Optimising Japanese exposure

• Maintain Outperform and target price of S$1.57. PLife REIT has acquired 11 nursing homes in Japan for S$107.3m at an average net property yield of 6.6% after withholding tax. With this acquisition, income contributions from Japan had increased to 38% from 28% in 1Q10. We maintain our DDM-based target price of S$1.57 (discount rate 7.2%) as we had earlier factored in S$170m of acquisitions for FY10. Stock catalysts could include early debt refinancing on lower costs in 2H10 and a change of the holding structure for its Japanese assets in 1H11 which would lower the withholding tax for its Japanese assets.

• Still opportunities for interest cost and tax savings. Management believes the REIT will be able to refinance a portion of its Japanese debt due next year by 2H10 on lower costs and longer debt tenure. Separately, PLife REIT has reached its minimum required size for issuing a change of holding structure which would enable it to lower its withholding tax from 20% to 5%. We anticipate a 6-12-month time frame for this change.

• Asset leverage at 35%. With its last announced acquisitions, asset leverage has reached 35%. While this is way below the regulatory cap of 60%, management aims to keep asset leverage under 40% in the long term. Hence, raising equity for the next sizeable acquisition is highly likely, in our view.

Likely More Acquisitions In Near Future

• PLife has made another acquisition in Japan, 5 nursing homes this time for 3.1 bln yen / S$46.8 mln.

• Only a month ago, PLife had bought 6 nursing homes in Japan for 3.9 bln yen / S$60.5 mln.

COMMENTS

1. The latest acquisition follows the same template as all other acquisitions made in Japan. (PLife now has 24 healthcare-related properties in Japan, where at least 25% of the population is above 65 years of age.)

2. It is yield accretive, with proforma DPU rising to 8.35 cents, from 8.06 cents after the Jun 10^th
acquisitions.

3. That’s because the purchase, like previous ones in Japan, will be fully debt funded.

4. In fact, the interest rate of 1.8% pa is the lowest for PLife in all of its purchases in Japan, ie the yield accretion is correspondingly the highest.

5. Given the long life of the leases (17.45 years for the latest 5), it is arguable that PLife’s gearing, rising to 34.4% from 32.2% after the last acquisitions, should have further room to grow, ie allowing for more acquisitions.

6. Indeed, because of the low interest rates in Japan, PLife is expected to make moré acquisitions in Japan in the not-too-distant future.

7. At 1.34, yield is 6.2%, which we still find alluring.

8. Because of the successful formula or template, PLife, which has been one of the best performing reits in Singapore, tested the $1.40 high for the 7th time this morning. It had however closed at $1.40 on three occasions in March this year.

On An Acquisition Spree

• Buys 5 nursing homes in Japan for S$46.8 million with net property yield of 8.35%

• Enlarged portfolio consists of 32 properties; 3 Singapore, 29 Japan

• Maintain Buy, raised fair value to $1.66

In the span of just one month, Parkway Life REIT (Plife) announced the acquisition of another 5 nursing homes in Japan, following the acquisition of six nursing homes also in Japan the prior month. Looking at the purchase statistics, this purchase appears to be one up over the previous. The latest acquisition was for a total consideration of S$46.8 million, a discount of 16% off the appraised value, and at a net property yield of 8.35%. The properties have an average weighted lease term of 17.45 years with average occupancy of 94.9%. There will be a backup operator arrangement and the vendor is providing a rental income guarantee for seven years up to a maximum claim of S$2.4 million. The acquisition will be funded wholly by debt at an all-in rate of 1.8% p.a. Gearing post acquisition will increase to approximately 34.4%. For the previous acquisition, the purchase consideration was at a 2.8% discount off the appraised value, at a net property yield of 8.08%. Funding cost was also higher at an all-in rate of 2.0% p.a.

With this acquisition, Plife now has 32 properties in its portfolio with 29 in Japan. Asset value breakdown is approximately 68% Singapore and 32% Japan. On a normalized basis, revenue contribution from Japan is about 35%.

From the acquisitions Plife had made in Japan, we can see that the credit environment is getting more and more conducive. Funding cost has come down from over 300 basis points to below 200 basis points. Net property yield is also attractive at eight-plus percentage points.

