Finally delivers on acquisition promise

Flattish growth. Macquarie MEAG Prime REIT’s (MMP) 1Q06 came in within expectation. Top-line came in at S$23.4m, improving 3.5% QoQ, but Net Property Income (NPI) of S$17.3m (-0.4% QoQ) led to flat distributable income per unit (DPU) of 1.47 cents. The top-line benefited from positive rental reversion, while the lower NPI was attributed to higher property expenses (mainly depreciation) as the result of the installation of escalators linking Wisma Atria basement to Orchard road and higher cost for changing the tenancy mix.

Organic growth to come from office. MMP’s office space is presently under-rented with rents at about S$5psf/mth, whereas market rents are approaching the S$8-10psf/mth mark. More importantly, with 182,000 sq ft (about 70% of office space) of leases due for renewal over the next two years, we see a lot of upside potential.

Finally bought something but accretion marginal. On the acquisition front, MMP has been fairly disappointing since its IPO in 2005. However recently, it has made up for lost time by making two separate acquisitions in two different countries. One was in Tokyo (7 retail properties) for a total of S$182.5m, while the other was for a 50% stake in a Chengdu retail mall
for S$30m. Though in absolute terms these purchases are small and has no material impact on its asset size of S$1.5bn, it is nevertheless a step in the right direction. With gearing at only 26%, debt funding makes the most sense. We estimate that if the acquisitions were fully debt funded,
the full year DPU accretion is about 0.2 cents. As our FY07 and FY08 forecasts already contain growth assumptions, we will retain our numbers for now and will review them in 2H07. We also remain hopeful that more meaningful assets can be acquired.

Maintain BUY. MMP remains one of the very few REITs with a low price to book ratio. It is currently trading at about 1.1x P/B. This implies that market has not factored in growth and that upside surprise is possible if a meaningful acquisition is done. Finally with a DPU yield of about 5.0% and a capital value upside of about 6.5%, total return of over 10% is possible. We thus remain positive on MMP and see it as one of the lowest-risk REITs in the market. Maintain BUY with a fair value of S$1.32.

First Acquisitions since listing

MMP REIT has done its first acquisitions since listing on the 20th Sept 05. MMP has entered into three separate conditional sale and purchase agreements to acquire seven properties in Tokyo, Japan for a total purchase price of approximately S$182.5m. This represents a discount of 1.5% to the appraised value of approximately S$185.4m. Properties under management will increase by 12% to S$1683m.

Minimal DPU Impact. The pro forma financial effect of the acquisitions on DPU for the FY06 would be an additional 0.108 cts per unit, representing an initial yield accretion of 1.9%. The Manager will finance the acquisitions wholly with debt. Upon completion of the acquisitions, the gearing ratio of MMP REIT is expected to increase from 25.6% to 34.0%. The date of completion may be extended until 31 May 2007. This translates to an additional DPU of 0.04 cts for FY07F, representing a yield accretion of 0.7%. We estimated that a distribution income of approximately S$1.0m would be contributed annually from the acquisitions. This works out to be only 1.8% of FY06 distribution income. Hence, we feel that the acquisitions will not have much impact to MMP DPU. This is mainly due to the low opportunity cost in Japan.

Acquisitions Information. The properties are acquired with an initial yield of approximately 4%. Local asset manager from Japan will manage the properties, with the management fee contributed by MMPs property managers fee. Profit will be taxed under Japan by approximately 12%. Average lease term for tenant is estimated to be 5.7 years. Four of the properties are under master lease. Rental rate are expected to be stable without increment during the lease term. Japan property recovering. We believe that Japan property market will rebound after 15 years of decline, backed by the recovering economy and low cost of debt. In addition, the strong demand from investment funds is also pushing up the property prices in capital city like Tokyo. We also expect Japanese yen to appreciate limiting any currency risk involved.

Valuation and recommendation. Although the DPU impact is not great, we feel that this acquisition will benefit MMP in long term. We feel that this will be a good start, and applause to MMPs first acquisitions. We expect to see more acquisitions in future. We also believe that MMPs orchard properties will continue to appreciate, increasing MMPs NAV by at least 10% this year.

With a WACC of 7.2% and a growth rate of 3.0%, we arrive at the fair value of S$1.37 for MMP. This translates to a 4.2% dividend yield and a price to net asset value of 1.1x for FY07. It represents an average spread of 1.5% as compared to the risk free rate of 2.7%. We upgrade MMP to a Buy with a 9.6% return.

Maiden Acquisition

MM Prime REIT has made its maiden acquisition of seven properties, predominantly for retail purposes, in Tokyo for about S$182.5m. The acquisitions will anchor MMP with a strategic foothold in Japan. Based on pro forma NPBT of S$0.7m from the properties these assets could add 0.108 cents to DPU, to be felt from FY08. We are maintaining our FY07 forecast of 5.8 cents, translating to a yield of 4.8%. Maintain BUY with a price target of S$1.28.

