Analysing REITS

[money]

To make the debate more interesting, let's take a look at a real case study.

With more than 80% (by valuation and by Net Property Income) of its portfolio leasehold land expiring on the same date (30-June-2047) which is less than 35 years away + substantial outstanding debt not repaid => how should one value "Fortune Reit" ?

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Fortune Reit : As at 31 Dec 2015:
Borrowing = HKD 11,009 m
Net Assets = HKD 24,106 m
NAV per unit = HKD 12.76
DPU (FY2015) = HKD 0.4688
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hongkong's situation is a little special. Nobody knows what china will do. Perhaps they will renew the lease at a low premium. Perhaps they will take back the land together with the ageing buildings. How to value? i have no idea

[specuvestor]

Interesting example Boon. The expiry dates coincide with the HK 50 years basic law

I am not familiar with HK property laws and whether they allow lease top up but prima facie yes I would think their book value should trend down soon if it has yet started, and price too correspondingly. It is currently at 0.7XPTBV and 5.5% yield. Back of envelope, assuming it goes to zero at 2047 while paying 5.5% coupon for 31 years, the IRR is 3.7% vs HKD 10 year is trading 1.4% for a 2.3% spread; while CK 3 year bond is trading roughly 2% with HKD 3 year at 0.91% so credit spread is about 1.1%

I think 2-3% IRR spread over HKD makes sense currently and would keep watch on this case study. And if US yield curve continues to steepens (not my central assumption but more gradual parallel shift) the absolute yield will have to keep up more sharply cause the terminal value is zero.

[Boon]

@ money,
 
I could be wrong on this, but isn’t the “one country, two systems” of Hong Kong’s SAR status would end come 2047 – 50 years after 1997’s handover?
 
With that, isn’t it means that renewing of land lease (or land use right) would be administered in accordance with the current Chinese practice?
 
To renew or not to renew the land lease, it depends on the premium required to be paid at expiry - this is a future “add-on” or “optional” investment decision which could only be evaluated independently near to land lease expiry date. There is nothing much one could do about it now, I reckon.
 
To be prudent, I reckon, the “base case” would be for investors to value “Fortune Reit”, based on the assumptions that:
1)  The land lease would NOT be renewed upon expiry.
2)  All outstanding debt would need to be repaid before or upon expiry of land lease.
 
If you reckon, HK’s situation is a little special, look at CRCT (CapitaRetail China Trust) which has a very similar land lease expiring profile to that of Fortune Reit.
 
@ specuvestor,
 
Fortune Reit : As at 31 Dec 2015:
Borrowing = HKD 11,009 m
Net Assets = HKD 24,106 m
NAV per unit = HKD 12.76
DPU (FY2015) = HKD 0.4688
 
NPI (after Manager’s performance fee) = HKD 1,319.2 m
 
NPI (after Manager’s performance fee + base fee + trust expenses) = HKD 1,319.2 m – HKD 105.8 (Manager’s base fee) – HKD 42.4 m (trust expenses) = HKD 1,171 m
 
Assuming ROUGHLY 10 year’s NPI (after all fees) is required to pare down all outstanding debt, which means only 21 years of DPU would be left for unit-holders
_________________________________________________________________________________________________________

[specuvestor]

I'm guesstimating Book Value which is net of debt will mean cashflow from depreciation cost will be used to pay off the debt. Another way of course is to opportunistically sell off properties that has been reval up and pay down debt to add credence to the NAV.

Will need to take more time to look at the cashflow, which of course the 5.5% yield is itself an assumption. I don't disagree on your assertion, but it will mean the 5.5% yield will cut down 1/3 to maybe <4% yield to use part of cashflow to reduce debt over 31 years. Operating cashflow last year excluding WC was HK$1,281m

Actually it is not known what will happen after 50 years Basic Law. They only promise it wont be change in 50 years. It may extend another 50 years with modification on the Basic Law, so we can't really assume it will be current Chinese practice.

[yawnyawn]

To make the debate more interesting, let's take a look at a real case study.

With more than 80% (by valuation and by Net Property Income) of its portfolio leasehold land expiring on the same date (30-June-2047) which is less than 35 years away + substantial outstanding debt not repaid => how should one value "Fortune Reit" ?

