SINGAPORE (Nov 27): DBS Group Research is maintaining its “buy” call on AIMS APAC REIT (AA REIT) with an unchanged target price of $1.50, citing a positive outlook for the REIT on the back of its latest lease renewal.
In a Wednesday report, DBS analyst Derek Tan highlights that AA REIT had recently inked a renewal agreement with its largest tenant, Optus, for a further 12 years. Optus alone contributes 12.3% of the REIT’s total portfolio gross rental income (GRI).
Located in Macquarie Park, New South Wales, Australia, Optus Centre is fully occupied. According to the brokerage, this translates into a 3.25% annual rental escalation, with two options in place to further extend the lease for an additional 10 years.
“We understand that renewal rents and rent incentives are in line with current market rates for big leases in the same suburb,” says Tan. “For the renewal of such a large space (NLA of more than 906,000 sqft) on a 12-year long lease, we estimate that rent incentives are around the 30% level,” he adds.
In addition, the new lease is expected to commence following the completion of an asset enhancement initiative (AEI), to cater to Optus’ evolving requirements. The property, however, will remain operational throughout the AEI exercise.
Tan opines that this bodes well for AA REIT, as it can well expect a lift of 21.3% in its portfolio valuation compared to end September.
“The new valuation is a 51.4% increase from AA REIT’s acquisition price in 2014,” says Tan. “We estimate that A$60 million was spent on the AEI at Optus Centre, [hence] portfolio gearing will creep up by 1% if there are no changes to portfolio valuations.”
Along with the renewal, Optus Centre’s weighted average lease expiry (WALE) will increase to 13.6 years, with AA REIT’s portfolio WALE increasing in tandem to 3.80 years from 2.45 years previously.
“With the renewal of the largest tenancy secured, only Eurochem’s lease expiry at the end of 2019 remains to be ironed out,” says Tan, adding that Eurochem is the REIT’s fifth largest tenant and contributes some 7.2% to portfolio GRI.
Looking ahead, the brokerage appears bullish on the REIT’s ability to thrive on the recent lease renewal, among other factors.
“The extension of the master lease ahead of expiry will boost AA REIT’s earnings visibility in the near-to-medium term,” highlights Tan. “While the initial rent is estimated to be slightly lower than the expiring rent; we see positives from securing the tenant for a long-term lease tenure.”
Adding that the annual escalation are slated to bring cashflows back up in the longer-term, Tan emphasises that further improvement to earnings is expected on the back of additional contributions from Broadriders APAC HQ and the redevelopment of 3 Tuas Avenue 2 from 2H20.
In addition, Tan describes AA REIT as “unique”. Armed with an untapped gross floor area (GFA) of 600,000 sqft, Tan believes that the manager could take advantage of the prime location of selected properties to redevelop into “future-proof assets” such as data centres.
As the industrial markets bottom out, Tan is of the view that the increasingly competitive operating environment would start to abate in 2019 and 2020 amid the decline in new supply.
“AA REIT’s well-spread master lease expiries and WALE would allow the trust to have income stability while having room to ride an anticipated recovery in industrial yields from end-2019/2020,” says Tan.
“Judging by AA REIT’s track record, we believe that it will likely pursue complete redevelopment opportunities in favour of a more resilient, higher-spec portfolio – including data centres (if feasible),” he adds.
However, Tan is quick to note that the anticipated recovery could be derailed by a global economic slowdown, given the strong historical correlation between gross domestic product (GDP) figures and the demand for industrial real estate.
As at 11.39am, units in AIMS APAC REIT are trading 1 cent lower, or 0.7% down, at $1.44. This translates to a price-to-earnings (P/E) ratio of 15.3 times and a distribution yield of 7.05% for FY20F according to DBS valuations.
