On April 22, the manager of Lendlease Global Commercial REIT (LREIT) announced the completion of the REIT’s acquisition of Jem in Jurong Gateway, a transformational transaction which more than doubled the REIT’s assets under management to $3.6 billion.
Jem changes the entire complexion of LREIT but not just because of its size. Jem is largely a suburban mall with an office tower on longterm lease to the Ministry of National Development (MND). It also lengthens LREIT’s weighted average lease expiries (WALE).
In terms of assets, Singapore accounts for 88% of assets under management (AUM). Jem is LREIT’s largest asset followed by 313@Somerset, last valued at $983 million, and Sky Complex in Milan valued at the equivalent of $411.1 million.
“There is a link to the MRT and J-Walk. Besides the residential crowd, Jem is surrounded by offices, business parks, and Perennial Business City,” says Kelvin Chow, CEO of LREIT’s manager. Perennial Business City is the former Big Box, a shopping mall in Jurong East, while J-Walk is a covered walkway that connects Jem with Devan Nair Institute for Employment and Employability, Ng Teng Fong General Hospital and other shopping malls like Westgate and IMM.
“Outside of the radius, you can include people from Joo Koon. It is not only supported by the residential crowd, there is a worker’s crowd,” Chow continues.
A new town is also mushrooming in Jem’s vicinity: Tengah Town promises to house 42,000 residents in five districts and will include the creation of a 100m wide and 5km long forest corridor.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
As for transportation, Jurong East MRT Station Interchange is directly connected to Jem. At present, it is an interchange for the North-South Line and East-West Line. A third line, the Jurong Regional Line, will be connected to Jurong East MRT Station. It will open in 2029.
Jurong has also been touted as Singapore’s second CBD district, which was announced in 2008. Originally, Jurong was the terminal for the Kuala Lumpur-Singapore High Speed Rail (HSR) but that plan has been axed. Activity in the area is now dominated by the Jurong Innovation District, a 600-hectare precinct covering the Nanyang Technological University, JTC’s CleanTech Park, as well as the Bulim, Bahar and Tengah areas.
“These initiatives will continue to bring in the crowd to Jem,” Chow says. He also points out that Swedish home furnishings store Ikea is also now in Jem, which would attract new home owners to Jem and also IMM. “We provide more choice for new homeowners to have a look.”
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Jem’s other large tenants are supermarket chain Fairprice Xtra, Japanese lifestyle brand Don Don Donki, a food court by Koufu, Japanese clothing chain Uniqlo and Cathay Cineplexes. These tenants, in particular the supermarket chains and food court, enhance the resilience of a suburban mall.
Like most suburban malls, around one-third of the tenants are up for renewal in any one year. “Most of our leases have a step up rental on an annual basis and without changes to rentals, the lease allows us to increase rents by 3% on an annual basis and 90% of our tenants have this [escalation],” Chow says.
Jem costs around $2.079 billion in total. LREIT already owned 31.8% in Jem which was held under a couple of funds. As such, LREIT had acquired the funds’ NAV, excluding debt, in the course of October 2020 and September last year. When LREIT acquired the entirety of Jem, the property’s remaining stake cost $2.015 billion including debt, fees and expenses, financed by $648.8 million in equity — comprising a placement and preferential equity fund raising, $200 million in perpetual securities and $860 million in a sustainability-linked loan.
The acquisition net property income (NPI) yield was 4.4% for FY2021. The NPI yield excludes Covid-19 related oneoff rental abatement and expected credit loss. Based on the final fundraising and funding structure, the accretion to distribution per unit (DPU) is around 2% on a pro forma basis.
This may appear muted. But the pro forma numbers, even the ones excluding the impact of Covid-19, do not take into account the rise in tenant sales since the start of the year.
“Crowds are back to pre-Covid-19 numbers and tenant sales are 10% higher than pre-Covid-19,” Chow says.
Tenant sales are important because of the impact they have on occupancy cost ratio. Tenant sales psf is the total revenue a tenant earned in a year on a psf basis at a given location. To get the tenant sales number, the tenant’s annual gross sales at the location is divided by the square feet occupied by the tenant.
For more stories about where money flows, click here for Capital Section
Occupancy cost is total costs borne by tenants associated with occupying their space such as base rent, common area maintenance reimbursements, real estate tax reimbursements and percentage rent. Occupancy cost percentage is tenant’s annual occupancy cost at the location divided by the tenant’s annual gross sales at the location. In general, the lower the occupancy cost percentage, the better.
If the tenant’s occupancy cost percentage is too high, they might vacate their space or require a reduction in their base rent or reimbursements in order to stay. On the other hand, if the tenant’s occupancy cost is low, the landlord might have room to raise rents or demand higher reimbursements from the tenant.
“Tenant sales are used to calculate occupancy cost [ratio]. Rental is still at Covid-19 rental rates and there is probability to increase rental in the region of around 15%–20%. But this is not immediate. It depends on the lease cycle,” Chow adds.
