Saturday, January 13, 2018

One of my favourite REITs

Hi, hope everyone has a good start for the year.

I spent my 2017 Christmas in Kowloon Hong Kong and stayed at Cordis. It was formally known as Langham Place. I had a relaxing trip and the hotel experience and the shopping centre around Mongkok was really great. Despite having a good time, another purpose of going Hong Kong is to actually open a SMIP (Stocks Monthly Investment Plan), which uses dollar costs averaging concept to buy into stocks. Maybank Kim Eng offers such service, but only Hong Kong offers the option to purchase 2800 Stock Tracker Fund of Hong Kong. It's managed by SPDR, and tracks the index pretty well. (Will share this more in my next post on Portfolio Update )

As I love to look out for opportunities in investment, the crowded and lively shopping environment in Langham Place caught my attention. The Langham Place Shopping Mall is owned by Champion REIT, together with the Langham Place Office tower just next to it; whereas the hotel is separately owned by Langham Hospitality Trust, which also owned a portfolio of hotels in central region as well as overseas. However both Reits are actually investments spunned off by Great Eagle Holdings, -a Hong Kong real estate company listed in HKSE.

After returning to Singapore, I looked through its annual report on Champion Reit. As it currently owns only 3 properties- two proprties in Langham and Three Garden Road in the heart of Hong Kong's financial centre, it makes it easy to analyse each property too.

All under one roof
Langham Place is an integrated commercial development consisted of the shopping mall, office tower as well as the a 5 star Cordis Hotel. It is also easily accessible by MTR (HK's MRT), which is connected to Mongkok station. Closer to home, it's probably quite similar to Raffles City, with City Hall station, Raffles City shopping centre, Raffles City Tower, and Fairmont Singapore connected together. They properties are intelligently combined such that they complement each others businesses. For instance shopping mall gets to capture traffic from the hotel guests, office staff as well as train passagers alighting at Mongkok station, be it for dining or shopping or catching a movie or even a drink with friends at the sky bar. Having that convenience and accessibility to hotel guests is also what attracts them to become repeat customers. Additionally, they are one of the few malls which closes at 11pm in the evening (up to 11.30pm during Christmas season) compared to popular shopping centres in Tsim Sha Tsui which closes at 10pm. I visited the mall during my stay, and it was actually very crowded up till 11pm.

Busy District with Attractions
Even the name by itself 'Mong Kok' in cantonese, means busy corner. In fact, calling it a busy district is an understatement. By Guiness world records standards, it was described as the world's most densely populated place, with population density of 130,000/sqkm. (Average population density in HK stands at 6442.65/sqkm and Singapore 7987.52/sqkm) , and yet we are feeling crowded already. Being crowded is not without it's reason. Its famous Ladies Market, known as 'Lui Yan Gai', is also one of the most visited places in Hong Kong. Another reason which attributed to it's densely population area is the high density housing. Hence, situated in the city area which is busy, packed and vibrant, it naturally leads to more passerbys and visitors shopping in Langham Mall.

Focusing on shopping experience and clear positioning strategy
Today, online shopping provides consumer more convenience than ever. Goods could be easily bought even with mobile on the go and delivered to your doorstep. These days one could shop in brick and mortar stalls to check out the items just to purchase it online at a discount. When it comes to pricing and wide products selection, malls will never get to compete with online shopping. Hence, retail malls have to focus on the shopping experience and convenience. For instance, making it a hub for local community by positioning itself as a place for young couples to date, or even a place for quality time for family bonding.

In the case of Mongkok , its location is known as a playground for the young people, and a term 'MK people' is use to describe teenagers or young adults who hang out in Mongkok often and a high affinity to 'Mongkok culture'. In the 90s to early 2000s, the street was once dominated by Japanese pop culture, but was overtaken by Korean pop culture, from fashion, to food and music.
To ride on this Mongkok culture, Langham Mall has new concepts and pop ups stores, as well as a revamp of live stage in level 12 to bring in live performance and celebrities which potentially attracts more young people. The popular Nene Chicken also officially first opened it stall in Langham Mall with popular television personality Yoo Jae-Sul as spokesperson. Its opening attracted long queue.

When I was doing my shopping in Langham Place, I did notice that 'almost all' of the shops do cater for the young people. Unlike Ion Orchard, they don't see high end retail goods such as LV, Hermes or Prada. Instead the shops are mainly catered for youngsters such as retail chain Log-ON- a mega lifestyle specialty store catered for busy young professionals, and Line Friends Store.

Last Christmas season, they had an exhibition called Line Friends Christmas Planet at Langham Place, which has a playground ,interactive games and featuring a 7m illuminated BROWN at the Atrium (popular for selfies) .There's also this this Create Your Own Planet interactive photo design game, which you get to choose your favourite LINE friends 'Planet' and 'Costume' (Brown, Choco, Moon or Sally) which you wish to be transformed into. Your exlcusive photo with Line costume & planet will be on display in the venue which can also be downloadable via a Line App. Although, I am not a fan of Line and don't really enjoy taking selfies, the interesting concept captured my attention.

