Lendlease Global Commercial REIT – Analysis of JEM Acquisition

Since I first initiated an article on Lendlease Global Commercial REIT (LREIT) earlier this year, the share price of the REIT has grown by over 15% from $0.77 to around the $0.90 mark today, slightly above its IPO price of $0.88. There are various reasons as to why there has been such a strong recovery in the share price of the REIT. Since then, the Singapore government has announced that it is drawing out a road map in moving from COVID-19 pandemic into endemic as it prepares to progressively lift restrictions. With more than 80% of the Singapore population having received full vaccination at the time of writing, the country is gearing up to re-open its borders through the introduction of vaccinated travel lanes (VTL) on 8 September. A clearer path towards what experts call a “new normal” has undoubtedly injected greater investor optimism into the markets and LREIT has certainly benefited from that. Apart from the improved macroeconomic outlook, various analysts from DBS to Citi have cited the REIT as a potential candidate to be included into the FTSE NAREIT Global Real Estate Index Series. This speculation has been confirmed by the REIT manager on 2 September following the completion of the latest quarterly review by FTSE Russell. This follows FTSE Russell’s latest ground rule update that includes a lower investable market cap threshold of 0.1% compared to 0.3% previously. The long and short of this is that inclusion into the index would help the REIT improve liquidity, investor visibility and potential investability, as well as lower the cost of equity and make it easier for DPU-accretive acquisitions via equity raising. These positive catalysts have further boosted investor’s confidence in the counter and resulted in a strong recovery of its share price since hitting a trough of $0.44 in April 2020. That being said, I believe that another reason for the strong recovery in its share price is partly due to its recent announcement to further increase its stake in JEM via the acquisition of shares in the various funds that hold an interest in the property. This topic will be the key focus of this article as I will be diving into the details of this acquisition while offering my view on why I believe this acquisition is one that will benefit the REIT in the longer term.

Before diving straight into the analysis, I thought it may be useful to first develop a quick understanding of the asset of interest, JEM (an abbreviation for Jurong East Mall). JEM is a mixed-use office and retail development with a GFA of over 1 million square feet and an NLA of close to 900k square feet. With an NLA of 580k square feet, the retail component is effectively one of the largest suburban malls in Singapore and the most dominant one in the Jurong East sub-region. Its office component, at approximately 310k square feet, comprises 12 levels of office space which has been fully leased to the Ministry of National Development of Singapore (“MND”) with a remaining lease term of approximately 23 years at the time of writing. I have extracted the table below from the circular dated 2 July 2021 for your reference.

Source: LREIT Circular Dated 2 July 2021

Valued at close to S$2.1 billion, it is one of the largest and most prominent commercial developments in the Western region. The agreed property value translates to about $2,328 psf of NLA. For greater clarity on how the individual components stack up in terms of valuation, I have created a donut chart below.

From the above, it can be seen that the asset, while being a mixed-use office and retail asset, has about close to 80% of its valuation derived from the retail component. As such, the asset can be viewed more predominantly as a suburban retail mall and its longer term performance is likely to depend more on the retail component rather than the office component. In my opinion, the office component which is locked into a long lease with the MND will offer a relatively risk-free income stream backed by a good paymaster. The lease is subject to market rent review every 5 years. This is akin to a master lease agreement which will offer a good hedge to the more volatile nature of the retail component. In the later part of the article, I will share a little bit more about the valuation of the asset and why I believe there could be potential for further upsides. In terms of its locational attribute, I had previously discussed it in the first article that I had written about the REIT so I shall not dwell further into it. You can refer back to my article here

With a 99 year leasehold commencing in September 2010, it has about 88 years remaining on its lease tenure, which is one of the highest among prime-grade commercial assets in Suburban Singapore. Just as a guide, when Frasers Centrepoint Trust (FCT) acquired the PGIM ARF portfolio last year, most of the assets had a balance land tenure of 70 years on average. This is also the case for most suburban retail assets held by CapitaLand Integrated Commercial Trust (CICT) except for Bedok Mall and Westgate (adjacent to JEM) which has a very similar land tenure to JEM. Both Westgate and JEM were only developed in the last decade as part of the wider regeneration of the Jurong area while the majority of the balance stock of prime suburban retail assets have been developed more than 2 decades ago. In addition, JEM is the first mixed-use asset in Singapore to be awarded the Green Mark Platinum version 4 and received the Building and Construction Authority’s Universal Design Mark Gold Plus Design Award. This is a further testament of the strong sustainability credentials of Lendlease as a developer that is at the forefront of building green buildings that are future-proof. 

