With a focus on logistics properties, ESR-LOGOS REIT J91U (E-LOG) entered Japan in the latter half of 2022 by acquiring the ESR Sakura Distribution Centre in Chiba, Greater Tokyo.
At the release of its results for 1HFY2024 ended June 30, the manager announced a bigger push into Japan with the proposed acquisition of ESR Yatomi Kisosaki Distribution Centre (DC) in Nagoya for JPY38 billion, or an outlay of some $328.0 million as at the July 31 announcement.
Completed in April 2022, the freehold asset comprises a land area of 79,096 sq m, with a weighted average lease expiry (WALE) of 2.7 years as at June 30 and a committed occupancy of 89.4%.
According to the manager, the acquisition price is 5.9% below the average sale prices of comparable properties in Nagoya. The property has also achieved the CASBEE A sustainability rating, one of the highest sustainability ratings in Japan.
ESR Yatomi Kisosaki DC, located in Nagoya, Japan, was one of E-LOG’s proposed DPU-accretive acquisitions announced in July
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According to Adrian Chui, CEO and executive director of E-LOG’s manager, this means less capex is needed to fit out the asset with sustainability features, and the manager can immediately obtain sustainable financing.
Chui says ESR Kisosaki DC fits his team’s “4R Strategy” — “to recycle proceeds and invest into modern, in-demand, freehold or longer land lease new economy assets with sustainability features”.
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E-LOG’s “4R Strategy” refers to rejuvenating the asset portfolio, recapitalising for growth, recycling capital, and reinforcing the sponsor’s commitment.
Since it was first unveiled in 2022, the strategy has yielded rounds of asset enhancement initiatives (AEIs) and redevelopments, divestments of non-core assets and equity fundraising (EFR).
Not only is the acquisition of ESR Kisosaki DC accretive to distribution per unit (DPU), but it is also on freehold land, says Chui.
This alleviates the negative valuation impact caused by land lease decay, a common challenge for Singapore industrial assets, which typically have short land leases of 30 years or less, he adds. “In fact, the freehold nature of the ESR Kisosaki DC provides potential upside to valuation, thus improving total returns potential for our unitholders.”
E-LOG’s announcement coincided with another rate hike from the Bank of Japan, which triggered the worst stock market rout since 1987.
That said, Japanese equities quickly rebounded in a rollercoaster week. Against a backdrop of volatility in the Japanese markets, how does management justify its decision to expand in Japan, and how will a higher interest rate influence the REIT’s two properties in Japan?
According to Chui, the Japanese market presents “fundamentally attractive” opportunities.
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The acquisition of ESR Kisosaki DC, once complete, will increase E-LOG’s logistics assets in Japan from 3.7% to 8.9%, he adds, and grant the REIT exposure to the Nagoya logistics market to improve geographical diversification and network within Japan. “[This] augments E-LOG’s scalability in the quality Japan logistics market and allows E-LOG to leverage ESR Japan’s on-the-ground expertise for economies of scale.”
Despite recent increases in Japanese interest rates, the borrowing costs remain “relatively low”, says Chui. “The spread between the asset yield, at 4.0% for ESR Kisosaki DC and the all-in borrowing cost [of circa] 1.56%, remains favourable, contributing to DPU accretion for unitholders.
Moreover, this all-in borrowing cost of [circa] 1.56% has already taken into account the increases in Japanese interest rates”.
Chui does not expect the recent rise in Bank of Japan interest rates to impact the ESR Kisosaki DC acquisition. “This asset is fully naturally hedged. [This means the] impact on net asset value in Singapore dollar terms will be negligible [because] the acquisition is entirely funded by Japanese yen borrowings. We intend to hedge the interest rates of the Japanese yen borrowings for a period of four years, which locks in the yield spread between the net property income yield and borrowing costs. The DPU accretion of [positive] 3.0% for both the Singapore and Japan acquisitions has already accounted for the recent rate increases.”
Singapore acquisition
Along with the acquisition of ESR Kisosaki DC, management also announced the acquisition of 51% of 20 Tuas South Avenue 14 (20TSA) at a 2.3% discount to the valuation.
The agreed value for 100% of 20TSA, based on a net property income (NPI) yield of 6.1%, is $840 million.
20 Tuas South Avenue 14 comprises a high-specification manufacturing facility and Green Mark Platinum-certified ramp-up logistics warehouses
20TSA comprises a high-specification manufacturing facility and ramp-up logistics warehouses, both new economy assets that fit into E-LOG’s portfolio. The latter was only completed in 2022 and is Green Mark Platinum-certified.
20TSA sits on a total land area of 252,733 sqm and has an occupancy of 99.7% and a WALE of 11.2 years as at June 30. The leasehold property has approximately 44 years remaining.
“This is a rare asset in today’s Singapore industrial landscape,” says Chui. Located near the Tuas Mega Port, Chui says 20TSA presents an “attractive opportunity” to acquire a “sizeable and modern new economy asset” with a “long remaining land lease”.
“Tuas Mega Port is expected to consolidate Singapore’s global leading position as a transshipment hub. We believe this will further increase logistics and industrial sectors as port activity increases, which leads to higher demand for quality logistics and industrial space, translating to higher rental growth potential. 20STA is well-positioned to capture that.”
Chui believes 20TSA will provide stable income from its high-specification space, which is 100% leased to anchor tenant REC Solar on a long-term lease of approximately 19 years with an option to renew for a further 20-year lease. Annual contracted rent escalations average 1.15% per annum going forward, he adds.
