+ Retail recovery on track. Tenant sales have increased by 355.5% YoY at the portfolio level due to acquisition of Jem. Despite the slow return of Chinese tourists, tenant sales were still at c.120% of the pre-pandemic level since 80-90% of the sales are contributed by local demands. Portfolio occupancy remained strong at 99.8% (-0.1% YoY). As only 1.4% of leases expire in FY23, we expect the occupancy rate to remain stable. The retail side generated a positive rental reversion of 3.3% (+1.3% QoQ) while office rental escalation remained unchanged at 4%. With higher sales driving occupancy cost below average by c.3-5% at the portfolio level, there is still upside for the rental reversion.
- The cost of debt has increased to 2.51% (+0.16% QoQ, +1.53% YoY). After the refinancing of the €285m loan in FY24, we expect the overall cost of debt to increase to c.3% and further deteriorate the adjusted interest coverage ratio (ICR) to c.2.1x. The gearing ratio is 39.3% (+0.1% QoQ, +11.6% YoY). As 61% of the borrowing is hedged for the next 18 months and there will be no refinancing risks till FY25, we expect the gearing to remain at its current level.
In order to maintain gearing, we believe inorganic growth is unlikely unless LREIT is willing to take equity fundraising. However, there are still catalysts generated by organic growth, such as the additional 10,200 GFA at 313@Somerset. Upon full deployment, this could lift the NPI by 2-3%. We also expect rental reversion from the retail side to remain positive.
Key Investment Merits
Organic growth to support valuation and DPU:
Potential Inorganic growth opportunities: After capping gearing at 45%, LREIT is estimated to have a debt headroom of c.$207m which allows for piecemeal acquisitions of a small stake in PLQ Mall or Parkway Parade (PP) as Singapore remains its focus. We believe LREIT can acquire c.6.2% of PLQ Mall or c.14.7% of PP, assuming the cap rate for PLQ Mall and PP is c.4.5%.
Attractive Valuation: Based on the 2% terminal growth rate, we reinitiate with a BUY recommendation, and the DDM-backed target price is $0.91. We increased the COE to 7.6% to reflect the higher interest rates. We expect FY23-24e DPUs of $4.63 – 4.78 cents.
Sky Complex Milan
Operating metrics at a glance
+ Rental growth on the back of positive reversions and impending annual inflation-linked escalation. LREIT delivered its third quarter of positive reversions at 313@Somerset, although signing rents are still c.3% below pre-pandemic levels. We understand that reversions at JEM, are also positive. LREIT's only Italian asset, Sky Complex, which is on a long lease that expires in May 2032, is subject to annual inflation-linked escalation every April. Using Mar22's CPI growth as in indication, we could see c. 5% of escalation on Sky Complex's rent in Apr22. Portfolio occupancy remained stable QoQ at 99.9% with only 3% of GRI to be de-risked in 4Q22.
- Tenant sales still below pre-pandemic levels due to absence of tourists. Tenant sales at 313@Somerset dipped 3.3% YoY due to dine-in cap of five pax in 3Q22 (3Q21: 8 pax). 3Q22 tenant sales were at 90% of pre-pandemic levels as tourists, who typically accounts for 20-25% of 313@Ochard's tenant sale, have yet to return to pre-pandemic levels. Meanwhile, footfall and tenant sales at JEM have surpassed pre-pandemic levels, the latter coming in at 110% of 2019's levels. The lifting of workplace capacity to 100% should bring more footfall to both JEM and 313@Somerset, which are located near offices, and could further uplift tenant sales.
LREIT has c.10k sq ft of additional GFA to unlock at 313@Somerset and intends to deploy it at the basement and ground floors of the mall, which command higher rents, timing AEIs to coincide with lease renewals to minimise disruption. Once fully deployed, the additional GFA could increase NPI by 2-3%. Acquisition remains a lever of growth for LREIT. Among its two pipeline assets, Paya Lebar Quarters (PLQ) and Parkway Parade, the former will likely be the priority as Parkway Parade has not yet stabilised. Due to PLQ’s size, LREIT may acquire PLQ in tranches via the respective strata titles.
