On Oct 26, ARA LOGOS Logistics Trust (ALOG) announced the proposed acquisition of five logistics properties located at the Port of Brisbane, including a development asset on the corner of Heron Drive and Curlew Street (Heron properties), all for $225.9 million. ALOG also plans to acquire a 49.5% stake in New LAIVS Trust and 40% stake in Oxford Property Fund for $178.5 million. The two funds together own five logistics properties in New South Wales and Victoria. Altogether, including expenses, the acquisition will cost $441.2 million.
The proposed acquisition is likely to be funded by a combination of debt and equity. ALOG raised $50 million in a placement of 90.5 million units at 55.25 cents each on Nov 3. The manager is also proposing an issuance to Ivanhoé Cambridge China Inc, a fund manager which owns stakes in the two funds, of up to $70 million worth of new units, and to sponsor LOGOS for up to $18.7 million worth of new units.
Terms of a preferential equity fund raising to unitholders will be announced in a circular at a later date. The remaining amount will be funded by debt and on a pro-forma basis, gearing would rise to 42.9% from 40.4% if the acquisition had been completed in 1H2020.
“We have a strong sponsor and they’ve backstopped the preferential equity offering. They’ve shown their commitment to grow the REIT in the long run,” notes Karen Lee, CEO of ALOG’s manager.
The transaction requires unitholders approval in an EGM as LOGOS is the manager for the five properties in Brisbane and the five properties in the property funds.
Not immediately DPU and NAV accretive
Because of the additional 332 million or so new units to be issued, the transaction is not immediately accretive to FY2019’s DPU or NAV. Lee acknowledges that ALOG’s DPU yield is high, but explains that there is a capital component embedded in the DPU due to the shorter land leases doled out by JTC.
“That’s why the yield is higher. Because of the shortening land lease, there is a need to rebalance the portfolio with assets that have longer land lease tenures.” And because of the capital component that is distributed to unitholders in DPU, ALOG’s DPU yield is likely to be higher than its larger peers such as Mapletree Logistics Trust, and Ascendas REIT. “Optically, it’s not accretive at this point. If you strip out the capital component embedded in DPU, the acquisition is on an accretive basis,” Lee explains.
She sees many merits in the new portfolio, compared to what ALOG could have acquired in Singapore. She would rather not buy a property which offers a high entry yield because of a shorter land lease. “In my view, it’s not good for the REIT,” Lee says.
With the acquisition, ALOG’s overall leasehold land lease rises to 29 years from 24 years and ALOG’s weighted average lease to expiry (WALE) will be extended to a pro forma of 4.6 years from 2.8 years if the transaction had been completed based on 1HFY2020 statistics. The new properties have long leases, ranging from 11 years to 20 years with an overall WALE of 11.3 years. The extended land lease would also bring ALOG closer to levels of logistics and industrial REITs of the “big boys”.
“For this transaction, the opportunity came to us. It’s an off-market deal and we have the support of the sponsor,” Lee adds. It was a closed bidding. “After rebranding [as ARA LOGOS], we needed to rebalance the portfolio and increase the weightage of freehold assets so we can reduce the impact of a drop in NAV because of shortening land leases in Singapore.”
ALOG is buying into a portfolio with a blended net property income yield of 5% with an occupancy of 97%. If Heron Properties which are under development and the Australia Fund Properties were excluded, blended NPI yield would have been 5.8%.
Both the five Brisbane properties and the five properties in the two funds are backed by a strong and reputable tenant base, which includes established names such as ACFS Port Logistics and Agility Logistics. In addition, the proposed fund investments will also provide visibility of a future growth pipeline, which includes pre-emptive rights over the balance 50.5% and 60% stakes in the New LAIVS Fund and Oxford Property Fund, respectively.
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Larger size, more liquidity, eventual index inclusion
The transaction will raise ALOG’s deposited property value by 28.2% from $1.3 billion to $1.7 billion. The Australian portfolio will rise to 47.6% of total AUM from 32.5% currently. “We need to grow platform as quickly as possible, and yet have the right assets. We want investors to understand that. By enlarging the platform we can get ourselves re-rated, we hope to tighten the trading yield and then acquire more accretive asset. If our market capitalisation rises, it could be large enough to get ourselves in the indices and that’s what our investors want,” Lee says.