If a picture is worth a thousand words, a video is probably worth a few thousands more. You can check out the youtube video to have a better idea of what I am talking about:





The results also speaks for itself, as you can see the chart below suggests that retail sales for Langham Place Mall grew by 1.9%, outperforming the general market which is down by 0.9%.


More room for Rental Reversion of Three Garden Road

Not forgetting its office property in Central- Three Garden Road, which got its name in June 2016 after a renaming exercise and publicity campaign. It went through an extensive Asset Enhancement Initiatives (AEI) with improvements in carpark facilities, lobby design and decorative greenary elements resulting in a more dynamic and healthy work-space. It also enhances the property's reputation.

Despite the facelift, it rental psf is still much below the average rental for commercial properties in HK. Currently, average rental psf for Three Garden Road for 1H2017 is 84.65 HK$ psf.

Rental Reversion during 1H 2017 for Three Garden Road


The chart above shows the widening rental gap between Hong Kong and Singapore. Though it be seen that that there's more room for Singapore's commercial rental growth, my point is that the average rent in HK for Q2 these days is above HK$100 (1USD: 7.81HKD), which means Three Garden Road's passing rent is still significantly below current market levels.

You can check out this article: http://www.scmp.com/property/hong-kong-china/article/2066752/hong-kongs-record-office-rents-drive-more-firms-out-central


Champion Reit 1H 2017 Interim Results

Valuation
Next, I will be working out its potential yield should its rental improves.

Total Rental Income- Net Property Operating Expenses = Net Property Income


The annual report suggested that the ratio between Operating Expenses and the Total Rental Income improved due to higher average occupancy. As the Property Expenses is pretty stable relative to changes in total rental income, we can project future expenses to be the average of three years, 277 HK$ mil, rather than its ratio.

Profit for the year, before distribution to shareholders=
Net property Income + Interest Income +Manager's Fee + Trust & Other Expenses + Increase in Fair Value of Investment Expenses + Gain on Repurchase of Medium Term Notes + Finance Costs - Income Tax

Profit for the year, before distribution to unitholders - Adjustments*=  Total Distributable Income
(Basically is adding non-cash expenses/losses i.e.manager's fee paid and payable in units, and minusing off gains that doesn't affect cashflow, i.e fair value gain in investment properties)

Total Distributable Income X Effective payout ratio = Distribution to unitholders.

*Adjustments: 1. Manager's fee paid and payable in units
                        2. Increase in fair value of investment properties
                        3. Non-cash finance costs
                        4. Deferred Tax

For calculation, we can assume effective payout ratio of 94.5% (which has been pretty consistent over the past few years)

To project distributable income, it would be quite tedious to add all the fees and valuation gains to adjust the non-cash expenses. We can work out the relation between Net Property Income and Distributable Income by calculating its ratio.


We can either take the average or use the lower figure, at 0.679.
In our case, let's be conservative and use 0.679.

Manager is entitled to receive a fee equivalent to 12% of net property income: 50% payable in units and 50% payable in cash. Hence there will be a dilution of units yearly.

As retail sector is still facing challenging times ahead, one of the catalyst for growth for Champion REIT would be its rental income of Three Garden Road as current rental psf is 'significantly' below market price.

This was how rental income for Three Garden Road was derived
(For this exercise, we will assume Champion REIT price to be HK$ 5.68, based on closing price on 10th Jan 2018)

Total rentable area: 1,268,000sq. ft.
Occupancy Rate: 92.6% (as of 30th June 2017)
Effective rent per sq. ft: 84.65 HK$

Total rent for 1H 2017= Total Rentable area X Occupancy Rate X Effective rent psf X 6 months
                                    ≈ 596 HK$ mil

Should it hit full committed occupancy in a year and 100 HK$ psq, and keeping other rentals constant,

Rental Income (Three Garden Road)= 1,268,000 X 100% X 100HK$ psq X 12 = 1,521 HK$ mil
Rental Income (Langham Place Mall) = 412 HK$ mil X 2 = 824 HK$ mil
Rental Income (Langham Place Office) = 175 HK$ mil X 2 = 350 HK$ mil.