[Image: 8vu7nm.jpg]

Fortune Reit : As at 31 Dec 2015:
Borrowing = HKD 11,009 m
Net Assets = HKD 24,106 m
NAV per unit = HKD 12.76
DPU (FY2015) = HKD 0.4688
__________________________________________________________________________________________________________________

I did a rough calculation using DCF on the future distributions to unitholders for the next 31 years since the properties have 31 year remaining lease.

Assuming

1) distributions can grow at 7% for the next 20 years, 5% from 21th - 31 year.
2) Debt remains at HK$11B over next 20 years
2) Company starts paying down its debt from the 21st year to the 31st year by HK$1B annually

At 10% discount rate, company is worth HK$7.6B or $4.0/share

At 7% discount rate, company is worth HK$16.3B or $8.6/share

At 5% discount rate, company is worth HK$25.8B or $13.50/share

Note that Fortune REIT IPO-ed in 2003 and distributed HK$140M in 2004. In 2016, HK$ 885M was distributed to unitholders, a CAGR of 16.7% over 12 years.

[Boon]

[Image: 11hux69.jpg]

From 2004 to 2015, DPU grow at CAGR 3% only
 
Share price of Fortune Reit closed at HK 9.05
 
Assuming DPU grow at 3% for the remaining 30 years:
 
If one pays HKD 9.05 today in exchange for 30 years of DPU = HKD 0.4688 x 1.03 (year 1) growing at 3% p.a. => IRR = 6.2%
 
Assuming further that the cash flow from the last 10 years is used to pare down debt,:
 
i.e. one pays HKD 9.05 today in exchange for 20 years of DPU only, the IRR  would drop from 6.2% to roughly 3.35%
_______________________________________________________________________________________________________________________________________

[yawnyawn]

[Image: 11hux69.jpg]

From 2004 to 2015, DPU grow at CAGR 3% only
 
Share price of Fortune Reit closed at HK 9.05
 
Assuming DPU grow at 3% for the remaining 30 years:
 
If one pays HKD 9.05 today in exchange for 30 years of DPU = HKD 0.4688 x 1.03 (year 1) growing at 3% p.a. => IRR = 6.2%
 
Assuming further that the cash flow from the last 10 years is used to pare down debt,:
 
i.e. one pays HKD 9.05 today in exchange for 20 years of DPU only, the IRR  would drop from 6.2% to roughly 3.35%
_______________________________________________________________________________________________________________________________________

I think we get different numbers because you are using DPU and i am using total distributions to unitholders.

There was a 1 for 1 rights issue in 2009 to acquire 3 properties http://fortunereit.todayir.com.sg/attach...917_en.pdf

[soros]

This is copied from the HK Government Rates Dept website :

All land leases in the New Territories and New Kowloon north of Boundary Street expired on 27 June 1997. However, Annex III to the Sino-British Joint Declaration provided that non-renewable land leases which expired before 30 June 1997 were automatically extended up to 30 June 2047 without payment of an additional premium but with a new Government rent becoming payable from the date of extension. In addition, all land leases whether on Hong Kong Island, Kowloon, or the New Territories which have been granted since 27 May 1985, the date from which the Joint Declaration took effect, are also liable for the new Government rent from 1 July 1997.

The assessment and collection of the new Government rent is governed by the Government Rent (Assessment and Collection) Ordinance (Cap. 515). The Government rent charged under the Ordinance is calculated at 3% of the rateable value of the property and is adjusted in step with any subsequent changes in the rateable value.

So the leases will have to be renewed soon or the property valuation system will come to a full stop and the end of the HK banking system .

[Boon]

This is copied from the HK Government Rates Dept website :

All land leases in the New Territories and New Kowloon north of Boundary Street expired on 27 June 1997. However, Annex III to the Sino-British Joint Declaration provided that non-renewable land leases which expired before 30 June 1997 were automatically extended up to 30 June 2047 without payment of an additional premium but with a new Government rent becoming payable from the date of extension. In addition, all land leases whether on Hong Kong Island, Kowloon, or the New Territories which have been granted since 27 May 1985, the date from which the Joint Declaration took effect, are also liable for the new Government rent from 1 July 1997.

The assessment and collection of the new Government rent is governed by the Government Rent (Assessment and Collection) Ordinance (Cap. 515). The Government rent charged under the Ordinance is calculated at 3% of the rateable value of the property and is adjusted in step with any subsequent changes in the rateable value.

