Actively Improving Yields

Busy improving unitholders’ returns. In a space of two weeks, K-REIT announced that it had obtained tax transparency for rental income from MBFC Phase 1, and that it had acquired another 12.39% stake in Ocean Financial Centre (OFC). We recognize that these are proactive steps to improve unitholders’ returns. As we raise our DPU forecasts, we are also upgrading K-REIT to a HOLD recommendation.

Greater tax transparency. One of the advantages of investing in a REIT for individual unitholders is the tax transparency. However, K-REIT’s one-third stake in MBFC Phase 1 was previously held by a private limited company, which meant that the rental income attracted corporate income tax of 17%. The vehicle was recently converted to a limited liability partnership (LLP), which is tax exempt. This should result in estimated annual tax savings of SGD2.2-5.2m for FY12-15F, leading to higher distributions to unitholders.

Almost full control of OFC. K-REIT also acquired an additional 12.39% stake in Ocean Properties LLP, taking its 99-year interest in OFC to 99.9%. Including rental support of SGD24.1m, the stake is valued at SGD285.7m, or SGD2,600 psf – in line with what K-REIT had paid for the original 87.51% in Oct 2011. The acquisition will be partly funded by a placement of 60m new units to the Vendor, pegged at a price of SGD1.17 per unit, which was at a 14.6% premium to the VWAP then. With the remainder funded by borrowings, K-REIT’s look-through gearing is expected to increase to 43.9% from 41.8% as at 1Q12.

Raising our estimates. On the back of these corporate actions, we have raised our DPU estimates by between 6% and 12% for FY12-14F respectively. DPUs are expected to remain fairly stable up till FY15, with further upside possible if the vehicle holding its one-third stake in One Raffles Quay is also converted to an LLP for tax transparency. With a long WALE of 6.4 years as at 1Q12 (peers average at 3-4 years), K-REIT will be able to weather the near-term market volatilities.

Upgrade to HOLD. We raise our DDM-derived target price to SGD0.99, on the back of higher DPUs and a terminal growth rate assumption of 1.5% (previously 0.5%) as we become less pessimistic on the long-term prospects. 1H12 results will be released on 16 July.

Gaining full control of OFC

• Acquisition of another 12.39% in OFC for S$2,380 psf

• Funding will be 75% by debt and 25% by placement

• DPU boosted by c.3.0%; Maintain BUY at TP of S$1.21

Strategic long-term positive move. K-Reit announced that it is purchasing a 12.39% interest in Ocean Financial Centre (OFC) from Avan Investment Pte Ltd (AIPL) for S$261.6m. This works out to S$ S$2,380psf, netting off income support of S$24.1m which expires end-2017. Including the rental support, total consideration will be S$285.7m or c.S$2,600psf, which is in line with the 87.5% interest in Ocean Financial Centre (OFC) that the reit purchased from its sponsor in October last year. AIPL will sell the property for a period of 99 years and would have the right to acquire the interest for S$1.00 at the end of the period. Following the completion of the acquisition, K-REIT will gain full control of OFC at 99.9% interest in OFC. AIPL will hold the remaining 0.1%. The new acquisition will start contributing from 2H12.

Funding structure: Committed occupancy at OFC is currently 90.6% with underlying monthly gross rent of slightly below S$10psf. Based on the acquisition price, net yield works out at sub 4% but a higher 4.7% with the rental support. Kreit will fund the purchase with S$216m debt (75%) and S$70.2 m proceeds from a placement of 60m new units. The units were issued at $1.17 per unit, at c.15% premium to the market closing price of $1.02 per unit yesterday, and have been fully subscribed by the vendor. All-in interest rate for the debt is expected to be 2.0% -2.5%.

