United Hampshire US REIT: Initiation Report

Business Model of United Hampshire US REIT Limited

United Hampshire US REIT Limited (‘UHREIT’) is a REIT listed on the Singapore stock exchange (SGX) under ticker code ‘ODBU’. It owns a diversified portfolio of (i) grocery-anchored and necessity-based retail properties and (ii) modern, climate controlled self-storage facilities located in the United States. It trades in the USD and at a unit price of US$0.585, its market capitalisation is US$289 million. This is a steep fall from its IPO price of US$0.80 in March 2020- which was also the month when the fastest bear market occurred. Heartland Boy thinks this approx. 30% decline (against his entry price) is probably unjustified and here are the reasons why.

Portfolio of United Hampshire US REIT

As seen its Diagram 1, UHREIT’s main business segments can be broken down into (i) Grocery-anchored Shopping Center and (ii) Self-Storage facilities.

(i) Grocery-Anchored & Necessity Properties

This segment is less vulnerable to cyclical shifts in the economy as it provides consumers with convenience, value and a broad range of non-discretionary products and services. The tenants are resilient to the impact of e-commerce as they have strong omni-channel platforms. This segment contributed to 96% of the gross revenue in 1H2020. Occupancy for the retail segment is relatively healthy at 95% as at 30 June 2020.

Of the 18 retail properties, the US Sponsor is the property manager for 14 of them. The remaining 4 are managed by an unrelated third-party professional property management company, MCB Property Management LLC.

(ii) Self-Storage Facilities

Self-storage is an attractive real estate class as it has a lower maintenance and capital expenditure, resulting in higher returns. Operations of the self-storage facilities are outsourced to Extra Space Storage, an unrelated publicly listed operator.

Overall Portfolio

Together with its self-storage facilities, most of its properties are located in the North-east and South-east regions of the USA. 97% of its portfolio is freehold, enjoying a long WALE of 8.4 years which provides certainty to its operating cashflow.

Investment Merits of United Hampshire US REIT

1. High Dividend Yield

In 1H2020, UHREIT announced and paid out dividends of US$1.78 cents between the period of 12 March to 30 June 2020. This meets its IPO forecast on a pro-rata basis. Based on its IPO’s projection*, this translates into dividend yield of 10.1% at unit price of US$0.585.

*IPO estimates US$4.93 cents for the period from 1 March to 31 December 2020.

Double-digit dividend yield is definitely high and could turn out to be a dividend trap. Hence, further analysis is required and this is Heartland Boy’s hypothesis on why the share price has performed so poorly since its listing.

a) Lack of familiarity with asset class

To the Singapore retail investor, grocery-anchored retail centers would be a very unfamiliar real estate asset class. They simply do not exist in Singapore and the closest thing might be NTUC’s warehouse club located in Joo Koon. However, strip malls are actually the norm in the US. While taking advantage of Singapore’s favourable tax regimes for REITs, the downside is that the Manager would be required to invest significantly in educating the Singapore investment community on this unfamiliar real estate class. Heartland Boy compares this situation to Keppel DC REIT- it traded range-bound for 18 months after its listing as data centre was still a very alien concept back in 2014. (See diagram 2)

b) Perception of Covid-19 impact on Retail assets

This unfamiliarity was compounded further when Covid-19 arrived. With the incident still fresh in everyone’s minds, investors in Singapore recounted with horror on how the Circuit Breaker led to massive store closures for 2 months. Therefore, investment community’s perception is that UHREIT’s portfolio consists of retail malls and were not spared from the Covid-19 onslaught. Never mind that UHREIT is heavily anchored towards groceries and necessities and that at least 87% of the mall’s tenants were open for business in May during the height of the lockdown!

c) Spooked by Eagle Hospitality Trust

Finally, the last reason could possibly be Singapore investors getting cold feet after what happened to Eagle Hospitality Trust (‘EHT’). This was a REIT that Heartland Boy reviewed, took a position in and eventually had to cut loss in just 2 days for a 10% loss. Today, EHT has not paid a single dividend, its directors got hauled up for questioning and it is suspended from trading. Is there a possibility United Hampshire REIT will end up in the same fate as EHT? Well, never said no, but Heartland Boy is comforted by 2 things that he sees:

(i) Reputable Sponsors

The Sponsors of UHREIT are UOB Global Capital and Hampshire Companies. UOB Global Capital is the global asset management affiliate of the UOB Group, which certainly needs no further introduction in Singapore. It has more than 20 years of operating history and manages funds (current AUM of >US$3 billion) from institutional investors. On the other hand, the Hampshire Companies is a family business spanning 3 generations, evolving from a regional manager to a fund manager with more than US$2 billion in assets. It has full real estate capabilities spanning from development to operations, bolstered by strong relationships and network on the ground.

