Company Update: Acquires 49.9% stake in a JV that owns interests in five office assets in Australia
Link REIT agreed to form a joint venture with Oxford Properties Group, through which the two companies will jointly hold stakes in five premium office assets in Sydney and Melbourne. Upon completion of the deal (expected in 1H22), Link REIT and Oxford Properties Group will own 49.9% and 50.1% stake in the joint venture respectively. Total contribution for Link REIT amounted to A$596.1m. This marks the REIT’s first venture in Melbourne’s office market, and the second in Sydney’s office market following the acquisition of 100 Market Street in Dec-19.
Oxford Properties Group (Oxford) is a leading global real estate investor and asset manager. It is solely owned by OMERS, one of the largest Canadian defined benefit pension plans. Founded in 1960, Oxford manages a c.C$80bn portfolio across four continents including USA, Canada, Europe and Asia Pacific. Link REIT, jointly with Oxford, will form an Investment Advisory Committee to govern and decide on major matters of the joint venture, including business plans and budgets. Meanwhile, Investa will act as the property manager, responsible for the daily operations of the portfolio. Investa, with AUM over A$11.7bn, is one of the largest and integrated real estate investment management and development companies in Australia.
Spanning a total net lettable area of 0.19msm, the portfolio comprises four and one premium office buildings strategically located at the heart of Sydney and Melbourne CBD respectively. All the properties have achieved or plan to achieve at least NABERS Star Rating of 5 for Energy and 4.5 for Water. This, coupled with its prime location and high transportation connectivity, make the portfolio well positioned to benefit from the emerging “flight to quality” trend in a post-COVID era. Specifications of each property are listed in the chart on page 4.
As of Dec-21, the portfolio was 92.5% let. It has a weighted average lease expiry of 5.8 years with <7% of floor area scheduled for roll over in 2022-23. This points to low vacancy risk in the near term.
The office leasing market in Australia is showing signs of picking up as occupiers start to return to office. The demand should continue to be underpinned by economic recovery with expected GDP growth of 4.5% in 2022 and low unemployment rate. Supply risk should be limited as softened pre-committed rate and inflation expectations have delayed new project launches. These should benefit its office portfolio.
Among trades, financial services is by far the largest tenant group, contributing 41.8% of the portfolio’s total gross rent. This is followed by professional services and healthcare and life science tenants, with 32.5% and 6.2% respectively. Despite economic slowdown amid the COVID outbreak, the portfolio has a healthy rental collection rate of c.100%, thanks to a diversified income base backed by tenants with strong covenants. Since all properties are either recently completed or have undergone major refurbishments, no material capital expenditure is expected in the near term.
Based on the agreed property value of A$1.13bn and net passing income of A$49.6m for 49.9% of the portfolio, initial rental yield stands at 4.4%. There will also be a built-in annual rental escalation of c.4% to mitigate impact of inflation over lease tenor. Overall, we estimate the acquisition would enhance the REIT’s FY23 DPU by c.1.2%.
Upon deal completion, Link REIT’s pro-forma adjusted gearing is expected to rise 1ppt to 24.6%. Link REIT remains financially sound to gear up for yield accretive acquisitions when opportunity knocks.
Following the acquisition, overseas assets will account for 6.4% of Link REIT’s total portfolio valuation. Meanwhile, proportion for Hong Kong and China assets stand at 76.9% and 16.7% respectively. With management guidance for China and oversea assets to be 20-25% and 10-15% respectively, we believe Link REIT will continue to explore acquisition opportunities in China and overseas to drive portfolio growth and meet its Vision 2025 target.
Link REIT is trading at distribution yields of 4.8-4.9% for FY22-23. This translates into yield spread of 3% which compares favourably to its 10-year average of 2.6%. The recent COVID resurgence has delayed the border re-opening, and is causing short-term disruption to the retail sector. While temporary rental relief may be required, concerns on Link REIT’s mall operations should not be overdone. The government has proposed to implement a vaccine pass in late Feb-22 which restricts non-vaccinated persons from visiting certain premises including shopping malls. Impact on shopper traffic should not be overplayed as >80% of the total population has received the first vaccine dose. On the other hand, continued acquisitions should augment the REIT’s distribution growth and diversify its income base. We maintain BUY with DDM-based TP increased slightly to HK$83.3. Any faster-than-expected interest rate hike remains the key investment risk, among others.