Despite a portfolio of mainly freehold assets comprising 20 grocery and necessity shopping properties, and soonto-be two self-storage facilities, United Hampshire US REIT (UH REIT) continues to trade at a DPU yield of 9.8% based on its DPU of 6.1 US cents for FY2021 ended Dec 31, 2021, and at 0.83x its net asset value.
“The high trading yield is not justified. We have a very resilient sector, with long-term weighted average lease expiries of around eight years and necessity-based shopping,” says Robert Schmitt, CEO of UH REIT’s manager.
Is there anything the manager can do about these high yields? “One of the problems is that the educational process for Asian investors to differentiate our suburban open-air necessity shopping from malls is longer. Everyone wants to lump them together. There are a lot of fundamental differences between malls and openair shopping centres. Strip centres are necessity-oriented, much localised in the community where housing is. They are easier and more convenient to get to; they are not destination locations like malls. They are selling day-today goods and services for consumer needs, be they food and hardware, medical products, services, hair salons, things that the consumer needs day to day and not discretionary,” Schmitt explains. “Trading at 9.5% to 10% yield feels like a misalignment in the risk of the profile we’re offering versus the yield,” Schmitt says.
According to him, the properties were resilient during the great recession (in 2008–2009). “Because of the necessity-based nature of anchor tenants such as the warehouse clubs, they did well in the great recession. There are certain periods when it’s more difficult to get a rental increase than others. But a lot of the tenants have rental escalations built-in annually with long-term leases where the WALE is over eight years. Over time this portfolio was 95%+ occupied,” Schmitt indicates.
During the pandemic, the rental reversionary rate was 4%. Last year, rents were up 3% nationwide, compared to malls where there were bankruptcies. The open-air centres continued to perform when malls had to shut down, Schmitt continues.
When asked whether it is more important to offer a stable, sustainable yield or growth, Schmitt believes it is important to offer both. “We need to offer both growth and yield. We can’t get away with just one. We have rental increase, long-term WALE, so we offer inorganic growth as well as the ability to enhance yields,” he says.
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Since UH REIT was listed in March 2020, the REIT has completed the construction of Perth Amboy Self Storage, completed the expansion of St Lucie West in Florida last March, and acquired Penrose Plaza in Pennsylvania and Colonial Square, Virginia. “We need to offer security with our WALE and to keep that distribution going regularly, and complement that with growth,” Schmitt says.
To partly fund the acquisition of Penrose Plaza and Colonial Square, UH REIT’s manager placed out 55.55 million units at US$0.63 per unit ($0.87 per unit). UH REIT’s IPO price was US$0.80. The REIT traded at US$0.61 on April 25.
Sale of properties at lower price
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UH REIT’s unit price has been in a downtrend since its IPO. This year alone, the REIT has lost around 6.7%. Part of the reason for the underperformance could be caused by a delay in the sale of two of its self-storage properties.
On Feb 23, UH REIT’s manager announced it had entered into a conditional purchase and sale agreement with an unrelated third party to divest Elizabeth Self-Storage and Perth Amboy Self-Storage for US$49 million. The manager announced that the purchaser is entitled to carry out due diligence on the properties from Feb 23 to March 21 and is entitled to terminate the agreement for any reason or no reason at all and at any time during the due diligence period.
After the Feb 23 announcement, the manager announced four extensions to the due diligence period, with the fourth extension announced on April 12. On April 23, UH REIT’s manager announced that the sale was going ahead but at a lower price of US$45.5 million.
“In the US, our contracts are structured differently from Singapore. In Singapore, you do due diligence first. In the US, you sign the contract upfront and then do due diligence. During this period, you can cancel the contract. The buyers have to commit to the property and have to put up a deposit,” Schmitt explains. “When we signed early in the year, the state of the markets was a lot different. Russia invaded Ukraine after we signed our deal. Inflation and rising interest rates became a concern,” he explains.
Hence, the need to reduce the price. The new price is 2.5% above the valuation of the properties of US$44.4 million as at Dec 31, 2021, and 4.9% above the purchase price of US$43.4 million. At IPO, the properties had a form of income support which the manager describes as a top-up but this has been depleted. According to the manager’s April 19 announcement, the properties are still in their stabilisation stage, with occupancy rates of 44.8% and 64.1% as at Dec 31. Divestment would allow for the recycling of capital for reinvestment into higher-yielding properties.
“It’s 4.9% above cost and divestment yield based on budgeted NPI yield was 2.67%. Income support was gone. And we have the opportunity to reinvest the capital into higher-yielding retail at a 6.5% capitalisation rate and we can enhance distributable income and DPU,” Schmitt says.
“We are still very bullish on the [self-storage] sector, dynamics are very strong; occupancy and rental rates are up. Socio-economic behaviour coming out of the pandemic supports self storage,” Schmitt says. “We have not given up on it. This [the sale] was an opportunistic situation. The buyer will be getting a 2.67% yield and we’re going to turn this 2.67% to 6.5% by reinvesting into retail.”
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In the US, Internal Revenue Code Section 1031 allows real estate investors to sell a property and buy a “like-kind” property without paying capital gains tax. This is known as the 1031 tax-deferred exchange. If the REIT reinvests the proceeds within six months from the sale date, then no capital gains tax is levied.
“Our goal is to reinvest much sooner. We have a couple of replacement properties identified,” Schmitt says. “We are looking at replacement properties that hit our criteria tenants focused on omnichannel retailing, long term WALE on the Eastern Seaboard.”
Cycle-agnostic tenants
UH REIT’s properties focus on serving the non-discretionary needs of the US consumer. Its grocery & necessity properties are primarily leased to cycle-agnostic tenants providing essential goods and services while anchored by retailers such as Walmart, Home Depot, Ahold Delhaize and Publix. According to Schmitt, these tenants have omnichannel platforms.
“Our tenants embrace omnichannel retailing and provide shopping options to meet the lifestyle needs of consumers both physical and digital, and enable consumers to come to the physical store. The fulfilment is done right out of the store itself, and it’s near where the consumer lives so it’s price-effective,” Schmitt says.
He points out that Amazon.com opened 100 physical stores and plans to open a further 55 this year. Walmart is adding 100 micro-fulfilment centres. Target is adding storing stations for online delivery pick up which are 40% cheaper than fulfilling purchases either online or in physical stores. BJ’s, Ahold, Home Depot and Lowes are some of UH REIT’s major tenants gaining market share through their omnichannel technology, Schmitt indicates.
Stable operating metrics
Last Nov, UH REIT completed the acquisition of Colonial Square and Penrose Plaza for US$26.25 million and US$52.0 million respectively. Both properties had undergone capital investment over the years, with progressive renovations and upgrades. The acquisitions, which come with long WALEs, are mildly DPU accretive on a pro forma basis.
In FY2021, UH REIT’s distributable income was US$31.2 million, which exceeded the IPO forecast of US$30.3 million by 3%. FY2021’s DPU of 6.1 US cents was also higher than the forecast by 0.2%. FY2021 gross revenue of US$55.2 million was 2.4% lower than the forecast of US$56.6 million while net property income of US$41.9 million was 0.7% higher than forecast.
Aggregate leverage as at end-Dec stood at 39%. The weighted average interest rate was 2.63% and the interest coverage ratio was 6.5 times; 79.6% of debt is on a fixed rate with no refinancing requirements until 2023. Net asset value, following DPU payout, stood at US$0.73 as at Dec 31, 2021.