Collectively, both UOB Global Capital and The Hampshire Companies have started 3 private funds. From what Heartland Boy found, United Hampshire US REIT is the genesis of its first funds as reported by UOB Global Capital on its website.

(ii) Board headed by well-regarded Chairman

The Chairman of the Board is Tan Tong Hai. He was previously CEO of Starhub and SCS Computer Systems Pte. Ltd. In the wake of the EHT saga, it is comforting to have a pair of safe hands from a corporate veteran guiding the UHREIT Manager.

2) Trading At Significant Discount On Several Levels

UHREIT is trading at a significant discount on 3 levels:

(i) The adjusted NAV per unit is US$0.74. At a stock price of US$0.585, this represents a 21% discount.

(ii) Overseas retail REITS such as Sasseur REIT and Dasin Retail Trust boasts prevailing dividend yields of 7.7% and 7.1% respectively. The near 300 basis points discount seems unjustified, notwithstanding China’s success in controlling the pandemic.

(iii) SGX-listed US Office REITS average around 8.1% dividend yield. Taking the office to retail discount of 100 basis points, UHREIT should be trading at 9.1%, or around 66 cents.

3. Benefactor of COVID-19 Outbreak

Both sectors (grocery-anchored malls and self-storage) provide basic goods and services directly to the U.S. consumer. Majority of its retail tenants remained open during the lockdown in their respective states, underlying how essential their services are to the population. The open-air concept and large car parks of strip malls also facilitate curbside pick-up as part of social-distancing measures. In fact, some of its tenants achieved strong sales growth and this bodes well for future lease negotiations. During the last reporting period, UHREIT renewed and extended 11 leases representing 170,000sf of retail space. It also secured an average rental reversion of +5% for the five new leases which is very commendable during a period whereby retail is struggling.

UHREIT also stated that as the restrictions were lifted gradually in the third quarter, it has also seen a reduction in tenants requesting for rent relief and deferrals with some even withdrawing their prior requests. The amount in question is potentially US$0.7m which is 6% of the Net Property Income in the last declared period.

4. Mega macro-trends

UHREIT’s shopping centres are located in suburban areas away from core urban locations. The pandemic has led to “work-from-home” trend being more commonplace. If this persists, workers may start to hollow out of urban centers to avoid paying expensive housing rents. Some families also migrate from urban to sub-urban areas in pursuit of greater work-life balance. This de-urbanisation trend would lead to a larger sub-urban population, leading to higher demand for groceries in sub-urban strip malls.

Investment Risks of United Hampshire US REIT

1. Income support from Sponsor

Heartland Boy previously explained what income support is and how it can be potentially dangerous when its effect wears off without the true underlying income catching up in time. Because some of its self-storage assets are in its ramp-up phase and a retail property undergoing AEI, rental support agreements are put in place with the Sponsor. Let’s examine the risks involved.

(i) Self-Storage Facilities

Elizabeth Self-Storage was completed in January 2020 while Perth Amboy Self-Storage was completed only in August 2020 after facing some delays owing to the pandemic. Given that they have not reached maturity, the Sponsor will provide Top-Ups for the Net Operating Income (‘NOI’) of Perth Amboy Self-Storage and Elizabeth Self-Storage for a period of up to four years from the IPO.

The REIT is entitled to receive the difference between the actual NOI and the Stabilised NOI- US$1.3mil for Elizabeth and US$1.1m for Perth. The aggregate amount of the top up shall not exceed an aggregate amount of US$2.2mil (Elizabeth) and US$2.5mil (Perth) on a cumulative basis during the 4-year period as shown in Diagram 4.

During its first financial reporting period (12 Mar-30 Jun), it was revealed that the REIT received US$486,000 from the top-up arrangement for Elizabeth Self-Storage. This is a rather high figure that certainly set some alarm bells ringing. That is because as at end Jun 2020, Elizabeth Self-Storage only reported 19% occupancy. It did rise to 29% as at 31 August 2020. The steep increase in the leasing velocity lends credence to the claim espoused by the Manager that “the absent leasing volume during peak lockdown measures for May and June was not lost, but instead delayed”. Fingers crossed that both Elizabeth Self-Storage and Perth Self-Storage will catch up on their operating performances quickly. This is certainly an operating metric that Heartland Boy will be actively monitoring.

(ii) St Lucie West Expansion

The other rental support is offered for St Lucie West as it is undergoing major AEI works that will expand its net leasable area. The top-up amount is guaranteed at US$1,100,000 in 2020 and an additional US$698,000 in 2021.

