(July 15): Prime US Real Estate Investment Trust registered its prospectus on July 8. The offer of 335.2 million units, subject to an overallotment option, consists of a placement of 318.44 million units to investors outside of the US and an offering of at least 16.76 million units to the Singapore public. The IPO price is 88 US cents per unit ($1.20 per unit for the Singapore offering) and up to US$295 million should be raised. At this price, the yield is 7.4% for forecast FY2019 and 7.6% in projection for FY2020.
The public offer, which opened on July 8, closes at noon on July 15. Trading of Prime US REIT units is set to start at 2pm on July 19. This is expected to be the largest IPO on the Singapore Exchange year to date, with market capitalisation of US$813 million ($1.1 billion) at IPO.
KBS REIT Properties III, which is selling the initial portfolio to Prime US REIT, has entered into an agreement to subscribe for 228.41 million units, or 24.7% of units outstanding, in the REIT. In order for distributions to investors outside of the US to be tax-transparent, no single investor can own more than 9.8% of units outstanding. “KBS REIT Properties III is a US REIT and, therefore, we are able to let it own more than 9.8%... the shareholders of REIT III will own less than 9.8% each, so we maintain that restriction,” says Sandip Talukdar, chief financial officer of Prime US REIT’s manager.
The REIT’s tax structure will be similar to that of Keppel KBS REIT and Manulife US REIT (MUST). To receive their distributions in full, unitholders who are non-US citizens will have to fill up Form W-8BEN.
Concurrent versus sequential
Unlike ARA US Hospitality Trust and Eagle Hospitality Trust, where the placement tranche was completed before the public tranche was made available at ATMs, Prime US REIT’s placement and public tranches run concurrently — so that the bankers can gauge demand and allocate accordingly. In the case of EHT, the placement tranche was fully taken up, but the public tranche was undersubscribed.
The underwriting agreement will only kick in at the close of the offer at noon on July 15. The bankers will look at the orders for the placement tranche and public offer and take a decision from there. This gives them more flexibility. In EHT’s case, the bankers did not have the flexibility to reallocate stapled securities because the placement tranche had closed. Then, on the first day of trading, one of the underwriting investment banks sold 4.32 million of EHT securities below the IPO price. Prices have not recovered to the IPO price.
Hutchison Port Holdings Trust was a concurrent offering; this is the first time a REIT has a concurrent IPO offering.
Strong cornerstones but REIT manager’s shareholding raises questions
Prime US REIT has secured commitments of US$317 million from nine cornerstone investors, including AT Capital, Keppel Capital, Singapore Press Holdings and Hiap Hoe. DBS Bank’s private banking customers — which are included in the cornerstone tranche — have once again been asked to subscribe to the IPO. Together, the cornerstone investors will subscribe for 360.25 million units, or a 39% stake, in the REIT.
Some of the cornerstone investors are also shareholders of the REIT manager of Prime US REIT. The manager is 60%-owned by sponsor KBS Asia Partners, 30%-owned by Keppel Capital, a unit of Keppel Corp, and 10%-owned by a unit of AT Capital Group. Times Properties, a unit of Singapore Press Holdings, has entered into a call option agreement to acquire a 20% stake in the manager from KAP after the listing date, subject to approval from the Monetary Authority of Singapore. If this materialises, no single party will be majority owner of the manager.
Previous S-REIT managers with multiple shareholders have usually been the subject of mergers and acquisitions. These include the managers of Sabana Sharia’ah Compliant REIT, Cache Logistics Trust, AIMS APAC Industrial REIT, Viva Industrial Trust, Lippo Malls Indonesia Retail Trust and Ascendas REIT when it listed in 2002.
“We have three independent directors as well as our two directors [on the board of the manager], and that provides independence for the group for key decisions,” says Barbara Cambon, CEO and chief investment officer of Prime US REIT, when asked how a manager with so many shareholders could manage the REIT. “They are all great owners to have and they have strategic stakes in the long-term future of this enterprise.”
