GBP430.6m (c.S$766.5m) vs valuation of GBP436m (with income guarantee) and GBP431.5m (without income guarantee).
    • Total acquisition cost is GBP439.4m.
    • The asset comprises two Grade A office buildings with NLA of 480k sqft (85.9%) and ancillary retail with NLA of 79k sqft (14.1%) which was completed in 2016/2017. Total NLA is 559k sqft. The Nova Properties is the newest large-scale addition to the West End.
    • The asset is strategically located in London’s prime West End business district, opposite Victoria Station (direct train ride to Gatwick Airport) and within proximity to landmark attractions in West End such as Buckingham Palace, Westminster Abbey and the Houses of Parliament.
    • The NPI yield based on in-place rentals is 4.6%, which we understand to be similar to that on a market equivalent basis.
    • Income guarantee of up to GBP5m (c.S$8.9m) for two years. The amount is equivalent of two years of the retail income.
    • 100% committed occupancy with WALE of 11.1 years with no expiries until 2027.
    • Office tenants contribute c.90% of total rental income with WALE of 10.6 years. Top 10 tenants contribute 70.5% of GRI. Key office tenants include Atkins, The Argyll Club, Vitol and BlueCrest. Government and government-linked offices contributes 9.8% of GRI due to its location.
    • Average rents at c.GBP76 psf p.a., in line with market rents of GBP70-80 psf p.a.
    • The acquisition will be 100% debt-funded, with 46% GBP-denominated loan and 54% SGD-denominated loan.
    • Estimated weighted average cost of borrowings is 2.6%.
    • Based on FY19 proforma figures, the DPU accretion is estimated to be 3.6%. Based on 1H20 annualised DPU, the DPU accretion is estimated to be 4.9%.
    • Suntec REIT's gearing is expected to increase from 41.3% to 45.2%.
    • NAV as at 30 June 2020 is expected to remain relatively flat at S$2.09.
    • Proposed acquisition needs shareholders’ approval by way of an Ordinary Resolution with the EGM expected to be held in December 2020. Expected completion in December 2020.

Our View

Expanding overseas portfolio with medium-to-long term target contribution of 30-40%.

  • With the proposed acquisition of Nova Properties, Suntec REIT has taken its first steps into investing in the UK office market as it continues to seek opportunities to expand its overseas portfolio with prime Grade A offices in key gateway cities. The addition of quality assets with long WALE to its portfolio adds income visibility to Suntec REIT and reduces near-term earnings risks, thus securing stable returns to unitholders in the near-to-medium term.
  • Management expressed its plans to increase its overseas portfolio by 30-40% in the medium-to-long term and the addition of another developed market will widen its network of opportunities.

DPU-accretive acquisition to drive underlying DPU growth with potential upside from rent review in 2023.

  • We believe the DPU-accretive acquisition will drive underlying DPU growth and further reduces the reliance on its capital distribution. The long WALE and 100% committed occupancy will provide stable earnings contribution from the asset.
  • In addition, possible upside could be derived from rent review generally every five years at market or existing rent, whichever is higher.

Not an equity fund-raising (EFR) at this price; REIT should tap perpetual securities instead.

  • Suntec REIT’s gearing will rise to 45.2%, one of the highest among peers. We do not subscribe to the view that Suntec REIT will tap the equity market for funds to pare down gearing as it will not be beneficial to unitholders at this price.
  • While investors may be uncomfortable at this high gearing of 45.2% relative to its peers, we see a more measured pace of deleveraging over time with potential asset divestments and tapping the perpetual market to manage its earing.
  • Concerns that gearing could rise further at the end of 2020 on the back of potential asset devaluations may be valid. However, in view of the 1.5-3.0% devaluations seen in office/retail properties year-to-date (YTD), we do not see gearing hitting close to 50%.
  • To fund the acquisition of the Nova Properties, we believe that Suntec REIT can address this through tapping other means of funding. Perpetual securities are one of the options which has reopened as per our report: Singapore REITs - DBS Research 2020-09-15: S-REIT Perpetuals Market Reopens.
  • Management estimates that if the proposed acquisition is partly funded by perpetual securities, DPU accretion is estimated to be c.2.5% while gearing will be < 45%.

On route to recovery.

  • Separately, despite the challenges arising from the COVID-19 pandemic, Suntec REIT's management is encouraged to see that Suntec City Mall’s tenant sales have progressively recovered to c.70% of pre-COVID levels while its office portfolio has remained relatively stable. However, Suntec Convention still faces challenges given the current social distancing restrictions.
  • While we acknowledge that recovery could be gradual for Suntec City Mall, the progressive relaxation and the return of office workers will bode well for Suntec City Mall and its office buildings as the economy gradually recovers. With increased effort to relax travel border restrictions, we believe we will continue to see steady progressive return of traffic.
  • Suntec REIT, currently trading at 0.7x P/NAV (close to -1SD), has limited downside risks and is poised to ride on the recovery.
  • See Suntec REIT Share Price; Suntec REIT Target Price; Suntec REIT Analyst Reports; Suntec REIT Dividend History; Suntec REIT Announcements; Suntec REIT Latest News.

Rachel TAN DBS Group Research | Derek TAN DBS Research | 2020-10-12
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