To Yong Yean Chau, CEO of manager of ParkwayLife REIT (PLife REIT), sustainability of net property income (NPI), DPU and hence the ability of the master lessee of the REIT’s three Singapore-based hospitals to pay rental income to the REIT for the next 20 years, were important considerations in the new master lease agreement announced on July 14, 2021. Further details will be revealed in a circular ahead of an EGM to vote for the new agreement.
PLife REIT owns Mount Elizabeth Hospital, Gleneagles Hospital and Parkway East Hospital which contribute around 59.4% to gross revenue. It also owns around 52 Japanese nursing homes. Among the key considerations between PLife REIT’s manager and IHH Healthcare, the REIT’s sponsor and major unitholder, is the occupancy cost of the three hospitals. “The occupancy cost did not deviate too much from the IPO and the objective is to assess the sustainabilility of the rental agreement. In our view it’s a very important consideration for us,” Yong says in a media briefing on July 14.
Occupancy cost, which refers to the rental of the hospitals as a ratio of the cash flow or ebitda generated by the operator, continues to be affordable and sustainable for the next 20 years, Yong indicates. For healthcare REITs, a reasonable Rent/Ebitda ratio ranges from 45% to 55%. The master lease agreement comes with “renewal capex”, which is the capital expenditure taken by PLife REIT of $150 million to improve the three properties so that they maintain a competitive edge to enable IHH to capture a growing market share.
“The new rents are sustainable and [renewal capex] will put IHH in a better position to capture more market share,” Yong says.
The renewal capex works will start in January 2023 and last for three years. The bulk of the renewal work is likely to be at Mount Elizabeth Hospital.
Rental uplift accretive to DPU
The initial rent for FY2023, or Year 1, is $97.2 million and represents an increase of approximately 36.9% or $26.2 million, compared to the estimated expiring rent for Year 15 of the existing term of $71.0 million (which is likely to be FY2021). An annual rent review formula will be applicable for Year 4 to Year 20 of the renewal term (FY2026 to FY2042) and the formula is similar to the current annual rent review formula under the existing master lease agreements. At the end of Year 4 of the renewal term, the rent will reflect total rental growth of approximately 39.6% as compared to the estimated Year 15 rent.
Based on pro forma numbers for FY2020, the DPU of 13.79 cents rises to 14.3 cents at the end of Year 1 of the renewal term and to 18.26 cents at the end of Year 4. The increase in rents of the new master lease agreement will also have a positive impact on valuation. PLife REIT’s NAV was at $1.96 as at Dec 31, 2020. Based on this, pro forma NAV would be $2.35 at the end of Year 1 and $2.49 at the end of Year 4. Asset valuation of the REIT would rise to $1.45 billion at the end of Year 1 from $1.21 billion as at Dec 31, 2020, and to $1.69 billion at the end of Year 4.
The DPU and NAV accretion included the downtime period during the AEI when there will be operational and income disruptions to the master lessee, during which a rebate of $60.9 million will be granted to the master lessee. Gearing, which stood at 38.5% as at Dec 31, 2020, is likely to ease to 37.3% by Year 4, inclusive of the proposed renewal capex, assuming it is funded by debt.
Strategy remains focused on developed markets
“As a strategy, first, the only three asset classes I would look at are hospitals, medical centres and nursing homes. And second, to move into mature economies like Singapore, Japan, Australia. We look at matured economies because these are countries with less political and currency risk and the healthcare market must be fairly developed. The issue about specialised REITs is tenant default risk. If the tenant defaults, I must find a new tenant,” Yong explains.
As an example of executing its strategy of divesting properties with compressed yields, in January this year, PLife REIT divested a non-core pharmaceutical manufacturing facility in Japan for $37.1 million, a 12% premium over cost, and at an NPI yield of 4.3%. In June 30, PLife REIT announced the acquisition of two nursing homes in Japan at a yield of 5.7%, which is likely to be accretive to the REIT’s NPI yield.
When PLife REIT was listed it had a right of first refusal to IHH Healthcare’s assets from 2007 up to 2012. Yong says IHH is a growth stock and hence most of its hospitals are in Turkey, Malaysia, India and China.
“We see ourselves as a defensive REIT. We prefer to move into countries which, in terms of political structure and currency, are stable and in terms of the healthcare market it is mature. If you look at the whole universe of IHH, the only asset we are keen on is Mount Elizabeth Novena,” Yong says.
In connection with the master lease agreement, and the proposed capital expenditure of $150 million to upgrade the properties (renewal capex), PLife REIT’s sponsor IHH Healthcare will grant the REIT a right of first refusal for the Mount Elizabeth Novena Hospital property for a period of 10 years. Mount Elizabeth Novena Hospital was valued at RM3.96 billion ($1.32 billion) as at Dec 31, 2020.
If the valuation uplift of the REIT’s assets with the new master lease agreement takes PLife REIT’s assets to $1.69 billion by Year 4, its entire portfolio is likely to be valued at around $2.5 billion. The REIT’s current market capitalisation is a shade under $3 billion. If Mount Elizabeth Novena is to be acquired with debt and equity in the ratio of 50:50, PLife REIT could sneak in a placement, without having to engage in a preferential equity fund raising (EFR) exercise. However, PLife REIT’s unitholders and investors on the sidelines waiting to acquire PLife REIT units would welcome an EFR as an opportunity to acquire more units.
DBS Research says this is the deal of the decade and has a target of $5.75. CGS-CIMB has an “add” recommendation while UOB Kay Hian has a “hold”.