In essence, in my opinion, JEM is a dominant best-in-class asset located in an area that is prime for further rejuvenation in the coming decades. Given its strategic location right next to Jurong East MRT station and the regeneration of the Jurong Lake District that will bring over 20,000 new homes and 100,000 new jobs, the asset is likely to benefit from higher footfall and hence sales in the long-run. Being a relatively new asset with strong sustainability credentials and combined with the fact that it is managed by one of the leading developers in the world, I do think that there is very strong potential for the REIT to reap further upsides from the asset. In the section ahead, I will be drilling down into the details as to why I believe the proposed acquisition is a good addition to the REIT.

Well Orchestrated Transaction That is DPU Accretive

For people who have been following LREIT closely, you would have probably seen this acquisition coming. Prior to LREIT announcing the proposed increase of its effective stake in JEM on 7 June 2021, it had actually announced an inaugural issuance of $200 million of perpetual securities with a coupon rate of 4.2% on 27 May 2021. This signalled to me that an impending acquisition was on the horizon as it wouldn’t make sense for the REIT to raise perpetuals to pay off debt (without carrying out an acquisition) given the REIT’s already below sector average gearing of ~35% prior to the issuance of the perpetuals. It made sense to raise perpetuals to increase its stake in JEM given that its share price back when the announcement was made was $0.79 which translated to a FY22F dividend yield of >6%. The relatively higher cost of equity meant that it would not be optimal to do an equity fund raising to carry out the acquisition. The lower coupon rate of the perpetuals has allowed the REIT to achieve a DPU accretion of 3.6% on a FY2020 Pro Forma basis as seen below.

Source: LREIT “Increased Interest in Jem of Up to 31.8%” Presentation Slides

Another key thing to look out for apart from the impact on DPU is the impact of the acquisition on the NAV of the REIT. Ideally, as a REIT investor, you would like to see growth both in the DPU as well as the NAV. In terms of the acquisition’s implication on the REIT’s NAV, the NAV per unit remains neutral after the acquisition as per the table below. 

Source: LREIT Circular Dated 2 July 2021 

While I would have hoped for a growth in terms of the NAV, I am still satisfied that the acquisition did not have a significant dilution on the REIT’s NAV while achieving a DPU accretion in excess of 3%. In terms of the proforma impact on the balance sheet, I have extracted the below table for reference.

Source: LREIT Circular Dated 2 July 2021

As per the table above, assuming that LREIT succeeds in increasing its effective stake in JEM to 31.8%, its gearing post-acquisition would come in at 33.8% which would still put it in a very favourable position to further expand its portfolio. One thing I would like to point out though is that as JEM is currently owned by private funds, the debt on the balance sheet of those funds have not been reflected in the above gearing. If LREIT were to further increase its effective stake in JEM, it would eventually have to consolidate the debts onto its balance sheet. As funds typically have a higher gearing in excess of 40%, I believe that LREIT is keeping its gearing relatively low at 33.8% in anticipation that it would ultimately conduct a major equity fund raising to further increase its stakes in the various funds that own JEM.

The markets seem to have viewed this proposed acquisition favourably as the share price of the REIT have advanced by more than 10% since the announcement was made, hitting a 52 week high of $0.915 on 1 Sep. At its current share price, its forward dividend yield is below 6% and I personally think that it is a matter of time before the manager decides to conduct an equity fund raising to further increase its stake in JEM. My guess is that the management will wait for the share price to appreciate nearer to the $1 mark before considering doing so. With Singapore planning for further reopening and travelling to progressively resume as more economies reopen, I am cautiously optimistic that LREIT will ultimately climb above the $1 mark in the mid-term.

