SINGAPORE (Feb 17): In the three months to Dec 31, 2019, for its 2QFY2020, Lendlease Global Commercial REIT (LREIT) outperformed its forecast numbers. Distribution per unit was 1.29 cents, 3.1% above forecast DPU of 1.25 cents. Distributable income of $15.0 million was 2.4% higher than forecast.
Gross revenue of $21.4 million was 1% higher than forecast, mainly driven by gross rental income (GRI) from 313@somerset. The hip, popular mall along Orchard Road, which sits atop Somerset MRT Station, reg-istered positive rental reversion of 0.5% for the October-to-December quarter. “313 outperformed relative to forecasts because of rental uplift. [We had] a slight increase of gross rental income,” said Kelvin Chow, CEO of LREIT’s manager, in a recent interview.
Net property income (NPI) of $16.2 million exceeded the forecast by 3.2%, due to lower property operating expenses. “On the expenses front, we had property tax and elec-tricity savings, giving us a positive variance resulting in a $200,000 increase in GRI and a $500,000 increase in NPI,” Chow adds.
Finance costs were lower than forecast, which boosted distributable income. LREIT’s annualised distribution yield based on the initial offering price of 88 cents would have increased to 5.86%, up by 0.18 percentage point from the IPO forecast of 5.68%. Howev-er, since LREIT’s share price is above its IPO price, its annualised yield is likely to be 5.6%.
Beneficiary of Master Plan 2019
Among one of the more exciting plans in the longer term which has implications for 313@somerset is the URA’s Master Plan 2019. The Master Plan has formalised the increase in per-missible plot ratio for 313@somerset from 4.9+ to 5.6, resulting in an increase of up to 1,008 sq m (10,850 sq ft) of gross floor area (GFA).
“For us there is a positive uplift in plot ratio, of 1,008 sq m, and we can do something to increase space in our mall. We are still doing feasibility studies to utilise this additional space. An example would be converting car-park space or it could be on a floor-to-floor basis to unlock space,” Chow says.
“It’s not something not doable. And it will be business as usual for the other tenants,” Chow adds. He declines to give further details except to say that he needs to come out with the right formula to unlock best value for investors. “I’m quite sure we won’t need to tear down the property. It’s 5%-6% of GFA,” he says.
‘No one will be spared’
On a more sombre note, retail is a sector that is likely to be impacted by the Covid-19 coro-navirus outbreak. Singapore has the largest number of cases outside of China. The Singapore Tourism Board (STB) on Feb 11 projected a fall of tourist arrivals of around 25% to 30% in 2020, owing to the travel ban on inbound Chinese travellers. Meanwhile travel advisories from other economies including South Korea, Taiwan, Kuwait, Qatar, Israel, and the UK are discouraging travel to Singapore.
“Taking the preliminary tourism receipt estimates at S$27.1 billion in 2019, and assuming a share for share reduction of 25% to 30% of tourism arrivals, Singapore could see a fall of between $6.8 billion and $8.1 billion of tourist receipts in 2020,” UOB Economic Research economist Barnabas Gan estimates in a recent report.
“If we are to take cues from the SARS out-break in 2003, retail sales had fallen 6.5% and 3.7% y-o-y in February and March 2003, respectively. This would suggest that a sus-tained fall of retail sales value in the coming two months is possible,” Gan of UOB says.
“No one will be spared from the virus and no one is immune from the impact of the virus. It is too early for us to determine the impact [on 313@somerset]. We have inbuilt rental esca-lation in our portfolio on 90% of leases annu-ally which will help us cushion the shock,” Chow says. “And at 313 we don’t have clinics which is one of the sensitive operations now. It’s a blessing in disguise.”
While the retail sector has had to grapple with the twin challenges of e-commerce and Covid-19, retail space fundamentals have improved. Limited supply is expected over the next two years on Orchard Road. In addition, the government’s plans to rejuvenate Orchard Road should drive footfall into 313@som-erset in the longer term. The new plan will see the Somerset sub-precinct developed as a youth-oriented hub with lifestyle options. There could also be a further transformation of the Grange Road open-air carpark, adjacent to 313@somerset, into a dedicated event space.
Leasing strategy for 313@somerset
Market watchers keep a close eye on tenant sales because that provides a hint about how well a mall is doing, even though turnover rent is not a big part of most REITs’ lease structures.
“Turnover rent is not a key component of our revenue. Because we are managing a REIT, the structure of our lease is on fixed rents with rental escalations built in,” Chow explains. “When we structure a lease, we want to have a high fixed component and rental escalations are structured on the fixed component.”