Upgrade from ACCUMULATE to BUY, DDM target price raised from S$0.94 to S$1.05
FY22e-26e DPUs lowered by 0.6-3.8% to factor in the issuance of perpetual securities. We lower our COE from 7.7% to 7.0% to reflect the lower risk associated with its predominantly Singapore-focused portfolio post-acquisition of JEM. As such, our DDM-TP is increased from S$0.94 to S$1.05. LREIT’s portfolio is anchored by JEM and 313@Somerset, which are dominant malls in their respective catchments and will benefit from return to office and tourist visits.
Proposed acquisition of the remaining 86.15% stake in JEM. JEM is a suburban integrated development located in Jurong East with a total NLA of 892,502 sq ft. The six-storey retail mall accounts 65.1% of NLA with the remaining 34.9% in a 12-storey Grade A office space which is fully leased to the Ministry of National Development of Singapore until 2045. LREIT acquired its first 3.75% stake in JEM in Oct20 and picked up an additional 28.1% stake over Aug-Sep21, taking its stake to 31.85%. The total acquisition cost of S$2,015mn is based on the agreed property value of S$2,079mn (100% basis) and will increase LREIT’s deposited property by 2.1x from S$1.7bn to S$3.6bn. The acquisition will be financed through a combination of debt and equity and could enlarge the share base by 100-121%. The proposed acquisition is subject to shareholders’ approval at an EGM which will be held on 7 March 2021. If approved at the EGM, completion of the acquisition is expected to materialise before 15 May 2022.
What do we think?
The proposed acquisition will double AUM and market capitalisation, making it one of the top 20 largest SREITs, increasing LREIT’s visibility and investor relevance. JEM is one of the dominant malls in the Jurong East, pulling from a catchment of approximately 1.1mn residents as of 2020. JEM’s retail occupancy was 100% as at 31 Dec 21 and remained above 98% throughout the pandemic. Despite the 100% occupancy, the manager managed to increase revenue for the property by creating 1,500 sq ft in additional NLA at Level 1 and Basement 1. The office component is fully leased to the Ministry of National Development on a 30-year lease ending in 2045. The lease is subject to a rent review every 5 years and contributes 20% and 35% of JEM’s GRI and NLA for the year ended 31 December 2021. Strong tenant demand from JEM’s dominant positioning in the Jurong East catchment and stable income from the office component will help to anchor LREIT’s portfolio, forming 58% of FY23e NPI. Acquiring 100% of JEM allows LREIT to qualify for tax transparency on the property, resulting in tax savings.
The large quantum of the acquisition necessitates equity fund raising, which carries a higher cost of capital, making this leg of the JEM acquisition less accretive compared to previous rounds. Based on our forecast, the acquisition of the remaining 86.15% stake in JEM is marginally accretive at 0.1%, in line with the pro-forma DPU accretion of 0.1-3.0%.
Maintain ACCUMULATE and DDM target price of S$0.94
We tweak our forecast to incorporate the acquisition of the remaining 68.15% stake in JEM. FY22e/23e DPUs have been increased by 1.7%/0.3% while FY24-26e DPUs were lowered by 0.4-1.1% due to the enlarged share base. The current share price implies FY22e DPU yields of 6.0%. Pipeline assets for LREIT include Paya Lebar Quarters and Parkway Parade.
+ Higher occupancy, positive reversions and unlocking of GFA at 313@Somerset. 99.7% occupancy at 313@Somerset is at an all-time high, up 1.0ppt YoY. Approximately 20K sq ft of NLA, or 17% of GRI signed in 1H22, reducing FY22 expiries by GRI from 24% to 7%. Leases signed in 1H22 yielded positive, high single-digit reversions, a sharp reversal from negative double-digit reversion seen in FY21. LREIT utilised 660 sq ft out of the 11k sq ft arising from the increase in permissible plot ratio from 4.9x to 5.6x. The unlocked space will be deployed to two stores, Puma and Ohayo Mama San, which are located at prime units on the ground floor. Remixing of tenant mix in earlier quarters has pulled in more shoppers, improving tenants’ sales for existing tenants. Tenants were more willing to renew their leases at higher rates given the improvement in tenant sales.
