SINGAPORE (Sept 24): On Sept 11, OUE Commercial Real Estate Investment Trust (OUE C-REIT) announced the acquisition of the office portion of OUE Downtown, and a dilutive rights issue to part-fund it. The transaction is subject to unitholder approval as it is an interested-party transaction.
OUE C-REIT’s sponsor and major unitholder is OUE and its parent companies, which own 55.88% of the REIT. Other large unitholders are Gordon Tang and his wife who together own 16.35%, and Janet Yeo who owns 4.51%. The free float is 23.26%, according to OUE C-REIT’s rights circular. Yeo is the sole shareholder of Gold Pot Developments, which holds 54.3 million OUE C-REIT units. Tang has power-of-attorney for Gold Pot, according to OUE C-REIT’s annual report.
The 83-for-100 rights issue at 45.6 cents per unit, or a 31% discount to Sept 10’s price of 66.5 cents, will raise $567.5 million. The theoretical ex-rights price is 57 cents. Since the ratio of 83% is more than what OUE C-REIT’s general mandate of 50% allows, the rights issue is subject to unitholders’ approval in an extraordinary general meeting on Sept 28. OUE has given an undertaking to subscribe for its share of the rights issue. Three resolutions will be voted on at the EGM.
Resolution 1 is to acquire the office component of OUE Downtown, comprising office space from the 35th to 46th storeys of OUE Downtown 1, and the seventh to 34th floors of OUE Downtown 2. Net lettable area is 88,400 sq ft for the OUE Downtown 1 office component and 441,581 sq ft for the OUE Downtown 2 office component, bringing the total NLA to 529,981 sq ft.
Resolution 2 is the underwritten and renounceable rights issue. Resolution 3 is the proposed payment by the joint lead managers and underwriters (which are Oversea-Chinese Banking Corp and Credit Suisse) to OUE, of the sub-underwriting commission of 1.80% of the rights issue price multiplied by 66% of the total number of the underwritten rights units.
The three resolutions are inter-conditional on one another. This means that if any resolution is not approved, none of Resolution 1, Resolution 2 or Resolution 3 will be carried.
Likelihood of unitholder approval high
Based on the arithmetic, there is a high probability that the resolutions will be carried. This is because the free float is small, and 90% of the minority unitholders would have to vote against the resolutions, either by presence or by proxy, for them not to be carried. On the face of it then, the rights issue and non-accretive acquisition look like a done deal. This assumes that Tang, his wife and Yeo vote in favour of the three resolutions.
Unitholders voting for the resolutions would be doing so on the advice of the independent financial adviser (IFA), Deloitte & Touche Corporate Finance, to the independent directors of OUE C-REIT’s manager. In a statement, Deloitte said: “We advise that the independent directors may recommend that the unitholders vote in favour of the proposed acquisition”.
The advice is made on the basis of some notable dilution for unitholders, but a growth in assets under management (AUM), which benefits OUE. OUE C-REIT’s net asset value will fall to 91 cents from 70 cents. Distribution per unit (DPU) will decrease from 4.67 cents to 3.54 cents, assuming no change in the outstanding convertible perpetual preferred units. OUE C-REIT issued $550 million of CPPUs to OUE to part finance the acquisition of One Raffles Place in 2015, and there are now about $381 million of CPPUs outstanding.
Valuation of OUE Downtown office component
There is not much literature in the rights document on valuation assumptions. The valuation certificates for OUE Downtown in OUE C-REIT’s rights issue document had limited information. In the US and the UK, details of the properties that are common in most valuation certificates include the rent rolls, the passing rents, outlook for rents, comparable rents and occupancy rates. Collier’s valuation certificate comprised three pages on the property, and six pages of caveats and assumptions. Savills’ valuation certificate was all of two pages.
The IFA attempts to illuminate. A letter to unitholders from the IFA points out that the implied price per NLA of $1,713 (psf) of OUE Downtown is lower than the mean and median of $2,134 psf and $2,094 psf of comparable transactions. Since the land tenure of OUE Downtown is 48 years, the document marked the value to a 99-year lease, where implied value would be $2,234 psf. This is lower than the mean and median of $2,495 psf and $2,504 of comparable transactions. The IFA also says OUE Downtown is a Grade A building.
