1. Could you describe the sponsor’s background and the trust’s portfolio of real estate assets?

Daiwa House Logistics Trust (DHLT)’s sponsor is Daiwa House Industry (DHI). Founded in 1955, DHI is listed on the Tokyo Stock Exchange (TSE) and is one of the largest construction and real estate development companies in Japan with a market capitalisation of around $24 billion.

As at Sept 30, 2021, DHI has developed or was developing more than 300 logistics assets in Japan with total gross floor area (GFA) of nearly 11 million sq m, and has announced plans to pursue development opportunities more aggressively in the logistics asset class, with Southeast Asia being a key area of focus, where there is strong growth potential for such assets. The sponsor is also highly experienced in fund management with total assets under management at approximately JPY1,655 billion ($19 billion) as at Sept 30, 2021.

DHLT is established with the investment strategy of principally investing in a portfolio of income-producing logistics and industrial real estate assets across Asia. The initial portfolio of DHLT as at the listing date (Nov 26, 2021) comprises 14 modern logistics properties in Japan. They have a total net lettable area (NLA) of 423,920 sq m, and were valued at JPY81,070 million as at 31 Dec, 2021. These properties are well diversified across Japan, situated in strategic locations within both metropolitan and regional markets where demand for logistics space is high.

The 14 properties were all built with modern specifications with an average age of less than five years. In general, there is a structural shortage of modern and mid-to-large scale logistics facilities in Japan.

2. Who are some of DHLT’s key tenants?

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DHLT has a high portfolio occupancy rate at 96.3% and a long portfolio weighted average lease expiry (WALE) of 7.0 years (by occupied NLA) as at Dec 31, 2021, with well-staggered lease expiry. The majority of the tenants are listed on the TSE, entities related to TSE-listed companies, or reputable multinational companies.

In addition, almost 80% of the tenants are engaged in the growing third-party logistics and e-commerce sectors. Such a tenant base helps to enhance the resilience of the portfolio and improve the stability of income.

3. How has DHLT performed since its listing in November 2021?

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DHLT’s portfolio occupancy rate is consistently high, at 96.3% as at Dec 31, 2021. DHLT’s portfolio is expected to remain resilient. As of end-2021, there had not been any request for rental relief or abatements from the tenants throughout the Covid-19 period, demonstrating the quality of the tenants.

As a demonstration of the sponsor’s strong commitment to DHLT and its IPO, the portfolio was acquired from the sponsor at a substantial discount to the portfolio valuation as at June 30 last year. The portfolio was revalued at Dec 31 with a valuation of JPY81,070 million, which was 14.1% higher than the purchase consideration of the portfolio. With the revaluation of the portfolio, aggregate leverage was a healthy 37.7% as at Dec 31 last year. All the borrowings of DHLT are at fixed interest rates.

We note that unit trading price has been relatively stable despite market volatility due to geopolitical crisis, on-going Covid-19 pandemic and inflationary pressure, which may lead to higher interest rates.

4. What is DHLT doing to grow its distribution per unit (DPU) over the medium to long term, and what are some key drivers of growth in the next few years for DHLT?

DHLT has a right of first refusal (ROFR), granted by DHI, over its logistics and industrial real estate assets located in Asia (subject to terms of agreement). DHLT intends to leverage on the ROFR for DPU-accretive acquisitions, including expanding and diversifying its portfolio into Southeast Asia where DHI has a growing number of logistics properties. DHLT will also consider properties from third parties, where such properties are able to enhance the quality of the portfolio.

DHLT will also seek to achieve positive rental reversion through proactive asset management when extending leases or negotiating new leases, in particular for the multi-tenanted properties (approximately 75% of the current portfolio by NLA). While supply of logistics space in Japan is expected to increase, we believe that demand for logistics space will continue to be robust, driven by e-commerce and third-party logistics (3PL) service providers.

5. Are there plans for DHLT to expand its portfolio beyond its current 14 logistics properties in Japan?

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DHLT plans to expand its portfolio beyond its current 14 logistics properties in Japan through future acquisitions, both in Japan as well as in Southeast Asia.

We believe that this will help DHLT increase its scale and broaden its earnings base. Our vision is that Japan properties provide quality and stable income while properties in Southeast Asia offer growth opportunities, and the two streams of income provide a good blend of stability and growth.