+ Robust portfolio metrics. Interest coverage ratio improved QOQ, from 8.8x to 9.7x (adjusted ICR: 5.0x) with cost of borrowing steady at 0.92%. 90% of borrowing have been hedged in 1H22, lower compared to the 100% hedge employed previously. We understand that this was due to revolving facilities in place, which are usually on floating rates. Gearing improved by 0.8ppts from 34.3% to 33.5%. The management shared that rent in arrears has reduced and is below pre-pandemic levels, crediting the improvement to the rebalancing of tenant mix in favour of tenants that are trading better and have stronger cash flows.
- 1H22 revenue dragged down by lower GRI from negative reversions and lower GTO rent from 313@Somerset. YoY decline in turnover rent. 1H22 GRI was c.7% lower YoY due to negative double-digit reversions on 14k sq ft, or 17% of GRI signed at 313@Somerset in FY21. The negative reversions were inevitable given the tenants' market in 2020 and 2021. However, we think that the strategy to prioritise occupancy and refresh 313's tenant mix has paid off. LREIT retained and signed tenants that weathered the pandemic well or are expanding, lifting the vibrancy and positioning of 313@Somerset as a lifestyle and shopping destination. This ensured high occupancy and pricing power for positive reversions in 1H22. 2Q22 tenant sales grew 31.7% QoQ but were 5.1% lower YoY due to tighter restrictions during the Oct-Nov21 period. 1H22 tenants’ sales were 9.2% lower YoY, leading to a 30.7% YoY decline in GTO revenue.
+ 313 bucking the negative reversion trend. 5% of NLA signed in 1Q22 at positive, high single-digit reversions, outperforming negative reversion for downtown malls. This is an improvement compared to the negative double-digit reversions signed in earlier quarters. LREIT has been rebalancing the tenant mix over the past few quarters. The refreshed offerings increased footfall and lifted sales for other tenants in the mall. Tenants were more willing to renew their leases at higher rates given the improvement in tenant sales. Most of the leases signed this quarter were from the F&B sector, located on floors B3 to Level 2. Tenant retention improved QoQ from 61.5% to 90.0%. We understand that most tenants are opting for traditional lease structures, with higher base rent and a smaller GTO component, implying confidence in maintaining and growing sales. About two-thirds of leases are on traditional lease structures.
- 1Q22 tenant sales +3.1% QoQ, but still c.70-80% of 2019 levels. Slight improvement in tenant sales attributed to a shorter 2.5weeks dine-in ban in 1Q22, compared to 5 weeks in 4Q21. Footfall increase QoQ by 10.4%.
Acquisition of an additional 28.1% stake in JEM in Aug/Sep21 brings LREIT’s stake to 31.8%. The management is optimistic about acquiring the remaining stake in JEM within the next 12 months and is in avid discussions with the remaining investors. The remaining stake of JEM carries a valuation of c.S$1.4bn. Gearing of 34.4% implies a debt headroom of c.S$150mn. LREIT will consider a combination of debt, equity fund raising and issuance of perpetuals to fund the acquisition. If successfully acquired, we expect LREIT to apply for tax transparency status for the JEM entity, reaping tax savings.
All three buildings in Sky Complex are 100% leased to Sky Italia, a broadcasting and cable television company. Sky Complex is Sky Italia’s headquarters and only office location. The asset is on a long lease that expires in May 2032, with a lease break option in 2024, subject to a one-year notice period. In-place rents are c.30% below market rents, implying possible positive reversions if the lease break is executed.
Lendlease Global Commercial REIT (LREIT) primarily invests in stabilised income-producing real-estate assets globally, for retail and/or office purposes. Its portfolio comprises a leasehold interest in 313@Somerset (313), a retail mall in the heart of Singapore, and a freehold interest in Sky Complex (SC), a Grade A office asset in Milan. Its portfolio has an appraised value of S$1.4bn. On 1 October 2020, LREIT acquired an effective 3.75% stake in Jem for S$45mn, a shopping mall in Jurong, Singapore.
