Another week, another acquisition.
Not a week has passed without yet another REIT announcing their latest acquisition.
Last week, we wrote about Mapletree Industrial Trust’s (SGX: ME8U) acquisition of a data centre cum commercial property in the US.
Ascendas REIT (SGX: A17U) had also just announced the acquisition of a freehold commercial property in Australia.
Now, Mapletree North Asia Commercial Trust (SGX: RW0U), or MNACT, has announced the acquisition of a 50% interest in a freehold office building in Gangnam, Seoul for around S$267.6 million.
The announcement was made in conjunction with the REIT’s extension of its investment mandate to include South Korea.
However, unlike the first two announcements, we feel that this acquisition may not be as attractive as it seems.
Here are three reasons why we think so.
Details of the acquisition
The acquisition involves a 20-storey freehold office building known as The Pinnacle Gangnam, located in the Gangnam district in Seoul, South Korea.
The building’s gross floor area is around 44,400 square metres and the occupancy rate was 89.6% as of 31 July 2020.
Initial net property income yield stands at 3.2%, with a weighted average lease expiry of 2.8 years.
This acquisition will be wholly funded by debt and is expected to be completed by the third quarter of the fiscal year 2020/2021 (i.e. by end December 2020).
Tenant concentration risk
The Pinnacle has a tenant base that is spread out across various industries such as Manufacturing (25.4%), information technology (25.2%) and services (15.1%).
However, the top five tenants make up more than half of monthly gross rental income (GRI), at 55.4%.
This strikes us as having significant concentration risk as the average GRI weight for each tenant is around 11%.
These five tenants include Qualcomm (NASDAQ: QCOM), a reputable multi-national semiconductor manufacturer, and Ralph Lauren (NYSE: RL), a high-end premium lifestyle brand.
Another two tenants are JustCo, a co-working space provider, and Echo Marketing (KOSDAQ: 230360), an advertising agency.
JustCo has no credit rating while Echo Marketing’s credit rating is BBB+, rated by a Korean rating agency.
As the pandemic has yet to subside, there are risks relating to the demand for office space and advertising that may adversely impact these two companies, thus crimping their ability to service rental income.
Vacancy rate may rise further
The vacancy rate for the Pinnacle Gangnam stands at 10.4% as of 31 July 2020.
According to a Colliers study, the vacancy rate in the Gangnam Business District (GBD) was 4.2% in the second quarter of 2020 and is projected to hit surpass 6% in 2021.
Significant new supply of commercial property is expected to flood the market in 2021, resulting in this expected increase in vacancy.
Colliers has projected the vacancy rate to gradually fall back to the 4% level as no new supply is due in GBD until 2024.
However, COVID-19 may throw a spanner in the REIT’s works if it depresses demand for office space post-2021.
Rental rate is expected to increase in 2021 and 2022, but if the new supply is not fully absorbed in time, it may end up depressing rental rates.
Looming lease expiries
A third concern is that 60% of the REIT’s monthly GRI is up for renewal in both fiscal years 2021 and 2022.
These looming expiries may result in downward rental reversions should vacancy rates increase, or if tenants request for a renewal at lower rates due to financial stress brought on by the crisis.
Although 97% of the leases within the building have fixed annual rental escalations of between 2% to 3%, there is a risk that the tenant may not wish to renew at higher rates, or may be unable to afford the rental.
Get Smart: Risks seem to outweigh the benefits
The risks related to this acquisition seem to outweigh the potential benefits.
The combination of tenant concentration, looming lease expiries and weak rental growth may result in stagnant distribution per unit (DPU) growth for the REIT at best, or even cause DPU to decline at worst.
Also, the pro forma DPU increase is projected to be just 0.4%, which hardly moves the needle for MNACT.
Furthermore, the initial NPI yield for the property stands at just 3.2%, which is fairly low compared to Ascendas REIT’s commercial property acquisition’s NPI yield of 6.1%.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.
