Source of opportunity

We initiate coverage of Macquarie Prime REIT with a DCF-based 12-month target price of S$1.24 and a Neutral rating. Listed in Sept 2005, Prime REIT is a play on Singapore’s prime Orchard Road retail and office space with stakes in Ngee Ann City (NAC) and Wisma Atria (WA) contributing 84% of FY08 earnings by our estimates. Acquisitions in Tokyo and Chengdu, China in FY07 of S$182.5mn and S$70m, respectively, reflect its regional expansion plans, but in our view have diluted the quality of its portfolio.

We think the lack of a developer sponsor limits Prime REIT’s acquisition growth potential, in a market where competition for prime commercial assets remains challenging. Organic growth prospects for Prime REIT’s Singapore assets are mixed; its office portfolio has about 160,000 sq. ft. of space (69% of its office portfolio), up for renewal in FY08/09 and is currently under-rented at about S$5.60 psfpm based on our assessment. As we see it, retail rental growth is limited by the master lease structure of Toshin (cap on rental increase of 25%). Also, we think CapitaLand’s upcoming ION Orchard (end-08 completion) poses a treat to Prime REIT’s ability to command premium rentals for NAC and WA. While valuation appears undemanding, we see no strong driver for re-rating of the stock. In the SREIT retail space, we prefer sector leaders CMT and Suntec, which we believe have good organic growth prospects.

Catalyst

In our view, there is significant potential upside for retail rents versus historical peaks in Singapore and scope for a pickup in growth of retail base rents, although we think that upside for Prime REIT is limited given its master lease structure. We think the stock’s near-term share price performance will be driven by the company delivering on its regional growth strategy. We note that Japan and China have been identified as its main overseas contributors, potentially doubling NPI contribution to 30% from 16% in two years based on our estimates. In the longer term, we view Prime REIT as a potential takeover candidate, with the stock offering exposure to Orchard Road at a large discount to book value.

Valuation

We derive our 12-month target price of S$1.24 using a DCF base-case per share value of S$1.13 and acquisition premium of S$0.10. With the acquisitions of Chinese assets earlier this year, we estimate that Prime REIT will see 84% of 08E NPI from Singapore assets, 9% from Japan assets, and 7% from its China assets. Its portfolio has an 85/15 Retail/Office split. Lifted by upward asset revaluations, Prime REIT’s relatively conservative debt/asset ratio of 35% (FY07E) implies maximum debt capacity of about S$1.2 bn (at 60% debt/asset) to fund future acquisitions. In our view, respective FY07E and FY08E dividend yields of 6.1% and 6.7% and P/NAV of 0.75x are undemanding. We think there is limited downside risk for Prime REIT given its relatively high yield and attractive P/NAV. However, we are mindful of the potential
negative impact on Prime Reit’s retail malls, NAC and WA, due to the opening of neighboring ION Orchard in late 2008. Also, we think it will be hard for Prime REIT to make future acquisitions of trophy assets such as NAC and WA, owing to intense competition for commercial assets.

Key risks

Regulatory risk in China could slow the pace of overseas acquisition growth plans.

SGX-ST Announcement

COMPLETION OF ACQUISITION OF “FLEG AMERICA-BASHI BUILDING”

Defensive in uncertain market

Slight growth in 2Q07 results. Macquarie MEAG Prime REIT’s (MMP)recently reported its 2Q07 result that was broadly in line with our expectation. Revenue growths were tepid at 5.5% YoY and 1.1% QoQ to S$23.6m. Net property income (NPI) did better sequentially, improving 4.0% (+3.5% YoY). This was due to lower expenses related to leases renewal commission and depreciation. DPU for 2Q07 was 1.50 cents (+4.2% YoY and 2.0% QoQ). The key reason for the slightly better performance was better rentals and lower operating expenses.

Buys into China and Japan. MMP has recently been pretty active on the acquisition front, buying properties in Japan for about S$182m and in Chengdu for S$70m. The Chengdu property will have an attractive NPI yield of 7.5% and will be guaranteed for 2 years. Though these purchases are small in absolute terms and the bottom line growth impact is only about 5%, the impact on MMP’s asset size is more material at about 17% or by about S$250m to S$1.8bn. We expect these acquisitions to be fully debt funded and this is likely to push gearing to about 33% (from 26% in 1Q07), still well within the allowable limit. In terms of DPU growth from these acquisitions, we have already allowed for this in our FY08 DPU of 6.4 cents hence will maintain our forecast for now.

Organic growth to come from office. MMP’s office space is presently under-rented with rents at about S$5 psf/mth, whereas market rents are approaching the S$10-13 psf/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 good potential for upward revisions in rental rates.

Maintain BUY. MMP remains one of the very few REITs with a low priceto-book ratio. This low valuation means that it is likely to be more resilient in market uncertainty. Since our last report (April 07), MMP’s share price has corrected by only about 2%. It is currently trading at just under 1.0x P/B and implies that the market has not factored in growth. With a DPU yield of about 5.0% and a capital value upside of about 8.0%, total return of over 13% is possible with little downside risk. 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.

COMPLETION OF ACQUISITION OF RETAIL PROPERTY IN CHENGDU

Further to the announcements of 22 August 2007 and 23 August 2007, Macquarie Pacific Star Prime REIT Management Limited (“Manager”), the Manager of Macquarie MEAG Prime Real Estate Investment Trust (“MMP REIT”), is pleased to announce that HSBC Institutional Trust Services (Singapore) Limited, the Trustee of MMP REIT (“Trustee”), has today completed the indirect acquisition of Renhe Spring Department Store in Chengdu, China (the “Property”).

SGX-ST Announcement

ESTABLISHMENT OF WHOLLY-OWNED SUBSIDIARY