Acquired seven properties in Tokyo. MMP has entered an agreement with Yugen Kaisha Triton Property and Fund Creation Co. Ltd to acquire six completed retail properties under the Fund Creation portfolio located in prime areas of Tokyo, Japan for S$110.4m. Currently these properties are enjoying close to 100% occupancy.

The 7th property, the FLEG America-Bashi Building, is a seven-storey retail-cum-office development located in the Ebisu area, which is expected to be completed in September this year. This property will be acquired for S$72.1m from FLEG International a major Japanese retail leasing group and a growing real estate developer.

Full impact to be felt from FY08. The acquisitions will be yield accretive to MMP’s distribution per unit (DPU). The pro forma financial effect would be an additional NPBT of S$0.7m or 0.108 cents per unit, representing an initial yield accretion of 1.8%. As completion of transaction is expected at end May 07, the boost to income would be felt from FY08.

Capacity for expansion. The acquisition would be funded by debt, thus further enhancing to bottomline post acquisition. MMP would have a gearing ratio of 34.0%, up from 26.5% previously. This leaves the group with significant funding capacity for new purchases.

Maintain FY07 forecast. We are maintaining our FY07 forecast of 5.8 cents, translating to a yield of 4.8%. Maintain BUY with price target of S$1.28.

Not just one but seven

Finally, not one but seven. After listing in Sept 2005, MMP has finally delivered acquisitions to drive yield accretion. And for MMP’s debut deal, it is not just one, but a basket of seven properties for S$182.5m at property yield of 4-4.2%, located in various prime areas of Tokyo which is spread across Roppongi, Shibuya-ku, Minato-ku and Meguro-ku. Six of the assets (Fund Creation portfolio) are completed assets with income generation, most with 100% occupancy, while the remaining asset (FLEG America-Bashi Building) is a retail/office building in the Shibuya-ku area currently under construction and expected to complete in Sept 07. Completion of the acquisition of the Fund Creation portfolio is expected to complete by May and FLEG America-Bashi Building on a completion basis.

Yield accretion fully funded by debt. With current gearing of 25.6% preacquisition, MMP has considerable debt capacity to pursue yieldenhancing transactions. We expect MMP to fund its debut acquisitions fully by lower cost of borrowing in Japan, and estimate about 0.1 cents DPU accretion on full income contribution from these assets.

Time to bridge the gap. With a first acquisition from Japanese real estate developer FLEG International, this could mark the first of more acquisitions to be sourced from Japan as part of a possible indirect 3rd party pipeline. Moving forward, should MMP rack in more acquisitions and illustrate the Reit manager’s deal sourcing capability, we could see further yield compression for MMP and narrow the yield gap between MMP and other retail S-Reits which are trading at a comparative premium backed by developers.

Maintaining Buy, TP S$ 1.34. We have factored in the above acquisitions into our DCF calculations and arrive at fair value of S$ 1.34. At 5.1% distribution yield compared to other retail S-Reits currently trading at 3.5%, this suggest room for further upside with yield compression. Hence, we maintain our BUY call for MMP REIT, and target price of S$ 1.34 based on DCF valuation. Downside risk is limited due to resilient prime retail rents and office market upswing.

Macquarie Reit in talks to buy assets worth US$1b

SINGAPORE – Singapore’s Macquarie MEAG Prime Real Estate Investment Trust (Reit) said on Monday that it is in talks to buy assets worth over US$1 billion in total, and expects to make the first deal since its 2005 listing by June.

The trust — controlled by Australia’s Macquarie Bank and MEAG, the asset management arm of German reinsurer Munich Re ERGG.DE — is also in talks to take a stake in a non-Singaporean property trust.

The deals would be the first acquisitions for Macquarie MEAG which listed two years ago with just two office-mall complexes in its portfolio. These two properties are now valued at $1.5 billion (US$78.5 million).

‘We are confident we can announce something by the first half,’ Franklin Heng, chief executive officer of Macquarie Pacific Star Prime Reit Management told Reuters in an interview. Mr Heng said the trust was in talks to buy properties in Malaysia, Japan and China, ranging in value from US$10 million to US$1 billion. ‘I’ve got different balls in the air for each country. But (our first acquisition) is very unlikely to be in Singapore,’ he said.

The trust has a current gearing of about 26 per cent but this could be raised to 45 per cent as the trust plans to borrow about $530 million from banks to fund its acquisitions. ‘Our long-term optimal gearing ratio is between 40-45 per cent but there’s no stopping us to leverage us to 50-55 per cent if we find the right deal. But if that happens, I will put in a bridging loan and issue new equity to bring the gearing back down,’ he said.

He added that the trust would focus on growth outside of Singapore because competition for commercial assets in the city-state was intense. — REUTERS