United Hampshire US REIT’s (UH REIT) unit price is down 4.4% this year. Although this may not be great, investors should compare it with the performance of US office REITs. Keppel Pacific Oak US REIT’s (KORE) unit price is down 51% while Prime US REIT’s unit price has lost 66%. The numbers do not even describe what is going on with Manulife US REIT (MUST), which is struggling to survive.
Why? When valuations decline, the value of assets under the management of REITs declines too. However, the impact of this decline is not the same for asset value and net asset value (NAV). Analysts have indicated that NAV falls a lot more for a small decline in portfolio value.
Take for instance the portfolio of a REIT valued at $100 and has a loan-to-value (aggregate leverage) of 40%. A 10% decline in asset value would result in a 16.7% decline in NAV. With a 50% LTV, the REIT’s NAV would fall by 20%.
Hence, if KORE’s portfolio declined by 10% (KORE’s portfolio was last valued in December 2022), then its NAV would fall by 16.2% based on its aggregate leverage of 38.4%. As it is, KORE’s unit price is down a lot more since the end of December 2022, with a market capitalisation of US$229.8 million ($311.9 million), compared to unitholders’ fund of US$881 million and cash facilities of US$38 million. Notably, KORE’s manager takes all its fees in cash, which may account for some of the discounts.
Elsewhere, Prime US REIT’s LTV is at 42.8%. If its portfolio declined by 10%, NAV would fall by 17.5%. It has a market cap of US$163.8 million.
UH REIT’s portfolio comprises 21 mainly retail grocery & necessity properties, and two self-storage properties. Its unit price is trading at a hefty discount to its NAV of 71 US cents. For US REITs, its market capitalisation of US$246.9 million is second only to Digital Core REIT’s (DC REIT) market cap of US$625 million. On Sept 15, DC REIT will join the EPRA NAREIT Developed Index.
See also: Changes in ICR, leverage to come into effect immediately, with additional disclosures in March
Apart from trading almost normally at DPU yields of 12%, UH REIT’s manager completed the divestment of a small property in August for US$9.9 million, a premium of 3.7% above the end-December 2022 valuation, and a 7.7% premium over the purchase price, which is an indication that the valuation of its portfolio is holding up.
Prefers AEI
Gerard Yuen, CEO of UH REIT’s manager, says: “It will be challenging [on the financing front to acquire]. Instead, we are focusing on asset enhancement initiatives (AEI). We recently announced a new building on our existing Florida property Academy Sports, one of the largest sporting goods retailers in the US for a 15-year lease. It’s all incrementally positive.”
See also: IREIT signs 20-year lease contract with UK hotel chain, Premier Inn, in Berlin Campus
According to UH REIT’s financial statement, Yuen is the spouse of the cousin of Wee Teng Wen, a director of UH REIT’s manager. Wee is also the managing director of The Lo and Behold Group and son of United Overseas Bank group CEO Wee Ee Cheong and grandson of Wee Cho Yaw.
Yuen has also said that his focus is not AUM but distributable income as his fees are linked to distributable income, hence the preference for ways to enhance NPI and DPU rather than AUM.
Says Yuen: “We will always look at AEI, especially in this current market, which is where there probably is a good way to enhance income, without having to put in a lot of capital. There is definitely some of this available space [for AEI].”
Office vs grocery & retail
Yuen is keen to draw a distinction between US grocery retail and US office sectors. US retail has gone through a paradigm shift in the past 15 years or so. Consultants point out that in the past decade, a lot of retail supply has been removed from the market. According to Coresight Research, US grocery retail is forecast to grow by 5.6% y-o-y to US$1.5 trillion this year and by a further 4.2% y-o-y to US$1.56 trillion in 2024.
Yuen says US grocery retail is somewhat a defensive sector. “Retail is driven by consumers and the US consumer is very healthy. US consumption accounts for 2/3 of GDP and is a big part of the US economy,” Yuen points out. “Within retail, you have to differentiate between discretionary retail and things people can cut down on. Our segment of the market comprises day-to-day necessities, supermarkets and casual dining.”
In 1HFY2023 ended June, UH REIT’s committed occupancy was 97.9%. Yuen indicates that the occupancy figure is more or less the portfolio’s physical occupancy. Some movement from tenants moving in and out is inevitable, but physical occupancy is more or less at the committed occupancy.
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Yuen says: “When we say committed occupancy, our gap is actually units undergoing refurbishment before the tenant moves in. Office and retail are very different. The office sector is negatively affected by the work-from-home (WFH) phenomenon and physical occupancy is between 30% and 50% currently.”
Based on data released by the US Census Bureau, total retail sales for 1H2023 was up 3.2% y-o-y and Grocery Sales for June was up 1.1% y-o-y. US consumer confidence increased to a two
year high in July amid a persistently tight labour market and receding inflation.
Citing independent research, UH REIT says the strip centre sector has benefitted from flexible work arrangements as consumers are spending more time at home than in the city centres where their offices are located. The added flexibility has increased demand for the goods and services offered in strip centres, ranging from grocery shopping to dining.
Yuen says: “We went on weekdays and found traffic flow was very good. If people are working from home, they can go and do their groceries. The gyms were pretty crowded; It’s about flexibility. It’s no longer 9–5 and in the middle of the day you go to the gym.”
“There is talk about omnichannel and e-commerce. Our properties are well suited. They are situated where people can pick up their goods. We have huge parking lots. You buy your stuff online, you drive into the parking bay, and an employee puts your shopping into your boot. Some supermarkets create pods. The customer can go to the pod, open it and pick up their purchases. The majority of people who order stuff online go to the store and buy more,” he elaborates.
Since its IPO, UH REIT’s manager has divested two self-storage properties and acquired three grocery & necessity properties.
“We have talked about the resiliency of our asset class. Last year transaction volume was high for grocery retail and self-storage. This year interest rates have moved up, but ours is one of the least affected because borrowing is less key. Our properties range in value from US$10 million to US$90 million,” Yuen says.
In 1H2023, UH REIT’s gross revenue was US$36 million, up 13.3% y-o-y. This was mainly due to the rent commencement from new leases, rent escalations, and contributions from Upland Square, which was acquired in July 2022.
Property operating expenses for 1H2023 rose 9.7% y-o-y due to the acquisition of Upland Square. NPI rose 14% y-o-y to US$25.8 million while income available for distribution rose 2.2% y-o-y to US$16.7 million. However UH REIT opted to retain US$1.5 million income of its income available for distribution, causing DPU to fall by 8.9% y-o-y to 2.65 US cents.
The manager usually opts to take its fees in units, and hence now and again it sells these units. “We are currently taking units. The manager is owned by Hampshire and UOB Global Capital and we are subject to that same 9.8% ownership limit. So, when we receive units we have to sell them,” Yuen says.
Capital management
Yuen notes, “Our debt costs are thankfully not as high because if we were to borrow today, it can be quite expensive. It’s very important that we refinanced everything last year. We’ve locked in the cost of debt, and to some extent, locked in our hedging as well.”
As at June 30, UH REIT’s all-in cost of debt was at 3.57% and 80.90% of its debt is hedged. It has no expiries this year and a US$21.1 million expiry in 2024. However, finance costs of US$7.6 million for 1H2023 were higher than 1H2022 by US$3.2 million or 72.7%, largely due to the higher interest rates on the unhedged portion of Sofr term loan facilities.
In addition, the increase was also due to the Upland Square mortgage loan assumed in July 2022 to partially finance the acquisition of Upland Square.
Yuen also attributes the acquisition of Upland Square for US$85.7 million in July 2022 to UH REIT’s high aggregate leverage of 42%. The REIT divested two self-storage facilities which were lower yielding and acquired Upland Square which was higher yielding and it came with a mortgage loan priced at 3.62% for another four years.
“We were at 38% and we bought Upland Square. There was an existing mortgage loan and it was at 3.62% and we had a chance to assume that loan. It was an easy decision to make. We went above 40% because of this very attractive loan. The gearing is higher not because valuations are down. In December 2022, our valuations rose by 1.3% on a like-for-like basis. Even if our cap rate stayed constant, our net operating income has gone up which is why valuations are up,” Yuen explains.
In its financial results announcement, based on the discounted cash flow (DCF) valuation method, the discount rate for grocery & necessity properties ranged between 7.0% and 9.0% with a terminal capitalisation rate between 6.5% and 8.25%.
The discount rate for self-storage properties discount rate ranged between 7.75% and 8.0% with a terminal capitalisation rate of 5.25%. Capitalisation rates ranged between 6% and 7.75% for grocery & necessity properties while cap rates for self-storage properties were more compressed at 5%.
The financial statement said that a slight increase in the discount rate or terminal capitalisation rate would result in a significant decrease in fair value and vice versa. Similarly, a slight increase in the capitalisation rate would result in a significant decrease in fair value. Nevertheless, it has been so far so good for UH REIT. Of course, the management cannot control the unit price.
“We can deliver operational financial performance. When investors look at US REITs, unfortunately, one sector predominates. We have to differentiate ourselves. Secondly, within retail, we have to differentiate ourselves as necessity retail which is more resilient in downturns but doesn’t rise as much in upturns,” Yuen says.
