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Good quality assets for First REIT but master lease renewal overhang remains: Phillip

PC Lee
PC Lee10/9/2019 12:25 PM GMT+08  • 4 min read
Good quality assets for First REIT but master lease renewal overhang remains: Phillip
SINGAPORE (Oct 9): First REIT is supported by tertiary hospitals that provide highly specialised consultative care and handle complex cases.
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SINGAPORE (Oct 9): First REIT is supported by tertiary hospitals that provide highly specialised consultative care and handle complex cases.

This means the hospitals have higher revenue intensity per patient and margins compared to primary and secondary care hospitals.

In addition, each of First REIT’s hospital has its own “centre of excellence”, which focuses on certains areas of medicine such as Neuroscience, Cardiology and Oncology.

The resident and practising doctors are some of the nation’s best in their respective fields, so they attract patients from all the country.

With assets of such good quality, why then has First REIT’s unit price has fallen by 10.1% in the last 12 months?

First REIT’s $1.35 billion portfolio consists of 20 properties located in mainly in Indonesia as well as Singapore and South Korea.

Hospitals make up 78.6% of its assets, nursing homes make up 2.6% while integrated developments, or hospitals with adjoining retail and hotel facilities, make up the remaining 18.8%.

Its co-sponsors are PT Lippo Karawaci and OUE Lippo Healthcare (OUELH) who hold 18.52% and 8.9% of the REIT respectively, providing First REIT with two ROFR (right of first refusal) pipelines.

Lease structure

In First REIT’s lease structure, all its assets are leased out on master lease terms. This means the profitability of the hospital depends on the hospital operators, says Phillip Securities’ analyst Natalie Ong in an unrated research report on the REIT which was published on Oct 7.

The report followed a visit by Ong to four of First REIT’s assets in Jakarta – three hospitals and a hotel-country club asset – on Sept 26.

82% of the master leases are with PT Lippo Karawaci. These were signed before the listing of the hospital operator division as PT Siloam International Hospitals Tbk (Siloam) in September 2013 on the Indonesian Stock Exchange.

PT Lippo Karawaci owns 51% of Siloam and provides income support by way of subsidising 80% of the rental for the hospitals. As the rent paid to First REIT is denominated in SGD, this leaves First REIT unaffected by currency movements between IDR and SGD.

Risk of negative rental reversions

With PT Lippo Karawaci’s lease expiring in August and December 2020 and Siloam’s operations on stable footing, Ong says PT Lippo Karawaci could step out of lease renewal talks, leaving negotiations directly to Siloam and First REIT.

“Given the 80% rental gap, there is a risk that expiring leases will be re-negotiated with a lower quantum or on IDR-denominated terms.” says Ong.

To be sure, First REIT’s share price has been battered due to the downgrading of credit rating of sponsor PT Lippo Karawaci. This caused First REIT’s total receivables to balloon 24.7% from $26 million to $32 million in FY18.

Since its rights issue, the amount outstanding from PT Lippo Karawaci stands at $6 million.

Analyst Ong says the main overhang for First REIT’s unit price remains the renewal of the master lease with PT Lippo Karawaci. The lease renegotiation is further complicated by the lack of established market rents.

Based on the reported figures in Siloam’s FY18 annual report, rental expense accounts for 30% of Siloam’s EBITDA, leaving a net profit of IDR26.4 billion ($2.6 million).

The rental paid to PT Lippo Karawaci for FY18 was IDR125.5 billion, which constitutes 20% of the rent paid to First REIT.

“While we believe the properties in First REIT’s portfolio are of good quality and comparable to medical hubs globally, we are doubtful that Siloam would be able to afford renewing the leases at 30% of the rent and still remain profitable,” says Ong.

It is understood that First REIT has started discussions with PT Lippo Karawaci and lease negotiations are expected to be completed 12 months before the lease expiry.

As at 12.18pm, units in First REIT are trading at $1.02.

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