SINGAPORE (Nov 25): On Nov 1, Ascendas Real Estate Investment Trust (REIT) announced the proposed acquisition of 28 properties in the US and two business parks in Singapore for $1.66 billion from immediate parent Ascendas-Singbridge, now part of CapitaLand. Including expenses, the acquisition cost is likely to be $1.706 billion. This is being funded via a 16-for-100 rights issue at $2.63 a unit to raise $1.31 billion.
Since the properties are interested-party transactions, independent unitholders can vote for or against the deal in an extraordinary general meeting held on Nov 27. SAC Capital, who is the Independent Financial Adviser, has advised the independent directors and the audit and risk committee to urge independent unitholders to vote in favour of the proposed acquisitions.
Asked why Ascendas REIT opted for a rights issue instead of a placement and preferential equity fundraising (EFR), William Tay, CEO of Ascendas REIT’s manager, said, “We wanted to take the opportunity to thank the unitholders by allowing all of them to participate in the rights. This is a good price for unitholders if they want to continue with us in this journey.”
Could the real reason be different, such as lower cost of funding and a simplified US structure of the company that gives a better tax shield? JPMorgan is joint lead manager and underwriter of the rights issue. It is also the largest bank in the US.
It turns out that Ascendas REIT is taking on largely onshore debt for five years, with a 100-basis-point spread, taking the total cost of US dollar debt for the acquisition to 2.6% to 2.7% a year. As a result of onshore interest expense and depreciation, the REIT’s effective tax rate will be in single digits. There were gasps of surprise at the cost of debt and the effective tax rate when they were revealed during the results and acquisition briefing on Nov 1.
“Given our A3 credit rating, we were able to get very good support from Canadian and US banks and, as a result, the pricing for this loan is very attractive. This is cheaper than five-year Singapore dollar debt,” Tay says.
With a clean structure and cheap debt, Ascendas REIT has managed a DPU accretive transaction despite a large equity component in its financing. The average acquisition cap rates are at the 6.5% range. Interestingly, Ascendas REIT is not resorting to a shareholder loan as some US REITs listed in Singapore have done.
On the other hand, a placement and preferential EFR would have been less dilutive and well within reach, given the REIT’s market cap of more than $9 billion and asset size of $11.1 billion. In a recent report, Citi reckons the accretion would have been greater if Ascendas REIT had taken that route. “We think the market may frown upon the marginal DPU [distribution per unit] accretion (due to rights issue), as usage of preferential offering and/or placement could widen accretion to 2% to 3% on our estimate.”
Above-average occupancy
“The occupancy rate for the US properties is 97.6% in San Diego, 95.6% in Raleigh and 88.3% in Portland. Based on property consultancy reports, our occupancy rates in San Diego and Raleigh are above market average, while that in Portland is in line with market,” Tay says.
Citi points out that Portland, Oregon, where 15 CapitaLand properties are located, has the lowest occupancy rate (88%) and shortest weighted average lease to expiry (WALE) of 3.5 years, “with nine out of 15 buildings less than 100% occupied”. The Portland properties account for 23% of assets and net property income (NPI), Citi says.
For CapitaLand in general, vacancy rates correspond to opportunities to extract higher value from the properties. During the results briefing on Nov 1, Tay said these properties would yield low-hanging fruit. “There is strong demand in Portland, where we are seeing migration of tech companies because it is one of the cheaper locations for these companies. When I visited that place, tenants were moving there because it’s easier to get workers and there is a large research community. In the past one year, we’ve been able to fill vacant space.”
The sponsor has set up a local team in the US, Ascendas REIT’s manager says. “The 10- to 12-member team comprises country head, investment managers, asset managers and finance [people]. The asset managers are working on some enquiries as well as taking the opportunity to make some minor improvements to enhance leasing,” the manager says.
In an email response, the manager says 10.7% and 9.1% of US gross rental income are due for renewal in FY2020 and FY2021 respectively. “Generally, we expect to renew at higher rates, as market rents have been increasing during the past few years on the back of strong demand. Our portfolio is estimated to be 10% to 15% under-rented,” Tay says. Some 61% of the US portfolio by gross rental income is on a triple net lease and WALE is 4.2 years.
The sub-markets
Demand supply metrics are favourable, according to independent market consultants. It appears that there is very little new supply in the sub-markets of CapitaLand’s portfolio (see Table 1).
San Diego is a tech hub of sorts. Sorrento Valley, where the proposed acquisitions are located, is a tech hub because of Qualcomm’s presence, which has also attracted other tech companies, and it is also a life science and biotechnology hub, with the presence of CareFusion and DexCom. CareFusion occupies two properties in the proposed acquisition portfolio.