Prime buildings, some suburban locations
As at Dec 31, 2018, Prime US REIT’s portfolio consisted of 11 freehold Class A buildings. The assets are located in urban and suburban areas in nine cities: San Francisco Bay Area (Oakland); Salt Lake City; Denver; St Louis; Dallas; San Antonio; Philadelphia; Washington DC area (suburban Maryland and Virginia); and Atlanta.
According to Prime US REIT’s prospectus, 98.3% of contracted leases as at Jan 1, 2019, based on cash rental income, have built-in escalation clauses. The escalation clauses are on an annual fixed-rate basis, ranging from 1% to 3% and averaging 2.1%, based on net lettable area (NLA).
A large portion of leases — 96.9% by NLA — are triple net leases or modified/ full-service gross leases. These types of leases shield the REIT from increases in real estate taxes and property expenses, as the taxes and expenses are borne by tenants.
Also, according to the prospectus, rental reversions should be upwards, as current weighted average rents on expiring leases are generally below the rental rates projected by Cushman & Wakefield in its appraisal reports. For FY2019, weighted average contractual rents are 24.6% below market rents for expiring leases, and next year, weighted average contractual rents are 8.8% below market rents for expiring leases.
One aspect of the US market that is less of an issue for Singapore-focused REITs is tenant incentives such as rent-free periods and allowances. Usually, the longer the lease, the longer the rent-free periods: Tenants with 10-year leases have at least a 10-month rent-free period.
Cambon says the distributable income and distribution per unit in the forecast periods are computed after taking into account tenant incentives. In the US, it is common to give a rent-free component and tenant improvement allowances, she says. “The leases that are getting renewed have in them forecast tenant incentives.” She adds that there is no rental support in the distributable income.
The IPO portfolio has an occupancy rate of 96.7%, with a diversified base of tenants, Cambon says. The portfolio also has a long weighted average lease -expiry of 5½ years, based on NLA, and its top 10 tenants have long-tenured leases with a WALE of 6.7 years.
What about supply?
“We have identified the best sub-markets that have the best supply-demand situation. The supply in our markets is in landlord-favourable markets,” Cambon says. “Many of the markets do have some construction, but the new supply is not of concern, based on historical net absorption. Cushman does not believe we are going into an oversupply situation.”
According to Cushman, the primary markets in which the IPO portfolio properties are present are attractive. Seven of the primary markets are at the “accelerating” part of the office market cycle, in which rent growth is accelerating. All of the primary markets — San Francisco Bay Area (Oakland), Washington DC area (suburban Maryland and Virginia), Denver, Dallas, Philadelphia, Atlanta, St Louis, San Antonio and Salt Lake City — are at the “landlord-favourable” part of the office market cycle, in which rents continue to grow.
From the listing date to the end of projection year 2020, the REIT’s distribution policy is to distribute 100% of its annual distributable income. Thereafter, it will distribute at least 90% of its annual distributable income. Distributions are expected to be made semi-annually and declared in US dollars.
Unjustly compared with MUST
As Prime US REIT’s manager and investment bankers began marketing the offer, investors were comparing it to MUST (see table), which was listed in 2016. MUST’s properties are either Class A or trophy. All of them are located in the midtown, downtown or CBD areas except for Plaza in Secaucus, New Jersey. Since IPO, MUST has made four, largely accretive acquisitions. Its unitholders have also transitioned from high-net-worth individuals to institutional funds, hence the lower yield and higher price-to-book ratio compared with Prime US REIT, which is a new listing.
Prime US REIT is believed to have sought a listing in mid-2018, but market conditions were not right. “Market conditions played a role in the delay, and we also needed to rightsize. We have been able to watch the other US REITs and how they have evolved. We think we are offering great value. The interest rate market has changed a lot, the tax concern has been resolved and trade headwinds are not quite as bad,” Cambon explains.
Whether a smaller size, strong cornerstones and higher yields are sufficient to attract the investing public remains to be seen.