Improve Diversification and Greater Exposure To Suburban Retail

One of the key investment propositions cited by the manager in its acquisition of JEM is the improved diversification and exposure to the more resilient suburban retail. In my previous article on LREIT, I had mentioned that one of the key investment risks is its concentration risk since 313@Somerset accounts for around 70% of the REIT’s total Asset Value. With the increase in its effective stake in JEM of up to 31.8%, the proforma impact is illustrated as follows. 

Source: LREIT “Increased Interest in Jem of Up to 31.8%” Presentation Slides

Based on the above screenshot, it can be seen that post-acquisition, the contribution of 313@Somerset by asset value would reduce considerably from 68% today to 55%, thereby reducing the concentration risk of 313@Somerset which is a prime downtown retail asset. While 55% is still a considerable amount, I believe that the REIT is in a very strong position now to reduce this even further. First and foremost, its increased stake in the various funds holding the asset will provide the REIT with increased pre-emptive rights which provide further opportunities for the REIT to potentially increase its strategic stake over time. Secondly, with the recent run-up in its share price, the REIT is in a better position to potentially carry out an equity fund raising to increase its effective stake in JEM further. Hence, I do think that the REIT is moving in the right direction in terms of reducing its reliance on 313@Somerset and diversifying its risk away from prime retail into suburban retail. 

This brings me to the next point on increasing its exposure to the suburban retail segment. There is no doubt that suburban retail is seen as being more resilient as compared to the likes of prime (orchard) retail as indicated by the chart extracted from CBRE below.

Source: CBRE SG MarketView Q2 2021

As per the above chart, it can be seen that prime suburban retail rents are historically more resilient than prime orchard road rents. Despite the pandemic, prime suburban retail rents have held up relatively well while prime orchard road rents have fallen by close to 10% y-o-y. Moreover, taking reference from CICT’s latest 1HFY21 results presentation below, rental reversion on an incoming vs outgoing basis for 1HFY21 came in at -4.6% for its suburban retail assets while the corresponding number for its downtown retail assets came in at -15.5%, suggesting that suburban retail rents are indeed more resilient during downturns. 

Source: CICT 1HFY21 Results Presentation

In the case of FCT, which is Singapore’s largest suburban-centric retail REIT, the table below shows that its rental reversion on an incoming vs outgoing basis came in at -0.7%, further supporting the hypothesis that suburban retail rents tend to be more resilient.

Source: FCT 1HFY21 Results Presentation

In my view, given LREIT’s predominant exposure to Singapore’s prime downtown retail where rents tend to be more volatile, it makes perfect sense to increase the REIT’s exposure to the more resilient suburban retail segment that have historically been more recession-proof. Post-acquisition, LREIT’s exposure to the suburban retail asset class will rise to 16%. While this is a relatively small proportion of its entire asset value given that prime downtown retail still contributes 55%, I believe the manager’s plan over the mid-term is to increase its effective stake in JEM. This should ultimately give LREIT a more balanced exposure between the more volatile prime retail segment and resilient suburban retail segment.

Hence, I do agree with the manager in terms of its rationale for the acquisition of JEM from a diversification standpoint and also to increase its exposure to the resilient suburban retail segment. Moreover, in land scarce Singapore, good quality suburban retail malls are hard to come by and there is no doubt that JEM is one of the best suburban retail malls out there in the market today.

Under-Rented Asset

The final and most important reason as to why I view this acquisition favourably is because I think that the asset is currently being under-rented. Given that the retail component contributes about 80% of the total asset value, I will be focusing my analysis on the retail component for this section. I managed to obtain the passing rent of the asset from the Circular dated 2 July 2021. In the image below, which shows the valuation certificate of JEM done by JLL, it can be seen that the passing rent of the retail component of JEM is $12.68 psf. 