When investors look at a mall, rental re-version is not the only thing. Other areas such as NPI margin, operational expenses, occupancy cost, footfall, tenant sales, tenant mix and positioning of the mall are also important considerations. (Tenants look at occupancy costs which is the annual gross rent divided by sales turnover, hence the lower the bet-ter for tenants.)
“At this moment, our occupancy cost, tenant mix and footfall and sales tenants are sticky with our customers. We may not have to adopt a higher turnover rent. We will look into it on a lease by lease basis. Should [GTO rent] make sense, we would consider it. But now we prefer to have a higher fixed rent and if it’s a tenant we really like very much, and it has good sales turnover which is better than fixed rents, we would take that position. We prefer stabilised cash flow,” Chow elaborates.
“Playdress is a new tenant we brought in last quarter. Their sales is three times that of the existing tenants. These are tenants we want to bring in as they bring up sales of the whole mall because they will bring up foot-fall and they have optimum occupancy cost,” Chow explains. Playdress is a value-for-money hip clothing and accessories retailer that opened its flagship store at 313@somerset in December 2019.
Stability from Milan
Ironically, it is a Milanese asset – Milan is the world’s premier fashion capital – that provides LREIT with stability. On average, around 70% of GRI is from 313, and 30% from Sky Complex. Sky Complex comprises three office buildings with a total of 999,116 sq ft in net lettable area and is leased to a single tenant, Sky Italia. The latter is an Italian satellite television platform operated by Sky, and owned by Comcast. All three office buildings have Grade-A office building specifications and are equipped with facilities such as floating floor and suspended ceiling with integrated and cable ducts.
Sky Italia is on a single lease on a 12 + 12 year lease term since 2008. It waived the option to vacate the property on the first lease expiry. The next lease expiry is in May 2032 with a break clause in 2026 with 12 months’ advance notice. The rent is subject to an an-nual increase of 75% of ISTAT’s index variation starting from the second year of lease.
“Our Milan asset is a very stable asset, master leased to one tenant with a balance of 12.4 years, and we’ve hedged our cash flow com-ing in,” Chow says. “We are quite sure they will not break the lease because they have invested another EUR10 million [$15 million] to do up a canteen for staff, and earlier on they invested EUR40 million to EUR50 million to renovate the whole building.”
Sky Complex was developed by LREIT’s sponsor, Lendlease Group. Because of Sky Italia’s expansion, Lendlease developed an-other building for the television company five years ago. “Lendlease is looking after the master plan of the surrounding area and this gives us a macro perspective of the tenants,” Chow says.
On a micro perspective, the surrounding rentals next to Sky Complex are EUR200 to EUR300 psf per month. Sky Italia’s rentals are EUR175 psf per month. “We are happy for them to stay. If they leave, it’s an opportunity for us to unlock cash flow. Ten years down the road, we can mon-etise the cash flow and this will give a posi-tive aspect to the REIT,” Chow says.
“Our cash flow is so stable we can for-ward-hedge for two years, which is much higher than the current rate. We recorded a $5 million forex unrealised gain last quarter and this will be unlocked and will be [actu-al] cash flow to investors as and when it is realised,” Chow reveals. Furthermore, Milan benefited from Brexit, he adds.
Pipeline assets, conservative strategy
Lendlease has a lot of land in Milan, where Sky Complex is located, that has yet to be developed. “Lendlease has the opportunity to bring in more tenants for the offices and it can do a sales and leaseback arrangement that will continue to give us a pipeline,” Chow says.
What about Lendlease’s malls in Australia? In November 2019, Lendlease sold its 50% stake in Westfield Marion mall in Adelaide for A$670 million ($626 million) to SPH REIT, and in January this year, Lendlease started marketing its 50% stake in Westfield Carindale, Brisbane.
Westfield Marion was marketed ahead of LREIT’s IPO in September, and LREIT already had its IPO portfolio ready. “We were marketing [the IPO] based on our portfolio (313 and Sky Complex) so we were not involved,” Chow explains. “On Brisbane, we will not jump on any ac-quisition unless it’s very comfortable for investors. We’ve been listed for three months and the timing is not right to go into an acquisition. It’s more a timing issue.”
Not jumping into an acquisition soon after IPO will probably come as a relief to investors and attract even more investors to LREIT. The US commercial REITs that have listed on SGX have been serial acquirers, leaning on unitholders to fund their acquisitions.
As for NPI yield accretion in an acquisition, Chow says: “I have to emphasise that NPI yield is not the only thing we’re looking at. We’re looking at committed occupancy, lease expiries that are reasonable for the acquisition, and whether it’s possible to have rental escalations to grow cash flow, and of course the quality of the building.”
Just as important to Chow is whether rents are at the top of the cycle in that particular market. “You could meet the NPI yield but would it sustain?” he says.