We initiate coverage with an ACCUMULATE. Our DDM TP is S$0.78, implying 14.2% upside potential, inclusive of FY21e dividend yields of 6.1%.
LREIT was listed on 2 October 2019 on the main board of SGX at S$0.88 per share. Its Manager is Lendlease Global Commercial Trust Management Pte. Ltd., an indirect wholly-owned subsidiary of its sponsor. In May and June 2020, LREIT was included in the MSCI Singapore Index and GPR APREA Investable REIT 100 Index.
THE SPONSOR: LENDLEASE CORPORATION LIMITED
Lendlease Corporation Limited (LLC AU, Not Rated) is part of the Lendlease Group (LGroup), a leading international property and infrastructure group listed on the Australian Securities Exchange. Lendlease Group is one of the largest developers in the world, with a global development pipeline value approaching A$113bn. It operates in 17 gateway cities:
• Asia: Singapore, Sydney, Brisbane, Melbourne, Perth, Beijing, Shanghai, Tokyo and Kuala Lumpur
• Europe: London, Milan and Rome
• United States: New York, Boston, Chicago, San Francisco and Los Angeles
Lendlease Group (LGroup) has delivered projects globally for 60 years. To date, it has 21 urbanisation projects. These include Paya Lebar Quarter (Singapore), Melbourne Quarter (Melbourne, Australia, Fig. 2), The Exchange TRX (Kuala Lumpur, Malaysia) and Milano Santa Giulia (Milan, Italy). The Group’s core construction business had backlog revenue of A$14bn globally as at FY20. It also managed 14 wholesale funds with more than A$36bn for about 150 institutional investors.
LREIT holds two properties in its portfolio and an indirect 3.75% interest in Jem.
a. Sky Complex: stable income generator. Strategically located in one of Milan’s newest and most vibrant office precincts in the Milano Santa Giulia area, this property consists of three Grade-A office buildings wholly anchored by Sky Italia. Sky Italia is owned by ComCast Corporation, the world’s largest broadcasting company by revenue (Forbes, 2020). Milano Santa Giulia is a strategic area due to its connection to the historical centre of Milan and easy access to all transportation modes. The latter include the Tangenziale Est Milan Ring Road, a high-speed railway station, and Linate Airport. The strategic location and high-quality office buildings in Milan’s peripheral office submarket have led to its highest take-up rates in the Milan office market in the past three years.
b. 313@Somerset: a differentiated lifestyle destination mall. 313@Somerset offers 288,277 sqft of prime retail NLA along the main Orchard Road belt, Singapore’s most famous shopping and tourist precinct. It is situated smack in the middle of Orchard Road with direct access to the Somerset MRT Station. 313’s tenants include leading global brands such as Zara, Forever 21 and Cotton On and dining establishments such as Hai Di Lao, Brotzeit and Marché. Over the past three years, annual footfalls averaged 45.5mn, about 8x Singapore’s population.
1. Highly stable portfolio built for growth. Portfolio committed occupancy is 99%. We see income stability for SC, which contributes 33.7% (Fig. 8) to FY20 gross rental income. This is because SC has been 100% leased to Sky Italia in a triple net lease structure. Its WALE is long at 12.1 years, with a lease break option only in 2026. It has an annual step-up feature which is based on 75% ISTAT consumer price index variation. The remaining 66.3% of the portfolio’s income comes from 313, with a WALE of 1.8 years by GRI. About 60% of 313’s leases are built with annual rental escalations of 2.7%.
SC has been resilient throughout Covid-19. To date, Sky Italia has paid up all its rents in a timely manner. Over at 313, struggling tenants with leases expiring in 1Q21 had been offered short-term extensions of 6-12 months or 3-year leases with lower base rents and higher turnover rents in the first year. As recovering tenant sales and footfalls are expected to return confidence to tenants, we expect upcoming leases to be renewed with a higher fixed rent component. Historically, gross turnover rent accounts for less than 5% of LREIT’s gross revenue. We are expecting fixed rents to contribute more than 90% to portfolio GRI in FY22.