Source: LREIT Circular Dated 2 July 2021 

While passing rents of other comparable malls are not readily available in general, I did manage to obtain a DBS equity research report on its coverage of Suntec REIT back in 2018 which mentioned that passing rents of suburban malls tend to trade between $17 – $18 psf/mth. As suburban rents have held up relatively well in the last few years, I do believe that this range is still relevant as a guide for the type of passing rent that we should see for suburban retail assets. While I understand that the attainable passing rents very much depends on the location and the quality of the asset, I do think that a best-in-class mall like JEM should certainly trade somewhere nearer to that range. Just to be sure that the range of $17 – $18 psf/mth is not an overly aggressive range, I managed to also obtain the passing rent of Clementi Mall back in 2013 when SPH REIT was listed. 

Source: SPH REIT IPO Prospectus

Based on the above screenshot, the passing rent of Clementi Mall back in 2013 was about $15.80 psf/mth. Given that reversions at Clementi Mall have been mostly positive since the listing of SPH REIT back in 2013, I do think that the current passing rent of the mall should be trading in the range of $17 – $18 psf/mth. Assuming that JEM has potential to trade in that range, its current passing rent of $12.68 psf/mth represents an upside of over 30%. Even if $17 psf/mth seems like an overly optimistic figure and a number close to $15 psf/mth is considered more reasonable, that would still represent an upside of close to 20%.

I believe that one of the key reasons why the passing rent for JEM is so much lower than the range of $17 – $18 psf/mth is due to the current abundance of options for retailers in the immediate area surrounding Jurong East. There are currently 4 malls located within walking distance to the Jurong East MRT including JEM, with the other 3 being Westgate, JCube and IMM, all of which are owned by CICT. The diagram below shows the relative location of the various assets to Jurong East MRT station.

Source: LREIT Circular Dated 2 July 2021 

JEM and Westgate are the 2 latest additions to the Jurong East area, with both opening only in 2013 while JCube underwent a defensive Asset Enhancement Initiative (AEI) back in 2008 before reopening in 2012. With a combined retail NLA of over 1.6 million square foot across the 4 properties, there is certainly no shortage of options for retailers. As such, retailers do have pretty strong bargaining power against landlords given the availability of alternatives within the Jurong East sub-region. The competition for retailers has led to the smallest of the 4 assets i.e. JCube, experiencing a write-down in its valuation over the last 8 years from an initial S$360 million back in 2013 to S$276 million today. This is a classic example of “size and scale matters” as both JEM and Westgate have benefitted at the expense of JCube given that both JEM and Westgate have an NLA of above 400k square feet while JCube only has an NLA of about 200k square feet. The larger floor area allows both JEM and Westgate to have greater room to curate a better tenant mix for its shoppers, thereby allowing them to attract and retain shoppers. I do believe that Lendlease’s strategy back in 2014 when the mall was first launched was to sacrifice rents for occupancy given the abundance of retail space in Jurong Gateway then, as it was launched at the same as Westgate and only a year after JCube completed its AEI.

With further development in the Jurong Lake District, “Tengah, The Forest Town” and “Jurong Innovation District” taking off in the coming decade and beyond, the rejuvenation of the entire Jurong region will lead to more households and job creations in the vicinity. This, combined with the future development of the Jurong Region MRT Line (JRL) which is expected to be completed between 2027 and 2029 with Jurong East station serving as a key interchange station, will likely further boost consumer traffic from western residential areas into Jurong Gateway.

Source: Jurong-Clementi Town Council

Hence, for the above reasons, I do think that the rental gap between JEM and the wider suburban retail market should narrow as Jurong Lake District morphs into the second Central Business District of Singapore. If the disparity in the rental gap is narrowed over time, this will naturally translate to a higher valuation for the asset over the long run which would benefit shareholders in terms of a growing NAV. This should ultimately drive the share price higher in the longer term assuming the asset realises its potential.

Just to do a sanity check, I thought it might be useful to just have a look at the valuation of the asset and see how it stacks up against its competitors. At an agreed property value of $2.1 billion, it translates into a valuation $psf NLA of $2,328. Breaking down into its individual component, the retail component is valued at $2,761 psf NLA while the office component is valued at $1,520 psf NLA. Focusing on the retail component, I have extracted the following table from the circular showing comparable transactions of retail properties in the last 5 years. 