During the 2020 REIT Symposium which Heartland Boy attended, it was revealed that the construction is under budget and scheduled for completion in 1Q2021. The Manager also already successfully leased all of the additional net leasable area to its existing anchor tenant, Publix Super Market, on a long tenure of 20 years. A new lease was signed with Beall’s Outlet Stores to occupy 57% of the existing space that will be vacated by Publix when it relocates to the new store in 1Q2021. Therefore, the only risks that remains will be the remaining 43% space that will be vacated by Publix. The Manager has approximately until Oct 2021 to fill it up before the rental support agreement expires, which is something that Heartland Boy thinks should be a manageable feat.

2. “Questionable” IPO Agreements

On the surface, it appears that the REIT Manager has undertaken some questionable agreements during its IPO. They are certainly worth an extra look.

Carteret Self-Storage and Millburn Self-Storage Earn-out Agreements

If Carteret Self-Storage or Millburn Self-Storage achieves a NOI of at least US$954K and US$1,145k for any 12-month period on or before 30 June 2021 and 30 April 2022 respectively, the REIT is liable to pay the Sponsors US$200K and US$500K respectively. During an email exchange with its Investor Relations department, it was revealed that it would take an average 93% in occupancy rates for each of the properties to reach their target NOI.

There’s actually not too much to worry over here. Firstly, agreements like these are actually common in real estate (based on his own professional experience). Secondly, Heartland Boy feels that the risk of a higher purchase price have actually been passed to the Sponsor as they have undertaken to pay the Vendor first and be reimbursed later; which is subject to the actual underlying performances.

Wallkill Price Chopper Existing Investor Agreement

UHREIT will acquire 100% of the shares of company that holds the retail property named Wallkill Price Chopper. However, an existing JVA in place with an existing investor meant that the existing investor is entitled to receive 3% of the distributions for perpetuity despite not owning any shares. This is certainly odd, but Heartland Boy thinks that their hands are tied since it was disclosed in the Prospectus that this existing agreement simply does not have any termination provisions. If it helps, it was stated that the purchase consideration had taken into account this 3% perpetual leakage. Moreover, it is valued at only US$13.6mil and constitutes 2.3% of the overall portfolio AUM.

Parkway Crossing Existing Investor Agreement

Taking over the equity interest of the Vendor which has entered into an existing agreement with MCB Parkway Crossing LLC, UHREIT will own 90% of the interest in Parkway Crossing with the remaining held by MCB Parkway Crossing. However, distributions of available cash generated by Parkway Crossing will be distributed in a waterfall arrangement that could possibly result in UHREIT receiving disproportionately less than its equity share. If MCB rings a bell, that is because it is also the property manager for 4 of the retail properties not managed by the Sponsor.

Heartland Boy has studied the waterfall distribution in detail and finds nothing too alarming because this is once again common in the private equity world where the General Partner receives a carried interest (performance bonus). In its previous arrangement, Heartland Boy suspects that MCB was both a Sponsor and the GP managing the asset of behalf of third-party capital.

3. Relatively High Leverage

As at 2Q2020, its gearing ratio is 36.2% which is quite close to the psychological 40% mark. This suggests that any future sizeable acquisition may necessitate equity funding. Furthermore, if the REIT suffers any devaluation (current investment properties valued at US$598 mil) as a result of Covid-19, its gearing ratio would come under further stress.

This is mitigated by the fact that interest coverage is high at 6.1X and there is no refinancing required until 2023.

4. Low Liquidity

The liquidity of UHREIT is very low as majority of the units are held by the Sponsors (18%), Cornerstone Investors (61%) and Rollover Investors*(3%). Only 18% of the units are in the hands of retail investors. This also means that units are tightly held and any significant move by the cornerstone investors will lead to outsized movement in its share price. There is no lock-up period for the Cornerstone Investors and Rollover Investors but a lock-up period for 50% of the units held by the Sponsor only expires in March 2021.

*Rollover Investors are existing investors in the Hampshire funds which sold the properties to UHREIT.

Review of United Hampshire US REIT

As aforementioned, there exists sizeable risks in United Hampshire US REIT. Some of the risks flagged are unfounded upon deeper analysis, while some of them would be something that he is comfortable to live with, for now.  All things considered; Heartland Boy still feels that it has been unfairly “punished” by the market. His investment thesis is therefore one whereby UHREIT catches up on this discount to help unitholders realise some capital gain. Even if this does not materialize, 10% dividend yield is certainly not too shabby, provided that it gets paid!

Vested at an average price of US$0.56 cents since Sep 2020. He will continue to share his thoughts of United Hampshire US REIT Limited on forums such as InvestingNote. Analysts such as UBS and HSBC cover this REIT with target price of US$0.65 and US$0.79 respectively.

This article was published on 18 October 2020.

Disclaimer: The information contained herein is the writer’s personal opinion on his blog and do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein.