Sasseur REIT – Riding On The Growth Of The Chinese Middle-Class

In today’s article, I will be sharing my thoughts on Sasseur REIT, a highly underrated REIT that I believe has strong growth potential. In the sections that follow, I will be sharing some key pointers of why there is so much to love about this REIT but to complete the picture, I would also be pointing out a list of potential risk factors that I believe potential investors should be aware of. For the benefit of those who do not have much knowledge about this REIT, I would begin by giving a high-level overview of what Sasseur REIT does.

As a pure-play Chinese retail REIT, Sasseur REIT specialises in the People Republic of China’s (PRC) outlet market. It currently has 4 outlet malls located in the Tier 2 cities of Chongqing, Bishan, Hefei and Kunming. To avoid any confusion between Chongqing Municipality and the City of Chongqing, Chongqing Municipality  is one of four municipalities under the direct administration of the central government of PRC. The City of Chongqing and Bishan is in fact part of the larger Chongqing municipality. To give a better idea of the contribution of the various assets to the entire portfolio, I have created a chart below to show the asset value and EMA Rental Income breakdown by property.

Source: Sasseur REIT 2019 Annual Report

Based on the above chart, the REIT has a huge exposure to Chongqing as both the Outlets in City of Chongqing and Bishan makes up around half of both asset value as well as EMA Rental Income. The image below gives a snapshot of the key information of the properties as well as their relative location.

Source: Sasseur REIT Q32020 Presentation Slides

In case you are wondering what is an outlet mall and how different it is from other forms of retail concept, I have extracted a table from Sasseur REIT’s latest results presentation slides to clarify this.

Source: Sasseur REIT Q32020 Presentation Slides

In essence, outlet malls offer luxury and high-end products that are outdated/leftovers at a steep discount. As such, it allows the middle-class population an opportunity to get their hands on affordable luxuries that they would otherwise be priced out of. In the context of China, these outlet malls also tend to place strong emphasis on consumers’ experience by including facilities such as children’s playground and sports hall. These amenities allow families and individuals alike to indulge and have a holistic shopping experience within the self-containing compound.

Armed with a better idea of what Sasseur REIT does and its portfolio overview, I will proceed to discuss the factors that make it such an attractive investment while also pointing out potential risk factors before making a judgement as to whether it is a viable investment.

Growing Middle-Income Population Driving The Outlet Industry

From the table above, it can be seen that outlets’ main target segment is the middle-class segment. Given the outlet’s strong reliance on the middle-class, it is important to map out where the bulk of the middle-class are found across the country. With that in mind, I managed to dig out a map below from a McKinsey report showing that by 2022, Tier 2 cities will make up 45% of the middle-class population, the largest across all the tiers. Given that all the properties in Sasseur REIT’s portfolio are located in key Tier 2 cities that are the capital cities of their respective provinces, I do believe that the properties are primed to benefit from the burgeoning middle-class.

Source: McKinsey – Mapping China’s Middle Class

A recent article by SCMP published on 30 Nov 2020 was quoted as saying that the Chinese Communist Party wants to ‘significantly expand’ the middle-income earners by 2035. This will likely provide further tailwind to PRC’s outlet market. 

Moreover, the outlet market is still a relatively nascent market as compared to the likes of the US. Taking reference from an independent market research that was obtained from Sasseur REIT’s latest Q32020 results presentation slides, it is forecasted that China’s Outlet industry will grow to US$96.2 billion by 2030, approximately more than 4 times of its current size today.  

Source: Sasseur REIT Q32020 Results Presentation Slides

Assuming that the above forecast is true, there is still ample room for growth in the outlet industry in China. Putting the data aside and basing on my personal experience, I am not going to doubt the integrity of these data given that I have witnessed for myself the Chinese’s insatiable desire for luxury and high-end branded goods during my holidays in Paris and Italy.

China Pivoting Towards A Self-Reliant Economy

According to a recent article from FT, the ruling Chinese Communist Party announced that it will be prioritising expanding the domestic market as a means to ensure self-sufficiency. I do believe that this act of turning inwards towards boosting domestic consumption is beneficial for the wider retail sector as a whole amidst an increasingly uncertain geopolitical landscape. Moreover, with cross-border leisure travelling unlikely to resume back to Pre-COVID levels anytime soon due to the logistical challenges of mass vaccination, it makes perfect sense to encourage domestic spending as a means to drive its economy. 

Pivoting towards an economy that focuses on domestic demand also benefits unitholders of Sasseur REIT in other ways such as a stronger yuan. I came across a Bloomberg article that mentioned that pivoting the Chinese economy towards one that is driven by domestic demand would allow the People’s Bank of China more leeway to appreciate its currency. This is in contrast to the past where China was repeatedly lambasted by US President Trump for artificially devaluing its currency to ensure the price competitiveness of its exports. A currency appreciation is beneficial for unitholders of Sasseur REIT as distributions are given out in SGD and a stronger Yuan would increase the payout in SGD terms all else equal.

Source: XE Currency

Taking reference from the CNY to SGD chart above, the Chinese Yuan has strengthened quite substantially in recent months since the beginning of 2020 when China went into complete lockdown, suggesting that a strengthening Yuan is gaining momentum. In addition, a stronger Yuan could potentially stimulate imports and further expand the domestic consumption market. Since these high-end luxury goods are predominantly imported, a strong Yuan would make them even more affordable, potentially boosting sales.

Insider Trades

A key indication that I often look for when buying a stock is evidence of insider ownership by directors or C-Suites of the company. Looking at the table below, it can be seen that the current CEO, Anthony Ang had been diligently building up his stake in Sasseur REIT since its listing in 2018. He has increased his holding by almost 50% in 2020, taking advantage of the March 2020 stock market crash. 

Source: Sasseur REIT Website

In a world of imperfect information, I often view insider trades favourably as it is a sign of insider’s confidence in the performance of the company.

Entrusted Management Agreement (EMA)

Given the recent share price collapse in First REIT due to its unsustainable master lease agreement, I am quite skeptical whenever a REIT enters into an unconventional lease agreement such as this. As such, I decided to dig a little deeper to find out what this was all about and if such an agreement would be sustainable in the long run. To begin, I have extracted a slide from Sasseur REIT’s latest results presentation slides to explain how the EMA works.

Source: Sasseur REIT Q32020 Results Presentation Slides

In essence, the EMA is unlike the typical kind of retail leases that are being signed here in Singapore. In Singapore, tenants pay a fixed rent to the landlord regardless of their revenue stream. The landlord will then deduct whatever operating expenses to derive its Net Property Income (which is before financing expenses). As such, in the case of a typical landlord in Singapore, it will have to manage both its revenue and cost to maximise its income. In the context of Sasseur REIT, although it owns the 4 properties, it is not directly involved in the active leasing of the properties like a traditional Singapore landlord. Instead, it hires an Entrusted Manager (EM), in this case Sasseur Shanghai (wholly-owned subsidiary of the sponsor), to actively manage its asset i.e. the EM will be in charge of leasing out the space and optimising tenancy mix to maximise outlet sales. The EM will hence collect the rentals on behalf of Sasseur REIT before distributing what is known as EMA Rental Income to Sasseur REIT. In such an agreement, Sasseur REIT frees itself of the risk of having to manage its operating expenses for its properties which is actually a plus point in my opinion.

Referencing the image above, the interesting thing here is that the EM will collect rental income from the tenants first, usually ~10-16% of the total outlet sales, which is akin to a flexible lease structure. The total rental collected by the EM from the tenants (before distributing to Sasseur REIT) is called Gross Revenue (GR). Note that the GR is subjected to the volatility of the tenant’s performance. This could work both ways as during good times, the EM will be able to benefit from higher GR and vice versa. The EM then distributes EMA Rental Income to the REIT that is made up of 2 components: (i) EMA Resultant Rent = Fixed Component + Variable Component (ii) Residual.

Please note that the Residual component is also known as the performance sharing component where both the EM and Sasseur REIT get to split the remaining of what is left from the GR after the deduction of the EMA Resultant Income and the EM base fee in the ratio of 60:40. The EM base fee plus the EM’s portion of the Residual is what the EM derives as revenue to finance its operations. According to the IPO’s prospectus, the EM base fee is calculated in the way illustrated by the below table. 

Source: Sasseur REIT IPO Prospectus

In my opinion, the good thing about the EMA Rental Income from the perspective of Sasseur REIT is that it offers downside protection through the Fixed Component while allowing the REIT to benefit from any upside in the outlet sales through the Variable Component. Moreover, the Fixed Component is subjected to an annual escalation of 3% per annum, which is pretty decent. Assuming that all 4 outlets can consistently achieve y-o-y growth in the outlet sales, the REIT would be able to enjoy further upside from the Variable Component, thereby boosting the distribution to its unitholders. This is without having to worry about managing its operating expenses for its properties given that the risk is borne by the EM. From the perspective of Sasseur REIT’s unitholders, I believe such an agreement is a sure-win assuming the outlet sales will continue to thrive on the growing middle-class population and that the EM is consistently able to optimise its tenant mix to maximise value. 

Despite the pros of the EMA, my main concerns are with regards to the complexity and the sustainability of such an arrangement for the EM. Moreover, there is no transparency of the cost structure of the EM and whether the revenue generated to them from the EMA could more than cover the operating expenses of running the outlets. If such an agreement is used to solely drive up the valuation of the assets (which was the case for First REIT), it could be potentially disastrous for unitholders when it eventually unfolds. Such an agreement is also highly dependent on the credibility of the counterparty, which in this case is Sasseur Shanghai, a subsidiary of the sponsor Sasseur Group. This leads nicely into the next section on the reputation of the sponsor.

Relatively Unknown Sponsor

Given that Sasseur REIT is Sasseur Group’s first listed REIT, there is no way we can establish the credibility of the sponsor through its historical track record. According to the company’s website and annual report, Sasseur started off as a fashion label brand before expanding and branching into the outlet mall industry, making its maiden entry in 2008 when it launched its Chongqing outlets. Since then, the Group has grown tremendously, owning and operating 2 assets in Xi’an and Guiyang while having management contracts for 9 other properties (2 of which have yet to commence). 

