Friday, July 18, 2014

Is the New I-REIT IPO for U? Not For Me.

Simply, I don't think that it is right for me, and I will proceed to explain why.

A recent article by Finance Asia yesterday released plenty of information regarding the details of the new I-REIT IPO that is due to list on the SGX early next month. Institutional orders are coming in until the end of the month, followed by the retail segment, and then it goes live.

The article itself does miss out quite a bit of information, but going slightly back, they did post a previous article covering quite a fair bit of useful information about I-REIT.

Summary of the facts:
  • $400 mil SGD market cap
  • Assets are 4 office blocks in 4 German cities (Munich, Bonn, Darmstadt and Munster)
  • Gearing is 33%
  • 40% of the shares sold to the public
  • 60% of the shares to their strategic investor, Shanghai Summit Holings
  • Sponsor retains 35% in the REIT management 
  • Strategic investor is locked in 100% for first 6 months, and 50% for the next 6 months
  • First Right of Refusal (FROR) from both its sponsor and strategic investor

Those are the facts regarding the REIT. Comparatively to other REITs available locally, the yield for an office building is very attractive and they have big tenants with long leases, which I think is good. Also, this is the first REIT that gives a pure-play exposure to European properties.

However, I am slightly taken aback by this IPO. When a company goes IPO, it is usually because it is strategically the best time for them to sell off their assets, which in this case are the 4 office buildings in question. So, although the IPO price seems fair valued now, it may be only so because we are comparing the value now to commercial property prices in Germany (which may be "optimistic").

The questions we must ask ourselves are these: Is German commercial property expensive now, or is it cheap? It this IPO at the peak of a property cycle or the trough? 

With that, I refer to an official statistics website that track property prices, and that is the Deutsche Bundesbank on commercial property prices, their German Property Index (GPI). And here is their graph below.

Commercial property prices have been on a tear, steadily going up without much hiccups. What goes up, must come down?

Based on this report just 2 days ago, I think the consensus may already be out there. The report is based on the actual pdf report released earlier by the research company (found here), and even the title does not look like good news. "GPI Forecast Signals Market Slowdown"

The report said that total returns from German property has likely peaked last year in 2013, and they are forecasting lower total returns in the future. The lower total returns is a function of largely dividends and no capital gains growth.

The graph above shows the Y-o-Y total return of German real estate since back to the mid-90s and their forecast of the future shaded in grey. The Office segment is predicted to be the worse performing segment, with all 3 other segments of Residential, Industrial and Retail outperforming Office.

Essentially, they are forecasting returns only from dividends, and zero capital gains growth. Now, look at the first chart again. Do you see any periods of flat horizontal lines when capital prices remained constant? No, neither do I. If it is not going up, it is going down. Very few things go sideways. I think that the report by the German research team might be a bit too optimistic regarding the future returns of German property.

*of course, these are the views of a research team. The economy relies on economic forecasts, just like how the weather relies on weather forecasts. They don't.

Regardless, it is my personal view from a macro perspective, that foraying into the unknown, uncharted and unfamiliar land of German office properties is equally exciting, as it is risky. Nothing goes up forever, and I do think that the odds are in my favour that we instead see at least a stall in property prices, if not an outright fall in prices. Either way, it gives me plenty of time to wait and see how it pans outs before deciding to go in.

From a micro perspective, I think that the underlying assets are small and undiversified. I would feel a lot more comfortable if there was more assets of varying types and in more locations. Locking up the strategic investor would help with its price stability in the short run. But after 6 months or 1 year, what would happen? Things might get a lot more rocky. I think a telling sign of what can be expected in the medium term of this REIT can be subtly inferred by monitoring the actions of the strategic investor after the 6 month and 1 year period. That is yet another reason to hold the horses.

However, I do think that with the above average yields projected, investors are provided with a buffer of safety, even if the unit price does fall. If you aren't hung up about the short or medium term and are really in it for the long haul and the income yield, then now would be a good as ever.

I am taking a step back from this situation and looking at it from a big picture perspective. With the current situation set up as such, this does not seem like a great opportunity for me. I am willing to take my chances with a REIT like this, but not with all the headwinds that it will have to potentially deal with. I will be sitting this IPO out and instead watch it from the sidelines and periodically reassess opportunities in it.

What do you think? Will you be applying for this IPO and why? I would love to hear your thoughts.

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