Minimal drag on FY21 anticipated. As of date, most of 313 had reopened, except for one KTV which will reopen soon. Tenant sales and footfall had recovered to 70% and 60% of pre-Covid levels. Separately, LREIT has flushed out all the rental rebates to be given to tenants by the end of FY20 (30 June 2020). Hence, we are not expecting any residual abatements in FY21. Although six tenants had applied for rent deferral under Singapore’s Covid-19 temporary measures, none has exercised this. That said, we still expect FY21 revenue and NPI to underperform its IPO forecasts by 3% and 7.5% respectively, due to the short-term leases provided in 1Q21. We are expecting arrears to rise 20-30% as some tenants temporarily cancelled GIRO payments while waiting for government rebates.
313 to bottom out with the help of Phase 3. As Singapore moves towards Phase 3 reopening, more activities are expected to resume. An increase in the group size for gatherings and capacity as well as reopening of higher-risk bar, pub, karaoke and night-club outlets should bring back more get-togethers and consequently, consumption. As F&B tenants contribute 37.7% to 313’s GRI, we believe that further relaxation of Covid-19 measures will return footfalls to about 80% of pre-Covid levels. Tenant sales are expected to recover to 85% of pre-Covid levels. In addition, the air travel bubble announced by the Singapore and Hong Kong authorities in October, albeit delayed, could be a step towards the reopening of borders.
2. Organic growth for 313 with redevelopments
313’s lifestyle youth hub to appeal to New-Age tenants. 313 sits above the Somerset MRT station. This is an enviable location along Orchard Road, as it is smack in the heart of the shopping belt. With its proximity to public transportation, 313 is an optimal location for omnichannel players to locate their physical stores. Love, Bonito, Singapore's largest local fashion brand, chose 313 as the venue for its first physical store in Singapore. Further bridging the online to offline trend, 313 also attracted Pomelo, which opened its first store in Singapore in 2019. In our view, 313 is a gem that remains attractive to new-to-market online brands due to its strategic location in a prime leisure spot and ability to provide myriad experiences and services to similar target audiences. We are fairly certain that this differentiation of 313 as a ‘lifestyle x new-age mall’ will be able to draw more footfall and sales. Not resting on this laurel, LREIT is exploring partnerships with brands and education providers to monetise its atrium space.
Rejuvenating Orchard Road via Grange Road carpark redevelopment. On 13 June 2020, LREIT won a joint tender to redevelop the 48,200 sqft carpark at Grange Road into a new multi-functional event space. This redevelopment is part of the STB-URA-NParks-LTA’s blueprint to rejuvenate Orchard Road. Somerset has been designated to continue providing lifestyle offerings to youths. Set to be operational in the first half of 2022, the concept offers a first-of-its-kind lifestyle experience along Orchard Road. It will have multiple dedicated event spaces, an independent cinema, hawker stalls serving local delights and a food and beverage attraction. LREIT is collaborating with Live Nation, the world’s leading live entertainment company, on this project. Other partners include The Projector and Museum of Food. With the inclusion of the Grange Road event space, 313’s net lettable area will expand by 14% to 330,000 sq ft.
Development cost is S$10mn or less than 1% of LREIT’s deposited property value. This will be funded by LREIT's working capital, spread throughout the development phase. We are expecting the development to be yield-accretive at a conservative return of investment of 10% p.a. (FY22 DPU accretion: 1%). There are future upside opportunities if we consider joint marketing and cost synergies with 313 (Fig. 16).
AEI to increase plot ratio for 313. The URA granted 313 an increase in plot ratio under its Master Plan 2019, from 4.9+ to 5.6, resulting in a potential increase of up to 1,008 sqm of space. LREIT has identified areas of expansion. However, in light of current economic conditions, major work has been temporarily shelved. We are looking at a possible delay till FY22 before the AEI contributes to valuation.