So the leases will have to be renewed soon or the property  valuation system will come to a full stop and the end of the HK banking system .

http://www.landsd.gov.hk/en/service/landpolicy.htm

Land Tenure System and Land Policy in Hong Kong

          Virtually all land in Hong Kong is leased or otherwise held from the Government of the HKSAR. In the early days, leases were for terms of 75, 99 or 999 years, subsequently standardised in the urban areas of Hong Kong Island and Kowloon to a term of 75 years, renewable at a re-assessed annual rent under the provisions of the old Crown Leases Ordinance. Leases for land in the New Territories and New Kowloon were normally sold for the residue of a term of 99 years less three days from 1 July, 1898.

          From 27 May, 1985 (the date of entry into the Joint Declaration) to 30 June, 1997, the policy with regard to land grants and leases accorded with the provisions of Annex III to the Joint Declaration. Normal land grants throughout the whole of the territory were made for terms expiring not later than 30 June, 2047. They were granted at a premium and nominal rental until 30 June, 1997, after which date an annual rent equivalent to three percent of rateable value of the property would be charged. Leases expiring before 30 June 1997, with the exception of short term tenancies and leases for special purposes, might also be extended to 2047 under the provisions of the Joint Declaration.

          On 15th July 1997, Executive Council endorsed various provisions covering land leases and related matters under the Hong Kong Special Administrative Region Government (HKSARG).

          The general land grant policy as endorsed by ExCo is set out as follows :-

i.     New leases of land shall be granted for a term of 50 years from the date of grant (except new special purpose leases for recreational purposes and petrol filling stations, new special purpose leases covered by franchises or operating licences and short term tenancies) at premium, and subject to payment from the date of grant of an annual rent equivalent to 3% of the rateable value of the property at that date, adjusted in step with any changes in the rateable value thereafter. Certain rural land holdings such as small house grants are exempted from the obligation to pay government rent.   

ii.   New special purpose leases for recreational purposes and petrol filling station will be granted for a term of 21 years from the date of grant. New special purpose leases covered by franchises or operating licences will normally be for a term commensurate with that of the associated franchise or licence. Short term tenancies shall continue to be granted for a term not exceeding 7 years.    

iii.   Modifications, whether by modification letter or conditions of exchange, shall continue to be granted at premium reflecting the difference between the "before" and "after" land value. For modifications not involving boundary adjustments and thus conducted by modification letter, the existing lease term and provisions for annual rent will remain unchanged. For modifications conducted by conditions of exchange, the new lease term and rent shall be 50 years from the date of regrant and 3% rateable value as provided for new leases in (i) above.     

iv.  Non-renewable leases (i.e. those fixed term leases containing no right of renewal), may, upon expiry, be extended for a term of 50 years without payment of an additional premium but subject to payment of an annual rent from the date of extension at 3% rateable value as for new leases in (i) above. The extension of such leases is wholly at the discretion of the HKSARG; for instance, if the land is required for a public purpose or is no longer being used for the purpose for which it was originally granted, then the lease is unlikely to be extended.     

v.   In the case of special purpose leases (broadly defined as leases containing a total prohibition against assignment), upon their expiry, and provided that the land is being used for the specified purposes and is not required for a public purpose, then they may, at the sole discretion of the HKSARG, be extended for a term of 50 years without payment of a premium but subject to payment of an annual rent of 3% of rateable value as in the case of new leases. Exceptions to this general statement are as follows :-

a.     leases for recreational purposes may not be extended beyond a term of 15 years;     

b.    leases of land covered by franchises or operating licences will normally be extended co-terminous with the franchise or licence;     

c.     leases for petrol filling stations will not be extended upon expiry of existing leases, petrol filling station sites will be re-tendered on the open market; and      

d.     leases for kerosene stores will not be extended; however, short term tenancies at full market rental may be offered to existing lessees for an initial term of three years.
_____________________________________________________________________________________________________________________________________

New leases of land shall be granted for a term of 50 years from the date of grant, with premium +annual rental 

Land sold in 1998 has a lease up to 2048, 
Land sold in 1999 has a lease goes until 2049, 
Land sold in 2015 has a lease goes until 2065 and so on................................

If one has to pay premium + rental for a 50 years new land leases, I don't see why the authority would not charge "premium" for "extension" of existing lease........

http://www.news.gov.hk/en/categories/inf...2759.shtml
http://www.ejinsight.com/20160915-land-l...over-2047/

[Boon]

CRCT is another Reit counter with substantial debt on its book and owns only leasehold properties in China with SHORT weighted average land lease term to expiry.

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