2020's first REIT IPO: 3 important aspects of Elite Commercial REIT

Many Singaporean investors love having income from their stocks.

In fact, it's no secret that many investors hold a portfolio of income stocks that provide steady dividend payments.

Over the years, real estate investment trusts, or REITs, have emerged as a favourite dividend-paying asset class.

These securitised bundles of real estate assets generate a steady, dependable rental income stream year after year, allowing them to pay a regular (and at times, increasing) distribution to unitholders.

So, it is fitting that the very first IPO for the decade would be Elite Commercial REIT.

Elite Commercial REIT holds a portfolio of 97 quality properties located in the United Kingdom (UK) with 96 properties being freehold.

The offer price for the IPO is set at £0.68 (S$1.21) per unit. This is the first REIT that will be denominated in British pound sterling (GBP). The term sheet stated that the indicative forecast yield is a high 7.1 per cent to 7.4 per cent for the fiscal year 2020.

Here are three noteworthy aspects of this REIT that investors should be aware of.

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TENANT CONCENTRATION

The prospectus said that 99 per cent of the REIT's gross rental income is derived from leases with the UK government via the Secretary of State for Housing, Communities and Local Government.

The Department for Work and Pensions (DWP) is the entity that occupies each property.

The DWP is the government's largest public service department and helps to administer the State Pension and other benefits to around 20 million claimants and customers.

Though the 97 properties are well spread out over multiples locations within the UK, including London, Midlands, Yorkshire, Scotland and Wales, investors need to be mindful that there is essentially only one tenant involved.

To summarise, the REIT is entirely dependent on the UK government for almost all of its rental income.

The UK government had just signed new 10-year leases on the properties within the IPO back in 2018, and these leases come with rental escalation clauses every five years, subject to a minimum annual increase of 1 per cent and a maximum of 5 per cent.

The current structure reduces the risk of the UK government switching to alternative properties as the lease was just renewed two years ago, and will stretch to 2028.

However, with the reliance of the REIT on a single tenant, we cannot ignore the risk of the concentration involved.

Should there be any event impacting the UK Government's ability to pay its dues, whether it is because of Brexit or budget cuts, there could be a negative impact on the rental income enjoyed by the REIT.

CURRENCY CONCENTRATION 

Elite Commercial REIT touts itself to be the first REIT listed in Singapore to be denominated in GBP.

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However, this proclamation may not be a good thing as the UK is now embroiled in a messy Brexit situation, and there has been a loss of confidence as political parties wrestle for control.

The GBP-SGD (Singapore dollar) exchange rate has witnessed a steep plunge from a high of 2.15 back in Sep 2015, to the current 1.76. For those who are counting, that is an 18.1 per cent fall in the currency over a period of over four years.

If Brexit is not resolved satisfactorily, there could be further downside to the GBP.

Though unitholders can opt to receive their distributions in either GBP or SGD, those who live in Singapore would surely prefer SGD.

Receiving your distributions in GBP would mean that your distributions will be exposed to the GBP-SGD exchange rate, and could fluctuate significantly due to the uncertain political situation in the UK.

FEE STRUCTURE

As part of my research, I also took a look at Elite Commercial REIT's fee structure.

There are two components to the management fee - the base fee and the performance fee. The base fee is computed based on 10 per cent of the REIT's annual distribution income, while the performance fee is computed as 25 per cent of the increase in the distribution per unit (DPU) in the current year compared to the DPU declared a year ago, multiplied by the weighted average number of units in issue.

To get a sense of whether these numbers seemed reasonable, I compared the fee structure to another REIT with overseas office properties - Manulife US REIT. It turns out that Manulife US REIT has exactly the same fee structure as Elite Commercial REIT, so it is fair to say that the fees are reasonable and not excessive.

Manulife US REIT's units were priced at US$0.83 (S$1.12) per unit, and the share price has since risen to US$1.02. Notably, the US-based REIT had carried out a series of acquisitions since its IPO.

Investors should note that by tying performance fee to the increase in DPU for the REIT, the manager and unitholders are aligned in wanting a higher year-on-year DPU, which could be a positive aspect.

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This article was first published in The Smart Investor. All content is displayed for general information purposes only and does not constitute professional financial advice.