The gold standard for local REITs and properties is to be included into the FTSE EPRA NAREIT Developed Index (NAREIT). This index requires REITs to derive at least 75% of Ebitda from developed markets to initially qualify, and the REIT should have a free float market capitalisation of around $1.4 billion.
Last year, Frasers Logistics and Commercial Trust, Frasers Centrepoint Trust, and Keppel DC REIT were included into the NAREIT Index. This year, Ascott Residence Trust and ParkwayLife REIT gained inclusion.
ALOG, formerly Cache Logistics Trust, was rebranded in April following a reorganisation at its sponsor level. ARA Asset Management acquired a controlling stake in LOGOS and ALOG is now managed by LOGOS.
In Australia, logistics properties remain in demand, underpinned by the needs of basic day-to-day necessities of Australians in supply, unprecedented infrastructure investment and growth in defensive downstream industries such as e-commerce. The properties are equipped with modern specifications and situated at favourable locations. As a result, they are well-positioned to capture the growing demand for prime logistics properties in key industrial precincts, according to an announcement by ALOG’s manager.
“We have the right fundamentals because these are good quality assets with strong tenants in prime locations. The portfolio will become defensive in longer term and we can deliver long term sustainable returns,” Lee says.
Four of the properties in Brisbane are on 39-year land leases. Lee explains that land lease structures in Singapore and Australia are different. In Singapore, the manager has to liaise with JTC when the land lease is down to 10 years or lower to make its case for renewal. In Australia, the authorities are more prescriptive.
“In Brisbane the authorities are focused on landlords bringing in in tenants who are good quality and able to use their facilities. If you bring in a new tenant, you can request for lease top up. And LOGOS has been managing the assets and they’ve topped up leases successfully to 40 years,” Lee points out.
Mark-to-market risk with long WALEs
ALOG’s WALE is 2.8 years as at end-June 2020. While most of the leases are renewed for this year, around 31% of leases are up for renewal next year, and Lee says the manager is already liaising with tenants. Since ALOG’s WALE is relatively short, its passing rents are likely to be near market levels. However, in Australia, long leases for logistics properties usually have rental escalations which are sometimes pegged to inflation.
Often, when the lease nears expiry, passing rents are somewhat above market rents which can lead to negative rent reversions once the lease is renewed. “There’s a market norm; there is inbuilt rental escalation and tenants are not able to negotiate. At the end of the lease, tenants will want to mark to market. If the market has escalated beyond what the tenant is paying, we want to bring the rental higher but if market falls behind, you give the tenant the opportunity to adjust back to market,” Lee explains.
That is the other reason why ALOG needs to grow bigger, so that its portfolio is more diversified not just with tenants, but with diversified leases. “We should start to rebalance early. We need to grow big enough so this risk in 11 years will be immaterial to our unitholders,” Lee says.
Fortunately for ALOG, the supply demand metrics of the Singapore logistics sector has stabilised. From 2014 to 2016, JTC allocated new land to 3PLs (third-party logistics companies) in places like Bulim and Tampines Logistics Hub. This huge supply of logistics space pressured rentals. This supply has tapered off and with Covid-19, the logistics sector has become a cog in the wheel of ecommerce.
“Everybody needs to store something somewhere. Covid has tightened supply and the vacancy rate has come down quite a lot. In our portfolio, we had been maintaining an occupancy rate of 95% and this year, it is 97%. Hence the logistics sector has been quite resilient, supply in Singapore has been absorbed by demand, and JTC has stopped allocating so much land,” Lee elaborates.
Over time though, Lee is glancing to other horizons to grow ALOG. “If we can acquire 100% of the two funds, we would want to buy 100%. The vendors themselves were only prepared to divest less than 50%. The balance stake is worth close to $600 million and it becomes a natural pipeline for ALOG to acquire in the future,” she concludes.