Total Rental Income= 2695 HK$ mil.
Net Property Operating Expenses= 277 HK$ mil
Net Property Income= 2695 - 277 =2,418 HK$ mil
Distributable Income= 0.679 * Net Property Income= 1,614.822HK$ mil
Distribution to Unitholders= 0.945 * Distributable Income =1,551.52179 HK$ mil.
Total Units as of 1H 2017= 5,811,998,520
Total units after potential dilution= 5,811,998,520 + 0.06(2,418,000,000)/5.68= 5,837,540,773 units
DPU= Distribution to shareholders/ total units after potential dilution= 0.266 HK$

Potential Dividend upside=(0.2658/2 - 0.1173)/ 0.1173 X 100% = 13.3%

If we are looking for 5% yield for 100% occupancy,

DPU= 5% X 5.68= 0.284 HK$

I have worked out the fomula to derive the DPU and simplified it,

DPU = 0.945 X 0.679 NPI / (5,811,998,520 + 0.06 NPI /5.68)
          = 0.641655 NPI/ (5,811,998,520+  0.06 NPI/5.68)

NPI = 2,584,505,844 HK$

Assuming Net Property Operating Expenses= 277 HK$ mil,

Total Rental Income= 2,861,505,844 HK$

Assuming Rental Income for Langham Place Mall and Office remains unchanged,

Rental Income for Three Garden Road= HK$ 2,861,505,844 - 824 HK$ mil- 350 HK$ mil = 1,687,505,844 HK$

Effective Rent psf/ yr= 1,687,505,844 / 1,268,000 =1,330 HK$
Effective Rent psf/ mth= 111 HK$ /month.

5% yield at 92.6% occupancy,

Effective rent = 1,687,505,844 / (1,268,000 *0.926)= 1,437 HK$
Effective Rent psf/ mth = 120 HK$/psf , which is still below the rental price in Central.

Just to give you an idea on the rental rates at  Central: Cheung Kong Centre, which is just two mins walk away from Three Garden Road currently has an average rental of 159 HK$ psf.
Here it is : http://www.hongkongoffices.com/en/cheung_kong_center/61/building_info

If you check out the curent listings of Three Garden Road here, they are asking for 125 HK$ psf. Its  average rent is still below 100 HK$ psf because many expiring leases have yet to undergo a rent review. It's just a matter of time.




Possible Sale of Langham Office Tower
On 5th July, Champion Reit announced its potential divestment of its Langham Office Towerin light of current favourable commercial market condition.

As of 30th June 2017, Knight Frank, independant principle valuer of this Reit, valued 8.734b HK$.
Current 6months NPI (Jan- Jun 2017) is 163.280m HK$ up 13% from previous year. Annualizing its rental brings about a NPI yield of 3.74%, with potential upside in rental reversion.

Although I believe management will only consider a dispoal at an exit NPI yield below 3%, but assuming if the deal went through, and it still trades at 0.5 pb ratio and management decides to give up special dividend, expected special dividend= 8.734b HK$/ 5.81b units =1.5 HK$.

For 6 months
Expected Total Rental Income =1,183-175=  1008m HK$ mil
Expected NPI = 1064/1183 X 1008 =906.6 HK$ mil
Distributable Income= 0.679 X 906.6 HK$ mm = 615.58 HK$ mil
Distribution to Shareholders = 0.945 X 615.58 HK$ = 581.73 HK$ mil
DPU= 581.73 HK$ mil/ 5.81 bil= 0.10 HK$

DPU for the year= 0.10009065 X 2 = 0.2001813HK$.
Based on 11th Jan's closing price of 5.68 HK$, price after special dividend would be 5.68-1.5= 4.18 HK$
Dividend yield = 0.200/4.18 X 100% = 4.8%, which is above 4.17%.

Please note that this is just a rough gauge. There are also transaction costs and management may not distribute 100% of the proceeds of sale & may consider other commercial properties which are more yield accretive.

Thanks for spending your time to read this long post. I will write on portfolio update in the next post, which is long overdue.

If you are keen to follow my posts or get updates, do like/follow my FB page here where I will update it when there's a new post.

4 comments:

  1. Hi EOTS

    Wow awesome post on Champion Reit.

    I stayed before in Cordis like you do and found their strategic location really well.

    HK asset class tends to be really well graded but they've been compressed much in recent years.

    Do you know if Langham tower is sitting on freehold land or are they generally on 60 years lease?

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    Replies
    1. Hi Brian
      Thanks for visiting my blog page and the compliment.Was having dinner outside when you commented on my blog.

      Yup, it's my 5th time (if I remember correctly) staying at Cordis. Their service is great too.

      To be honest, I had the same query as you before. In HK, there are no freehold properties except for St John Cathedral. The leases for the properties expire 30th June 2047. In fact, most of the land lease in HK expires in 2047.

      Back then, government extended most of land lease to 2047 (another 50 years) since 1997 during transfer of sovereignty over HK from UK to China. It was not clearly made known what would happen after 2047 and land extension will be entirely dependent on government’s discretion.

      Currently if you buy a property in HK, banks would not allow mortgage extending beyond 2047. But my view is that they would extend another 50 years if there is no change in land policy, and from the way investors value HK properties suggest so too. If government had plans to takes back all the properties or charge a high rent after 2047, probably Li Ka-Shing would have anticipated it and be the first to sell away all his HK assets.

      Hopeit helps

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  2. Replies
    1. Thanks Kyith for dropping by!

      Champion Reit only owns has 3 properties, which makes sense to analyse each property in depth.

      Also credit goes to the management for providing much details in the annual report which makes it easy to read too. I did write to investor relations on some queries and they are very prompt in their reply.

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