Investment merits shine through for AA Reit in 'transformational' acquisition of Woolworths HQ

THINGS are about to change for industrial property landlord Aims Apac Reit (AA Reit) O5RU : O5RU 0%, following what chairman of the manager George Wang described as "transformational acquisition" for the Singapore-listed real estate investment trust (S-Reit).

Weeks after rumours first surfaced that it was on the verge of sealing a deal, AA Reit after market close on Sept 30 announced that it is acquiring the headquarters of Australian supermarket and grocery chain Woolworths in Sydney, Australia, for an eye-smarting purchase consideration of A$463.3 million (S$454 million).

"We see the acquisition as transformative for AA Reit. It is quite a significant transaction in both the scale and the quality of the asset, as well as the tenancy profile," said Russell Ng, CEO-designate of the manager, at a media briefing on Friday morning.

The freehold business park, which sits on a total land area spanning 90,010 square metres (sq m) with a total net lettable area (NLA) of 44,972 sq m, will be the largest asset in AA Reit's portfolio, which currently consists of 26 properties in Singapore and two in Australia.

Post-acquisition, AA Reit's assets under management will jump 26.6 per cent to S$2.18 billion, with the Australian properties accounting for 38.4 per cent of its portfolio by valuation, up from 21.8 per cent currently.

Meanwhile, Woolworths will become AA Reit's largest tenant by gross rental income contribution.

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The way Mr Ng sees it, the acquisition replicates AA Reit's investment strategy when it made its maiden overseas acquisition of a 49 per cent stake in Optus' headquarters at Macquarie Park in Sydney back in 2014.

"At the time, that property value was about A$377 million. Today, it is over A$660 million," he said. "That was a really good result for us, and we hope this (Woolworths) asset provides us with the same investment metrics going forward."

The Reit manager is not alone in feeling bullish over the acquisition. Following the announcement, DBS has upgraded its recommendation on AA Reit to "buy", from "hold" previously, with an unchanged target price of S$1.60.

"We continue to like AA Reit for its growth trajectory and this acquisition demonstrates its ability to compete for quality income-producing assets by staving off competition from the likes of Centuria, Charter Hall and Growthpoint," said analysts Dale Lai and Derek Tan in a report on Friday.

"With the stock's recent inclusion into the FTSE EPRA Nareit Developed Asia Index, we believe the improved trading liquidity of AA Reit and potential lowering in cost of equity would enable it to embark on further accretive acquisitions despite the stiff competition for good quality income-producing assets," they added.

Meanwhile, Mr Ng, who will officially assume the role of CEO of the manager on Nov 29 after obtaining regulatory approval, brushed aside concerns on the cost of the proposed acquisition.

The deal will be a windfall for South Korea's Inmark Asset Management, which paid just A$336.5 million for the property five years ago. Including other transaction costs, the acquisition is estimated to set AA Reit back by a total of A$494.3 million.

The purchase consideration for the property is in line with an independent valuation conducted by Knight Frank NSW Valuations and Advisory, which valued the property at A$463.3 million as at Sept 30.

"With the whole Covid situation, there has been a lot of focus by investors on long WALE (weighted average lease expiry ), secured income assets," Mr Ng added. "Ultimately, when we see what the market has paid, it is in line, because even though the price has increased and the yield has compressed, the actual borrowing costs have also dropped materially."

"Five years ago, it was a very different point in the real estate cycle. Interest rates in Australia were close to about 3 or 4 per cent. Today, the base rate is just 0.2 or 0.25 per cent" he added. "We think the acquisition compares favourably now when compared to other long WALE transactions that have happened in the market."

Mr Ng noted that the property will be acquired at an initial net property income (NPI) yield of 5.17 per cent based on the purchase consideration, or at an NPI yield of 4.84 per cent on a total costs basis.

The DBS analysts, however, point out that the NPI yield seems tight, compared to yields of close to 5.5-6 per cent for Ascendas Reit's and Keppel Reit's business park acquisitions in Macquarie Park.

"However, we note that cap rates have compressed since then, and a slight premium on Woolworths HQ is justified given the long lease to one of Australia's largest and most reputable company," they said.

The proposed acquisition is also expected to be accretive to distribution per unit (DPU). With the planned funding in place, the Reit manager said the transaction will increase DPU to 9.37 Singapore cents, up 0.42 cents or 4.7 per cent from the FY2021 DPU of 8.95 cents.

Built in 2005, the Woolworths headquarters property is a corporate campus comprising three interconnecting buildings, which house A-grade office accommodation, a data centre operation, and amenities.

The property is fully leased to Woolworths, with 10 years left on the lease term, subject to built-in rental escalation of 2.75 per cent per annum.

"I think you have to look at where the market is," said Mr Ng. "Investors are looking for secured income. We like the asset not just not just because it has that secured income, but it also has that longer-term redevelopment potential."

Based on the maximum allowable gross floor area, the Reit manager said the current NLA provides for significant development potential to around 180,000 sq m.

The DBS analysts also pointed to the potential for further organic growth in AA Reit's portfolio as a positive point. "In addition to the potential to tap on unutilised gross floor area (GFA) of more than 500,000 square feet (sq ft) within its Singapore portfolio, Woolworths HQ presents the opportunity leverage on a further close to 1.5 million sq ft of unutilised GFA," they said.

However, Mr Ng said there were no plans for any redevelopment at the moment, and added that any redevelopment plans would need to be worked in partnership with Woolworths.

The manager has secured a local debt-financing package for 60 per cent of the purchase consideration, while the remainder is expected to be funded through net proceeds raised from AA Reit's recent issuance of S$250 million in perpetual securities.

Already, analysts are looking forward to AA Reit's next accretive acquisition.

"We have rolled forward our valuation for AA Reit, while assuming a S$100 million equity fund raising by end of FY2022, and the completion of the acquisition of 315 Alexandra Road in Q4 FY2022. Based on our new projections, AA Reit's DPU is expected to grow by close to 9 per cent in FY2023," said DBS's Mr Lai and Mr Tan.

They added: "Although we also note that AA Reit's balance sheet may seem stretched because of its heavy reliance on perpetual securities, our estimates show that the Woolworths HQ acquisition is DPU accretive even if there was an equity fund raising exercise."

Units of AA Reit closed S$0.02 or 1.4 per cent lower at S$1.42 on Friday.