Despite limited evidence of its track record in managing a REIT, I take comfort in the fact that the sponsor counts L Catterton Asia and Pingan Real Estate as its strategic shareholders, both being behemoths in their respective fields. Moreover, since its listing, the REIT has consistently outperformed its forecast and had in its most recent quarter’s financial results reported a surprised improvement in DPU over the preceding year, suggesting the resilience of REIT’s business model and its ability to deliver growth for its unitholders.

That being said, given the relative lack of information that I can find on the sponsor, I will certainly be keeping close tabs on any developments surrounding the Group to sieve out any potential red flags.

Short Land Tenure and Valuation

Another concern that I have is the relatively short land tenure of commercial properties (both retail and office) in China. To be fair, this risk is associated with all Chinese-listed retail REITs, including the likes of CapitaLand Retail China Trust (CRCT). Taking reference from the table below, it can be seen that the remaining lease tenure ranges from anywhere between 28 to 35 years.

Source: Sasseur REIT 2019 Annual Report

The relatively short leasehold land tenure is something that investors should be aware of. For investors that prefer freehold assets or assets with >50 years of lease left, this REIT might not be ideal for you. That said, if you believe in the growth story of this REIT, I do not see why you can’t hold this REIT as a mid-term investment to enjoy the high 8% yield in the meantime before making an exit say 10 years from now.

With regards to the valuation of its properties, I have managed to pull out the valuation table below from its latest 2019 Annual Report. One thing to note here is that unlike the typical income capitalisation method that other S-REITs tend to adopt, Sasseur REIT chose to adopt the Discounted Cash Flow (DCF) method for the valuation of its property. For readers who do not know what is the difference between these 2 valuation methods, please check out my article on Valuation 101 here.

Source: Sasseur REIT 2019 Annual Report

From the table above, the discount rates that have been applied ranges from 10.0% to 10.5%. To get an idea of whether the discount rates adopted are reasonable, I have extracted a table from CRCT’s 2019 Annual Report that shows its valuation assumptions. The table shows that CRCT adopts discount rates ranging between 7% to 9.5% for its properties. However, it is important to note that some of CRCT’s properties are located in more developed Tier 1 cities where discount rates adopted are likely to be lower. Taking that into consideration, I would think that the discount rates adopted by Sasseur REIT are reasonable and should not be a source of alarm.

Source: 2019 CRCT Annual Report 

Concluding Thoughts

Based on the above analysis, it isn’t very clear as to whether Sasseur REIT is a good buy or not given the various inherent risks from the EMA and the limited track record of the sponsor. In addition, the short land tenure is also something investors have to bear in mind when investing. 

Source: Google

At the end of the day, there is always a price for everything and I would rather buy a mediocre stock at a bargain than to purchase a growing stock at an absurd valuation. I have extracted Sasseur REIT’s price chart over the course of the last 1 year in the chart above. At the current share price of $0.82, it has rebounded by over 50% since touching a low of $0.525 in April 2020. Even at this price, it offers a yield of slightly under 8% based on 2019’s distribution payout and is trading at a reasonable valuation of around 0.9x of P/BV. For investors who are a little more risk-loving, the risk-reward seems to be quite attractive in my opinion but for someone who is slightly more risk averse like me, I would stay on the sidelines for now. If however, the share price moves towards the $0.76 to $0.78 range, I might consider adding to my existing position.

Thank you for reading my article and do leave your comments below if you have any differing views/pointers you would like to share. Cheers and stay tuned for more!

 

Please note that the information that I have shared are for informational purpose only. It represents my personal opinion and should NOT be taken as a business, legal, tax and investment advice.

8 thoughts on “Sasseur REIT – Riding On The Growth Of The Chinese Middle-Class

  1. A very detailed write up on Sasseur REIT. though the price chart that you attached is 1 day price chart instead of 1 year, lol.

    Btw, you mentioned you will stay at the sideline, but 12% of your portfolio is from Sasseur REIT?

    1. Hey buddy,

      Good spot. I actually didn’t realise the chart I had posted was a 1 day price chart lol. I have just updated it. Thanks for pointing it out!

      On the point about why I have 12% of my portfolio allocated to it, I had acquired most of the units around the low to mid 70s. I will probably not add more to it at the current price since I already have a fairly large exposure to it.

      1. Thanks for the clarification on your holding. I really like your post and have shared your REIT posts in my FB group – REIT Investing Community, a group that focuses on REIT topics. Wonder are you okay to share your REIT post directly there in the future?

        1. Hey Vince,

          Apologies for the delayed response as I have been quite caught up with work lately! Of course I would be more than happy to share my posts directly in your FB group. Do let me know what’s the name of your group so that I can join and start sharing any future posts that I have.

          Anyway, I have just posted a new article on why I believe a strong and reputable REIT sponsor matters. Do check it out and let me know your thoughts!

          1. Hi,

            The FB group’s name is REIT Investing Community. Your new post is quite well written. Although, whether a sponsor strong or not would be subjective as well.

Leave a Reply

Your email address will not be published. Required fields are marked *