3. Inorganic growth opportunities; the only REIT under sponsor. Keeping its global and broad-based investment mandate, LREIT will be the only investment vehicle that the Lendlease Group will have. LREIT has ROFR agreements with Lendlease Trust and Lendlease Corporation which covers any proposed offer or private funds managed by Lendlease Group, if it is to dispose any interest in any stabilized assets globally, used for office and/or retail purposes.
For the asset to be considered stabilized, there are a few criteria: 1) the asset must be generating rentals at market rates; 2) it must be operating at a minimum occupancy of 80%; 3) there should be no major AEI planned for the next two years so that the property is readily generating income for investors. Within the A$36bn FUM of the sponsor, we are estimating up to c.A$32.4bn worth of stabilized assets that may present future acquisition opportunities for LREIT.
Assets in the pipeline closer to home include Paya Lebar Quarter (PLQ, 30% interest), Parkway Parade (PP, 10% interest) and Jem, where LREIT recently acquired a 3.75% stake in. PLQ recently opened in 3Q19, hence it may be too early to conclude that the property is generating a stable income stream. While PP has been operational since 2012, it is not ideal due to its near-term need for AEIs and the nearby construction of Marine Parade MRT due for completion in 2023.
LREIT’s near-term priority is to add to its stake in Jem. Jem is an integrated office and retail development in Jurong Gateway, the commercial hub of the Jurong Lake District. It is one of the largest suburban malls in Singapore with retail space on six levels. Anchor tenants like NTUC FairPrice and IKEA occupy 30% of the mall. It also comprises 12 levels of office space which have been 100% leased to the Ministry of National Development for the next 30 years. It is a stabilised asset with high fixed recurring income.
On 1 October 2020, LREIT acquired 5.0% of Lendlease Asian Retail Investment Fund 3 (ARIF3), which holds a 75.0% indirect interest in Jem. This brings LREIT’s effective stake in JEM to 3.75%. The S$45mn cost is fully debt-funded. Return of investment is c.2%. The Lendlease Group still holds a 15.1% stake in ARIF3. The 3.75% stake in Jem is expected to add to 2% to FY21’s DPU.
Other probable markets to be evaluated include Australia, where LREIT’s sponsor has a significant presence. LREIT is also open to looking at third-party transactions in Europe. With pro-forma gearing of 36.9% post-acquisition and low cost of debt of 0.86% p.a., we see room for LREIT to pursue more acquisition opportunities.
We initiate coverage with an ACCUMULATE rating and DDM-derived target price of S$0.78. With prospective dividend yields of 6.1%, total potential upside is 14.2%. Our target price is based on 4-year projections and assumes cost of equity of 8% and a terminal growth rate of 2%.
LREIT is trading at 0.86x P/B, which is above pure retail REITs’ 0.74x but below diversified retail REITs’ 0.90x. LREIT’s FY21e/FY22e dividend yields of 6.1%/6.6% also outperform the average forward yields of diversified retail REITs’ 5.2%/6.0%. We believe valuations are still attractive, with Phase 3 reopening and potential developments providing near-term catalysts.
1. Small portfolio; subdued retail outlook. LREIT’s main portfolio comprise only two properties currently. About 58.1% of its FY20 NPI was reliant on Singapore’s prime retail market. Due to general economic weakness, retail leasing is expected to be subdued. Given that there are several malls in the Orchard Road belt (Ion Orchard, Orchard Central), 313 faces competition in retaining and attracting quality tenants. We conservatively estimate rental reversions of -10%/5%/10% for leases expiring in FY21e (25% of the GRI)/FY22e/FY23e. We assume that the 3% annual rent escalation remains constant for the next three years.
2. Limited growth prospects for SC in near term. Due to slower global economic growth, we are expecting limited growth in SC’s rental escalations. Its annual step-up feature is based on 75% ISTAT consumer price index variation. In our models, annual rental escalations estimated for the leases at SC in FY21e/FY22e/FY23e are 0%/0%/3%.