DBS Group Research has initiated coverage on Elite Commercial REIT with a “buy” call and a target price of 80 British pence ($1.49), implying an upside of some 21%.
The target price also implies a yield of 7.6% and 8.2% for FY2021 and FY2022 ending December respectively.
DBS analyst Dale Lai and the Singapore research team highlight that the REIT is the only UK-focused listed REIT in Singapore and holds a “unique position”, given that more than 99% of its portfolio gross floor area (GFA) is leased out to the UK government.
Elite Commercial REIT’s portfolio of 58 properties across the UK has 100% occupancy with a weighted average lease expiry (WALE) of 7.2 years. The Department for Work and Pensions (DWP) is the REIT's primary tenant, making up approximately 92.6% of its gross rental income in 1Q2021.
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The way the DBS team sees it, the REIT’s portfolio offers strong visibility to distributions. Assuming the tenant does not terminate its lease on the permissible break dates, 93.2% of total portfolio rent will only expire in 2028.
DBS believes this is unlikely for DWP, given that the properties leased are “crucial infrastructure integral to UK’s social fabric”. DWP has also invested in the maintenance and upkeep of the properties, indicating a low likelihood of breaking the lease.
In addition, DBS points out that DWP, which is responsible for welfare, pensions and child maintenance, serves as a counter-cyclical occupier, thus providing stable income throughout economic cycles. “The REIT has also consistently achieved c.100% of rent collection in advance since listing, notwithstanding UK lockdowns and Brexit,” the team says.
64.5% of the REIT’s portfolio has lease break options that will come into effect in March 2023. Assuming they are not exercised, the leases will continue until March 2028. Presently, DBS has taken a conservative stance and assumed half of the break options will be exercised, though they believe this to be unlikely.
To that end, the team anticipates a significant uplift in valuations. “Given that it is highly unlikely that the tenants will exercise this break option, we can expect to see a significant uplift in book valuations, bringing P/NAV down to less than one time once we confirm that the option is not exercised by Mar 2022,” they remark.
The REIT’s portfolio is also bolstered by inflation-linked rental escalations embedded in the leases, which are reviewed every 5 years and subject to an increase between 1-5%. “With the next rent review in April 2023, we can expect to see an increase of c.8% in rental growth for leases with rent review, resulting in c.7.4% rental growth for the portfolio,” DBS says,
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DBS’s target price for the REIT is derived using the discounted cashflow method, in view of its relatively stable and visible cash flows arising from its portfolio.
Key risks to their view include tenancy and concentration risks, given the predominant reliance on the UK government, and the proportion of revenue tied to lease agreements with break options in 2023.
As at 3.57pm, units in Elite Commercial REIT are up 1 pence or 1.5% higher at 67.5 pence.
Photo: Elite Commercial REIT