Source: LREIT Circular Dated 2 July 2021

As per the above table, the agreed property value of $2,761 psf NLA seems to be on the high end when compared to the mean of $2,381 psf NLA. However, taking a deeper look at the comparables suggest that some of the assets are considered inferior to JEM. For example, Sembawang Shopping Centre while being transacted at $1,727 psf NLA is not a best-in-class asset given that the nearest MRT, Canberra MRT is more than 1km away. Other assets like Bedok Point, The Star Vista and Chinatown Point Mall cannot be considered a comparable asset because of their much shorter land tenure. Arguably, the best comparable would be Westgate retail component given that it is located adjacent to JEM. JEM’s agreed property value of $2,761 psf NLA seems to be in line with the amount paid by CICT of $2,746 psf NLA back in 2018. Rivervale Mall which was transacted back in 2018 was sold at a $psf NLA of 2,833. More recently in May 21, FCT sold Yew Tee Point for $220 million which translates to a $psf NLA of $2,986. Given that JEM is arguably more superior than both Yew Tee Point and Rivervale Mall, I do think that the retail segment valued at $2,761 psf NLA, seems reasonable and definitely has potential for further upside when the current rental gap is narrowed. 

Moving on to the office component, I have extracted the following table from the circular showing comparable transactions of office properties going back to 2014.

Source: LREIT Circular Dated 2 July 2021

Based on the table above, the agreed property value at $1,520 psf NLA is slightly above the mean of $1,449 psf NLA. That being said, some comparables such as Galaxis and Mapletree Business City Phase 2 cannot be considered good comparables given that both are considered business parks rather than offices. Moreover, both have a lower land tenure as well. The best comparable would be Westgate Tower which is located adjacent to JEM. The transacted price of $1,899 psf NLA back in 2014 seems to suggest that JEM’s office component is acquired at a relatively attractive valuation but I personally do think that the consortium consisting of Low Keng Huat and Sun Ventures overpaid for the asset back in 2014. If we were to compare its valuation against Keppel Bay Tower which is a grade A office located within 500m of Harbourfront MRT, the valuation seems to be reasonable. Keppel Bay Tower’s higher $psf NLA of $1,700 is due to its more central location as it is located on the fringes of the CBD. Relative to the asset 7 and 9 Tampines Grande which was acquired by Evia Real Estate and Metro JV back in 2019 for $1,373 psf NLA, the agreed property value for JEM’s office component seems reasonable as 7 and 9 Tampines Grande has a more inferior location since its an 8 minutes walk from its nearest MRT station, Tampines MRT. Moreover, I think that the office component of JEM deserves to trade at a slight premium given that it is leased to the Singaporen government for a long lease term in excess of 23 years, making it a relatively “risk-free” investment. Putting everything in the balance, while I do think that the office component is fairly valued, the upside in the near term should be limited given its already very tight cap rate of 3.5%.

Concluding Thoughts

To conclude, I believe that the proposed increase in its effective stake in JEM of up to 31.8% is a good move from the perspective of the shareholders. While the agreed property value is not considered cheap by any means, I do think that the retail component of JEM is currently under-rented. Given the strong locational attribute of the asset and its best-in-class attributes, it is a matter of time before the manager realises the full potential of the asset and reap further upsides from it. With the recent success in its inaugural issuance of the perpetual securities, the REIT is also in a very favourable position to further increase its stake in the asset or to carry out other DPU-accretive acquisitions (hopefully). The proposed acquisition has no doubt also helped ease some of the investors’ initial concern that the REIT is being overly reliant on 313@Somerset which poses a concentration risk. With its recent surge in share price beyond its IPO price of $0.88, investors seem to be relatively positive on the prospects of this REIT . Should this positive momentum continue into the rest of the year and well into the next, I believe that it would be a matter of time before the manager announces an equity fund raising to further up its stake in JEM. Thank you for reading through my analysis and please do let me know your thoughts!

Leave a Reply

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