Jem remains undervalued
Investment properties are valued based on their cash flows which in turn depends on rentals. When LREIT started to acquire Jem through modest stakes in the funds that owned the property, it was still 2020, and the depths of the pandemic. From April 2020 onwards, landlords had been initially instructed to provide rental relief for their tenants. Since conditions are normalising, and travel has started, market watchers are expecting visitor arrivals to Singapore to rebound. Nearly all Covid-19 measures have been removed with the exception of keeping masks on indoors.
The manager has other levers to raise revenue from Jem. “There is no extra GFA in Jem but we can create more NLA of around 4,000 sq ft to unlock by converting the use of open space or under utilised space,” Chow points out.
At a question and answer session ahead of LREIT’s extraordinary general meeting in March, the manager had said that tax transparency for Jem in a REIT versus a fund would result in recurring tax savings of $5.6 million a year or more. In addition, the sustainability-linked loan will bring savings to borrowing costs based on certain sustainability targets, resulting in higher distributable income.
“The cost of funding is the same but the sustainability-linked loan is linked to performance. If you achieve sustainability targets there will be a step down on the [cost of the] loan. It makes you work towards reducing greenhouse gas emission, which is our overall objective,” Chow says.
The MND lease of the office component is for 30 years with rent review every five years. The office lease boosts Jem’s WALE, which is 5.9 years despite the shorter retail leases. Following the acquisition, LREIT’s proforma WALE is 8.9 years. Sky Complex has a WALE of 8.2 years and the expiry is in 2032.
Uplift in rents to pre-Covid-19 levels, possible AEI to enhance cash flow, and the reopening of SIngapore with measures lifted augur well, and are likely to lift revenue and outlook for Jem.
“We believe we can unlock more value in Jem,” he continues. Which is why he is not overly concerned about LREIT’s gearing level following the acquisition. This rises from 27.7% as at March 31 to around 40.7% post-acquisition. “Even at 40.7% we are not the highest but I don’t believe we should stay there. There are certain ways to bring down gearing and we can report revaluation gains because Jem is acquired on Covid-19 valuation. We believe there will be an uplift from that.”
Staying attractive to investors
Chow says many fund managers are investing through the lens of environmental, social, and corporate governance (ESG). “Fund managers have to rethink their actions in relation to ESG,” he notes. “We are trying to produce stable DPU returns and value preservation to investors. How do you preserve the value? The government is making significant efforts to change the ESG landscape. As a result, people will focus on ESG metrics when they invest in assets.”
REIT managers cannot ignore these changes as they impact the assets REITs acquire. “In the long run, investors and bankers who look at an asset that is not sustainable may add a premium to finance the asset and this becomes a cost to investors,” Chow says. “We proactively take steps to improve ourselves. So we look at assets with strong sustainability credentials and those which improve on scope one and two emissions to reduce energy use.”
This benefits unitholders because of lower energy consumption, and the energy saving enhancements preserve the value of the asset, he adds. Both Jem and 313@Somerset have greenmark platinum awards and Sky Complex has a LEED Green Council award. “Our portfolio is green and we target investors who want to future proof their investments. Besides delivering DPU accretion we want to preserve value in the asset.”
The next move
“The impact of new contributions from Jem is expected to be felt from 4QFY2022 onwards. The transformative deal boosted LREIT’s total portfolio NLA to 2.2 million sq ft and expanded its portfolio value to $3.6 billion, of which 47% is exposed to the more resilient suburban retail sector,” says a research note by CGS-CIMB. LREIT has a June year end.
According to LREIT’s 3QFY2022 business updates, 313@Somerset maintained positive rent reversion at mid single-digit and high occupancy of 99.4% while Sky Complex will be underpinned by rental escalation of 4.68% starting May based on the 6.24% increase in ISTAT CPI in April, says a UOB Kay Hian update. The full impact of Jem will only be felt in FY2023 for the 12 months to June 30, 2023, UOB Kay Hian says. The interview with Chow was conducted in PLQ 3, one of the three office towers in Lendlease’s Paya Lebar Quarter mixed development which includes residential units at Park Place Residence, which are sold, and PLQ Mall. Interestingly, Chow says there are around six strata titles to PLQ. The entirety — excluding the residences which are sold — is valued at around $3.6 billion.
More immediately, Chow says LREIT will have to deliver on Jem and that is likely to be the focus for the time being. In terms of acquisitions, he prefers retail in Singapore, but is open to office property where Lendlease has a presence.
“We are very familiar with the Singapore retail landscape and investors are also comfortable with it. Retail is three-dimensional: It’s a landlord, tenant and shopper relationship. So you need someone on the ground. Anything overseas, I would acquire an office because it’s more stable,” Chow says.
For PLQ, it depends which strata title is likely to be yield accretive to LREIT. The assets need to stabilise. In the first lease cycle, tenants are usually offered attractive, below market rentals to get them in.
“So long as the first cycle has not renewed your cash flow has not stabilised. It depends on the second lease cycle,” he explains. “We would have to look at the cash flow and see which strata title gives us the stabilised cash flow to bring into the REIT.”