Supply in Sorrento Valley is very modest. There is next to no supply coming up where the CareFusion Campus is located. The Campus at Sorrento Gateway (Table 1), with a unit of Dassault Systemes and TD Ameritrade as tenants, could have a limited potential supply.
Qualcomm had a recent downsizing, and if it downsizes further to consolidate in a single property, it could create instability and raise vacancy levels.
Rancho Bernardo (see Table 2) is a technology and innovation hub, anchored by the presence of companies such as Hewlett Packard Enterprise (a tenant), Microsoft (a tenant) and Broadcom. Five of CapitaLand’s San Diego properties at Innovation Corporate Center are located in this sub-market and Northrop Grumman is a tenant. According to independent market research reports in Ascendas REIT’s circular, rents are usually lower than other sub-markets with more coastal proximity. There is no indicated supply in this sub-market.
Of the three markets for the US properties, Raleigh appears to show the most potential. The city and its surroundings are part of the Research Triangle (Raleigh-Durham-Chapel), which houses three Tier 1 research universities, namely, Duke University, the University of North Carolina at Chapel Hill and North Carolina State University. The Research Triangle is one of the largest life sciences hubs in the east coast and provides companies in the area with good access to research talent.
In terms of supply, there are a couple of properties coming up in the Research Triangle Park sub-market, but they are not near CapitaLand’s properties. Independent market research points out that there could be future developments within the CBD of Raleigh, with potential new Class A developments.
Portland appears to be the weakest market currently in terms of occupancy, with vacancy rates higher than those in San Diego and Raleigh. But, independent market research reports indicate that the Portland office market is strong, with falling vacancy rates and rising absorption rates.
In 1H2019, the absorption rate rose 23.6% y-o-y and the vacancy rate dropped 80 basis points y-o-y to 10.3%. The vacancy rate for the Sunset Corridor sub-market was 18.6% in 2QCY2019, and this is higher than Portland’s average vacancy rate for all types of office properties. Interestingly, consultants are projecting a vacancy rate of 18% for CY2020, with only 10,000 sq ft of new completions by end 2020.
Although Portland is not Oregon’s capital (Salem is), it is the state’s business and start-up hub. Portland’s office market has attracted technology giants such as Amazon.com, Dell Technologies and Intel. It is also home to the global headquarters of Nike and Columbia Sportswear Co, the North American headquarters and footwear design centre of Adidas and the footwear design centres of Under Armour and Mizuno and other top sportswear companies. Portland holds the highest number of patents in the US in certain shoe-related products. Nike is a tenant of CapitaLand’s in Portland.
At present, two new developments in the Sunset Corridor sub-market are not near CapitaLand’s Cornell Oaks Corporate Center and do not appear to pose a threat.
Creekside Corporate Park, in the 217 Corridor sub-market, is at the perimeter of park land. While there is no new supply in the location, Nike is expanding its premises by 1.3 million sq ft. According to consultants, Nike could consolidate in one area by vacating their other leased space.
Market reaction, DPU accretion
When Ascendas REIT announced the rights issue, its unit price fell below the theoretical ex-rights price (TERP) of $3.0955. This is because units in the REIT started trading ex-rights and ex-dividend on Nov 8. Hence, on Nov 8, unit prices fell 14 cents to $2.89 for a loss of 4.6%. For 1HFY2020, the six months to Sept 30, Ascendas REIT announced DPU of 7.983 cents. Ascendas REIT’s financial year end will change to December from next year.
To calculate the accretion of the new properties, Ascendas REIT used FY2019’s NPI and distributable income (see Table 3). Based on FY2019 financials, the accretion is 1.7% to DPU and 3.3% to net asset value. Since the portfolio is under-rented, there is upside to DPU because accretion in Table 3 does not include the uplift if new leases are included with market rents that are 10% to 15% higher.
As at Sept 30, Ascendas REIT’s assets under management stood at $11.1 billion, comprising 97 properties in Singapore, 35 properties in Australia and 38 properties in the UK. If the independent unitholders vote in favour of the acquisition, AUM will rise to $12.8 billion. In this event, 28% of the REIT’s portfolio will comprise overseas properties, with 6% in the UK, 12% in Australia, 10% in the US and the remaining 72% in Singapore.
Post-acquisition, the top five tenants will still comprise Singapore Telecommunications, DSO National Laboratories, Citigroup, DBS Group Holdings and Wesfarmers. CareFusion will be No 6, contributing 1.3% to total revenue.
By Nov 21, Ascendas REIT had stabilised at $2.90, after rebounding from a low of $2.86 on Nov 11, compared with its TERP. At this price, pro forma DPU yield is 5.6%.