Maintain BUY, accretive purchase. We estimate that this acquisition will lift FY 12/13 DPU by 1.5-3.2% including the enlarged unit base and the recent tax savings. While gearing is expected to head up to 43.9% post acquisition on a see through basis – higher than its peers – we view this acquisition as a strategic move as this would allow the group to manage the asset more efficiently. Valuation remains attractive at 0.8x P/BV given its strong sponsor link and is offering FY12/13 yields of 7.3%, the highest in the office reit space. Retaining our BUY call at an unchanged DCF-backed TP of S$1.21

A fuller OFC

We are net positive on K-REIT’s acquisition of another 12.4% in OFC, with increased control and good placement price outweighing slight negatives from higher asset leverage. Placement price of S$1.17 (15% premium to VWAP) could provide a benchmark for the share price.

We raise our DPU estimates and DDM-based target price (discount rate: 8.2%), factoring in accretion from the purchase. Maintain Outperform on favourable risk-reward. We see catalysts from an earlier bottoming of the office market and tax savings.

What Happened

K-REIT announced the acquisition of an additional 12.4% stake in Ocean Financial Centre (OFC) for S$261.6m (S$2,380 psf) or S$285.7m (2,606psf) including S$24.1m in income support till Dec 2017 from Avan Investments. This acquisition will take its stake in OFC to 99.9%.Equity cost of S$228m will be funded by a mix of debt (S$158.2m) and equity (S$70.2mprivateplacement at S$1.17apieceto Ong Holdings, 14.6% premium to VWAP of S$1.02, though still below NAV at 0.9x P/BV).

What We Think

Overall acquisition price and terms were fairly similar to that for K-REIT’s acquisition of its initial 87.5% stake back in Oct 11. Slight difference came from a lower support quarterly NPI of S$27.6m (prev: S$30.5m) and rental of S$13-14psf. Positives came from increased control and stake in the asset and premium on the placement price (which could seta target/support for share price). We understand that K-REIT had approached the vendor forthe purchase who apparently paid a premium to VWAP due to his confidence in K-REIT. Slight negatives however came from a fairly high aggregate leverage of 43.9% (previously 41.8%) after the deal.

What You Should Do

Overall, we are net positive on the deal, as we see advantages from increased control in OFC and good placement price, outweighing slight negatives from higher asset leverage. We raise our DPU estimates and DDM-based target price (discount rate: 8.2%), factoring in accretion from the purchase. Maintain Outperform on favourable risk-reward.

Moody's affirms K-REIT's Baa3 corporate family rating

Moody's Investors Service on Monday affirmed K-REIT Asia's Baa3 corporate family rating.

The affirmation follows K-REIT's announcement that it will acquire the remaining 12.39 per cent stake in Ocean Financial Centre (OFC) from a private investor trust for $285.7 million.

"While K-REIT's leverage will increase as a result of its efforts to expand its portfolio, the outlook for the rating remains positive because we expect the company to bring its debt-to-total-assets to below 40 per cent in the near term," said analyst Jacintha Poh.

The company will fund the acquisition through a mix of 24 per cent equity and 76 per cent debt. K-REIT will raise $70 million through a private placement of 60 million new shares at $1.17 per share. The remaining $154 million will be funded by approximately two-year term loans.

K-REIT raises stake in Ocean Properties to 99.9% for $228.4m

K-REIT Asia has for $228.4 million, acquired an additional 12.39 per cent interest in Ocean Properties LLP for a period of 99 years from December 14, 2011, its manager K-REIT Asia Management Limited said on Monday.

Ocean Properties, in which K-REIT currently holds an 87.51 per cent stake, holds Ocean Financial Centre (OFC), a 43-storey premium Grade A office development located at the Raffles Place and Marina Bay precincts.

OFC is situated on a site with a 999-year leasehold title that commenced from June 22, 1862 and approximately 90 sq m of the basement area is situated on a site with a 99-year leasehold title that commenced from June 13, 2001.

The development has 887,423 sq ft of net lettable area and comprises an office tower with a car park and retail podium. The car park and retail podium are currently under construction and scheduled for completion in 2013.