Champion REIT, which is sponsored by Great Eagle Holdings, will be Hong KongÆs first REIT to have only one property in its portfolio at the time of listing. However, the fact that this sole property is a Grade A office building located in the Central district - also a first for a local REIT - will be far more important to investors than any potential concerns about it being less diversified than the three REITs already in the market.
This is because, according to property analysts, there will be a shortage of Grade A office supply in Hong KongÆs key business district over the next few years, which will put Champion REIT in a prime position to boost its income û especially since about 20% of its leases will expire in each of 2007 and 2008 and another 30% are up for rental reviews.
Investors have taken note and sources say Champion REIT will have a healthy level of coverage on its books already when it begins the official marketing today.
Citibank Plaza, which is the property in question, has a total floor area of 1.49 million square feet (excluding car parks) divided between two office towers. The building is popular with large tenants because of the ability to connect the two towers to achieve a large uninterrupted space of a scale that is rare in central Hong Kong.
In fact, Citibank and Merrill Lynch, which are joint bookrunners for the initial public offering together with JPMorgan, both have offices in the building.
Champion REIT will have a market capitalisation of up to HK$15.7 billion ($2 billion) at the time of listing, of which Great Eagle will retain 49%, while two other existing owners of Citibank Plaza will hold a combined 6%.
The remaining 45% will be sold to investors through an IPO that will comprise 1.23 billion units at an indicated price range of HK$5 to HK$5.75. There is a 15% greenshoe, which could boost the total offering size to $1.05 billion. However, the size of the REIT will remain the same as the additional units will be provided by Great Eagle, potentially reducing its stake to 43%.
Ten percent of the deal will be earmarked for retail investors and 4.4% will be offered to existing Great Eagle shareholders through a preferential offering. The remainder will be sold to institutions as there will be no cornerstone investors.
The price range will value the REIT at a 3.2% to 16% discount to its net asset value of HK$5.94 per unit, a source familiar with the offering said. The NAV includes HK$7 billion ($902 million) of debt that will give the REIT a gearing ratio of approximately 29%.
Citibank Plaza was valued at HK$22.67 billion ($2.9 billion) by an independent valuer in February, but will be sold to Champion REIT by its current owners at a discount between 7% and 16% depending on how much it raises from the IPO, according to one source. Another source said the REIT will pay between HK$12,750 and HK$14,088 per square foot for the property. Both estimates would put the total purchase price at roughly HK$19 billion to HK$21 billion.
The dividend yield range of 4.84% to 5.57% offered in 2006 is based on a guaranteed payout of at least HK$0.17 per unit and pitches Champion REIT in the middle of the three REITs already in the market.
As of TuesdayÆs close, The Link REIT offered a 2006 yield of 3.15% for the fiscal year to March 2007, while Prosperity REIT offered 5.26% and GZI REIT û which is considered riskier because its properties are located in China û offered 6.38% for the 2006 calendar year. The yields are all based on guaranteed payouts by their respective promoters.
The yield on The Link REIT has come down substantially from its IPO level in November due to a 65% surge in its unit price, but both Prosperity and GZI are trading close to the yields offered when they listed in December 2005.
To ensure there will be enough money for the payouts û and potentially boost the dividend beyond the minimum - the existing three shareholders of Champion REIT have waived their rights to receive any dividends in 2006. For 2007 and 2008 they will receive 45% and 80% respectively of the dividends they would have been entitled to based on the units they hold, according to a statement issued by Great Eagle last week.
Champion REIT, which is committed to paying out 100% of its distributable income, has also entered into an interest rate swap agreement that will progressively increase the interest payments on its HK$7 billion loan over the five-year maturity, sources say.
While the loan carries an average interest rate of 1.05%, the actual payment will range from 0.25% this year to about 1.8% in year five, they say.
The step-up payment feature, which is very similar to the swap arranged by Prosperity REIT ahead of its listing, essentially helps to increase the money available for dividend payments in the early years.
ôThe progressive step-up swap has no impact on the bottom line, but is a way of making the deal more attractive to retail investors by boosting the current yield at the expense of the later years,ö one observer says.
However, most investors are likely to focus more on the growth prospects of the new REIT which will come primarily from an increase in rental income as new leases are signed - potentially complemented by acquisitions.
According to one observer familiar with the Citibank Plaza property, the leases that will expire in 2006 and 2007 currently generate a rent between HK$23 and HK$39 per square foot and month, while new leases in the building are being signed at HK$53-55 per square foot and month.
One investor says information he had received on the deal assumed a spot rent of HK$50 per square foot and month in 2005, HK$68 in 2006, HK$78 in 2007 and HK$85 in 2008.
While hefty at first glance, industry specialists say such increases are entirely feasible based on the fact that prime office rents in Hong Kong have fallen 65% since their previous peak in 2001 and have surged 180% over the past two years.
In addition, the REIT manager is aiming to increase the occupancy at the property to about 98% at the end of 2007 from 86.1% at the end of 2005. As a result, syndicate research projects Champion REIT will see 30-35% growth in rental income in 2006-2008.
One potential investor was sceptical about these assumptions, however, which he says suggested a rent per square foot and month of HK$100 by 2010.
ôThat is very aggressive given that Two IFC is also renting for around HK$100. How can they expect that in three years they will be at the same level? After all, the locations are totally different,ö he says, referring to Hong KongÆs newest addition of prime office space.
According to Great Eagle, Citibank Plaza had a rental income of HK$319.5 million ($41.2 million) in 2005. The net profit stood at HK$10.0 billion, although this included a pre-tax revaluation gain on properties of HK$11.9 billion. Excluding that paper gain, the pre-tax profit would have been HK$195.8 million.
The roadshow will be in Hong Kong today and tomorrow and will move to Singapore on Friday before tackling investors in London, the Netherlands (where many investors specialising in Asian REITs are based) and the US. The book will close on May 15 and the pricing is expected a day later.
The trading debut is tentatively planned for May 24.
¬ Haymarket Media Limited. All rights reserved.
