Yield-Accretive Acquisition In North Sydney

KREIT has entered into an agreement to acquire Blue & William, a freehold Grade A office building under development in North Sydney for A$327.7m. The property provides coupon of 4.5% on cumulative progress payments during the development phase and NPI yield of 4.5% after practical completion. The acquisition will boost pro forma 2020 DPU by 3% and is fully funded by A$-denominated loans. Risk of merger with SPH REIT was averted. Maintain BUY. Target price: S$1.52.

WHAT’S NEW

• Expanding footprint down under. Keppel REIT (KREIT) has entered into an agreement to acquire Blue & William, a freehold Grade A office building with NLA of 14,133sqm under development in North Sydney for A$327.7m. The property is being developed by Lendlease, an integrated real estate and investment company headquartered in Australia.

• Protected by three-year rental guarantee. Lendlease will provide coupon of 4.5% on cumulative progress payments during the development phase. The property continues to provide net property income (NPI) yield of 4.5% after practical completion. Lendlease will provide a three-year rental guarantee on any unlet space after practical completion. Practical completion for Blue & William is estimated in mid-23.

• Organic growth from built-in rental escalation. Blue & William is able to attract tenants from the technology, media & telecommunication, professional services and insurance sectors. It provides built-in rental escalation of 3-4% post practical completion.

• Close proximity to key transportation nodes. North Sydney is the second largest office market after the Sydney CBD in the state of New South Wales. Blue & William is located at the junction of Blue Street and William Street and 160m from the North Sydney Train Station. It is 350m from the upcoming Victoria Cross Metro Station, which will reduce commuting time to Barangaroo and Martin Place in the Sydney CBD to three minutes and five minutes respectively, when completed in 2024.

• Built with best-in-class advanced green features. The property is designed to achieve the 5 Star Green Star Design and As Built Rating by the Green Building Council of Australia and 5.5 Stars Base Building Energy Rating by the National Australian Built Environment Rating System (NABERS). The property’s green credentials would ensure withholding tax is reduced from 15% to 10%.

• Increase geographical diversification by scaling up in Australia. KREIT’s AUM is expected to expand 4% to S$9.0b. The acquisition will expand exposure to Australia from 16.4% to 19.5% of AUM. The proportion of freehold assets in KREIT’s portfolio will increase from 30.1% to 32.6% of total NLA.

STOCK IMPACT

• Acquisition is yield accretive. The acquisition is expected to increase pro forma 2020 DPU by 3% to 5.90 S cents. NAV per unit remains unchanged at S$1.32.

• Fully financed by additional debt. Progressive payments will be made based on construction milestones. The acquisition is fully funded with A$-denominated loans at a cost of 1.97% for natural hedge. Aggregate leverage is expected to increase slightly by 2.3ppt to 39.9%.

EARNINGS REVISION/RISK

• We raised our existing DPU forecast for 2022 and 2023 by 1.8% and 2.5% respectively due to contribution from Blue & William.

VALUATION/RECOMMENDATION

• Keppel’s final offer fell short of Cuscaden Peak’s improved offer. Cuscaden Peak consortium has improved its offer for Singapore Press Holdings (SPH) to S$2.40 per share, beating Keppel Corp’s final offer of S$2.351 per share.

• Maintaining status as the only pure play on office. The probability of KREIT and SPH REIT merging to prevent conflict of interest has been reduced substantially. KREIT is likely to maintain its status and the attached premium as a pure play on office. Thus, we revert to using a lower cost of equity at 5.5% in our valuation of KREIT. Our new target price of S$1.52 is based on DDM (cost of equity: 5.5% (previous: 6.25%), terminal growth: 1.5%).

SHARE PRICE CATALYST

• Positive rental reversion for office properties in Singapore.

• Full-year contributions from Victoria Police Centre (311 Spencer Street) in Melbourne and Pinnacle Office Park in Sydney in 2021.