As such, its valuation should be compared with other Grade A buildings. Interestingly, Capital Tower on 80 Robinson Road, also considered a Grade A building with some 76 years of land tenure left, was valued at $1,872 psf as at June 30. Total value was $1.38 billion, and net property income yield for 1HFY2018 was $37.4 million, giving an NPI yield of 5.4%. Based on Bala’s table, Capital Tower would be valued at $2,019 psf for a 99-year lease. This would make Capital Tower cheaper than OUE Downtown. (Bala’s Table, or the Singapore Land Authority’s Leasehold Table, compares values across different tenures and land valuation.)
The implied NPI yield of OUE Downtown’s office portion is 5.01% if rental support is included, and 4% if excluded. The NPI yield of OUE C-REIT’s portfolio is 4.02%.
Capital Tower’s anchor tenants are global names — JPMorgan, GIC and, of course, CapitaLand. JPMorgan has naming rights until 2021 when it moves into CapitaSpring. Both Capital Tower and CapitaSpring are owned by CapitaLand Commercial Trust.
Capital Tower is also a newer building and has been retrofitted with energy saving systems, which attract global companies.
Rationale for rental support
Along with the acquisition, OUE will provide rental support for five years from the date of acquisition, at $8.90 psf pm for the first year, $9.10 psf pm for the second year, $9.25 psf pm for the third year, and $9.40 psf pm for the fourth and fifth years, subject to a maximum of $60 million in total.
Michael Seow, a former unitholder of OUE C-REIT, sold his units as soon as the acquisition and the rights were announced on Sept 11. “I agree that office rents are increasing and the prospect might be good for the office sector. However, I think we are overpaying for this asset.”
Seow points out that the passing rent for the properties as at June 2018 was about $7 psf per month. Most of the rentals were signed from 2015 to 2017, according to the rights offer document.
According to the Independent Market Research Report cited in the rights issue circular, Grade A office space in the Shenton Way/Tanjong Pagar submarket improved by 4.7% from 4Q2017 to $8.43 psf pm in 1Q2018, the highest q-o-q increase and the highest rent level of the past five years. “Looking ahead, rental growth momentum for premium and Grade A office space in the Shenton Way/Tanjong Pagar submarket is expected to continue in the following five years, reaching the range of $8.40 to $9.00 psf pm by the end of 2018 and rising to an estimated range of $9.30 to $9.75 psf per month by 2022,” the report says.
OUE Downtown rents to stay at discounts to Grade A buildings
Seow reckons that OUE Downtown’s rentals are unlikely to ever get to market rents. “Based on the chart on page 34 of the circular (see chart) the leases that were signed between 2015 and 2017 were secured at an average $7 psf pm when the market rate was around $8 psf pm. Even if the rents in the Shenton Way/Tanjong Pagar precinct were to increase in the future, OUE Downtown is unlikely to command the market price,” he reasons.
Seow has a point. The gap between OUE Downtown and other well-known properties in the precinct continues to persist. Based on data from Corporate Locations in its September issue on office properties, asking rents at OUE Downtown are $8.50 psf pm, while those at Mapletree Anson and Twenty Anson — with which OUE Downtown is compared in a circular to unitholders — are $9 psf pm and $9.50 psf pm. All prices including OUE Downtown’s asking rents are subject to 10% discounts, Corporate Locations says. That puts the rents at $7.65 psf pm for OUE Downtown.
The problem with rental support is what happens after it falls off. OUE Bayfront’s rental top-up payments from OUE were agreed at $50 million for five years, up to January 2019. If rental income for OUE Bayfront falls below $14.25 million a year during FY2014 to FY2018, OUE tops up the rent, subject to a maximum of $12 million a year. In FY2014, the top-up was $7.86 million, in FY2015 $8.35 million, FY2016 $2.55 million, FY2017 $3.31 million and in 1HFY2018, $2.03 million.
OUE Bayfront was an IPO property when OUE C-REIT listed in January 2014. In 2015, it acquired a controlling stake in One Raffles Place — without income support — for $1.06 billion. This was financed with a nine-for-20 renounceable rights issue at 55.5 cents each, which raised $218.3 million, and $550 million of CPPUs. One Raffles Place was also a non-accretive acquisition to DPU at the time.
Whatever the case, OUE C-REIT’s AUM jumps 26% higher to $4.43 billion. That will mean a step up in the base fee, which is 0.3% of AUM a year for the sponsor, OUE. OUE will also be entitled to an acquisition fee of 0.75% of the acquisition price, or $6.81 million, and a 1.8% sub-underwriting fee based on 66% of the rights issue (about $10.2 million). That should give the developer a boost to revenue and earnings for this year. In 1HFY2018, OUE reported revenue of $296 million, down 22% y-o-y, and a net profit of $6.35 million, down 64.9%.
