Joining the big leagues
Following the successful merger with ARA LOGOS Logistics Trust (ALOG) on 28 April 2022, ESR REIT has been renamed to ESR-LOGOS REIT (EREIT). Including ALOG’s c.S$2.0bn portfolio, EREIT’s total assets are valued at c.S$5.5bn. Its portfolio consists of 83 properties in Singapore and Australia, as well as investments in three property funds which form c.7.8% of EREIT’s AUM (EREIT’s stake in the funds valued at c.A$377.8m).
As the fifth largest industrial S-REIT (by total assets), we believe this could lead to an improvement in trading liquidity, and a potential rerating subsequently. Large cap REITs have historically traded at a premium to its mid cap peers. Looking at the historical 5-year average P/NAV multiple, large cap industrial S-REITs traded at a 1.31x multiple, while the average for medium cap industrial S-REITs was 1.11x. With large cap industrial S-REITs trading at a c.20 bps premium over its mid cap peers, we believe that the market has yet to re-rate EREIT, despite its ability to access a significant pipeline of assets and support from an enlarged sponsor group. In the medium term, as EREIT executes on its value-accretive plans, we expect its P/NAV to trade closer to its large cap peers, implying a c.18% upside to its share price from current levels.
Historically, large cap industrial S-REITs have also traded at a tighter dividend yield than the mid cap industrial S-REITs. Currently, the large cap industrial S-REITs are trading at a c.190 bps discount to its mid cap peers. With a market cap of more than S$2.7bn currently, we believe that there is room for EREIT’s dividend yield to compress closer to 5.3%, implying c.19.9% upside to its share price.
Increased concentration of highly sought-after logistics facilities
Prior to the merger, c.15.6% of EREIT’s gross rental income was sourced from warehouse and logistics properties. With the addition of the ALOG’s logistics portfolio, income contribution from warehouse and logistics properties has tripled to c.45.3%. ALOG’s properties in Singapore complements EREIT’s portfolio and allows it to gain exposure into new logistics clusters such as the Airport Logistics Park in Changi, where availability of supply is tight. It also enables EREIT to deepen its presence in clusters such as Changi International LogisPark and the new Tampines LogisPark, which are close to the airport, as well as the Penjuru and Pandan areas which are within proximity to the seaports and container yards. Notable assets within ALOG’s portfolio include the ALOG Cold Centre which is one of the largest multi-temperature controlled logistics facilities in Singapore, as well as the DHL Supply Chain Advanced Regional Centre which is a modern state-of-the-art logistics warehouse with a GFA of almost 1m sqft.
Enlarged portfolio of freehold properties and long land lease expiry
Having just diversified into Australia in late May 2021 through the acquisition of a 10% stake in ESR Australia Logistics Partnership (EALP), ALOG’s portfolio provides EREIT with the opportunity to grow its Australian exposure significantly. ALOG’s 21 logistics properties and two fund investments in Australia (New LAIVS Trust, Oxford Property Fund) has increased EREIT’s portfolio exposure to Australia to more than 23% (by AUM). Currently, more than 7% of EREIT’s enlarged portfolio, valued at A$1.2bn, are freehold assets, largely coming from its Australian portfolio. EREIT’s overall portfolio weighted land lease expiry has also been extended to c.38.2 years.
Upgrade in credit profile
Together with a larger AUM, EREIT’s free float market cap has almost doubled from c.S$1.2bn to c.S$2.1 bn. In addition to improved trading liquidity, EREIT’s weightage in the FTSE EPRA NAREIT Developed Asia Index is likely to increase. Prior to the merger, we estimate that EREIT and ALOG each had a c.0.4% weighting in the index. Following the merger and the doubling of EREIT’s free float market cap, its weighting in the index will likely double.
EREIT’s enlarged vehicle will also allow it to enjoy a lower cost of debt. Based on the terms agreed with lenders to refinance ALOG’s debt after the merger, we understand that EREIT will enjoy a c.60 bps savings in its cost of debt. Its overall cost of debt is expected to be lowered from c.3.3% to c.2.7%.
We also understand that EREIT is working on obtaining a credit rating to lower its cost of bond financing. With its larger AUM and stronger debt metrics, the Manager believes that the REIT is in a strong position to obtain an investment grade rating. Even with interest rates rising, a good credit rating will allow EREIT to benefit from more favourable credit margins.
Leveraging on Sponsor’s platform for c.US$2bn of pipeline in the medium term
Following its Sponsor’s own merger with ARA Asset Management in January 2022, ESR Group is now the world’s third largest listed real estate investment manager with an AUM of c.US$140bn. Within this, more than US$59bn of its AUM are new economy assets in APAC that EREIT could potentially tap on.
In the medium term, EREIT has identified c.US$2bn of new economy assets in APAC that it could execute on over the next two years. We understand that EREIT will continue to focus on growing its portfolio in developed APAC countries such as Singapore, Australia, Japan, and South Korea. However, given the rising interest rate environment and tight cap rates for logistics and industrial properties, acquisitions in most markets would likely lead to zero or negative cap rate spreads. Based on EREIT’s Sponsor pipeline, we believe that logistics assets in Singapore and Japan would be the most likely target in the near-to-medium term, as acquisition cap rate spreads are still positive in both markets.
In Japan, its Sponsor has a total of 32 logistics properties, with the bulk of these assets held in various private funds. In Singapore, its Sponsor currently holds seven logistics properties (LOGOS portfolio), with three that are still under development.