“Further, the multi-tenanted ramp-up logistics warehouses are leased to high-quality blue-chip tenants, such as Schneider Electric Asia, Maersk Logistics and Services Singapore, and DSV Solutions, with rental growth potential as the in-place rents are currently below market,” says Chui.
These tenants signed “first-round leases”, notes Chui, which were “intentionally set at more competitive rates” to attract tenants to the new facility then. “As Tuas Mega Port completes and port activities ramp up over the years, we believe that the expected increase in demand for logistics space augurs well for the high-quality warehouse space of 20TSA in terms of potential positive rental reversions.”
Following the acquisition, the remaining 49% stake will be owned by LOGOS Core Fund, which includes sovereign wealth funds and institutional investors. “Such high-quality partners further validate the quality and investment rationale of 20TSA,” says Chui.
Portfolio changes
Chui has said the REIT’s Singapore properties face a challenge from the 30-year underlying land leases.
However, E-LOG’s portfolio will remain focused on Singapore, even as it owns assets in Australia and Japan.
“Singapore will always remain a major component of E-LOG’s portfolio even as we seek to expand our footprint geographically,” he says. “Our portfolio focus will be in developed countries where there is the rule of law, good local lending market, funds can flow in and out easily [as] we need to pay dividends, scalability and ability to leverage on ESR Group’s operational and management footprint across the real estate value chain. These are the key criteria when we consider our portfolio mix.”
The REIT counts 71 properties in its portfolio, along with investments in three property funds. Excluding the proposed acquisitions, E-LOG’s 52 Singapore properties make up 75% of its $4.3 billion in assets under management (AUM), while its 18 Australian properties make up 14.3% of AUM.
E-LOG’s management has identified between $150 million and $200 million worth of “non-core assets” that may be divested over the next year. “These potential divestments could include assets in both Singapore and Australia, similar to those divested in 2023 and 2024,” says Chui.
“Non-core assets are typically characterised by short underlying land leases, smaller sizes, limited AEI or redevelopment potential and outdated property specifications,” he adds. “In particular, divesting assets with short land leases at close to their valuations is a strategic move, as these assets naturally lose capital value over time. As a simplistic example, an asset with a remaining land lease of 25 years and assuming a simple straight-lining of valuation might see its capital value decrease by approximately 4% per year.”
According to Chui, the proceeds from these divestments can then be reinvested into freehold or longer land lease assets, which would enhance the REIT’s NAV and contribute to long-term portfolio growth and earnings quality.
Intrinsic value
In 1HFY2024, E-LOG’s portfolio achieved a positive rental reversion of 11.2%, with logistics achieving a 14.3% increase and high-spec industrial assets a 13.8% increase.
Over the past few years, E-LOG has consistently reported positive rental reversions (11.1% in FY2023 and 11.8% in FY2022), largely fuelled by resilient demand in the logistics and high-spec industrial sectors.
NPI fell 9.2% y-o-y to $127.8 million in 1HFY2024, while DPU fell 18.6% y-o-y to 1.122 cents during the same period. This was primarily due to loss of income from the divestment of non-core assets and decommissioning of 2 Fishery Port Road, and partially offset by additional income contributions from 7002 Ang Mo Kio Avenue 5 and 21B Senoko Loop, which completed their asset enhancement initiatives in 3Q2023 and 1Q2024 respectively.
7002 Ang Mo Kio Avenue 5 is a high-specification industrial asset that underwent AEI to increase GFA by 25,000 sq m and attained TOP in September 2023
The REIT is currently trading below its NAV of 30.5 cents. This indicates a disconnect between the market price and the intrinsic value of the REIT’s assets, says Chui. “We believe this has to do with the current risk-off sentiments given global uncertainties like high inflation, interest rate environment and geopolitical risks.”
While management “firmly believes” that the two proposed acquisitions are “quality assets” that can address “immediate portfolio risks”, financing solely through debt would increase E-LOG’s gearing ratio to 44.7%.
21B Senoko Loop, which underwent a built-to-suit redevelopment from a general industrial to high-specification industrial asset for NTS Singapore with a 15-year master lease with built in annual rental escalations
To maintain a more prudent financial position, E-LOG plans to fund the proposed acquisitions via debt funding, EFR and perpetual securities. This includes the issuance of $100 million in perpetual securities, as announced in August, and a $94 million preferential offering, which the sponsor, ESR Group, has committed to the backstop for $88.2 million, with Ivanhoe Cambridge taking up to $5.8 million as consideration units at 30.5 cents per unit, which is the REIT’s NAV.
The backstop provides certainty of financing for the quality acquisitions, and an EGM is expected to be held in mid-October. These measures are expected to deliver DPU accretion of 3.0% for the proposed acquisitions and will bring the post-acquisition gearing ratio down to a “more comfortable” 41.0%, says Chui.
“The backstop not only ensures funding certainty for the acquisitions but also validates the sponsor’s confidence in the quality of the asset and alignment of interests with unitholders. Moreover, unitholders not only stand to benefit from the strategic merits of these assets, the DPU-accretive acquisitions give unitholders the flexibility to choose whether or not to participate in the EFR, depending on their individual investment strategies.”
He adds: “Together with the continued support of our sponsor, we believe that E-LOG is on track to become the leading new economy REIT comprising high-quality, modern and in-demand assets that remain relevant to industrialists, ensuring that our assets are future-ready.”
Photos: E-LOG