6. What is DHLT’s view of Japan’s logistics and industrial sector in the year ahead?

While supply in the logistics space in Japan has grown in recent years, supply-demand balance continues to remain tight, resulting in generally low vacancy rates. In the near future, a large supply of logistics properties is expected in certain markets, particularly in Greater Tokyo, which may lead to higher vacancy and moderation of rental rates growth. However, we believe that demand for logistics space will remain robust with the continued expansion of Japan’s e-commerce market and structural change in purchasing habits.

Of the current 14 properties in DHLT’s portfolio, six are located in Greater Tokyo. However, five of these properties are built-to-suit (BTS) facilities which are single-tenanted and have an average WALE of approximately 10 years. Therefore, we believe that the near-term impact from increased supply in Greater Tokyo is expected to be limited.

7. DHLT has around 15% of its portfolio in leasehold land interests of 40 years or less. Is this a risk factor?

Of the 14 properties within the portfolio, only four properties have land leases with expiry less than 40 years and the shortest land lease has more than 10 years to its expiry. The other eight properties are freehold or have land leases longer than 40 years. We have the option to approach land owners of such leasehold lands to negotiate extensions or acquire the land when the remaining term is shorter than 10 years.

Through active asset management, we may seek to divest properties with short land leases if extensions of lease terms or acquisitions of land are not feasible. We may also be able to reduce the proportion of properties with short land leases through acquisitions of properties with freehold land or longer land leases as DHLT looks to grow its portfolio.

Furthermore, we believe that leasehold properties offer higher yields and a more attractive returns profile as they are likely to have lower purchase price than comparable freehold properties.

8. Are there environmental risks given that the IPO portfolio is in Japan? How will DHLT deal with natural disasters such as earthquakes in Japan?

All properties in the current portfolio are developed by the sponsor, which is a well-established and experienced developer in Japan. When selecting project sites, DHI conducts due diligence over the land, including analysing risks of natural disasters. The properties are also designed to withstand earthquakes and heavy storms and were built in accordance with earthquake resistance building codes.

Earthquake insurance in Japan is generally costly with limited coverage, and we would consider obtaining earthquake insurance for a property with probable maximum loss (PML) exceeding 15%, which is generally in line with the market practice in Japan. PML measures the probable maximum loss that would be incurred from a major earthquake. For the current portfolio of DHLT, the overall PML is only 1.6%, with no individual property having PML in excess of 15%.

9. With sustainability and ESG increasingly a key focus, how is DHLT incorporating sustainability into its business model?

We share the sponsor’s fundamental approach to environmental, social, and governance (ESG) and follow these sustainability considerations as guidance in our real estate investment and management responsibilities:

<ul><li>prevention of global warming;</li><li>harmony with the environment;</li><li>conservation of natural resources (reducing waste, protecting water resources);</li><li>prevention of chemical pollution;</li><li>establishment of an internal framework and initiatives for employees;</li><li>building of trust relationships with external stakeholders; • promotion of communication through information disclosure; and</li><li>compliance with laws and regulations, and risk management.</li></ul>

Aligned with the above, 13 out of the 14 properties in the portfolio are certified green by the Development Bank of Japan Green Building Certification Programme, the leading programme in Japan which evaluates and measures the environmental and social awareness characteristics of real estate properties. Ten of our properties have solar panels installed with an aggregate capacity of 13.5MWp, and energy-efficient LED lights are installed in all but one property.

We will also continue to work closely with the local asset manager, property manager, tenants, and contractors to maintain the level of safety, efficiency, and worker-friendly conditions at our logistics properties.

10. What is DHLT’s value proposition to its shareholders and potential investors? What do you think investors may have overlooked about it?

DHI is one of the largest real estate players in Japan and will remain committed to DHLT’s continued success, following its strong support for its IPO. The sponsor has granted a ROFR to DHLT and as a developer, its pipeline of assets is expected to continue growing.

As DHLT looks to scale up, we believe that it will be able to take advantage of DHI’s continued support to drive future growth. There are three other existing funds by the sponsor with priority ahead of DHLT to the ROFR for properties in Japan. However, these existing funds have different focus, with preference for properties in metropolitan areas, while DHLT have a good mix of properties in both metropolitan and regional markets where demand for logistics space is also high.

Historically, the annual development output of the sponsor has also exceeded the absorption capabilities of the sponsor’s other real estate investment vehicles. As such, DHLT is expected to have access to a significant number of acquisition opportunities in Japan via the ROFR. The ROFR granted to DHLT in respect of properties in Asia outside of Japan is unique to DHLT.

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Candace Li is a research analyst with the Singapore Exchange

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