Factoring in the DPU contribution, the acquisition will increase our FY10E DPU forecast by 0.7% to 8.4 cents. Subsequent years DPU increase by approximately 4%. We have also raised our fair value to $1.66 and maintain our Buy recommendation. Again, we reiterate our preference for Plife. Our only concern now is the creeping gearing, notwithstanding that 35% is still a comfortable level.

On Life’s trail in Japan

• Additional 5 nursing homes acquired for JPY3.1bn ($48.6m); 11 in total over 5 weeks

• NPI yield at 8.35%, favourable against existing Japanese portfolio’s 7.16% and cost of funds at 1.8%

• FY10F DPU raised to 8.6 Scents (from 8.3 Scents), equating to 6.2% yield

• Maintain Buy; TP raised to S$1.59

5 more in bag, total of 11 in 5 weeks. PREIT announced that it has entered into an agreement to acquire 5 nursing homes in Japan for JPY3.1bn (c.S$48.6m), bringing total to 11 over the past 5 weeks. The 5 assets have a net property income (NPI) yield of 8.35%. The REIT will fund the acquisition via a 5-year revolving facility, swapped to an all-in cost of 1.8%. Gearing for the REIT will increase to 34.4%, from 32.2%. With this latest acquisition, the REIT will have 29 nursing homes valued at c.S$400m in Japan.

Long leases with rental deficit support. As per previous deals, the nursing homes have long-term lease agreements with the operators. It has a weighted average lease term to expiry of 17.45 years. Kenedix will provide rental deficit support for 7 years, capped at 5% of the purchase price (i.e. JPY154.4m or c.S$ 2.4m).

The right size for now. With a nursing homes asset size of c.S$400m, we believe this marks a temporary pause on acquisitions in Japan, though management will continue to look for opportunities in other markets, such as Australia and Malaysia. Management would be looking to embark on asset enhancement initiatives, as well as conversion into a TMK (Tokutei Mokuteki Kaisha) structure to enjoy 15% reduction in withholding tax, though the latter may take up to a year to materialise.

Maintain Buy, TP raised to S$1.59. The acquisition will be DPU accretive for unitholders with FY10F DPU at 8.58cents, from 8.3cents previously. This equates to a current yield of 6.2%. We raise our TP to S$1.59 (from S$1.51) as we factor in this and the previous acquisition in June, still based on DCF (WACC 6.6%). We continue to like PREIT for its defensive traits, while leveraging on the aging population.

PLife Reit buys five nursing homes to boost Japan portfolio

PARKWAY Life Real Estate Investment Trust (PLife Reit) is expanding its presence in Japan with the 3.1 billion yen (S$48.3 million) acquisition of five nursing home properties, through its wholly owned subsidiary Parkway Life Japan3 Pte Ltd.

PLife Reit is buying the five properties from Yugen Kaisha KSLC, a subsidiary of Japan- based real estate asset manager Kenedix Inc, whom the Reit had previously acquired 15 nursing home properties from in 2008 and 2009. Kenedix will be appointed asset manager of the five properties in a separate deal.

The acquisition, which will be completed by July 23, will be funded through a five-year revolving credit facility of up to 3.2 billion yen, which will increase PLife Reit’s gearing from 32.2 per cent to 34.4 per cent.

‘Firmly guided by our principal investment strategy of building a ‘healthcare eco-system’ with value-enhancing buys, this acquisition provides an expected net property yield of 8.35 per cent. It will also improve income diversification and deliver stable and sustainable distributions to our unitholders,’ said Yong Yean Chau, CEO of Parkway Trust Management Ltd. This is higher than the current property yield of 7.16 per cent for PLife Reit’s existing Japan portfolio.

As at June 30, the five properties had an average occupancy rate of 94.9 per cent. Each of the properties has a long-term lease agreement with the operators, with a weighted average lease term to expiry (by gross rental income) of 17.45 years, as at June 30. This will boost PLife Reit’s portfolio weighted average lease term to expiry from 13.42 years to 13.63 years.

Yugen Kaisha will also be providing a rental income guarantee for seven years with a cap of 5 per cent of the purchase price, offering certainty for the Reit’s future distributions, PLife Reit said.

This latest acquisition adds to the six nursing home and care facility properties in the Fukuoka and Akita prefectures which the healthcare Reit acquired recently.

‘Upon achieving a good 29 properties in our Japan portfolio today, we are ready to further generate synergies and sharpen our focus towards establishing a mark in our other core countries, which will certify a boost in geographical diversity,’ Mr Yong added.